There are good reasons to leave your IRA in trust:
- To keep a beneficiary from blowing all the money on a fancy car or worse
- To keep the assets away from the spouse of a beneficiary, a spouse who you never liked
- You have great control over the conditions which must exist before your beneficiary can access the funds (other than the mandatory IRA distributions)
But there are specific regulations to adhere to:
If you use your living trust as the beneficiary of your IRA (not recommended), the trust must meet four conditions to hold an IRA (see
Life and Death Planning for Retirement Benefits by Natalie Choate)
a. it must be valid under state rules
b. beneficiaries must be identifiable
c. the trust that will hold the IRA is irrevocable at death
d. trustee must supply the IRA custodian copy of trust
e. all beneficiaries must be individuals
When you leave an IRA to a trust, or sub trusts, there is only one measuring life for IRA distributions—the life of the oldest beneficiary. Therefore, if you have several beneficiaries who are far apart in age, you need to establish a separate trust for those for whom you want to maximize the post-death stretch distribution period.
Retirement asset will
The IRA beneficiary firms supplied by the bank or the securities firms are very poor and do not adequately allow you to spell out your IRA distribution desires. For example, consider this chart.
You probably think that if your son, John, predeceases you, his IRA distribution share goes to your grandson, Bob. That may or may not be the case depending on whether your custodian uses a per capita or per stirpes method of IRA distribution. If you’d rather not rely on the process of some large impersonal institution, have your attorney prepare a Retirement Asset Will to replace those very poor institutional beneficiary forms.
Custodian forcing distributions
Just because IRS has a rule that permits certain liberal action does not mean that the custodian of a retirement plan must follow those IRA distribution rules. For example, you may assume that leaving your 401k balance at the company is just fine. You have named your son as beneficiary and assume that he will inherit the IRA and can use the “stretch” concept to defer IRA distributions over his lifetime, allowing the funds to grow tax deferred for decades. The custodian may say no way—they may very well have a rule that says all IRA distributions to non-spouse beneficiaries are paid out within 5 years.
Have a professional review those booklets with tiny little type that you get from custodians if you want to avoid IRA distributions surprises. It is probably best not to leave assets in qualified plans but rather, roll them to an IRA where you can use your own IRA Asset Will or trust to determine your IRA distribution desires.
Rule 72t for those under age 59½
If you need IRA distributions prior to age 59½, the IRS does let you tap your plan and also avoid the 10% penalty for early IRA distribution. The simple rule is to set up a stream of lifetime equal distributions. For example, if your life expectancy at age 59 is 20 years and your IRA is $200,000, then it’s okay to take 1/20, or $10,000 annually. Of course, the calculation is a little more complex than this as the IRS must be assumed to earn interest that is not more than 120% of the federal mid-term rate (published monthly by
the Federal Reserve).
You can change the amount under the above calculations after 5 years and attainment of age 59½.
Here’s an IRA distribution example for a client age 52, spouse age 48, joint life, assuming lump sum of $800,000 and a projected interest rate of 6.72% (which is the IRS guideline). The 72t IRA distributions could be any of the following:
- Minimum distribution method – $24,845
- Amortization method – $57,451
- Annuitization method – $64,616
Note the age of the client in this example is age 51. He and his wife also had a college-age child. To create flexibility, the qualified plan distributions can be rolled into multiple IRAs. In this example, the client actually rolled the IRAs into three separate accounts utilizing the 72(t) option for two. The first was on a monthly basis; the second paid annually, and the third remained intact so the account could grow. Since no payment was being made from the third account it could be used for college funding, if needed.
(Remember, higher education expenses are one of your exceptions under the 10% penalty rules). This is a great way to create IRA distribution flexibility under the 72(t) election.
If you have multiple beneficiaries of your IRA, they can split your IRA after your date of death. The advantages to this are several:
- They each get to invest as they like
- One can go buy a yacht with their portion while another can stay invested
- They can have different IRA custodians
- They don’t have to make joint decisions
- They get to name their own beneficiaries
- They each have a separate IRA distribution schedule based on their age
Some advisors recommend splitting your IRA during your lifetime—one account for each beneficiary. If you like more paper and more accounts to manage, this is a good idea, however, it won’t make your life simpler. So just make your beneficiaries aware that they should split the account to maximize their IRA distribution benefits.
Make sure that the IRA is easily divided or you provide instructions. For example, if your IRA contains a note on property, you may want to have an IRA Asset Will describing how the split should occur.