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 A Lifetime of WealthSM

The IRA Stretch and Protection TrustSM

The purpose of the IRA Stretch and Protection TrustSM is to provide a means of ensuring the long term tax deferred STRETCH distribution of your IRA.  The most important advantage of your IRA is tax deferral. The deferred taxes are like an interest free loan.  Some of the money in the IRA will have to be paid to the government in taxes, but not until it is withdrawn from the IRA.  The longer the money stays in the IRA, the longer the IRA growth will compound on a tax deferred basis.  In other words, money in the IRA is money that you can invest and earn a return on until it has to be paid to the government in taxes.

This section discusses why the IRA Stretch and Protection TrustSM is the best method of ensuring that funds stay in your IRA for longest possible time.  Click on any of the topic titles to the right and you will be taken directly to that topic area.

The Importance of Proactive IRA Protection Planning

You might ask yourself why it is important to plan to protect the IRA at all.  If your beneficiaries can achieve lifetime STRETCH distributions simply by you appropriately naming them as Designated Beneficiaries, what does the IRA Stretch and Protection TrustSM add?

The problem with simply naming beneficiaries is that you have done nothing to ensure the STRETCH distributions.  The beneficiary may be able to take STRETCH distributions, but that result is not required.  The IRA is still subject to the following risks:

  • Creditor Claims
  • Bankruptcy
  • Divorce
  • The Beneficiary's Desire to have the Money NOW!

The most significant risk is the beneficiary, who is likely to either get a divorce or simply decide that tax deferral is not that important and cash out the IRA.

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The Creditor and Bankruptcy Risk

The laws of most states provide that retirement accounts, including IRAs, are exempt from creditor claims.  However, there have been several court cases that determined inherited IRAs are not exempt from the claims of a beneficiary's creditors.  Why the distinction?  The courts deciding an inherited IRA are not exempt typically point to the fact that qualified retirement accounts are exempt.  Since a beneficiary cannot make additional tax preferred contributions to an inherited retirement account or IRA, it is not qualified from the beneficiary's perspective, therefore it is not within the scope of the exemption statute.

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The Divorce Risk

It is a sad fact of life that somewhere around half of all marriages end in divorce.  In many cases an inherited IRA will be one spouse's property that cannot be distributed to the other spouse.  So where is the risk?

Only about 3% of civil cases (including divorces) end up decided by a judge.  The other 97% are settled by the parties outside of court.  What happens when parties settle a divorce?  In an attempt to end the divorce quickly they give up property that they may not be legally obligated to.  This includes an interest in an inherited IRA (which is often the largest single liquid asset that is available to use as a cash settlement).

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The Beneficiary "I Want it NOW!" Risk

Absent proactive planning on your part, your IRA beneficiaries will have the authority to cash out your IRA immediately after your death.  The cash out will cause all deferred taxes to be immediately payable and the opportunity for lifetime tax favored investing and STRETCH distributions will be lost forever.

How many IRAs are cashed out by beneficiaries?  Unfortunately no number is known with certainty.  However, various IRA custodians tell us that somewhere around 55% to 65% of IRA beneficiaries will cash out an inherited IRA.

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Using Trusts to Mitigate Planning Risks

Trusts are a basic asset protection and management tool.  While there are many types of trusts used for various purposes, at their basic level they all share certain common traits.  They are a three party agreement that require a grantor (the person creating the trust), a trustee (the person that will manage trust assets), and a beneficiary (the person that benefits from the administration of the assets).  The trust agreement sets forth the terms and conditions of management of the trust assets as well as when, how and how much of the trust assets can be distributed to the beneficiary.

A beneficiary does not have legal ownership of trust assets, only a beneficial interest in them.  We can, therefore, design a trust document that will protect beneficiaries from themselves and trust assets from a beneficiary's claimants and creditors.  If a trust beneficiary does not exercise control over the distribution of trust assets (which is the trustee's job), then the beneficiary cannot be compelled to distribute them to a creditor, claimant or soon-to-be ex-spouse.

In the case of a trust intended to be used as an IRA beneficiary, the IRS has set forth the following requirements:

  • The trust must be valid under state law.
  • The trust must be irrevocable at death.
  • The trust beneficiaries must be identifiable from the trust document.
  • All beneficiaries must be individuals.
  • Certain documentation must be provided to the IRA custodian by Oct. 31 of the year following the IRA owner's death.

(See Treasury Regulation Sec. 1.401(a)(9)-4.)

If these requirements are met, the trust will be considered a "see through" trust.  That means that we will be able to look through the trust at the individual beneficiaries to determine whether there are valid Designated Beneficiaries.  If there are, we are on the road to STRETCH distributions.

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The IRA Stretch and Protection TrustSM Advantage

While the IRS has told us how a trust can be looked through to determine whether there is a Designated Beneficiary, the Treasury Regulations noted above do not tell us how to make each individual beneficiary of the trust qualify as a Designated Beneficiary.  That is, if you have a trust that meets the above requirements and you name it beneficiary of your IRA, and that trust in turn has several beneficiaries, it does not necessarily follow that each of those beneficiaries will be a Designated Beneficiary as to his or her own individual interest.  Why does that matter?  Because the only way we can achieve the maximum STRETCH distributions is for each beneficiary to be recognized individually as the Designated Beneficiary of his or her share of the inherited IRA.  An example highlights the importance of this.

