IRA Stretch Planning

New IRS rules now permit an individual to create an IRA Beneficiary Trust^® to insure that your beneficiaries (those who will receive the IRA’s after you and your spouse pass away) “stretch-out” their taxable, required minimum IRA distributions over a much longer period of time. And, if they do it right, the IRAs can continue to compound for many years income-tax free – – and may literally grow to be worth millions of dollars! In 2005, the IRS issued a private letter ruling 200537044 (the “PLR”) that approved this new type of revocable trust created solely to be the beneficiary of an IRA account. As a result of this PLR, it is now possible for you to create a stand-alone trust.

IRA Inheritance Trusts^® insure that their beneficiaries will stretch-out payments from the IRA after they inherit their shares of the account so that the funds will grow inside the account without being taxed. This type of trust is also called an IRA trust, an IRA Inheritance Trust, a standalone IRA trust, an IRA stretch trust or an IRA protection trust.

If children and grandchildren who inherit IRA funds keep the funds in the IRA over their lives and only take the required minimum distributions each year (the “stretch-out”), the amount of money that can be earned, accumulated and paid to the beneficiaries can be staggering. To illustrate how this compounding can works, I have calculated how much money a beneficiary can receive from a parent’s $100,000 IRA account; I have used two different ages (10 and 35) for the beneficiary and have assumed that the account averages an annualized 8% return:

This wealth accumulation strategy only works if the beneficiaries retain the inherited funds inside the IRA account. If a beneficiary takes all of the funds out of the IRA account (called a “blow-out” because it blows the stretch-out), this wealth accumulation technique will be lost. One of the reasons to create an IRA Beneficiary Trust^® is because it can insure the stretch-out and can prevent a blow-out. This blow-out happens more often than you may think. The beneficiaries may not be aware of the tax rules and their distribution choices, so they may immediately withdraw the IRA’s at the first opportunity (or worse yet, do a prohibited rollover!). Or the beneficiary, influenced by his or her spouse, may just decide to withdraw the IRA’s to foolishly spend it. If the “stretch-out” isn’t done properly by the beneficiaries and income taxes are paid up front shortly after the IRA’s are inherited, your family may lose hundreds of thousands of dollars (or more).

Even if you assume that your beneficiaries will do the right thing – keep the funds in the IRA account for their lives to maximize the income tax “stretch-out” of the IRA’s –  the IRA’s may still be seriously exposed to one or more of the following threats that can arise years after you are gone:

The beneficiary’s spouse may snatch half (or more) of the inherited IRA’s in a divorce. The divorce rate is over 50% and a big pile of inherited money may become a divorce incentive for the ex-spouse. Even though inherited property is separate property, the beneficiary’s ex-spouse’s divorce lawyer will probably go after the IRA funds because the IRA account is frequently the largest asset and the lawyer knows there is a good chance the spouse who inherited the IRA will give a large portion or all of the IRA account just to end the divorce and to be rid of the ex-spouse.

• The beneficiary’s poor spending habits, creditors and lawsuits may grab all of an inherited IRA’s.
• The beneficiary could lose his or her needs-based government benefits (if he or she ever requires them), such as supplemental income (SSI) or long-term nursing care.
• And even if the beneficiary never encounters any of these problems, he or she may get walloped with a huge estate tax when he or she passes the IRA’s down to the next generation.

Like the Trust, your new beneficiary designation can be changed by you during your lifetime.  When the Trust becomes the beneficiary of your IRA following your death, the IRA required minimum distributions (and any additional IRA withdrawals which your Trustee deems appropriate) will pour into the Trust and the terms of the Trust will determine how and when the monies will be paid out to your beneficiaries.

Coordination With the Rest of Your Estate Plan.  In order for the IRA Beneficiary Trust^TM to be properly administered, we may have to integrate certain technical provisions into your Living Trust, Wills, and Powers of Attorney.  The modifications to these documents will not change the distribution of your assets under your basic estate plan (unless you request changes in the distribution); the changes merely support the proper operation of your IRA Inheritance Trust^TM.

We realize that there is quite a lot to review and absorb here, so again please do not hesitate to contact us to assist you.