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THE CASE OF THE $3,000,000 IRA AND THE SHOPAHOLIC SPOUSE

Dr. Allen, a retired surgeon in his early 70s, is not well.  His big concern is his spouse, who is a spendthrift, knows nothing about finances, and has never missed a sale.

Through great effort and secrecy, Dr. Allen has accumulated $3,000,000 in his IRA.  He is concerned about what will happen after he dies.  Will his wife run out of money? A virtual certainty if she is the direct beneficiary of his IRA and lives to her life expectancy, according to his calculations.

He met with his estate planning/ tax attorney for answers. This is what he learned.

He should not make his spouse the direct beneficiary of his IRA upon his death because there are no restrictions preventing the spouse from withdrawing IRA monies as she sees fit.

The better alternative is to set up a “see through trust” as the IRA beneficiary.  The trustee of the see-through trust, and not his spouse, will control access to the IRA, with the IRA being converted into an “Inherited IRA.”

Federal Tax law provides, as a general rule, that a minimum amount, known as the “Required Minimum Distribution” or “RMD,” must be distributed out of the IRA each year, starting the year after the IRA owner dies. The RMD is tied to the age of the oldest beneficiary since the purpose of the law is to amortize the IRA over the life expectancy of the beneficiary.  The older the beneficiary, the higher the RMD as the life expectancy is shorter.  In fact, this is why the identity of the beneficiary must be determined.

The individual beneficiary of the IRA whose life expectancy is being used to determine the rate of IRA payout is known as the “Designated Beneficiary.”  Only an individual can be a Designated Beneficiary.  Certain trusts, known as “see-through trusts” qualify by treating the beneficiary of the trust as a Designated Beneficiary.

A see through trust must meet the following requirements: (i) the trust must be valid under State law; (ii) the trust be irrevocable, at least immediately after the death of the IRA owner; (iii) the beneficiaries must be named or be members of a class of beneficiaries that make each beneficiary identifiable; (iv) only beneficiaries as of the Designation Date, September 30th  following the year of the IRA owner’s death, count; and (v) information must be provided to the Plan Administrator by October 31st following the year of death of the IRA owner.

There are two types of see through trusts. The simpler one, known as a “conduit trust,” provides that whatever monies that are distributed from the Inherited IRA to the conduit trust each year must be distributed to the beneficiary each year (less fees and costs).  The other type of see-through trust is known as an accumulation trust.  Here the RMD must be distributed from the inherited IRA each year to the accumulation trust, but the accumulation trust, depending upon its terms, need not distribute all of the monies so received to the beneficiary.

While either type of see-through trust accomplishes the goal of protecting a spouse from his or her spendthrift ways, an accumulation trust may be the better choice in our example as it provides the trustee with flexibility of not distributing all of the RMD it receives from the IRA to the spouse.

Just one more thing.  The decedent’s IRA must be converted into an “Inherited IRA.” Some beneficiaries have set up a “see through trust” and mistakenly pay all the IRA monies to the “see through trust.”  If the IRA is just a regular or rollover IRA, the entire IRA becomes taxable income immediately.  If the decedent’s IRA was a Roth IRA, all of the tax free growth is immediately lost.

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