Ted Jones is 74 years old and has four children, Ann (age 54), Bill (age 50), Frank (age 47) and Julie (age 43).  Ted passes away in 2008 with $250,000 remaining in his traditional IRA.

If Ted has no designated beneficiary (such as may be the case if he named his estate planning revocable living trust as his IRA beneficiary), the maximum IRA distribution period would be 10 years and the total net distributions would be approximately $353,170.  If instead he leaves the IRA to the class of his children, the oldest of them would qualify as our Designated Beneficiary.  Using Ann as the measuring life, the total payout of Ted's IRA would be $809,261.

If, however, Ted uses an IRA Stretch and Protection TrustSM, each of his children will qualify as a Designated Beneficiary and may take STRETCH distributions by using their own life expectancy for distribution calculations.  In that case, the total distributions would be $1,076,920.

In summary, Ted’s family MAY get an additional $267,659, but only if Ted has the foresight to ensure (a) each beneficiary can use his or her own life expectancy to maximize the STRETCH distributions, and (b) that each beneficiary’s interest in the IRA is appropriately PROTECTED so that the account and stretch is not jeopardized.  Stated another way, if Ted properly plans for each child to be a Designated Beneficiary, he gives his children the opportunity to use each of their own life expectancies to maximize STRETCH distributions, but he does nothing to ensure or enforce that STRETCH distributions actually happen.  There are, therefore, two aspects of the IRA Stretch and Protection TrustSM advantage.  First, it allows each beneficiary to qualify as a Designated Beneficiary and obtain STRETCH distributions.  Second, it enforces your goals by acting as a mechanism that deprives creditors, claimants, courts and beneficiaries from taking distributions from the IRA any earlier than required.

Conduit and Accumulation Trusts

Another dimension of the IRA Stretch and Protection TrustSM advantage is that each individual beneficiary of the trust will have his or her own sub-trust.  Each of these sub-trusts can be structured as either a conduit or accumulation trust.

A conduit trust is one where the trustee must withdraw all Required Minimum Distributions when required and immediately pay them over to the beneficiary.  The trustee may not retain or accumulate in the trust any IRA distributions that are made within the lifetime of the beneficiary.  In this type of trust there is still significant asset protection for the IRA.  It is true that once a Required Minimum Distribution is paid over to the beneficiary a creditor or claimant may reach it.  However, the IRA itself it still intact and out of the beneficiary's grasp.  The IRA is not, therefore, subject to the claims of the beneficiary's creditors or the beneficiary's whims and desires for early distributions.

An accumulation trust is any trust where the trustee has authority to withhold distributions to the trust beneficiary.  The trustee must still withdraw the Required Minimum Distribution from the IRA, but once withdrawn it can be held as a general trust asset (rather than paid over to the beneficiary).  This type of trust provides significant asset protection.  It prevents the distributed IRA funds from falling prey to the beneficiary's creditors and claimants while still giving the trustee some discretionary authority (as spelled out by you in the trust document) to make certain distributions to the trust beneficiary.

When is it appropriate to use a conduit trust versus an accumulation trust?  The answer will depend on the individual beneficiary.  Conduit trusts are appropriate where the beneficiary is in a very strong marriage, is not a spendthrift, has no special needs, is mature, does not have creditor problems and may have older remainder beneficiaries.  An accumulation trust is indicated where a beneficiary is more likely to divorce, may have problems managing money, has a stronger likelihood of creditor problems or bankruptcy, has substance abuse problems or special needs, or even where those factors do not exist but you desire a higher level of asset protection (such as where the beneficiary is in a professional practice that is likely to attract lawsuits).

Fortunately you can designate that certain sub-trusts will be accumulation trusts and others will be conduit trusts.  That is, the IRA Stretch and Protection TrustSM is flexible enough that it allows you to decide on a beneficiary by beneficiary basis whether conduit or accumulation is appropriate.  It can be made even more flexible by including a switch provision that allows the trustee, within a certain period of time after the IRA owner dies, to make a switch between a conduit or accumulation provision.  This aspect can be particularly useful in addressing circumstances that arise close to or immediately after the IRA owner's death, when the IRA owner does not have the opportunity to amend the trust.

Amendments

And what about making amendments to the IRA Stretch and Protection TrustSM?  Recall that the IRS requires that the trust be irrevocable upon death.  Up until that time, however, you can amend your IRA Stretch and Protection TrustSM as often as you like, adding or removing beneficiaries, changing trustees, revising discretionary distribution standards, etc.

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Comparing the IRA Stretch and Protection TrustSM to Your Estate Plan Revocable Living Trust

We are often asked why a standard estate planning revocable living trust cannot be used as an IRA beneficiary trust.  Remember that the goal is to have Designated Beneficiaries, not just beneficiaries.  Typical estate planning trusts are good at what they do, but they are a general purpose trust.  They nearly always include provisions that are good from a general estate planning point of view but disastrous from the perspective of maximizing the STRETCH distributions from your IRA.

The IRA Stretch and Protection TrustSM is a special purpose trust designed to accomplish one specific goal: the maximum STRETCH distributions of your IRA and PROTECTION of the IRA and distributed funds.

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