Posts Tagged ‘Generation Skipping Trusts’

Estate Planning With Individual Retirement Account Trusts

JULY 18, 2016 VOLUME 23 NUMBER 27
One of the great things about our area of law practice is that the community of practitioners is just that — a community. Take, for instance, our good friend Amos Goodall from State College, Pennsylvania: he’s one of the leading elder law attorneys in the country. Amos is not just nationally-known, either — he’s also an excellent communicator. This week he tackles a topic of considerable interest to our clients: estate planning for people who have Individual Retirement Accounts or other retirement savings. Here is his plain-language explanation:

Many folk have large retirement accounts. According to the Investment Company Institute 2016 Yearbook, in 2015, members of 60% of US households had invested $24 trillion in retirement market assets, including IRA’s, 401k’s, 403b’s, Simple IRAs, and others. This article discusses IRA’s, and someone with any of the other types of accounts should consult with knowledgeable legal and financial advisors. In fact, every single general rule stated in this article is subject to exceptions, and there may also be specific situations where these rules should be purposefully ignored. This article should be considered simply a guide for asking questions of your advisor (and better understanding the answers), rather than a roadmap for do-it-yourself action.

The typical estate plan for a married couple with IRAs is naming the surviving spouse as the first (or primary) successor owner. There are special tax benefits for a surviving spouse that do not apply to any other possible successor owners.  There are other options, but these should not be pursued without specialized advice.

Classically, they name their children as the contingent or remainder successor owners who will receive the accounts upon the second of their parents’ deaths. Single IRA owners may name their children as primary successor owners, and those without children typically name other family members to receive these accounts. Again, there are other options (including some charitable ones) that should be considered after appropriate advice.

Most IRA owners want to keep IRA assets invested as long as possible. Since growth is not taxed until the funds are withdrawn, they will grow faster. Thus, the longer they are invested, the greater they will be. This is called “stretching” the IRA.

One of the benefits to naming a surviving spouse as the first successor owner is that the spouse is permitted to “roll” the IRA into his or her own name as one of the available options.  No one else has this option, and everyone else must begin withdrawing funds (and paying taxes) as soon as the IRA becomes theirs, called the “minimum required distribution” (or MRD). For younger successors, the MRD is not great; an eight year old successor owner will need to withdraw a little over 1% (roughly one-seventy-fifth) as his or her MRD in the first year after the original owner’s death. In contrast, a sixty-five year old successor would have an MRD of almost 5%, and the MRD for a seventy-one year old spouse would be just over 6%.

Thus, it makes sense to name as young a beneficiary as possible so as to lengthen the process and thereby to maximize the effect of compounded tax-deferred growth. For example, if a seventy year old widow leaves an IRA with $100,000 to an eight year old great-grandchild (assuming there are no generation-skipping tax considerations), and the IRA grows at 3%, then at age 65, the great-grandchild will have withdrawn over $207,000 from the account and it will still be worth over $130,000–quite a positive result for a $100,000 IRA. (At a higher rate of growth, say 6%, that same $100,000 IRA would be worth $700,000 at age 65, and MRD withdrawals would be as high as $40,000/year).

Most IRAs don’t last this long, and it would not surprise anyone that when our eight year old turns eighteen, he or she will find a reason to withdraw much of this inherited wealth. One way to be certain that MRD withdrawals are made and to limit extra withdrawals to actual needs, is naming a trust as successor owner. IRS regulations do not allow many traditional trusts to stretch. However, if the trustee is required to withdraw and pay out at least the MRD each year, the IRS will allow the trustee to use the great grandchild’s life expectancy. This is called a “conduit” trust.  Another IRA trust is called an “accumulation” trust, but this are fairly complicated to set up. Describing any IRA trust as “simple” might be stating an oxymoron, but compared to an accumulation trust, a conduit trust is straightforward for knowledgeable counsel.

The trustee of a conduit trust may make larger withdrawals if necessary (like helping with medical expenses or college) but the beneficiary will need to convince the trustee that other withdrawals are truly necessary. The trustee might say “I agree you need a new car, but look for a good used Chevrolet rather than the new Tesla you want”. Several institutions offer “Trusteed IRA”  plans for a fee, and this has the added benefit of having professionals invest the IRA funds (which may result closer to 6% than 3% growth, as in the example above); it also provides continuity in trust management. Other investors opt for family members as trustees, which may save money in fees but might impose a burden on family members.

With good planning, it is possible to provide a great gift to descendants; a trust makes it more likely they will receive it.

