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If IRA is in Trust,
Look Out!
By KELLY GREENE
January 30, 2005
Should you have a trust inherit your
individual retirement account?
Two recent columns about inherited IRAs brought a blizzard of questions
about leaving such investments to trusts. In most cases, people don't
need to name trusts as IRA beneficiaries and may even be risking higher
taxes for their heirs by doing so, contends Ed Slott, a Rockville
Centre, N.Y., accountant who specializes in individual retirement
accounts.
"I always say you have to have a reason" to set up a trust for an IRA,
Mr. Slott says, "and the fact that your attorney said to do it isn't
good enough."
Some people assume that you need a trust to benefit from the federal
estate-tax exemption (currently $1.5 million). Not true. Let's say you
have a $3 million IRA. If you split it into two separate IRAs, you could
leave a $1.5 million IRA to your surviving spouse, which doesn't count
against your exemption, and another $1.5 million IRA to your children,
avoiding the estate taxes just as effectively as you would have done
with a trust, Mr. Slott says.
And if you set up a trust to hold onto your IRA distributions, it's
likely the trust would pay higher taxes on the money than your heirs
would, he adds, because trust tax rates are higher than most
individuals' rates. (Tax rates on a trust hit the maximum 35% when
income exceeds $9,750, compared with $326,450 for individuals.)
Still, there are situations when a trust makes sense, and they typically
involve control issues, not tax savings. Here are some examples Mr.
Slott notes in his new book, "Parlay Your IRA into a Family Fortune":
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If your IRA beneficiary is a minor child, because minors aren't
allowed to make tax elections.
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If your IRA beneficiary is disabled and cannot care for himself. But
if you have a choice, it's better to fund such a "special-needs
trust" with other assets, because required IRA withdrawals may
interfere with the beneficiary's ability to qualify for government
assistance.
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If your beneficiary needs help managing distributions from an
inherited IRA, or potentially needs help sheltering the assets in a
divorce.
Once you've determined that you do need a trust to inherit your IRA,
consider setting up a separate, revocable trust "to inherit the IRA and
only the IRA," Mr. Slott says. That way, you can make sure it doesn't
get mingled with assets that aren't subject to the same, strict
distribution rules.
Also consider leaving a Roth IRA to such a trust. That way, the trust
would owe no taxes on any distributions it held (though it would have to
pay tax on any additional earnings).
You may remember from our earlier columns that your heirs can split an
IRA that they inherit outright, and then use their own life expectancies
to stretch withdrawals across their lifetimes. You couldn't do that with
a trust. Instead, you would have to use the oldest heir's life
expectancy.
To allow each heir to stretch withdrawals across his or her own
lifetime, you would have to split your IRA, create a separate trust as
beneficiary of each IRA, and leave the trusts to separate heirs.
Finally, for any of this to work, Mr. Slott cautions, the trust has to
qualify (in the words of the Internal Revenue Service) as a
"look-through" or "see-through" trust, meaning that it's clear who your
beneficiaries are.
If you spell out a lot of conditions your heirs must meet, for example,
and name a charity as an alternative beneficiary, the IRS could decide
that the trust doesn't qualify for the stretched withdrawals "because
the charity could have a better shot of getting the money than the
kids," Mr. Slott explains.
With a trust, you still have to follow the deadlines we talked about in
our earlier columns regarding distributions from inherited IRAs. You can
link to them by clicking on this article at
our Web site4.
Kelly Greene writes
for "Encore," The Wall Street Journal's quarterly guide to retirement.
Write to her at
encore@wsj.com
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