Saturday, February 5, 2011

IRA Inheritance Trust - IRA Beneficiary Trust - IRA Management Trust??

You may have heard something about these types of trusts. They all are the same thing; just different names for marketing purposes. For our purposes I will call them “IRA inheritance trusts.” The use of these trusts is gathering momentum by knowledgeable estate planning professionals. There is a clear reason for the increasing use of these trusts; and, that is, they are essential when planning for the safe financial future of one’s children and grandchildren. They are relatively new because of recent changes in IRS positions and state laws. Here’s why:

As more "baby boomers" are retiring and rolling over large 401(k) and other retirement plans to IRAs, proper tax and estate planning for IRAs have become increasingly important.

I have drafted a fair number of these IRA inheritance trusts over the last few years. The proper use of these trusts permits the IRA owner and his or her family to enjoy maximum “stretchout” and protection benefits at the same time. The protective features of certain “spendthrift trusts” have previously been tested and proven over many years of court decisions. And now, finally, the IRS has approved the income tax “stretchout” feature as well. This new stand-alone IRA beneficiary trust is not the “garden variety” that has existed for some time, but rather represents a huge breakthrough. State law changes have made these trusts even more special. The IRA inheritance trust is the most advanced “next generation” trust that solves many earlier, tricky drafting problems associated with maximizing both the stretchout and protection benefits.

Consider this: IRAs are where most people deposit their 401(k) funds, making them a major source of wealth. Often, an IRA is the single largest asset a family may possess. An IRA inheritance trust is the answer to the question, "What happens if I pass away before using my IRA?"

Often, when an heir inherits the proceeds of an IRA or other retirement plan, they withdraw all of the funds immediately. Once they withdraw these funds, they will be liable for income taxes on the entire amount of the IRA. Additionally, if an heir receives an IRA through an inheritance or beneficiary transfer, the proceeds of the IRA could be lost in a divorce, or subject to creditors.

An IRA inheritance trust will stretch the IRA over a long period of time, ensuring continued deferral of income taxes, protection against lawsuits, creditors and divorces, and maximizing the value of the IRA or retirement plan.

Tuesday, January 25, 2011


       Over these 34 years of practice I have had many clients come to me asking that I “UNDO” a situation brought about by unwise use of joint ownership of assets with a child or children. Although they received their “advice” from well-meaning friends or advisors, the fact that they placed their assets in this form of ownership brought them and their family to disastrous consequences. The loss of control of the asset and the exposure to the joint tenant’s liabilities are not thought of when the client merely wants to “avoid probate.”  I thought the information would be helpful.
Larry Robertson

Aging parents often want to name a child as a joint owner of a house or other property to avoid Probate estate problems. It's not a good idea, estate planning lawyers say.
Probate, according to Webster’s, is the “act or process of proving before a duly authorized person that a document submitted for official certification and registration, especially a will, is genuine.” Probate, instituted in the 1500’s in England, makes sure that creditors get paid and that the proper persons (heirs, beneficiaries, legatees…etc.) actually receive that which is rightfully theirs by law or by last will and testament.

Probate makes a lot of people cringe, and they’ll do just about anything to avoid it. The probate process can be time-consuming (10-12 months average) and costly. Attorney’s fees and personal representative’s fees in probate are expensive. It also puts everything that transpires in court on public record for every citizen of their town to see.

One of the most popular ways parents try to avoid probate is by naming a child as joint owner of a property -- a bank account, CD or house, for example.
Knowledgeable lawyers and financial advisors say this is a mistake.
Opens a can of worms-
Laws vary by state but, generally, you’ll bypass probate with a joint ownership agreement. In combination with a joint bank account, it would make life easier for a child who’s taking care of an elderly parent. But a joint ownership agreement opens up the proverbial can of worms, too.

The scenario that is usually the greatest problem is when a sole surviving parent puts one of several children on the deed to their house or a financial account.

The problem is that they just made a gift of that property to the one child to the exclusion of the others. Usually, it’s done with the understanding that the daughter, or whoever, will split it with her siblings. That doesn’t always happen. One child can totally withhold the property from the others unless the recipient child voluntarily makes gifts to the others.

If the child does divide the property with the other siblings, that creates a problem, too!

As an example: A parent has $100,000 in CDs in a joint account with Sally, a daughter who lives nearby. There are two other children. The parent tells Sally, “after I die, divide the cash equally with your siblings.” Sally is a good daughter and transfers $33,000 to each of her siblings. But now she has made a gift that's potentially subject to gift taxes.

