Leave kids money by trust or outright/tax implications

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bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Mon May 16, 2016 2:00 pm

NMJack wrote:Bruce - I'm struggling to reconcile the following two comments you've made:

bsteiner wrote:As to how to structure the trust, about half the states have enacted the Uniform Trust Code, though there are variations in it from state to state. Some states have enacted the provision that's been quoted, whereby the trust assets are protected even if the beneficiary is a trustee and may distribute to himself/herself, so long as the trustee/beneficiary can't make distributions to himself/herself except for an ascertainable standard.


bsteiner wrote:I don't think the identity of the trustees should matter, assuming that the beneficiary, if he/she is a trustee, has no power to make distributions to himself/herself.


Does your second quote only apply where states have NOT adopted section 504(e) of the UTC or similar? This is important to several of us since if the first is true in our particular state, we can avoid a corporate trustee and allow our responsible adult children to act as sole trustee. This would have obvious financial advantages over a long period of time as well as providing more flexibility in how the trust funds are distributed.


If a beneficiary has the power to distribute to himself/herself for an ascertainable standard, it may be available for Medicaid, the income is more likely to be taken into account in determining alimony and child support, and in a state that doesn't have this UTC provision it may be available to creditors to the extent of the ascertainable standard.

Some people do as you suggest, and let each child be his/her own sole trustee, with the power to add a co-trustee if he/she ever wants a distribution (or ever wants a distribution beyond an ascertainable standard). We prefer to have a co-trustee from the inception (which can be one or more of the child's spouse and siblings), with the child having the power to remove and replace his/her co-trustee (provided the replacement trustee is not a close relative or subordinate employee). Obviously there are cases where that's not appropriate, and there are cases where a corporate trustee is needed.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 16, 2016 2:18 pm

bsteiner wrote:If a beneficiary has the power to distribute to himself/herself for an ascertainable standard, it may be available for Medicaid, the income is more likely to be taken into account in determining alimony and child support, and in a state that doesn't have this UTC provision it may be available to creditors to the extent of the ascertainable standard.


Thanks Bruce. I thought I knew what you meant, but it is good to have clarification. These are extremely important topics for those of us in the trust-generation phase. I've been told consistently, by local attorneys, that if a trust allowing a beneficiary to serve as trustee and distribute per HEMS, further allows that beneficiary to resign as trustee and appoint an independent trustee with full discretion; then the assets are robustly protected. I realize that this varies from state to state.

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Mon May 16, 2016 2:33 pm

Yes, I am anxious to hear that as well. If the independence of the trustee does not matter much, as long as there is either an ascertainable standard (in some states) or a second trustee to make distributions to the beneficiary (in others), then the major reason for a corporate trustee disappears. Over decades, even Vanguard's 0.4% would add up. No point in paying it if not needed.

I am still curious about what happens when there is a Pfannenstiehl-type decision in the state where the beneficiary lives, but the trust is sited in a state with more friendliness to asset protection? Expensive legal proceedings in multiple states?? I suppose if trustee independence does not matter, then there is little I can do about it in any case?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Mon May 16, 2016 2:44 pm

NMJack wrote:
bsteiner wrote:If a beneficiary has the power to distribute to himself/herself for an ascertainable standard, it may be available for Medicaid, the income is more likely to be taken into account in determining alimony and child support, and in a state that doesn't have this UTC provision it may be available to creditors to the extent of the ascertainable standard.


Thanks Bruce. I thought I knew what you meant, but it is good to have clarification. These are extremely important topics for those of us in the trust-generation phase. I've been told consistently, by local attorneys, that if a trust allowing a beneficiary to serve as trustee and distribute per HEMS, further allows that beneficiary to resign as trustee and appoint an independent trustee with full discretion; then the assets are robustly protected. I realize that this varies from state to state.


I haven't considered whether that would trigger a lookback period for Medicaid. It also runs the risk that the beneficiary wouldn't resign in time.

When you refer to local attorneys, you might want to say what state they're in.

bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Mon May 16, 2016 2:52 pm

afan wrote:Yes, I am anxious to hear that as well. If the independence of the trustee does not matter much, as long as there is either an ascertainable standard (in some states) or a second trustee to make distributions to the beneficiary (in others), then the major reason for a corporate trustee disappears. Over decades, even Vanguard's 0.4% would add up. No point in paying it if not needed.

