Stand-Alone Retirement Plan Trusts

Dear Clients and Friends,

IRA’s, and in particular inherited IRA’s, represent one of the greatest sources of family wealth, yet many clients and estate planners are not aware of the significant benefits of utilizing Stand-Alone Retirement Plan Trusts, sometimes referred to as Stand-Alone IRA Beneficiary Trusts.

Who should read this letter? Owners of substantial IRA’s or benefits under retirement plans that permit a stretch-out of benefits.

What is a Stand-Alone Retirement Plan Trust? A trust document established by an IRA owner or participant in a qualified retirement plan. It is separate from the IRA agreement and the beneficiary designation form. The trust is a revocable standby trust which is not funded during the IRA owner’s lifetime but becomes the beneficiary of the IRA or qualified plan benefits upon the death of the IRA or plan owner or the death of the owner’s spouse, whichever is later.

What’s at Stake?

  1. Protection of children and grandchildren from divorced spouses and creditors.
  2. Providing for maximum stretch-out of benefits for maximum income tax deferral and wealth accumulation.

Why is Protection Necessary? In 2014, the U.S. Supreme Court ruled in Clark v. Rameker that inherited IRA’s are not protected by federal bankruptcy law. The effect of this ruling is to allow bankruptcy creditors to attach inherited IRA’s. Some states, including Massachusetts and Florida, have adopted laws that protect inherited IRA’s from creditors, but these state laws cannot be relied upon as beneficiaries often move from state to state and may live in a state where there is no exemption. If the IRA owner or qualified plan participant desires to protect the account for their children and grandchildren after their death, a trust should be part of the plan.

Separate trust shares can be established for each beneficiary and the beneficiaries can be a Trustee or Cotrustee of their shares and have significant control so that trust property will be available for their benefit when needed. These trusts can be structured as beneficiary controlled multigenerational trusts and be excluded from the taxable estates of the children and grandchildren and protected from their divorced spouses and creditors.

Why is an Accumulation Trust Beneficial?  In drafting a trust for a beneficiary, the IRA owner or plan beneficiary has two options (if authorized by the trust instrument): permit the beneficiary to select a “conduit trust” or an “accumulation trust”.

In a conduit trust, the required minimum distribution (“RMD”) is distributed from the plan to the trust and the trust is required to distribute the RMD to the beneficiary. The Trustee has no power to accumulate or hold the RMDs. The trust is protecting the underlying plan but not the RMDs for which it is merely a pass through or conduit to the beneficiary. Thus, a conduit trust is not the best tool for asset protection as the distributions when received by the beneficiary may be reached by former spouses and creditors.

An accumulation trust, however, offers much better creditor protection. In an accumulation trust, the plan distributes the RMD to the trust but the trust is not required to distribute the RMD to the beneficiary. Rather, the distributions may be retained and accumulated in the trust and be available for distribution to the beneficiary when needed. The RMDs can be retained in the accumulation trust and be protected.

In order for the trust to qualify as an accumulation trust, specific issues need to be dealt with in the trust drafting: identifiable separate trust shares must be established and linked specifically to beneficiary designations under the plan; a mechanism (such as an authorized Trust Protector) has to be included in the trust to prohibit trust distributions to persons significantly older than the trust beneficiary whose life expectancy is to be used for calculating RMDs; and other technical provisions should be included.

Living Trust vs. Stand-Alone Retirement Plan Trust. Since maximum stretch-out of benefits is desired, naming the living trust as the beneficiary of an IRA or retirement plan may create substantial uncertainty as to whose life expectancies will control the RMDs. Unless the living trust is coordinated with a division detailed in the IRA beneficiary designation form, the beneficiaries will all be required to use the life expectancy of the oldest beneficiary of the living trust, or possibly a five-year period, depending on the living trust terms.

Also, an accumulation trust is difficult to draft in a living trust since a mechanism is necessary to remove contingent beneficiaries whose life expectancy would shorten the term of the payout and such removal is usually inconsistent with the IRA or plan owner’s objectives for the disposition of assets not in the IRA or plan.

Recommendation: For owners of substantial IRA’s or retirement plan benefits, strong consideration should be given to establishing a Stand-Alone Retirement Plan Trust granting beneficiaries the option to establish accumulation trusts and retain all or part of the RMDs in such trusts thereby building wealth in a vehicle that is creditor protected for beneficiaries and their descendants.

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