The IRS recently made it easier to use a trust with your IRA to protect assets for future generations. You still should use an Estate Planning attorney to ensure things are done properly, but the new ruling adds more certainty than we had in the past.
The type of trust people most often want to use with an IRA is the QTIP or qualified terminable interest property trust. The QTIP provides for a surviving spouse but also ensures that any remaining property goes to your children or to other heirs you designate. Under a QTIP, the surviving spouse receives all income from the trust and also can tap principal for certain needs. After that, the children receive the remainder. No estate taxes are due until the surviving spouse dies.
Naming a QTIP as an IRA beneficiary has been difficult, because the QTIP rules require that the surviving spouse receive all the income each year. The IRS has ruled this means all the IRA’s income must be passed to the trust and then to the surviving spouse each year. Defining the income of the IRA was a difficult issue. A mistake would invalidate the trust and the tax deferrals.
In the recent ruling, the IRS defined when the QTIP could be combined safely with an IRA. The trust is named beneficiary of the IRA. Each year, the surviving spouse’s life expectancy is determined using IRS tables, and that is used to compute the required minimum distribution from the IRA. The RMD is distributed from the IRA to the trust.
The IRS ruling explains how much of the RMD must be paid from the trustee to the surviving spouse each year. The calculation can become complicated. Many people probably will need an attorney or accountant to calculate the proper distribution. Details are in Revenue Ruling 2006-26. If your survivors and their advisors follow this ruling, you safely can leave your IRA to a qtip trust.
There are other estate planning details and cautions.
Be sure to name the trust as the IRA beneficiary on the beneficiary designation form. Anything you say in the will or trust agreement won’t count unless the form is properly completed.
The RMDs and required payouts might result in the trust having few or no assets after the surviving spouse dies, leaving little for the children. But the arrangement does prevent remaining assets from going to anyone other than your designated heirs.
To receive the tax benefits, the estate tax return must elect QTIP treatment for both the IRA and the trust.
An alternative to consider is to avoid trusts altogether. Instead, consider splitting your IRA or advising your heirs to split them.
For example, you can determine how much of your IRA is needed by your spouse. Take the rest of the IRA and transfer it to a new IRA. Name your spouse as beneficiary of the original IRA and your children as heirs of the second IRA.
In addition, be sure your children know that they are allowed to split an IRA after inheriting it. Each child can have his or her own IRA. Splitting IRAs means there are no disputes over how the IRA should be managed. Plus, each IRA uses its owner’s life expectancy to determine required minimum distributions. If the children share one IRA, the life expectancy of the oldest child determines the RMDs.
Your heirs also need to know other details about IRAs that we covered in past visits. For example, the name on the IRA account must retain the name of the deceased original owner, that it is an IRA, and that it is for the benefit of (or FBO) the beneficiary. For more details see our September 2006 and August 2004 issues or visit the Archive on the web site.