I am still curious about what happens when there is a Pfannenstiehl-type decision in the state where the beneficiary lives, but the trust is sited in a state with more friendliness to asset protection? Expensive legal proceedings in multiple states?? I suppose if trustee independence does not matter, then there is little I can do about it in any case?


An independent trustee is an independent trustee, whether individual or corporate, though independent individual trustees sometimes want to be paid for serving.

If there's a Phannnenstiehl type decision in a different state, the payor spouse has to come up with the money to pay the alimony or child support. Presumably the trustees will continue to make distributions, or will resume making distributions, so that the payor spouse will have the money to make the payments. Whether the recipient spouse will be able to go after the trust as an exception creditor will vary from state to state. The children are probably also beneficiaries, so they (or the recipient spouse on their behalf) can ask for distributions, and the trustees have to consider their request in good faith. Most likely the payor spouse will want to see his/her children taken care of since they're still his/her children.

There's no purpose trying to speculate over all of this, or to try to figure out all 50 states, or to try to predict future law, or in seeing how close to the line you can go without falling over. If you provide for your children in discretionary trusts they'll be better protected than if you don't. If the child can't participate in distributions to himself/herself, the child will be better protected than if he/she can. The child will still have effective control through his/her power to remove and replace his/her co-trustee.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 16, 2016 4:58 pm

bsteiner wrote:There's no purpose trying to speculate over all of this, or to try to figure out all 50 states, or to try to predict future law, or in seeing how close to the line you can go without falling over.


I see a trade off, with risks and potential costs on both sides of the equation. I appreciate your position, since I haven't indicated which state(s) I'm involved with. The future law issue is obviously a big unknown. I'll toss out the concept of a trust protector once again to mitigate risks of state law changes adversely affecting the asset protection aspects of my trust(s). As I understand it, if the state laws allow it and the trust has the option, a trust protector may be appointed five, ten, twenty years from now for the purpose of updating the trust document to modify certain provisions (e.g. investment directions, tax law changes, trust law changes, etc.). In the current context, if my state's laws drop 504(e) and expose my beneficiary-trustee to increased creditor risks; a trust protector could modify the trust to "tighten things up." Assuming this is all correct, I can get much closer to that line without worrying about the fall. The benefit for me is that I don't have to worry about the risks and costs of a corporate trustee. I'm sure there are many who do a great job, but as we all know, the world can change quickly.

bsteiner wrote:If you provide for your children in discretionary trusts they'll be better protected than if you don't. If the child can't participate in distributions to himself/herself, the child will be better protected than if he/she can. The child will still have effective control through his/her power to remove and replace his/her co-trustee.


That is a very useful summary. :sharebeer

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Fri Jul 15, 2016 12:22 pm

Bumping this thread with another question for the estate planning experts: Accumulation vs Conduit trusts for retirement assets. I know (or I should say, I THINK) bsteiner has suggested accumulation trusts are preferable. They keep assets protected even after the trust has taken RMD's from the retirement account. This is good for asset protection. Apparently some attorneys prefer to draft conduit trusts because they are easier to write?? Not being a lawyer, I don't know what that means, but people say it, so I suppose it may be true.

The asset protection opportunities with accumulation trusts are appealing. But the lines quoted below suggest they may not work as intended and they appear to be substantially more complicated to administer. IT sounds like an individual could well be the trustee of his/her own conduit trust, but would need to pay lawyers, accountants and perhaps a trust company to manage an accumulation trust. Is it as complicated as this makes it appear?

Reading on this, I came across a discussion that, to me, suggests the real life performance of accumulation trusts remains unresolved. Are there really questions about how the IRS will view them and pitfalls into which even professional trustees might fall in determining the amounts to be distributed? For client with single digit millions in retirement accounts, are these concerns enough to suggest a conduit over an accumulation trust?

Until the beneficiary
reaches age 71, the RMDs are less than 6% each year, so the
majority of the retirement account will stay protected in a conduit trust

until the beneficiary is well into his/her retirement years.
...
In some situations it is important to avoid putting any assets directly
into the beneficiary’s hands, such as when the beneficiary has
creditors looming or the beneficiary has serious substance abuse
problems. In these situations, the Accumulation Trust allows the trustee
to make distributions indirectly for the benefit of the beneficiary,
without exposing any trust assets to the beneficiary’s direct ownership.

