IRA Beneficiary - Individuals or Trust

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lstone19
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IRA Beneficiary - Individuals or Trust

Post by lstone19 » Mon Jun 29, 2020 5:45 pm

My wife will (AFAweK) be both executor and trustee when her mother (currently 90+ with some health issues but still mentally sharp) dies. My wife is one of seven surviving 55 y.o.+ children (one sister has already passed but as she was never married and had no children, any inheritance claim has been extinguished). Taxable accounts are in her living trust so that part is simple. Trust beneficiaries should be the same seven children.

She has, again AFAweK, a six figure traditional IRA. We're not sure how the beneficiaries are set up on the IRA. I've seen various things about leaving IRAs to trusts vs. actual persons and am confused. I know she could designate the beneficiaries as 1/7 to each child and each would then get that as an inherited IRA that under the new rules must be distributed within 10 years. Seems simple.

But if the IRA is left to her trust, then what happens. Can it pass through the trust so each child still ends with an inherited IRA? Or does the trust have to take distributions, pay taxes on it, and then pass it on to the trust beneficiaries. Or something else.

We'd like to verify with her what the beneficiary designation is and if it's a problem, discuss having her change it.

Note that this is not a relationship issue. MIL wants this to be as simple as possible for my wife when that time comes and will be open to the conversation. Please don't sidetrack this by bringing up relationship issues.

Alan S.
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Re: IRA Beneficiary - Individuals or Trust

Post by Alan S. » Mon Jun 29, 2020 6:33 pm

lstone19 wrote:
Mon Jun 29, 2020 5:45 pm
My wife will (AFAweK) be both executor and trustee when her mother (currently 90+ with some health issues but still mentally sharp) dies. My wife is one of seven surviving 55 y.o.+ children (one sister has already passed but as she was never married and had no children, any inheritance claim has been extinguished). Taxable accounts are in her living trust so that part is simple. Trust beneficiaries should be the same seven children.

She has, again AFAweK, a six figure traditional IRA. We're not sure how the beneficiaries are set up on the IRA. I've seen various things about leaving IRAs to trusts vs. actual persons and am confused. I know she could designate the beneficiaries as 1/7 to each child and each would then get that as an inherited IRA that under the new rules must be distributed within 10 years. Seems simple.

But if the IRA is left to her trust, then what happens. Can it pass through the trust so each child still ends with an inherited IRA? Or does the trust have to take distributions, pay taxes on it, and then pass it on to the trust beneficiaries. Or something else.

We'd like to verify with her what the beneficiary designation is and if it's a problem, discuss having her change it.

Note that this is not a relationship issue. MIL wants this to be as simple as possible for my wife when that time comes and will be open to the conversation. Please don't sidetrack this by bringing up relationship issues.
When she passes the new Secure Act will apply whether the beneficiaries are named or a trust inherits the IRA. As you indicated the 10 year rule will generally apply, but if any of the beneficiaries is disabled or chronically ill, that beneficiary may still receive a life expectancy stretch.

Your wife as trustee of any trust will have to abide by the trust provisions. Those provisions may or may not give her discretion to perform various actions. One of those actions might be to terminate the trust or distribute the shares of the IRA to each beneficiary in the form of their own inherited IRA. Each beneficiary could then fully control their inherited IRA, name their own beneficiary, change the investments, choose the custodian, and decide how to best deal with the 10 year rule, under which no annual RMDs are required, but a beneficiary might want to take some distributions along the way to avoid having a large distribution at the end of the 10 year period. However, note that the trust DOES provide creditor protection for the IRA that in most states does not exist once the IRA is distributed out of the trust.

Another key factor is whether the trust is "qualified" or not, meaning that the IRS looks through the trust to the actual beneficiaries rather than treating the trust as a "non individual" beneficiary. A non qualified trust would not be subject to the 10 year rule, but rather the remaining life expectancy of the IRA owner. Being over 90, that is far less than 10 years, therefore if a trust is the beneficiary your wife should determine if it was drafted to be "qualified" and if so she needs to be sure to provide the trust beneficiary info to the IRA custodian no later than 10/31 of the year following mother's death (so called Halloween rule). If she forgets to do that the trust will lose qualification.

Another trust provision regards passing through distributions each year to the trust beneficiaries, which are then reported and taxable on each beneficiary's own 1040. If any distributions are accumulated in the trust, then the trust will be taxed at the much higher trust tax rates.

As you can see her work will be much shorter and easier if she is allowed to assign the IRA to the beneficiaries. One important issue to look into while mother is still alive is whether the current IRA custodian will cooperate with assignment if that is the desired action at the time. Many custodians do not cooperate with the trustee, and almost no custodian really wants to turn one inherited IRA into 7. Therefore, it might be wise to consider transferring the current IRA account to a custodian who indicates they will cooperate with the assignment request should your wife want to do that, and I would suggest getting that in writing if possible. You can't take some CSRs answer as binding on something like that especially if the question will not be actionable until later on.

