Retirement Asset Beneficiary Trust
By: Kimmer W. Callahan, JD, LL.M.
A Retirement Asset Beneficiary Trust (hereafter RABT) is a custom-written trust agreement and beneficiary designation. Retirement accounts often make up one of the largest components of a person’s estate. However, the designation of the beneficiary usually receives the least amount of planning, in comparison to the time spent planning a will or a Living Trust. More often than not, the beneficiary designation is the result of a 15 second choice on a “check-the-box” form. A RABT allows the account owner to establish a detailed distribution plan for the intended beneficiaries beyond what is generally available on the IRA standard beneficiary form.
Why should someone consider using a RABT? The following discusses several situations or issues that illustrate the benefits of using a RABT.
- Disinheriting Grandchildren. Under most IRA custodial agreements, if a named beneficiary fails to survive the owner, the share designated for the deceased beneficiary is added to the shares of the surviving named beneficiaries. The named beneficiary’s children would not receive anything from the IRA. For example, you name your three children as beneficiaries of your IRA. Each of your children have two children. If child A predeceased you, at your death, your IRA would be split 50/50 with child B and child C. Child A’s children would be disinherited from the IRA. This result is easily avoided with a RABT.
- Unintended beneficiary: If you name your child as the beneficiary of your IRA and your child and child’s spouse are killed in a common accident, your child’s spouse’s estate may inherit your IRA rather than your grandchildren. Under most custodial IRA account agreements, if the named primary beneficiary survives the account owner, the named beneficiary becomes the new account owner and has the absolute right to determine who will inherit the IRA at the primary beneficiary’s death. If the named primary beneficiary has not yet named a new beneficiary, the primary beneficiary’s estate will be the default beneficiary. Presumably, the spouse would be the beneficiary of your child’s estate, resulting in your child’s spouse’s estate determining what will happen to your IRA. With a RABT you can avoid this result by determining in advance who will receive the account benefits upon the death of the primary beneficiary.
- Your Estate as default beneficiary. If you name your child as the primary beneficiary, with no contingent beneficiary, and you and your child are killed in a common accident, either your estate or your child’s estate will end up as the beneficiary, depending upon who is deemed to have survived the other. The result is the loss of the ability to pay the benefits out over the beneficiary’s life expectancy. A RABT can designate who the beneficiary is in this type of situation to avoid having an estate as the beneficiary.
- Court appointed Guardian of minor beneficiary. If a child or grandchild is a beneficiary and a minor at the time of your death, it may be necessary for a court appointed guardian and conservator be appointed to accept and manage the minor child’s interest in the IRA. With a RABT, you can designate in advance when and how distributions will be made to a minor, removing the need for a court-appointed guardian.
- Lump Sum Distributions. One of the distribution options that is almost always available to a beneficiary is the option to liquidate the beneficiary’s entire interest in the account immediately. The national average is that a beneficiary will consume their entire inheritance within four months. With a RABT you can restrict a beneficiary’s withdrawal rights. You can limit the distribution to the required annual distribution amount, or you can allow additional distributions set on a specific standard.
- Transferability. Under a standard beneficiary designation, the beneficiary becomes the new account owner and has the right to move the account to any investment firm of their choice. A RABT can restrict or limit this right to prevent a child from moving the account to a “discount” broker which offers no advice or to a self-directed IRA where the child makes the investment decisions.
- Successor Beneficiary. A RABT can be set up to allow a child-beneficiary to appoint their interest in your IRA to a new beneficiary upon the child’s death.
- Trust as Beneficiary. Most of the above-identified benefits can be accomplished by naming a Trust Agreement (Living Trust or Family Trust) as the beneficiary. However, naming such a trust as a beneficiary can result in complications and difficulties which do not arise when using a RABT.
- Trust Accounting vs. Income Tax Accounting: The rules that regulate how a trust calculates income for distribution purposes are very different from the rules that determine a trust’s taxable income. Generally speaking, distributions made to a trust from a retirement account are considered principal, rather than income, for trust accounting purposes, but would be taxable income to the trust for income tax purposes. For example, a Family By-Pass trust is the named beneficiary of an IRA, and states that all income is to be distributed to the surviving spouse with the principal retained for the benefit of the children at the surviving spouse’s death. If the IRA distributes $50,000 to the By-Pass trust, the trust will have taxable income of $50,000. However, the trustee would not be able to distribute the $50,000 to the spouse because it is considered principal for trust accounting purposes. This could result in the spouse having higher income taxes of $15,000 (assuming a 30% tax bracket) with no access to the distribution to pay the tax.
- Qualified “See Through Trust”: If the trust is not a qualified see-through trust, the payout options are very limited. The IRA will be treated as if there is no “designated beneficiary.” In order for a trust to be considered a see-through trust, the trust must meet very specific rules. On their face, the rules appear simple to meet, but the IRS regulations leave several issues unresolved in regards to the rules. Even if the trust qualifies as a see through trust, the payout options are not as generous as when there is an individual beneficiary. For example, your spouse would not be able to roll the IRA over to a new account in the spouse’s name, and the account could not be split among multiple beneficiaries to take advantage of each beneficiary’s age. The oldest beneficiary’s age would be used to calculate the Required Minimum Distribution for all beneficiaries.
- Trust Tax Brackets: The tax brackets for a trust are very condensed. Trust income in excess of about $12,000 is taxed at the maximum income tax bracket.
A RABT avoids these trust issues because it is specifically drafted to hold only retirement beneficiary interests. It will hold no other assets.
Kimmer W. Callahan is an attorney and the owner of Callahan & Associates, Chtd. His practice emphasizes estate planning, including living trusts, asset protection planning, long-term care planning, charitable planning, generation skipping planning, living wills and advanced directives.
Kimmer is a graduate of Gonzaga University’s School of Law and holds a Master of Law’s Degree in Taxation from the University of Denver. He is licensed before the state and federal courts of Idaho, the state courts of Colorado and Washington, and the US Tax Court. Kimmer is a member of and the past president of the Panhandle Estate Planning Council, and a member of the Washington Bar Association’s Section on Taxation and the Idaho Bar Association’s Section on Taxation and Trusts, and Estates. Kimmer is also a member of the National Academy of Elder Law Attorneys and the Elder Care Matters Alliance.
Kimmer lives in Coeur d’Alene with his wife, daughter and son. He has been a resident of North Idaho for over 30 years.