By WILLIAM B. HOWELL
The largest single asset many of us have is our retirement fund, whether it is an IRA, 401k, 403b, TSP, or other. The rules on what can happen when the owner passes are changing for the better. If your surviving spouse is the beneficiary, the fund can go to that person and they can continue the Required Minimum Distribution (RMD). Also, the fund is protected from the creditors of yours and/or your surviving spouse. You may recall that O. J. Simpson is receiving RMDs from his retirement funds and it is not available to his creditors. But what happens if your beneficiary is NOT your surviving spouse, but a child or grandchild?
With proper structuring of your account beneficiary designations, the child beneficiary may be allowed to take out the balance over a long period of time, even over their life expectancy. But that is merely one option. Often the child beneficiary will instead elect to take it all out at one time rather than wait to receive a little each year. That will result in almost half of your retirement fund going immediately to the taxman. Remember, unless it is a Roth, the taxes have never been paid, but will have to be paid when the child takes it out. So out of a $100,000 IRA, for example, after taxes there may be enough to buy that new Corvette and then it is all gone. What you had managed to accumulate over years of working disappears with hardly a ripple.
There is another problem that is often not talked about, or frequently misunderstood. As stated above, your retirement funds are exempt from being taken by your creditors, so long as you or your spouse is the beneficiary. But when it goes to another person (child or grandchild) it is what is called an “inherited IRA” and loses its asset protection. As an example, your child can lose every penny to their divorce, bankruptcy, a car wreck or other lawsuit, or just foolish mismanagement. You are gone, so you cannot prevent it. Is there a way to prevent it?
Yes. Thanks to some newer interpretations of IRS regulations, you may now set up a special type of trust to be the beneficiary of your retirement funds that will assure that your child or grandchild beneficiary doesn’t take a “lump sum” distribution and lose a huge amount to immediate taxes. Instead, they can be given annual distributions based on each individual’s life expectancy. But that is not the only advantage. The assets in the fund will continue to grow tax deferred over their lifetime, just as if it were their own IRA. And, when properly structured, the trust can prevent loss of these funds to their creditors, divorce, or other types of danger.
With this type arrangement you continue to control your retirement funds. You can take out any sum you need during your lifetime. You (and your surviving spouse, if any) are not affected in any way. It is only after you are gone that this trust becomes the beneficiary. There is very little in the way of expense involved, especially in light of the many benefits—benefits that cannot be provided in any other way. This is not something your heirs can do for themselves. Only you can do it for them. It can provide them security for many, many years after you are gone. And it is protected. Many of my clients have expressed how much better they can rest knowing with certainty what is going to happen with their retirement funds. How about you?