I had the best of intentions on writing posts during the summer, but the travel bug bit hard and I had a wonderful time enjoying England and Scotland, northern California and the eclipse in Oregon.
I hope that you, your family and friends were able to reconnect with each other and the pleasurable aspects of life.
One of the most frequent questions I am asked is, "Who should the beneficiary of my IRA be?" Often clients have set up a revocable family trust and think or have been advised by their attorneys that everything they own should now be titled in the name of the trust and that all beneficiaries should be the trust.
This makes total sense from a legal perspective, especially if the beneficiaries of the trust are minors (you know those kids you love and want to provide for. You responsible parent you). A trust provides a mechanism for someone to manage the finances for your children and provides protection from creditors or in a divorce.
The tax consequence of having your revocable trust be an IRA beneficiary however is that any amount over $12,500 (as of 2017) distributed and kept by the trust will be taxed at 39.6% and that is just the federal income tax!
Yikes you say! "I didn't work hard to save money to provide for my spouse and kids only to have Uncle Sam take almost 40% of it if I die." So what are you to do?
Glad you asked.
The reason the trust has to take 100% of the account value upon your death is because the trust isn't a person, but is a separate legal and taxable entity. If a person inherits an IRA, then distributions from the IRA account can be made over their expected lifetime. Trusts don't die and so don't have life expediencies.
Now the good news! If your trust document contains language that permits a conduit IRA account to be established upon your death, the funds will be distributed and owned by the trust (think centralized financial management and liability protection), but ties the life expectancy to the older of the trust beneficiaries.
When IRA withdrawals are made either due to required minimum distributions or because the funds are needed, they will be made to the trust and so the trust will receive the Form 1099 reporting the taxable income.
However if the trust then distributes those funds to the beneficiary the trust then receives an income distribution deduction. So in effect, the trust is not taxed on the IRA distribution. The taxable income flows through to the beneficiary's tax return and is reported on Schedule K-1 and the tax is paid with their individual return.
For this to work, all of the beneficiaries of the conduit IRA must be people and not organizations. So if you want to make a gift to a charitable organization as part of your estate, you should specifically identify in the trust document that the bequest be paid from non IRA funds.
In my many years of practice, I have rarely seen this provision included in the trust document, even when the attorney preparing the agreement is very knowledgeable about estate matters.