Establishing an Individual Retirement Account (IRA) is a great way to build retirement assets and being able to designate beneficiaries simplifies the issue of passing it on after death. However, a lot can happen once it is passed on to the primary beneficiary (usually the spouse) and beyond to contingent beneficiaries (the children) that can produce harmful, unintended consequences. If leaving a legacy that can endure is your goal, simply naming beneficiaries on your IRA is not the way to go.
What Can Happen?
When an IRA is transferred to a beneficiary, many of its characteristics change in an adverse way for the beneficiary. For instance, when held by the owner, an IRA is a protected asset, free from the claims of creditors, lawsuits, bankruptcy seizures and divorcing spouses. But in most states, once it passes directly to a beneficiary it loses its protected status. An inherited IRA could be wiped out along with any promise of a legacy.
According to a study by the Texas A&M Foundation, most inheritances are spent within 17 months due to excessive spending, bad decisions and investment mistakes by beneficiaries. If the designated beneficiaries are 18 or older, there is nothing to stop them from spending the money at will.
If the beneficiaries desire to keep the assets working for them, they will be forced through required minimum distribution rules to withdraw funds based on the original owner’s life expectancy, leaving no opportunity to stretch them out over the beneficiaries’ lifetime.
If a spouse from a second marriage is named as a beneficiary, there is nothing preventing the spouse from passing the inherited IRA on to his or her family or a new spouse if your spouse remarries.
Naming a family living trust won’t necessarily solve these issues and it could create a new one. When you name a family trust without including the proper see-through trust language, it can affect the required minimum distribution (RMD) rule. Beneficiaries may be forced to withdraw more money within a shorter period of time, resulting in higher taxes and less investment growth.
Securing Your Legacy with an IRA Inheritance Trust
The way to avoid all of these legacy-busting actions and to exert control over the distribution of your IRA assets is to create an IRA Inheritance Trust – also referred to as a Standalone Retirement Trust – and name the trust the beneficiary of your IRA.
With an IRA Inheritance Trust, you can dictate the timing of the distribution of assets and how they are to be spent. You can make it so that funds only become available to certain beneficiaries in certain amounts over their lifetimes. You can also direct that required minimum distributions be stretched out based on the life expectancy of the youngest beneficiary. This will preserve assets not needed by the beneficiaries for their beneficiaries and beyond.
An IRA held in an irrevocable IRA Inheritance Trust maintains the protections afforded the original owner, ensuring fortifying against creditors, lawsuits, divorcing spouses and bankruptcy seizures. These protections remain in place as long as the assets are held in the trust, which can be passed to future generations.
If any of your beneficiaries have special needs, a subtrust can be created specifically for the beneficiary to ensure he or she can continue to receive government assistance.
Legacy Planning Done Right
If you have a sizable IRA with a desire to have it benefit future generations, there is no way to ensure that will happen without an IRA Inheritance Trust. Depending on your needs and circumstances, there is a lot of planning that can go into a properly structured trust with consideration for complex Internal Revenue Code statutes. Proper planning can help you create lifetime income opportunities for your spouse and a lasting legacy for your beneficiaries. Always seek the guidance of a qualified estate attorney or accountant when considering an advanced estate planning tool such as an IRA Inheritance Trust.