A potential solution would have been to put the CD’s (and all other property) in a Revocable Living Trust with Sally as the trustee. She’d have a clearly defined duty to make payments, and there would be no tax consequence to her.
Add up the tax consequences-
Take a look at what happens to a child tax-wise when you make him co-owner of your house. You’re giving half the property to the child – that’s a gift. The gift is valued at half of whatever you paid for the house!

The child doesn’t get a stepped-up basis on that half of the house when you die. A stepped-up basis would bring the value of the gift up to its present-day value and would result in a far lower capital gain tax if the child eventually made a profit selling the house. Instead, when you die, the other half of the house passes to the child as an inheritance and the child receives a stepped-up basis on that half only.

Property held in joint ownership usually passes automatically upon the death of one owner to the other owner. The person, presumably the child, becomes the sole owner and can do what he wants with the property.

The joint ownership supersedes a Will, (that is, joint assets are not probate assets and not affected by the Will) so even if the parent stipulates in a Will that a particular property should be divided evenly among all the children, the surviving owner doesn’t have to carry out those wishes – because the assets are not probated.
Other nightmarish scenarios-
Even if there are no other siblings, a joint ownership with a child can become a nightmare because of circumstances outside your control.

You may find your jointly held property at risk if the child is involved in a contentious divorce (it’s marital property in Missouri)! The court orders YOUR house sold in a divorce to which you are not a party??

If the child has credit problems, the creditor may go after the child’s half of the property.

Assume three children and mother become joint owners. If one of the joint owners (presumably children of the deceased) would predecease Mom or Dad and leave children; those grandchildren would receive NONE of the asset because only the surviving owners – the other siblings - would take. The grandchildren are cut out!

The lesson to be learned is that somebody is in court over this and paying attorneys. That’s not something the mother wanted. The question is, what are you achieving by putting accounts in joint names?

By the way, even if your child (your joint-owner) has perfect credit and handles money in the most responsible fashion, his or her assets could be targeted someday because of an auto accident or some other catastrophic incident.

Sometimes the goal is to protect assets in the event the parent needs to go into a nursing home. Most states require individuals to pretty much deplete their assets before Medicaid will pay nursing home costs.

In all cases, the state will ask you if you’ve made any transfers of property in the last FIVE years. That property will be counted as an asset for you. They’ll say, “We’ll make you ineligible for as long a period of time where you could have paid for nursing home care with the property you gave away.”

That’s not to say you absolutely can’t qualify for Medicaid if you’ve put property into joint ownership within five years. There are exceptions and a good Medicaid estate attorney can help you protect assets legally.
Seek out the alternatives-
There are alternatives to joint ownership.

If you have a bank account you want to pass to a child and avoid probate, consider a pay-on-death designation or, in the case of stocks, a transfer-on-death account.

A more common and sensible option is a Revocable Living Trust. Assets pass seamlessly to your child, or equal shares to all of them. While you’re alive, the assets are yours and are not subject to the claims of your child’s creditors or spouse.

A house can be left to a child in a trust -- with no probate, and the benefit of a stepped-up basis. The child would also get a stepped-up basis if the house is in a will, but wills are subject to probate.


Spousal Rollover of IRA?  –  Take Care!

When a spouse inherits an IRA, it is “generally desirable” to perform a spousal rollover. This allows the spouse to defer required minimum distributions until he/she reaches his/her required beginning date and also allows for further deferral to after the surviving spouse’s death if the spouse does proper beneficiary planning.  

However, as this case highlights, if a spouse is younger than age 59 ½, a spousal rollover should not be automatic. If there is a possibility that the spouse will need to access the IRA funds before age 59 ½, a rollover should not be performed. 


Case Illustrates That One Rule Does Not Fit All Situations

In Peggy A. Sears v. Commissioner, the taxpayer was found to be liable for the 10% early distribution penalty from an IRA she inherited from her husband because she performed a spousal rollover of an inherited IRA before taking the distribution.

Mrs. Sears’ husband died in 1998. Before his death he maintained an IRA at Morgan Stanley with account number ended in 7189. Mrs. Sears was the primary beneficiary of this IRA.

Mrs. Sears also had an IRA rollover account at Morgan Stanley with an account number ending in 9853.  As of the end of February 1999, account No. 9853 had a zero balance. On March 24, 1999, Morgan Stanley transferred securities valued at $442,863.87 from account No. 7189 (the IRA Mrs. Sears inherited from her husband) to account No. 9853.

As of 2005 Mrs. Sears also maintained a non-IRA account at Morgan Stanley ending with 9860. On May 24, 2005, she signed two distribution request forms directing on-demand distributions from account No. 7189 to her non-IRA account in variable amounts.

