First, a basic fact that's often misunderstood. The legal document that controls who gets
your IRA is your beneficiary designation form. When someone says he is leaving an
IRA `to my will', or 'to my living trust', he means either that he didn't fill out the IRA beneficiary form at all, or that he used the form to name his will or his trust as the beneficiary. In either case, the result is that he has made his estate his IRA beneficiary. His
will (or his living trust) directs how his estate is to be distributed. It sounds as if your father has left his IRA to his living trust. And that creates a potential problem: When you name a human being as your IRA beneficiary, that person can stretch withdrawals from the account over his or her own life
expectancy. If your heir has a long life expectancy, that
stretch-out can make a huge difference to the size of his or her
inheritance.
Let's say you leave a $400,000 IRA to a
40-year-old, for example. He can stretch his required annual withdrawals from the account over another 43.6 years. (His first required minimum distribution would
be $9,174 —$400,000 divided by 43.6.) He'd owe taxes on the withdrawals, but the IRA
balance could keep growing untaxed for more than four decades. Assuming an 8 percent annual return and minimum annual withdrawals, by the time he turned 65, the IRA would be worth almost $1.2 million, says Barry C. Picker , a Brooklyn NY IRA expert -- and in the meantime, he would have received $671,000 in annual distributions!
But it's a different story when you name a non-human beneficiary. Legally speaking, your estate expires when you do. It has no life expectancy, so it can't stretch out
its withdrawals from the IRA. Instead, the IRA must
be emptied within five years of your death, or on a schedule that's based on your remaining
single life expectancy according to the Internal Revenue Service actuarial
table -- depending on the age at which you died. (The five year rule applies if you were under 70 and a half when you
died. The IRS single life actuarial table applies if you were over 70 and a
half when you died.)
Either way, the
IRA must be emptied much faster than if your kids were using their own life
expectancies.
You can avoid this problem if the trust is worded properly. If it's written right, for tax purposes it becomes only a conduit to the human trust beneficiaries. In that case, the IRA can be emptied over the life expectancy of the oldest trust
beneficiary.
But your father doesn't have to worry about whether his trust is correctly worded.
There's a simple, cost-free way for him to make sure his IRA beneficiaries inherit the account in the most advantageous way. All he needs to do is to name them on his IRA beneficiary form. If he has already named his living trust, he can ask the IRA custodian for a new form and can change his beneficiary designation.
When your heir is a disabled or minor child who'll need help handling his inheritance, it makes sense to leave your IRA to a correctly worded trust (and to name a reliable trustee.) But otherwise, using a trust as your IRA beneficiary doesn't really provide any advantage -- and if it isn't done correctly, it could inadvertently hurt your survivors by making the IRA taxable much faster than necessary.
(c) Lynn Brenner, All Rights Reserved.