Why You Might Want to Create a Trust for Your Kids


This conversation comes up a lot with our estate planning clients. “So, you’re leaving your entire estate equally to your three kids,” we say to our client. “Do you want to leave it outright or would you consider putting it in a trust for them?” The two most common responses:

  1. “No, my kids are all OK. They can manage money and would be insulted if their inheritance was left in trust.”
  2. “No. If they can’t manage their inheritance then I can’t help them. I don’t want to try to control things after I’m gone.”

Then we explain that creating a trust is actually a good thing for the kids — but it’s usually hard to convince clients. So let’s try it here, and then we can just hand them this newsletter.

Why consider a trust for your child’s inheritance? It may be a real benefit to them, protecting their inheritance from their creditors, spouses — even estate taxes. Let’s look at each of those concepts briefly.

One common concern we hear: “we love and trust our daughter, but though we like her husband he doesn’t really have any money sense.” There’s good news for that client: even though Arizona is a community property state, inheritances start out as separate property. In other words, the money you leave to your daughter is not immediately available to her husband, even in a community property state.

But wait. It’s really easy for your daughter to turn that separate property into community or joint property. All she has to do is add it to her joint banking account, or add her husband to the account title. Once it has become joint property, it is difficult to return it to separate property status. If your son-in-law or daughter-in-law is a “spendthrift,” that can expose your estate to loss after your death.

By creating a trust for your child’s inheritance, you make it easier to keep the property separate from spouses, and more likely to pass to your grandchildren on your child’s death. Sadly, divorce is very common: you can help keep the inheritance from being considered as part of the property to be divided if your daughter does divorce.

Let’s consider creditors. “Our son is a doctor,” you say, “and he has plenty of money.” Ah, but professionals are vulnerable to future malpractice lawsuits, and anyone can have even a substantial estate drained by an auto accident or medical crisis. Creating a trust for your son can help protect the inheritance from lawsuits, creditors, and bankruptcy.

How about taxes? If your daughter is a successful professional, she might well have a taxable estate on her death. That could be true even though she is not particularly close to that figure today. If estate taxes do kick in, they start at a very high 40%. And though we tend to ignore state estate tax considerations in Arizona (we don’t have a state estate tax at all), other states do impose taxes, even on much smaller estates. You may have settled in Arizona for good, but your children may move several times before picking their final residence — and that may subject them to a state estate tax.

If you leave your daughter’s inheritance in trust, you can fairly easily arrange to keep it out of her “estate” for tax purposes. Even though she is worth, say, $3 million, and you are only going to leave her another $500,000, the math is compelling: by the time she dies, that $500,000 could mean $200,000 or more in additional tax liability to her estate.

So there are good reasons to leave an inheritance in trust, even though all your children are responsible and your estate is modest. But aren’t there some serious downsides? Doesn’t it mean a lot of additional costs and imposition of a bunch of difficult rules? Not really.

Depending on your family circumstances, you might even name your son trustee of his own trust. Or make your son trustee of the trust for your daughter, and make her trustee of his trust. Or make your daughter (you know, the one with her CPA who works for the bank) trustee for all the kids’ trusts. In other words, creating a trust does not mean you have to incur professional trustee fees — though it might actually make sense to name a non-family trustee. We can talk about those options.

The trusts for your children will have to file tax returns each year. That will in fact mean a small additional cost. But the total amount of income tax paid need not increase — it should be fairly easy to assure that each trust’s income is taxed to its beneficiary, rather than paying taxes at the (often much higher) trust rates. We can talk about those issues, as well.

What about your son’s access to the money? Do you think he might want to use his inheritance to pay off his mortgage, or to allow him to put more away for retirement, or to send your grandkids to college? You can give him the power to demand money from the trust, or give the trustee direction to follow those kinds of requests. Let’s talk about how much control you want to give each of your children over the trust while they are alive. And on their death, you can even give your children the power to name which of their children (or spouses, or charities, or whomever you want to permit) will receive the remaining trust’s assets. This concept, incidentally, is sometimes described as a “dynasty” trust — which makes it sound like a very fancy, expensive idea only for rich people.

Cost? Setting up a trust for each of your children will likely increase the cost of your estate planning — but by a pretty small number, in most cases. We do this a lot, and so we already have a library of provisions and ideas to draw on. We almost always charge flat fees for our estate planning work, so we can tell you upfront how much additional cost such provisions will add to our fees — and we predict that you will be at least mildly surprised at how little cost it adds.

Oh, and these principles apply even (perhaps especially) if you are leaving your estate to grandchildren, nieces and nephews, or anyone other than your children. The illustrations we use are not intended to limit the point by gender, either — whenever we say “son” you can substitute “daughter” and the point is still valid.

More on Types of Trusts — Some of the Less Common Varieties

Last week we wrote about different types of trusts you might have encountered, and tried to explain some of the generic terms, differences among and between types, and likely settings where a given type of trust might be appropriate. We wrote about spendthrift trusts, bypass trusts, special needs trusts and the difference between revocable and irrevocable trusts. Let’s see if we can clear up some of the confusion over less-common trust names.

