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The IRA Stretch Trust
The purpose of an IRA Stretch Trust is to insure the long term tax deferred stretch distribution of your IRA. By stretching the distributions, your beneficiaries have the ability to take advantage of your IRA tax deferred growth. The deferred taxes are similar to an interest free loan. As money is distributed from your IRA, taxes have to be paid. The longer the money stays in the IRA, the longer the growth will compound on tax deferred basis. Money in the IRA is money that you can invest and earn a return on until it has to be paid to the government in taxes. Stretch IRA Trusts insure that the funds stay in your IRA for the longest possible time to take advantage of this growth.
Many financial advisors believe that by simply designating your children as beneficiaries, that they can achieve lifetime stretch distributions. The problem with simply naming beneficiaries on your IRA documents is that you have done nothing to insure the stretch distributions. Your children may be able to take stretch distributions but that may not be the result. The IRA is still subject to creditor claims, bankruptcy, divorce, and a beneficiaries desire to have the money now. An IRA Stretch Trust not only insures the stretch of the distributions but also protects the distributions in the hands of your beneficiaries. It is estimated that somewhere between 55%-65% of IRA beneficiaries will cash out an inherited IRA.
For a Trust to be used as an IRA beneficiary, the IRS requires that:
a.) The Trust is valid under state law.
b.)The Trust is irrevocable at death.
c.) The Trust beneficiaries are identifiable from the Trust
document.
d.) All the beneficiaries must be individuals.
e.) Certain documentation must be provided to the IRA
custodian by October 31 of the year following the
IRA’s owner’s death.
If these requirements are met the Trust will be considered a “see through” Trust and the IRS will allow the stretch and creditor protection.
The question then becomes what are valid “designated beneficiaries” under the Internal Revenue Code. Unfortunately the Treasury Regulations do not tell us how to make each individual beneficiary of the Trust qualify as a “designated beneficiary.” This is important because the only way you can achieve maximum stretch distributions is for each beneficiary to be recognized individually as a designated beneficiary of his or her share of the inherited IRA.
By way of example, let us assume that John is 74 years old and has four children, Bill age 54, Sue age 50, Frank age 47 and Nancy age 43. John passes away in 2009 with $250,000 remaining in his IRA. If John had designated his predeceased wife (Mary) or had no designated beneficiary, the maximum IRA distribution period would be 10 years and the total distributions would be approximately $353,170. If instead he leaves the IRA to his class of children the oldest would than qualify as our designated beneficiary. Using Bill as the oldest child as the measuring life, the total payout of John’s IRA would $809,261. If however John used an IRA Stretch, each of his children would qualify as a designated beneficiary and may stretch distributions by using their own life expectancies for distribution calculations. In that case the total distributions would be $1,076,920. John’s family would receive an additional $267,659 if he has the foresight to set up such a Trust.
The second advantage of an IRA Stretch Trust is that each individual beneficiary of the Trust will have his or her own sub-Trust. Each of the sub-Trusts can be structured as either an accumulation or conduit Trust. An accumulation Trust is a where the Trustee has the authority to withhold distributions to the beneficiary. The Trustee must still withdrawal the required minimum distribution from the IRA, but once withdrawn it can be held as a general Trust asset rather than paid to the beneficiary. This type of Trust provides significant asset protection. It prevents the IRA distributions from being accessible to the beneficiary’s creditors and claimants while still giving the Trustee discretionary authority to make distributions to the beneficiary.
A Conduit Trust is where the Trustee must withdraw all minimum distributions when required and immediately pay them over the beneficiary. The Trustee may not retain or accumulate in the Trust any IRA distributions that are made within the lifetime of the beneficiary. In this type of Trust there is still significant asset protection. It is true that once the required minimum distribution is paid over to the beneficiary, a creditor a claimant may reach it. However the IRA itself is still intact and out of the beneficiary’s grasp. Therefore, the IRA is not subject to the claims of the beneficiary’s creditors or the beneficiary’s whim’s and desires for early distributions.
Whether to use a conduit trust verses an accumulation trust depends on the individual beneficiary. Accumulation trusts are appropriate where a beneficiary is more likely to have special needs, divorce, may have problems managing money, has a stronger likelihood of creditor problems or bankruptcy, has substance abuse problems, or where you desire to have a higher level of asset protection. This may be the case where your beneficiary is in a professional practice that is likely to attract law suits such as a doctor, lawyer, or small business owner. Conduit Trusts work well where the beneficiary is in a very strong marriage, is not a spend thrift, has no special needs, is mature, does not creditor problems, and may have older remainder beneficiaries.
You can design your sub-Trust to be either an Accumulation Trust or Conduit Trust, based on each individual beneficiary. It is flexible enough to allow you to decide on an individual basis for each individual beneficiary whether a Conduit or an Accumulation Trust is appropriate. You can build even more flexibility into the Trust by including a switch provision that allows the Trustee within a certain period of time after the IRA owner dies to choose between a Conduit or an Accumulation provision. This aspect can be particularly useful in addressing circumstances that arrive close to or immediately after the IRA owner’s death. In regards to amendments, the IRS only requires that the Trust be irrevocable upon death. Up until that time, you can amend your Trust as often as you like, adding and removing beneficiaries, changing Trustee and changing discretionary distribution standards.
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Meurer Law Offices
5347 S. Valentia Way, Suite 220
Greenwood Village, Co. 80111
303.991.3544
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MEURER LAW OFFICES, P.C.
5347 South Valentia Way, Suite 220
Greenwood Village, CO 80111
Phone: 303-991-3544