When there are strong reasons why the beneficiary of the trust cannot
receive the RMDs outright, then the conduit trust does not work.
With a conduit trust one can be certain that the beneficiary’s life
expectancy will be used to calculate the RMDs if separate accounts are
created on the beneficiary designation form as provided in Exhibit A. In
most cases an Accumulation Trust will use the life expectancy of the
oldest of the children. This could be an issue if there is a wide gap in
the children’s ages. If after the death of the beneficiary the remaining
assets will pass to a charity, then one must use a conduit trust if the trust
is to qualify for a life expectancy payout
(as the first line remainder
beneficiaries must be considered with an Accumulation Trust).



If a trust will be named, then the next question is whether to use a
conduit trust or an Accumulation Trust. An Accumulation Trust allows
the RMDs to be retained in the trust but has drawbacks. The Accumulation
Trust may be more difficult to administer if the retirement custodian
does not interpret the law consistent with the existing letter ruling
analysis.
With an Accumulation Trust one must take into account the
first line remainder beneficiaries when determining the oldest trust beneficiary,
but with a conduit trust one can ignore all remainder beneficiaries.
There is also the possibility of a 50% tax on the undistributed
amount of the RMD if the IRS audits the trust Form 1041 and successfully
argues that the RMD calculation is based on the wrong life expectancy
– or worse that the trust does not qualify for the life expectancy
payout at all (because there is a non-individual beneficiary of the trust)
.
To safeguard against this, the trustee can file Form 5329 each year to
start the 3-year statute of limitations running, but this is an additional
administrative complexity the client should be aware of before opting
for an Accumulation Trust. Adding a savings clause to an Accumulation
Trust may provide enough assurance to avoid filing the Form 5329 each
year.
The advantage of the conduit trust is that we know it works. The
disadvantage is that all distributions from the retirement account must
be immediately distributed outright to the trust beneficiary. However,

the RMDs may initially be so small that some leakage from the trust to
the beneficiary outright is not a significant concern, depending on the
particular facts and purpose of the trust.



140 ACTEC LAW JOURNAL [Vol. 39:101
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Fri Jul 15, 2016 3:57 pm

afan wrote:Bumping this thread with another question for the estate planning experts: Accumulation vs Conduit trusts for retirement assets. I know (or I should say, I THINK) bsteiner has suggested accumulation trusts are preferable. They keep assets protected even after the trust has taken RMD's from the retirement account. This is good for asset protection. Apparently some attorneys prefer to draft conduit trusts because they are easier to write?? Not being a lawyer, I don't know what that means, but people say it, so I suppose it may be true.


afan - I realize you've invited responses from the estate planning experts, but in the event they are busy with clients I'll go ahead and toss out my 2 cents worth. I have spent many hours educating myself on this topic. As you read various articles, you will likely encounter references to the book/author in the following link:

https://www.amazon.com/Life-Death-Plann ... t+benefits

Based upon the information I have found, the claim that this book is the "bible of distribution planning" is not hyperbole. I have personally dealt with two estate attorney's who have confirmed the validity of this resource. I believe that if you are interested, but don't wish to spend the $$$, the book can be accessed on-line through the author's website for around $10 per month. There is an entire chapter in this book discussing accumulation and conduit trusts, along with their IRS treatment via both formal rulings and personal letter rulings (which, I'm sure somebody will jump in and state doesn't establish precedence).

To your question, the IRS has only formally "blessed" conduit trusts. They are straightforward for an attorney, as the only meaningful beneficiary for calculation of the ADP is the primary beneficiary. Unfortunately, they seriously jeopardize asset protection, because the trustee is "forced" to distribute the full RMD each year to the beneficiary. Accumulation trusts provide much more flexibility, which in turn provides very robust asset protection. Unlike the conduit trust, the accumulation trust has never been "formally" approved by the IRS, but if written in a way that meets the IRS qualified beneficiary requirements, they have repeatedly stood up to IRS scrutiny. I'm sure you've probably become familiar with the IRS qualified beneficiary requirements (trust must by valid in the state created, beneficiary(s) must be a person, etc.).