Crummey trusts. In 1962 Californian Dr. Clifford Crummey created a trust for the benefit of his four children, who then ranged in age from 11 to 22. He was trying to address a problem with estate tax law: he could give the money to his children outright (and then worry about how they spent it) or put it in trust for them to protect it (but then not get it out of his own estate for estate tax purposes). His clever idea: put the money in a trust for each kid’s benefit, but give that child the right to withdraw his “gift” from the trust until the end of the year. When they didn’t exercise that right (hey — the youngest was only 11, and even the oldest would understand that withdrawing his money might affect future gifts) it would lapse, and the gift would be completed but stay in trust.

The Internal Revenue Service thought it was a trick, and they argued that Dr. Crummey and his wife had not made gifts at all. The IRS lost that argument, and the “Crummey” trust was born, in a 1968 decision by the U.S. Ninth Circuit Court of Appeals. If you’d like to read the actual decision in Crummey v. Commissioner you may — but we warn you that it will be interesting to only a few diehards, most of them lawyers or accountants.

For nearly a half-century, then, the Crummey trust has been a primary tool in the estate planner’s toolbox. The trusts have morphed over time — now they are often used to purchase life insurance (and may be called Irrevocable Life Insurance Trusts, or ILITs). The length of time for a beneficiary to withdraw the funds has been shortened in most cases — often to a month and sometimes even less. Some practitioners even give the withdrawal right to people other than the primary trust beneficiary. The Crummey trust in each case is an irrevocable trust intended to get a gift out of the donor’s estate for tax purposes but into a trust to control the use of the money after the gift is completed. With the present high gift tax exemption in federal law ($5 million for 2011 and 2012) the use of Crummey trusts will probably diminish appreciably.

Generation-Skipping trusts. In the simplest sense, a GST (practitioners love acronyms) is any trust that continues for more than one generation of beneficiaries. The “current” generation, if you will, might or might not have the right to receive income, or access to principal, of the trust — but it will continue until at least the death of that current generation representative.

GSTs are often constructed to skip multiple generations. The model for the maintenance of accumulated family wealth is usually the Rockefeller family — some of the trusts established by John D. Rockefeller before his 1937 death and valued collectively at over $1.4 billion at the time — are still chugging along for the benefit of his descendants.

Because of concerns about the accumulation of family wealth, and the avoidance of estate taxes in multiple generations by the use of such trusts, the federal government in 1976 introduced a new GST taxation scheme. More recent changes in the GST tax have driven the types, terms and use of GSTs. The GST tax is very high, but only applies (as of 2011 — the rules may change in two years or thereafter) to “skips” of over $5 million. Very elaborate GSTs are sometimes marketed as Dynasty trusts. One common problem in addition to tax issues: the common-law “Rule Against Perpetuities” may make it difficult to extend trusts for multiple generations. In Arizona it is now at least theoretically possible to extend a trust over more than 500 years without facing problems with the Rule. That is a sobering thought when you consider that 500 years ago the land that was to become Arizona was all but unknown to ancestors of the Europeans, Asians, Africans and even many Native Americans who live here now.

QTIP trusts. QTIP stands for “Qualified Terminable Interest Property.” Does that explain the trust type? Well, not quite.

In very general terms, a QTIP trust is probably designed for one narrow purpose. It permits a wealthy spouse to leave property for the benefit of a less-well-off surviving spouse without consuming the deceased spouse’s full estate tax exemption amount. In other words: if you were worth, say, $10 million dollars in 2009, when the estate tax exemption was at $3.5 million, you might have left $3.5 million to your adult children from your first marriage and most of the rest of your property in a QTIP trust for your second husband (or wife). That way your estate would pay no estate tax, and the tax would be due on the death of the surviving spouse. Since he (or she) had no property in our example, that means that his (or her) $3.5 million exemption would get used on your property first, and only the excess would be subject to taxation as it passed to your children from the first marriage.

As you can see, it is getting harder and harder to make a QTIP trust a good planning opportunity, except for extremely large estates with very high disparity in net worth between the spouses. But the QTIP trust isn’t dead yet — uncertainty about the federal estate tax, continued state estate taxes in some states (but not Arizona) and inertia preventing modification of older estate plans will all contribute to keeping the QTIP alive for a few more years, at least.

We don’t know about you, but we’re exhausted. Maybe we’ll tackle some more trust types on another day. Suggestions? Do you want to know about QDoTs (sometimes called QDTs or QDOTs)? QDisTs (Qualified Disability Trusts)? Cristofani Trusts? Just ask, and we’ll take a run at them.

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