Retirement Planning

IRAs and qualified plans create a unique planning challenge in that these assets are subject to income tax when received by the beneficiary (this is discussed more fully under Planning for Tax Qualified Plans). One way to help reduce the tax impact is to structure these accounts to provide the longest term payout possible; deferring income tax as long as possible minimizes the overall tax impact and allows the account to grow tax free.

To achieve this maximum ‘stretch-out’, you should name individuals who are young (e.g., children or grandchildren) as the designated beneficiary of your tax-qualified plans and, significantly, the beneficiary should take only those minimum distributions that are required by law. The younger the beneficiary, the smaller these required minimum distributions. By naming a trust as the beneficiary of your tax-qualified plans, you can ensure that the beneficiary defers the income and that these assets remain protected from creditors or a former son or daughter-in-law.

We recommend that this trust be a stand-alone Retirement Trust (separate from your revocable living trust and other trusts) to ensure that it accomplishes your objectives while also ensuring the maximum tax deferral permitted under the law. This trust can either pay out the required minimum distribution to the beneficiary or it can accumulate these distributions and pay out trust assets pursuant to the standard you set in advance (e.g., for higher education, etc.)

Historically, parents often left their tax deferred retirement accounts (IRA, 403(b), 457 plans) to their children outright, or free from trust. In other words, they named their children as direct beneficiaries of these accounts. This traditional method of dealing with retirement accounts often resulted in some unintended consequences.

  • The child decided to cash in the retirement account and was subjected to massive and virtually immediate tax liabilities.
  • The child lost out on the tax-deferred growth afforded by the IRS.
  • The child lost the retirement account balance to divorce, creditors or predators.
  • The child was a minor or was incapacitated at the time of the parent’s death, resulting in the need to probate this otherwise non-probate asset.

These unintended consequences can be easily avoided by leaving your retirement account to your child or grandchild in a specialized IRA Legacy Trust – a trust that comports with all of the IRS requirements to permit your child to “stretch out” the tax deferred growth but also provides asset protection otherwise unavailable when the child is named as a direct beneficiary.

Stretch benefits can be illustrated by the following example. If a child inherits a $100,000 IRA and withdraws it immediately, he may have to pay up to 40% in federal and state income taxes, leaving him only $60,000 to invest. Whatever that $60,000 earns each year is taxable in that year. Alternatively, if he takes only the required minimum distributions, only those distributions are taxable, and the remainder can continue to accumulate tax-deferred. Assuming a 6% rate of return over 30 years, in the first instance, the child will have “spent” $134,237; but in the second, $332,466, or almost three times more!

The IRA Legacy Trust further ensures that the funds are fully protected from waste, bankruptcy, divorce, and the government. And if your child dies before the complete distribution of the IRA, it can be passed to your grandchildren.

Once your Legacy Trusts are set up and named as the beneficiaries of your IRA, those funds will receive immediate asset protection at your passing because they are distributed directly into the trusts. You can also provide more or less protection by naming your child or another as the trustee.

Importantly, a child cannot create this type of trust for his own benefit with his own assets and achieve the same tax benefits, creditor protections, and other advantages. Therefore, you can do something for your children that they are not able to do for themselves. You can create a trust which will make their inheritance bullet-proof.

Attorney and Estate Planning specialist Anthony G. Celaya assists clients throughout Napa, Yountiville, St. Helena, Calistoga, Sonoma, Vallejo, Benicia, Fairfield, Suisun City, and Vacaville in Napa County and Solano County, but also in Sonoma County, Contra Costa County, Alameda County, Marin County, Santa Clara County, San Mateo County, San Francisco County, Sacramento County, and other Northern and Southern California areas.