Based upon my personal experience, I've found there are two classes of estate attorneys out there. Those who understand and correctly draft accumulation trusts, and those who don't even understand what they are. If you find one of the former, I don't think an accumulation trust is anything more complicated or risky.

afan wrote: IT sounds like an individual could well be the trustee of his/her own conduit trust, but would need to pay lawyers, accountants and perhaps a trust company to manage an accumulation trust. Is it as complicated as this makes it appear?



I am fairly confident that this part is false.

Best of luck. :sharebeer

(I am not a lawyer and any advice presented should be considered for entertainment only)
Last edited by NMJack on Fri Jul 15, 2016 4:03 pm, edited 1 time in total.

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Fri Jul 15, 2016 4:03 pm

NMJack,

Thanks for the reply. I appreciate your input. My concerns were that the article I cited seemed to say that the accumulation trusts were supported only by private letter rulings, which the IRS says cannot be relied upon. That, plus the apparent risks of doing it wrong and paying big penalties makes me wonder whether I am doing heirs a favor by using such a trust. The conduit trust does expose the RMD's, but those remain small fractions of the account until later in life. That is where I am stuck at the moment. Still trying to get some more information on the implications.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Fri Jul 15, 2016 4:07 pm

I am fairly confident that this part is false.


Which part is false? That an individual can be trustee of his/her own conduit trust? OR that managing an accumulation trust is much more complicated?

Thanks
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Fri Jul 15, 2016 4:13 pm

afan wrote:My concerns were that the article I cited seemed to say that the accumulation trusts were supported only by private letter rulings, which the IRS says cannot be relied upon.


I believe that this is true *to a point*. I was at a similar cross roads until I found the book referenced in my previous post. The chapter on trusts describes most/all of the pertinent PLRs, and the IRS has been quite consistent provided the attorney who drafted the trust understood the rules. After reading that chapter, and the many examples cited, I gained a certain level of confidence that I understood the rules well enough to look over an attorney's shoulder. If your attorney doesn't recognize the credentials of that book's author, I believe it is time to find a new attorney.


afan wrote:That, plus the apparent risks of doing it wrong and paying big penalties makes me wonder whether I am doing heirs a favor by using such a trust. The conduit trust does expose the RMD's, but those remain small fractions of the account until later in life.


Hopefully Bruce et al will weigh in as well. Since the conduit trust creates a steady, known, reliable "income" stream; I believe the implications for asset protection extend beyond the immediate year's RMD. I could be wrong. We definitely don't want to "do it wrong." At the extreme, I believe if a person establishes a qualified retirement plan trust, even though not yet funded, they can theoretically request a PLR for their specific trust from the IRS. I think that starts at around $10K and goes up from there. Maybe better to just watch other rulings and ensure that one's trusts are kept up to date. This is another potential area where a trust protector may play a role (you likely recall my mentions of trust protectors in other recent threads).
Last edited by NMJack on Fri Jul 15, 2016 4:16 pm, edited 1 time in total.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Fri Jul 15, 2016 4:16 pm

afan wrote:
I am fairly confident that this part is false.


Which part is false? That an individual can be trustee of his/her own conduit trust? OR that managing an accumulation trust is much more complicated?

Thanks


Sorry, I wasn't clear on that. It is the part about needing accountants, lawyers, etc. to manage an accumulation trust. I believe that a beneficiary can act as sole or co-trustee of an accumulation trust just as easily as they can with any other type of trust. Bruce can and should correct me if I am wrong on that. 8-)
Last edited by NMJack on Sat Jul 16, 2016 12:57 am, edited 2 times in total.

Van
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Re: Leave kids money by trust or outright/tax implications

Post by Van » Fri Jul 15, 2016 4:42 pm

I have been wrestling with this issue for a few years, since I had a new will drawn up. My estate attorney works for a very large well-known firm and only does this type of work. According to her.......and I asked the question over and over.......trust assets are protected against creditors and spouses even if the beneficiary is also the only trustee.

I must admit, I'm skeptical despite the reassurances of the estate attorney!

From time-to-time, I think about changing things so the money just goes directly to the kids, and let the chips fall where they may.

bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Sat Jul 16, 2016 10:44 pm

afan wrote:Bumping this thread with another question for the estate planning experts: Accumulation vs Conduit trusts for retirement assets. I know (or I should say, I THINK) bsteiner has suggested accumulation trusts are preferable. They keep assets protected even after the trust has taken RMD's from the retirement account. This is good for asset protection. Apparently some attorneys prefer to draft conduit trusts because they are easier to write? Not being a lawyer, I don't know what that means, but people say it, so I suppose it may be true.

