When your primary wealth is in IRA’s
Estate planning addresses the varying wealth of the client together with his or her desires in passing on this wealth. For those with cash assets and land as their primary financial holding, a revocable trust may be the right answer to control those assets for the benefit of future generations. But, what if the primary assets are held in IRA’s?
First, IRA’s cannot be a part of your revocable trust. To transfer them during your lifetime into your trust (as you would your home and bank accounts) would be a distribution of the assets, subjecting them to income tax. Most individuals, therefore, simply name beneficiaries on their IRA’s to receive the balance of the funds when the individual dies.
The so-call “stretch” provisions allow for a calculation or re-calculation of a Required Minimum Distribution (RMD) for each of the beneficiaries based upon each of their life expectancies. They each must take this RMD annually, or be subject to a 50% penalty. The distribution of the small RMD’s is usually in line with the wishes of the individual who has died.
Many clients desire a plan where the child withdraws only the RMD, gradually over his or her lifetime. What if the child decides to withdraw 100% of the principal and pay the tax in one year? He or she can do this as there is no prohibition on doing so.
How can the distribution of an IRA be controlled in the same way as the assets in a revocable trust so that the wishes of the client are honored? By establishing a separate Conduit Trust. These IRA trusts are specially drawn to comply with the requirements set forth by the IRS so that the money is able to pass through the conduit trust in the specific manner desired without being subject to the large tax penalties that would result if the entire amount were distributed in one year.
This type of trust is ideal for the client that has a revocable trust and desires to set up a mechanism to control the distribution of his or her IRA so that it stretches over the lifetime of the child. It is a free-standing trust and requires a trustee. It can protect the large IRA from being wasted by children who are not mature enough to handle the large principal amount that would otherwise be available. It also provides an income stream to that child, gradually, over his or her lifetime.
While a Conduit IRA Trust is not for every client, it is the right estate planning tool for individuals with considerable wealth in IRAs who is concerned about limiting the distribution of the principal upon death.