If the beneficiaries are mostly in one state, provide the state and I can look up whether that state provides creditor protection for inherited IRAs.

bsteiner
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Re: IRA Beneficiary - Individuals or Trust

Post by bsteiner » Mon Jun 29, 2020 7:55 pm

There wouldn’t be any purpose to leaving the IRA to the revocable trust.

She could leave it to the children outright or to separate trusts for their benefit.

Trusts would keep the assets out of the children’s estates and protect against their creditors and spouses but may not be practical for the amount involved.

Topic Author
lstone19
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Re: IRA Beneficiary - Individuals or Trust

Post by lstone19 » Mon Jun 29, 2020 8:00 pm

Alan, thank you for the detailed reply.

To address the points you made:
- All beneficiaries are in Illinois
- No disabled or chronically ill
- To the best of her knowledge, the trust is simply to avoid having things tied up in probate to get things to the beneficiaries as quickly as possible. We do not believe there will be any restrictions on distributing anything.

With her mother residing in a CCRC which has been locked down due to COVID-19, we realized how much more difficult that makes getting access to the documents. Having copies of everything is an immediate goal.

The IRA is with Fidelity. Since they allow up to eight beneficiaries to be specified on-line and up to 50 on the paper form, I would not expect a seven-way split to be an issue.

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lstone19
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Re: IRA Beneficiary - Individuals or Trust

Post by lstone19 » Mon Jun 29, 2020 8:03 pm

bsteiner wrote:
Mon Jun 29, 2020 7:55 pm
There wouldn’t be any purpose to leaving the IRA to the revocable trust.

She could leave it to the children outright or to separate trusts for their benefit.

Trusts would keep the assets out of the children’s estates and protect against their creditors and spouses but may not be practical for the amount involved.
That's been my thought. Since my MIL's goal is to make this simple for us, we just need to verify that that is what she's done.

neverpanic
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Re: IRA Beneficiary - Individuals or Trust

Post by neverpanic » Mon Jun 29, 2020 8:36 pm

Alan S. wrote:
Mon Jun 29, 2020 6:33 pm
When she passes the new Secure Act will apply whether the beneficiaries are named or a trust inherits the IRA. As you indicated the 10 year rule will generally apply, but if any of the beneficiaries is disabled or chronically ill, that beneficiary may still receive a life expectancy stretch.

Your wife as trustee of any trust will have to abide by the trust provisions. Those provisions may or may not give her discretion to perform various actions. One of those actions might be to terminate the trust or distribute the shares of the IRA to each beneficiary in the form of their own inherited IRA. Each beneficiary could then fully control their inherited IRA, name their own beneficiary, change the investments, choose the custodian, and decide how to best deal with the 10 year rule, under which no annual RMDs are required, but a beneficiary might want to take some distributions along the way to avoid having a large distribution at the end of the 10 year period. However, note that the trust DOES provide creditor protection for the IRA that in most states does not exist once the IRA is distributed out of the trust.

Another key factor is whether the trust is "qualified" or not, meaning that the IRS looks through the trust to the actual beneficiaries rather than treating the trust as a "non individual" beneficiary. A non qualified trust would not be subject to the 10 year rule, but rather the remaining life expectancy of the IRA owner. Being over 90, that is far less than 10 years, therefore if a trust is the beneficiary your wife should determine if it was drafted to be "qualified" and if so she needs to be sure to provide the trust beneficiary info to the IRA custodian no later than 10/31 of the year following mother's death (so called Halloween rule). If she forgets to do that the trust will lose qualification.

Another trust provision regards passing through distributions each year to the trust beneficiaries, which are then reported and taxable on each beneficiary's own 1040. If any distributions are accumulated in the trust, then the trust will be taxed at the much higher trust tax rates.

As you can see her work will be much shorter and easier if she is allowed to assign the IRA to the beneficiaries. One important issue to look into while mother is still alive is whether the current IRA custodian will cooperate with assignment if that is the desired action at the time. Many custodians do not cooperate with the trustee, and almost no custodian really wants to turn one inherited IRA into 7. Therefore, it might be wise to consider transferring the current IRA account to a custodian who indicates they will cooperate with the assignment request should your wife want to do that, and I would suggest getting that in writing if possible. You can't take some CSRs answer as binding on something like that especially if the question will not be actionable until later on.

If the beneficiaries are mostly in one state, provide the state and I can look up whether that state provides creditor protection for inherited IRAs.
Thanks so much for this great post.

(Since all the beneficiaries are over 55, I'd seek to liquidate and eliminate the hassle of dealing with an extra tax return for the next 10 years.)
I am not a financial professional or guru. I'm a schmuck who got lucky 10 times. Such is the life of the trader.

Alan S.
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Re: IRA Beneficiary - Individuals or Trust

Post by Alan S. » Mon Jun 29, 2020 8:50 pm

lstone19 wrote:
Mon Jun 29, 2020 8:00 pm
Alan, thank you for the detailed reply.

To address the points you made:
- All beneficiaries are in Illinois
- No disabled or chronically ill
- To the best of her knowledge, the trust is simply to avoid having things tied up in probate to get things to the beneficiaries as quickly as possible. We do not believe there will be any restrictions on distributing anything.