The asset protection opportunities with accumulation trusts are appealing. But the lines quoted below suggest they may not work as intended and they appear to be substantially more complicated to administer. It sounds like an individual could well be the trustee of his/her own conduit trust, but would need to pay lawyers, accountants and perhaps a trust company to manage an accumulation trust. Is it as complicated as this makes it appear?

Reading on this, I came across a discussion that, to me, suggests the real life performance of accumulation trusts remains unresolved. Are there really questions about how the IRS will view them and pitfalls into which even professional trustees might fall in determining the amounts to be distributed? For client with single digit millions in retirement accounts, are these concerns enough to suggest a conduit over an accumulation trust?

Until the beneficiary
reaches age 71, the RMDs are less than 6% each year, so the
majority of the retirement account will stay protected in a conduit trust

until the beneficiary is well into his/her retirement years.
...
In some situations it is important to avoid putting any assets directly
into the beneficiary’s hands, such as when the beneficiary has
creditors looming or the beneficiary has serious substance abuse
problems. In these situations, the Accumulation Trust allows the trustee
to make distributions indirectly for the benefit of the beneficiary,
without exposing any trust assets to the beneficiary’s direct ownership.

When there are strong reasons why the beneficiary of the trust cannot
receive the RMDs outright, then the conduit trust does not work.
With a conduit trust one can be certain that the beneficiary’s life
expectancy will be used to calculate the RMDs if separate accounts are
created on the beneficiary designation form as provided in Exhibit A. In
most cases an Accumulation Trust will use the life expectancy of the
oldest of the children. This could be an issue if there is a wide gap in
the children’s ages. If after the death of the beneficiary the remaining
assets will pass to a charity, then one must use a conduit trust if the trust
is to qualify for a life expectancy payout
(as the first line remainder
beneficiaries must be considered with an Accumulation Trust).


If a trust will be named, then the next question is whether to use a
conduit trust or an Accumulation Trust. An Accumulation Trust allows
the RMDs to be retained in the trust but has drawbacks. The Accumulation
Trust may be more difficult to administer if the retirement custodian
does not interpret the law consistent with the existing letter ruling
analysis.
With an Accumulation Trust one must take into account the
first line remainder beneficiaries when determining the oldest trust beneficiary,
but with a conduit trust one can ignore all remainder beneficiaries.
There is also the possibility of a 50% tax on the undistributed
amount of the RMD if the IRS audits the trust Form 1041 and successfully
argues that the RMD calculation is based on the wrong life expectancy
– or worse that the trust does not qualify for the life expectancy
payout at all (because there is a non-individual beneficiary of the trust)
.
To safeguard against this, the trustee can file Form 5329 each year to
start the 3-year statute of limitations running, but this is an additional
administrative complexity the client should be aware of before opting
for an Accumulation Trust. Adding a savings clause to an Accumulation
Trust may provide enough assurance to avoid filing the Form 5329 each
year.
The advantage of the conduit trust is that we know it works. The
disadvantage is that all distributions from the retirement account must
be immediately distributed outright to the trust beneficiary. However,
the RMDs may initially be so small that some leakage from the trust to
the beneficiary outright is not a significant concern, depending on the
particular facts and purpose of the trust.


140 ACTEC LAW JOURNAL [Vol. 39:101


The article you quoted from is well-written. (Did you see where he cited one of my articles at note 113 on page 234?)

I'm surprised that you found this article if you're not a lawyer.

It's not that hard to draft a discretionary (accumulation) trust. The author provides a sample form at pages 251-253.

The author is correct that in the early years the leakage from the conduit trust is relatively small, but it becomes large in the later years until the trust is exhausted. If the beneficiary lives to life expectancy, nothing will be left in the trust. All of the IRA benefits will be thrown into the beneficiary's estate and exposed to the beneficiary's creditors and spouses. That's why I prefer the discretionary (accumulation) trust, especially in your example of someone with a 7-figure IRA.

NMJack wrote:... As you read various articles, you will likely encounter references to [Natalie Choate's] book [https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/order-form/] ....

Based upon the information I have found, the claim that this book is the "bible of distribution planning" is not hyperbole. I have personally dealt with two estate attorneys who have confirmed the validity of this resource. ...