On June 13, 2005, petitioner signed another distribution request form directing monthly distributions of $1,370 from account No. 9853. In September 2005 petitioner made her last withdrawal from account No. 7189, thereby depleting the funds in that account. On May 31, 2006, petitioner signed a distribution request form with respect to account No. 9853 requesting distributions in amounts to be determined by her for each payment and directing Morgan Stanley to deposit the amounts in her non-IRA account.

On her 2006 Form 1040, Mrs. Sears reported $60,937 in distributions from her IRAs but did not report the 10-percent additional tax pursuant to section 72(t) for an early withdrawal from an IRA. The IRS adjusted her tax by adding 10 percent of the total distributions on the ground that petitioner had not reached age 59½ in 2006 and no other exception to the additional tax under section 72(t) applied.
Mrs. Sears argued that the distributions should not be subject to the additional tax under section 72(t) because the exception under section 72(t)(2)(A)(ii) (distributions made to a beneficiary on or after the death of the employee) applies. She apparently argued that, in effect, the assets in account No. 9853 were transferred from her deceased husband's IRA account No. 7189 to account No. 9853 in 1999 without her authorization and that the 2006 distributions from account No. 9853 should have been treated as distributions to her as the beneficiary of her deceased husband's IRA.

The IRS was able to show that the distributions were not from the IRA inherited from Mrs. Sears’ husband (i.e. account No. 7189). Consequently, Mrs. Sears has both the burden of producing evidence to show that the 2006 distributions from account No. 9853 are not subject to the additional tax under section 72(t) and the burden of proving that respondent's determination is incorrect. Mrs. Sears failed to meet this burden.

The court had previously held that the beneficiary loses the ability to claim the exception under section 72(t)(2)(A)(ii) if the beneficiary rolls over the funds from the deceased spouse's IRA into his or her IRA and thereafter withdraws funds from the IRA. See Gee v. Commissioner, 127 T.C. 1, 4-5 (2006). In Gee v. Commissioner, the court held that when a beneficiary rolls over funds from the deceased spouse's IRA, the funds become the beneficiary's own and any subsequent distributions are no longer occasioned by the death of the spouse. Thus, such distributions do not qualify for the section 72(t)(2)(A)(ii) exception. 

The court found that this is the case even if custodian error can be found.
The court stated that it did not need to decide whether the exception from the 10-percent additional tax under section 72(t)(2)(A)(ii) applies when the transfer from the deceased employee's IRA account to the beneficiary's IRA resulted from a trustee's advice or from a lack thereof or from a mere bookkeeping error. The court was unable to conclude that the transfers were the result of a trustee or custodial mistake.

When a spouse inherits an IRA, it is generally desirable to perform a spousal rollover. This allows the spouse to defer required minimum distributions until he/she reaches his/her required beginning date and also allows for further deferral to after the surviving spouse’s death if the spouse does proper beneficiary planning.

However, as this case highlights, if a spouse is younger than age 59 ½, a spousal rollover should not be automatic. If there is a possibility that the spouse will need to access the IRA funds before age 59 ½, a rollover should not be performed.
Instead, the IRA should remain titled in the name of the deceased spouse for the benefit of the surviving spouse. Distributions can then be taken from this inherited IRA without imposition of the 10% early distribution penalty because of the IRC Sec. 72(t)(2)(A)(ii) exception.

Once the surviving spouse reaches age 59 ½, a rollover can be performed as there is no time limit imposed on a spousal rollover.

Saturday, January 22, 2011

Will the Tax Relief Act of 2010 Mean Undesirable Results For Some Trust Estate Plans

Congress passed new tax legislation re-enacting the Federal Estate Tax (Death Tax) on December 17, 2010. But the Death Tax will, at least for the years 2011 and 2012, apply only to estates that exceed $5 million net worth at death, (or $10 million for married couples).

Quite frequently over the years, estate planning attorneys drafted wills and revocable trusts establishing and funding, at death one spouse, of a “Family Trust.” These trust provisions are common in those past documents. Wills and Revocable Trusts with these type of provisions generally featured a “formula clause” that provided for the year of death exclusion amount of assets to be placed into the (irrevocable) Family Trust to be held until the surviving spouse’s death. This amount that was to be forced into such a trust was the exclusion amount. 

Now, with the exclusion amount at $5 million, there are likely several trusts that exist, where the couple have $2-3 million or so; that at the death of the first spouse the whole estate could be forced into the irrevocable Family Trust, where the survivor would receive only income and not have complete control over these assets.

It is clearly time to review your trust with your attorney to determine if this potential exists in your own estate plan.

Larry Robertson, Attorney