With her mother residing in a CCRC which has been locked down due to COVID-19, we realized how much more difficult that makes getting access to the documents. Having copies of everything is an immediate goal.

The IRA is with Fidelity. Since they allow up to eight beneficiaries to be specified on-line and up to 50 on the paper form, I would not expect a seven-way split to be an issue.
Illinois does NOT provide creditor protection for non spouse inherited IRAs.

An IRA is not subject to probate unless it is left to the estate. If individuals were named directly as beneficiaries there is no probate, and no assignment to inherited IRAs from a trust. Each designated (named) beneficiary can handle the establishment of their own inherited IRA directly with Fidelity. For this to happen, the individuals can be named as beneficiaries and the trust deleted as beneficiary. No need to change the trust unless there are other issues.

All designated beneficiaries will be subject to the 10 year rule regardless of age.

The number of beneficiaries should not be an issue if named directly since there wouldn't be any assignment of the IRA out of a trust. Each beneficiary can establish their own separate inherited IRA at different times.

RMDs will resume in 2021 under current law. It will simplify things for the beneficiaries if Mom's 2021 RMD is distributed early in 2021 so beneficiaries will not have to deal with "year of death" RMD issues if Mom passes before completing the 2021 RMD.

Unless loss of creditor protection is a major concern, it is simpler to name all 7 beneficiaries directly on the IRA.

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Watty
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Re: IRA Beneficiary - Individuals or Trust

Post by Watty » Mon Jun 29, 2020 9:22 pm

Would it make sense to split the IRA into seven IRAs with different beneficiaries, and contingent beneficiaries for each IRA?

That would complicate her RMDs but it might make settling her estate easier especially if something happens like one of the siblings dies before her mom since it would be clear how their share the IRA should be distributed.

Topic Author
lstone19
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Re: IRA Beneficiary - Individuals or Trust

Post by lstone19 » Mon Jun 29, 2020 9:58 pm

Watty wrote:
Mon Jun 29, 2020 9:22 pm
Would it make sense to split the IRA into seven IRAs with different beneficiaries, and contingent beneficiaries for each IRA?

That would complicate her RMDs but it might make settling her estate easier especially if something happens like one of the siblings dies before her mom since it would be clear how their share the IRA should be distributed.
That seems unnecessarily complicated, particularly if one of beneficiaries dies first. If one of the three unmarried and no children siblings dies, it becomes a 1/6 share to the others. If one of the four who do have children dies, then that 1/7 share passes to the grandchildren in equal shares of the 1/7 (assuming a per stirpes designation).

Plus, unless all seven IRAs had the exact same contents, market changes would cause them to become unequal.

Alan S.
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Re: IRA Beneficiary - Individuals or Trust

Post by Alan S. » Tue Jun 30, 2020 2:06 pm

Most IRA agreements provide that if there are multiple beneficiaries and one dies (or disclaims), their share goes equally to the remaining beneficiaries.

If you don't want that, specify "per stirpes" or "per capita" after each beneficiaries name where you want their share to pass to their issue. If you have several beneficiaries you might want to only specify "Per stirpes" for some of them and not for others, although some custodians might not allow that differentiation.

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FIREchief
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Re: IRA Beneficiary - Individuals or Trust

Post by FIREchief » Tue Jun 30, 2020 2:44 pm

bsteiner wrote:
Mon Jun 29, 2020 7:55 pm
There wouldn’t be any purpose to leaving the IRA to the revocable trust.
In light of Alan's post:
Alan S. wrote:
Mon Jun 29, 2020 8:50 pm
Illinois does NOT provide creditor protection for non spouse inherited IRAs.
Wouldn't there be asset protection advantages to having the trust inherit the IRA's instead of the individuals?
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

Alan S.
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Re: IRA Beneficiary - Individuals or Trust

Post by Alan S. » Tue Jun 30, 2020 2:59 pm

Yes, there would be better asset protection. But there might be offsetting disadvantages with a trust beneficiary.

bsteiner
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Re: IRA Beneficiary - Individuals or Trust

Post by bsteiner » Tue Jun 30, 2020 3:12 pm

Alan S. wrote:
Tue Jun 30, 2020 2:06 pm
Most IRA agreements provide that if there are multiple beneficiaries and one dies (or disclaims), their share goes equally to the remaining beneficiaries.

If you don't want that, specify "per stirpes" or "per capita" after each beneficiaries name where you want their share to pass to their issue. If you have several beneficiaries you might want to only specify "Per stirpes" for some of them and not for others, although some custodians might not allow that differentiation.
The key is to make it clear what happens under any possible contingency.

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Peter Foley
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Re: IRA Beneficiary - Individuals or Trust

Post by Peter Foley » Tue Jun 30, 2020 3:15 pm

If the mother is currently in long term care and as a result in a very low tax bracket (perhaps zero) I would look at withdrawing funds from the IRA or doing a partial (or full) Roth conversion.

Why, you might ask? A number of people will be receiving shares of the IRA and will pay taxes on withdrawals. There will likely be those who will pay much more in taxes than their siblings. I would try to devise a solution that would provide each heir with an approximately similar amount of after tax inheritance.

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