Make that three.

NMJack wrote:
afan wrote:My concerns were that the article I cited seemed to say that the accumulation trusts were supported only by private letter rulings, which the IRS says cannot be relied upon.


I believe that this is true *to a point*. I was at a similar cross roads until I found the book referenced in my previous post. The chapter on trusts describes most/all of the pertinent PLRs, and the IRS has been quite consistent provided the attorney who drafted the trust understood the rules. After reading that chapter, and the many examples cited, I gained a certain level of confidence that I understood the rules well enough to look over an attorney's shoulder. If your attorney doesn't recognize the credentials of that book's author, I believe it is time to find a new attorney.

afan wrote:That, plus the apparent risks of doing it wrong and paying big penalties makes me wonder whether I am doing heirs a favor by using such a trust. The conduit trust does expose the RMD's, but those remain small fractions of the account until later in life.


Hopefully Bruce et al will weigh in as well. Since the conduit trust creates a steady, known, reliable "income" stream; I believe the implications for asset protection extend beyond the immediate year's RMD. I could be wrong. We definitely don't want to "do it wrong." At the extreme, I believe if a person establishes a qualified retirement plan trust, even though not yet funded, they can theoretically request a PLR for their specific trust from the IRS. I think that starts at around $10K and goes up from there. Maybe better to just watch other rulings and ensure that one's trusts are kept up to date. This is another potential area where a trust protector may play a role (you likely recall my mentions of trust protectors in other recent threads).


You are correct that whether the trust is conduit or discretionary (accumulation) has no effect on the selection of trustees or accountants or who manages the trust assets.

Natalie is the leading authority on this. Everyone who focuses on IRAs has her book and uses it regularly.

You can't get a private letter ruling on an IRA issue until after the IRA owner has died.

Van wrote:I have been wrestling with this issue for a few years, since I had a new will drawn up. My estate attorney works for a very large well-known firm and only does this type of work. According to her.......and I asked the question over and over.......trust assets are protected against creditors and spouses even if the beneficiary is also the only trustee.

I must admit, I'm skeptical despite the reassurances of the estate attorney!

From time-to-time, I think about changing things so the money just goes directly to the kids, and let the chips fall where they may.


Having each child as the sole trustee of his/her own trust will provide more protection than leaving the assets to the children outright. If you're not comfortable with having the child be the sole trustee of his/her trust, you could add a co-trustee and give the child the power to remove and replace his/her co-trustee (provided the replacement trustee is not a close relative or subordinate employee). I generally do it that way, though others do it the way you describe.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat Jul 16, 2016 11:41 pm

bsteiner wrote:
NMJack wrote:... As you read various articles, you will likely encounter references to [Natalie Choate's] book [https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/order-form/] ....

Based upon the information I have found, the claim that this book is the "bible of distribution planning" is not hyperbole. I have personally dealt with two estate attorneys who have confirmed the validity of this resource. ...


Make that three.

Natalie is the leading authority on this. Everyone who focuses on IRAs has her book and uses it regularly.



Bruce - thank you very much for your post. I was confident that I was on the right track basing my approaches on Natalie's book, but it is great to receive confirmation from a third highly qualified estate attorney. Hopefully this will help afan in his quest. :beer

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sun Jul 17, 2016 5:03 am

So the child can be trustee with discretionary distribution power over his/her own accumulation trust? That does not expose the assets to creditors? A court could not order the child to use their discretion to pay a creditor?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sun Jul 17, 2016 11:03 am

Thank you so much NMJack and bsteiner. Particularly for pointing me to Natalie Choate. Still working my way through, but she is clear that many important points are either unresolved, or inferred based on PLRs. She does not seem concerned about this and she certainly appears to be THE authority on the subject.

From what i gather, there is little to lose by going accumulation rather than conduit. For either, the retirement plan will be empty if the beneficiary on whose life expectancy the required distributions are based lives to their average expected age as of the time they inherit. With the conduit, that money will then have gone to the beneficiary, with no asset protection and it will be added to their estate. With the accumulation, the retirement plan will still be empty and the tax deferral lost, but the funds will stay protected in the trust and out of the beneficiary's estate.

With proposals to eliminate the stretch for non-spouse heirs, this could become a huge problem if the retirement plan had to be emptied out in 5 years, or even immediately, rather than over decades.

