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Standalone Retirement TrustSome lawyers feel that trusts are unnecessary for most people. But some lawyers also don’t know what a standalone retirement trust is. Trusts can be an invaluable planning tool, and here is another example of how they can be used.

What is a Standalone Retirement Trust and Why are they So Important?

A standalone retirement trust is a trust, typically drafted separate and apart from your revocable living trust, that is named as a beneficiary of your retirement accounts.

Why are they so important?

Did you know that qualified retirement benefits (your 401k), IRA’s and life insurance proceeds make up between 75 and 80% of all the intangible wealth of middle-class Americans?

Not only that, but all of these benefits are subject to not only estate taxes, but also income taxes when you die? In other words, your beneficiaries will have to pay income taxes when they receive the benefits from your IRA.

And if you have an estate that is large enough to pay estate taxes, they would have to withdraw funds from those retirement accounts to pay the estate taxes, while at the same time having to pay income taxes on the withdrawals.

Why You Should Use a Standalone Retirement Trust

All that being said, tax avoidance is NOT the primary goal of a retirement trust. I know that sounds weird, but it’s true.

Most people won’t have to pay estate taxes, and an inherited IRA can be withdrawn over time to reduce the overall tax burden. For those reasons, tax avoidance is not the reason to use a retirement trust.

The most important reason to use a retirement trust is to protect and structure your assets for your kids and grandkids. This is something that most people need, regardless of how much money you have saved for retirement.

The Story of Ruth Heffron and her Daughter Heidi Heffron-Clark

A recent US Supreme Court case, Clark v. Rameker, illustrates why it is so important to consider a standalone retirement trust as part of your overall estate planning strategy.

In 2000, Ruth Heffron established an IRA. Her daughter, Heidi Heffron-Clark was the sole beneficiary of this account when Ruth passed away in 2001.

Over the years, Heidi took monthly distributions from this account, and in 2010 the account was worth $300,000.

We can all remember how bad the economy had gotten in around that time, and as a result, Heidi and her husband filed a joint Chapter 7 Bankruptcy in Wisconsin. They identified the inherited IRA in their petition but classified it as an “exempt” asset under the Bankruptcy Code. This meant that the creditors could not use that asset to satisfy any dischargeable debts.

Unfortunately for Heidi and her husband, the Supreme Court was unanimous in its decision that an inherited IRA is not considered “retirement funds” and thus, are not exempt from the bankruptcy estate. This means that the bankruptcy trustee may consider the inherited IRA to be an asset of the bankruptcy estate and thus available to satisfy the claims of the creditors.

The important takeaway from this case is that when you name someone other than your spouse as a beneficiary of your retirement account, you may be unwittingly providing assets for their creditors.

And these creditors don’t have to be immediate and known. If your beneficiaries are spendthrifts or cannot be careful with money, your wealth may be at risk.

Which begs the question, who should use a standalone retirement trust?

When Should You Consider a Standalone Retirement Trust?

Anyone who wants to protect their assets and maximize their “stretch” for their beneficiaries when passing wealth should consider a standalone retirement trust.

Here are several important situations in which you may want to consider a standalone retirement trust:

  1. The beneficiary is a minor child
  2. The beneficiary is incompetent or disabled
  3. The beneficiary cannot make good financial decisions or needs divorce or creditor protection
  4. You want to guarantee coordination for payments of estate taxes
  5. You are in a second marriage and want to provide for children from your first marriage as well as your current spouse

Legal Requirements for a Standalone Retirement Trust to Qualify as a Beneficiary of an Inherited IRA

If you wish to leave retirement assets to a spouse or another individual, you are leaving them what is commonly referred to as an “inherited IRA”.

Under the Internal Revenue Code and Treasury Regulations, the IRA assets can then be withdrawn penalty-free (but subject to income taxes) based upon the life expectancy of the beneficiary. These are considered required minimum distributions or RMDs.

However, there are certain legal requirements that must be met if you decide to name a trust as the beneficiary of your IRA.

First, all of the beneficiaries must be individuals, and the oldest beneficiary must be identified. So if you are leaving your IRA to your three kids, you must know who and where the oldest child is. This is because the RMD will be calculated based on the life expectancy of the oldest beneficiary.

Note, that you CANNOT leave these assets to any of the following:

  • Your Estate
  • Charities
  • Partnerships, Corporations, or LLC’s
  • Many trusts, unless the trust is a “see through” trust where the individual beneficiaries are known, and all beneficiaries are individuals

In addition, the trust must be valid under your state laws, and it must be irrevocable upon the death of the plan owner. When doing a standalone trust, we typically recommend making the trust irrevocable from the outset and funding it (required to make the trust valid) with a $10 bill.

You must also provide the trust documents to the plan administrator or custodian by October 31st of the year after the plan participant’s death. For this reason, we recommend sending the documents to the custodian immediately so that there is no question that they have what they need to properly pay out the benefits.

Interested in Preparing a Standalone Retirement Trust?

If you are interested in learning more or would like to set up a standalone retirement trust as part of your overall estate plan, please fill out our contact form or call us at (919) 460-5422 to set up an initial wealth planning session.