How to Ensure Your IRA Gets Stretched Out for Your Children and Provides Them Asset Protection

Even with the decline in the stock market this past year, there are trillions of dollars still being held in IRAs. In fact, for a large number of people, their IRA represents one of the largest assets they own at death. However, the problem with owning an IRA with a significant balance at death is that the tax laws for IRAs were designed for accumulation of wealth for retirement not for accumulation of wealth to pass to future generations.

Most commonly, the owner of an IRA lists a beneficiary on their account in the event they do not consume the entire IRA during their lifetime. This person is most often the IRA owner’s spouse. They also often list a contingent beneficiary if the spouse and IRA owner were to parish in a common accident or disaster. This contingent beneficiary is usually the IRA owner’s children.

This “contingency” plan works just fine so long as the children “stretch out” the IRA. What this means is that they do not cash out the IRA or take more than the required minimum distributions (RMDs) based on their own life expectancy. There are two main reasons why children blow this “stretch out” opportunity. The first is poor money management, meaning that they think a bird in the hand today is worth more than two tomorrow. The second reason is failure to understand the rules related to IRAs.

For example, father Richard dies leaving $500,000 in an IRA and no spouse. Rick, Jr., Richard’s only child (age 39), calls up the IRA plan administrator and requests the money in the IRA. The plan administrator doesn’t admonish Rick of the tax implications. If Rick were to cash out his father’s $500,000 IRA today the net result would be a check for approximately $295,000. But if Rick had been forced to “stretch out” the IRA, this account could have yielded him about $2,274,691 based on a conservative 6% rate of return. This stretched out amount is nearly 8 times more than what Rick would have received if he cashed out the IRA right after his father’s passing due to all of the taxes and penalties associated with an early IRA withdrawal.

One innovative way to spearhead this problem is to list a special type of trust (called a Retirement Plan Trust) as the beneficiary of your IRA. The Retirement Plan Trust not only forces the stretch out of your IRA for your children (or other designated beneficiaries of the Trust), but it acts as an asset protection vehicle as well.

Creditors, predators and divorcing spouses of your children cannot reach the money held in the IRA which lists the Trust as it’s primary beneficiary. There is a specific way that the Trust must be drafted to ensure this extra “asset protection” for your children which is called an accumulation type Trust. This simply means that the Trustee can “accumulate” the required minimum distributions within the Trust instead of kicking them out to the beneficiaries. In the alternative, a 2005 IRS Private Letter Ruling has provided some guidance on drafting a traditional “conduit” type Trust with the option to toggle to an accumulation type trust if the Trustee saw trouble on the horizon for a beneficiary and wanted to accumulate the required minimum distributions inside the trust to asset protect the money from the beneficiary’s creditors.

In the end, for those with large IRA balances, it’s wise to consider the Retirement Plan Trust to protect children not only from others, but from themselves. For more information about the Retirement Plan Trust or any other trust related topic, please contact Brenda at (760) 448-2220 or visit us on the web at www.geigerlawoffice.net.

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