Although I am still worried about the uncertainty of relying on PLR's for guidance, it seems there are no other alternatives. One either uses the trust, preferably accumulation, or leaves the funds outright in the retirement plan, with no protection at all.

In effect, using the trust provides a different form of insurance against the sorts of claims for which conventional liability insurance would not be available. If it works and the situation arises, then the beneficiaries are protected. If it does not work because of all the uncertainties about IRS interpretations, it was a relatively small amount to spend on the best attempt to protect the funds. In either case, the accumulation trust should keep money out of the beneficiaries' estates.

Thank you again for all the help.
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NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sun Jul 17, 2016 1:02 pm

afan wrote:So the child can be trustee with discretionary distribution power over his/her own accumulation trust? That does not expose the assets to creditors? A court could not order the child to use their discretion to pay a creditor?


I don't believe the trust would provide asset protection if the child has full discretionary power to distribute to himself. I believe that in some states, if the trust limits the child to distribution to themselves for HEMS, then there is protection. These trusts would generally allow the child to resign as trustee and to appoint an independent trustee in the event that asset protection became a great concern.
Last edited by NMJack on Sun Jul 17, 2016 1:12 pm, edited 1 time in total.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sun Jul 17, 2016 1:10 pm

afan wrote: With the accumulation, the retirement plan will still be empty and the tax deferral lost, but the funds will stay protected in the trust and out of the beneficiary's estate.

With proposals to eliminate the stretch for non-spouse heirs, this could become a huge problem if the retirement plan had to be emptied out in 5 years, or even immediately, rather than over decades.



This brings up the value of Roth conversions. If one is able to substantially fund an accumulation trust with Roth assets, the situation becomes much better. Even if Washington eliminates the stretch, the Roth dollars won't generate an immediate tax liability for the trust. They can remain in an accumulation trust in an after-tax brokerage account invested in one or more index funds. Only the dividends and occasional capital gains distributions would need to be considered for immediate distribution to the beneficiary (to avoid the higher trust tax rates). The principle would still benefit from long term tax deferral. I need to educate myself more on the tax treatment of LTCGs and QDs generated by assets held in a trust.

bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Sun Jul 17, 2016 1:43 pm

afan wrote:Thank you so much NMJack and bsteiner. Particularly for pointing me to Natalie Choate. Still working my way through, but she is clear that many important points are either unresolved, or inferred based on PLRs. She does not seem concerned about this and she certainly appears to be THE authority on the subject. ....


I've known Natalie for many years, and she is definitely the leading authority on IRA matters.

afan wrote:... From what i gather, there is little to lose by going accumulation rather than conduit. For either, the retirement plan will be empty if the beneficiary on whose life expectancy the required distributions are based lives to their average expected age as of the time they inherit. With the conduit, that money will then have gone to the beneficiary, with no asset protection and it will be added to their estate. With the accumulation, the retirement plan will still be empty and the tax deferral lost, but the funds will stay protected in the trust and out of the beneficiary's estate. ...


That's the way I see it.

The conduit may make sense if you want to have a charity as a remainder beneficiary, but if you really want to benefit charity this might not work. If the beneficiary lives to life expectancy (which will happen at least half the time) nothing will be left for the charity.

It also slows down the required distributions in a trust for the spouse, since in that case you can recalculate the spouse's life expectancy each year. However, that doesn't come up very often since leaving IRA benefits to the spouse in trust gives up the rollover and the possible Roth conversion. It also gives the spouse control over the amounts required to be distributed, which may be counter to the reasons for leaving the IRA to the spouse in trust.

I think people who mandate that trusts for children end at age 30 or 35 like the conduit trust since it's simple and the mandatory distributions before age 35 are small. However, as previously discussed, I don't like to mandate that trusts end at a specified age.

afan wrote:... With proposals to eliminate the stretch for non-spouse heirs, this could become a huge problem if the retirement plan had to be emptied out in 5 years, or even immediately, rather than over decades.

This brings up the value of Roth conversions. If one is able to substantially fund an accumulation trust with Roth assets, the situation becomes much better. Even if Washington eliminates the stretch, the Roth dollars won't generate an immediate tax liability for the trust. They can remain in an accumulation trust in an after-tax brokerage account invested in one or more index funds. Only the dividends and occasional capital gains distributions would need to be considered for immediate distribution to the beneficiary (to avoid the higher trust tax rates). The principle would still benefit from long term tax deferral. I need to educate myself more on the tax treatment of LTCGs and QDs generated by assets held in a trust. ...


