Author’s note: This is part four of a five-part series on estate planning. Part one dealt with minimizing death taxes; in part two, we discussed how to avoid the costs, delays and publicity associated with probate in the event of your death or incapacity; and in part three, we looked at techniques to set forth your dispositive wishes (i.e., who gets what, when and how). In this part four, we’ll examine how to coordinate the myriad technical rules relating to IRAs and other retirement plans with your overall estate plan. And in part five, we’ll discuss advance directives regarding your medical decisions upon incapacity, including end-of-life decisions.
Estate planning for retirement benefits
If you are married, then your spouse is likely the best beneficiary of your IRA. That's because only your spouse can roll over your IRA into his/her own IRA. Thus, your spouse will be able to stretch out the required minimum distributions (RMDs) over his/her own life expectancy, thereby minimizing income taxes. It also allows the beneficiaries your spouse names to stretch RMDs over their own life expectancies. And, depending on state law, the roll over IRA will remain creditor-protected.
For a second marriage, you may not want to name your spouse as the primary beneficiary of your IRA because you then lose control over what happens to the IRA. Instead, you might consider naming an A-B trust (described below) as the primary beneficiary. If you have a taxable estate, your IRA (if payable to the B trust) can help shelter some of your estate tax exemption. But, without careful drafting, placing IRA benefits in the B trust can result in accelerating the income taxes on the IRA. Another problem is that when your spouse dies, the remainder beneficiaries of the B trust — your children or grandchildren, for example — will be forced to take RMDs over your spouse's remaining life expectancy, not their own. Thus, the opportunity to defer income taxes over a longer period of time is lost.
If you're single and your beneficiaries are competent adults, then you can leave your IRA directly to your beneficiaries. This will allow each beneficiary to stretch out the RMDs over his or her own life expectancy. However, for minor beneficiaries where a court-supervised guardianship or conservatorship will be needed to manage the IRA account until age 18 or 21, depending on state law — or for beneficiaries that might forego the stretch opportunity by withdrawing all of the IRA assets immediately — then you should name your living trust as the primary beneficiary. If your living trust has the appropriate "see through" language, then each trust beneficiary can stretch the RMDs out over his/her own life expectancy. Otherwise, the life expectancy of the oldest trust beneficiary must be used. You may also want to consider creating a special dynasty "IRA trust" for each beneficiary so as to force the stretch out, while protecting the beneficiary from creditors, ex-spouses and possibly estate taxes.
Finally, if you are charitably inclined, then IRAs are an excellent choice for meeting your charitable goals. Not only are bequests of IRA funds to charity 100 percent estate tax free, the charity does not have to pay income tax on the bequest. In contrast, IRA accounts payable to individuals are subject to estate taxes (if the IRA owner has a taxable estate), and the beneficiaries must include IRA distributions in their ordinary income. But, the beneficiary receives an income tax deduction for any federal estate taxes paid on the IRA benefits.
In the fifth and final part of this series we’ll discuss advance directives regarding your medical decisions upon incapacity, including end-of-life decisions.