The Roth conversion generally adds much more value than most people realize.

Trusts reach the 39.6% rate on ordinary income and the 20% rate on qualified dividends and long-term capital gains, and become subject to the 3.8% net investment income, beginning at $12,400. So there's often a tradeoff between making distributions to beneficiaries in lower tax brackets and accumulating income to continue the asset protection. The Roth conversion eliminates this tradeoff, at least as to the IRA distributions.

I usually don't give much thought to proposed legislation until it appears likely to be enacted. A large number of bills are introduced each year, and there's not enough time to analyze them. However, this one has a reasonable chance of being enacted. It's already come close once or twice. It would raise revenue without increasing tax rates. We had something similar before the proposed regulations were revised in 2001. IRA owners reaching the required beginning date had to choose between term certain or recalculation (or, if they were married, hybrid methods). The workaround for those who chose recalculation and didn't have a spouse beneficiary was to leave the IRA to a charitable remainder trust (CRT), with "income" to one or more individuals and then remainder to charity. While CRTs aren't very flexible, and the requirements for CRTs have been tightened since then, they still essentially offer the equivalent of a stretch. If this passes, we'll go back to naming CRTs as beneficiaries. In any event, there's nothing we can do about it. Putting money into retirement plans and IRAs is still better than not putting money into retirement plans and IRAs.

afan wrote:... Although I am still worried about the uncertainty of relying on PLR's for guidance, it seems there are no other alternatives. One either uses the trust, preferably accumulation, or leaves the funds outright in the retirement plan, with no protection at all.

In effect, using the trust provides a different form of insurance against the sorts of claims for which conventional liability insurance would not be available. If it works and the situation arises, then the beneficiaries are protected. If it does not work because of all the uncertainties about IRS interpretations, it was a relatively small amount to spend on the best attempt to protect the funds. In either case, the accumulation trust should keep money out of the beneficiaries' estates.
....


I agree with your analysis. For better or worse, all we have are the regulations and the PLRs.

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sun Jul 17, 2016 2:37 pm

NMJack wrote:[
This brings up the value of Roth conversions.


I agree that moving to a Roth would eliminate the concern about the required distributions. I assume with no required distributions, then the complexities of the accumulation trust would also go away? The IRS would have already received its cut and there would be no need to determine which beneficiary's age determines distributions.

But that comes at the expense of paying upfront taxes on the retirement funds. I will look it over again, but right now it is hard to see the logic in doing Roth conversions until I stop working.

Can an accumulation trust do a Roth conversion after the participant has died? If the beneficiaries were below the top tax rate, could the trust push the taxable income out to the beneficiaries and have it taxed at their rates, rather than the trust rate?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sun Jul 17, 2016 3:41 pm

afan wrote: I agree that moving to a Roth would eliminate the concern about the required distributions. I assume with no required distributions, then the complexities of the accumulation trust would also go away? The IRS would have already received its cut and there would be no need to determine which beneficiary's age determines distributions.


Inherited Roth IRA's are subject to the same RMD rules as traditional funds. It is only during the original owner's lifetime that they are exempt from RMDs. Because of this, the oldest beneficiary's age will determine the RMD for all beneficiaries. As an alternative, if the trust is written to establish shares (aka subtrusts) for each primary beneficiary, and the subtrusts are directly named as beneficiaries, then the RMDs are calculated based upon each beneficiary's own age.

afan wrote:But that comes at the expense of paying upfront taxes on the retirement funds. I will look it over again, but right now it is hard to see the logic in doing Roth conversions until I stop working.


This is very much a case by case decision. As Bruce has pointed out, there are a lot of benefits to having Roth assets available to pass on to our heirs (especially through a qualified trust).

afan wrote:Can an accumulation trust do a Roth conversion after the participant has died? If the beneficiaries were below the top tax rate, could the trust push the taxable income out to the beneficiaries and have it taxed at their rates, rather than the trust rate?


I don't believe this is possible, but hopefully others will weigh in. As I mentioned earlier in the thread, I still need to educate myself more on the tax treatment of trusts. If an accumulation trust is funded with Roth dollars, the tax concerns are greatly reduced.

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