If you have an individual retirement account (IRA) and have been planning on using your Last Will and Testament to leave it to your heirs, you may want to explore all of your available options before doing so. While there are some very solid reasons for using a will to pass on your IRA, there are equally solid reasons for choosing to use a living trust to accomplish that goal. Ultimately, your unique circumstances and goals should determine whether you use a will or a trust to pass your IRA on to your surviving heirs when you die.
Using a Will
Like many other types of assets, you can choose to use your Last Will and Testament to pass on an IRA to an heir or heirs. In many instances, the easiest way to do this is to simply leave it to a spouse, since he or she actually enjoys some exceptions to the general rules governing inherited IRAs. Unlike other heirs, a spouse who receives an IRA through inheritance is permitted to roll that account over into what is referred to as a regular IRA and treat it just as if he or she had set it up in the first place. That allows that spouse to add money to it just as you would.
With other heirs, the normal IRA rules simply don’t apply. A recent Supreme Court case suggests that inherited IRAs are often stripped of the legal safeguards they might otherwise provide – leaving them vulnerable to creditors. The Court’s reasoning was based on the idea that IRAs are established and funded to provide for the account holder’s retirement. If that account holder dies, then the standard protections against creditors are no longer necessary since the IRAs original purpose is void.
Heirs other than spouses are also required by law to withdraw all of the money from the IRA within the five-year period following the death of the original owner, or to take a certain minimum amount from the account each year. If left in the account, the money continues to grow over time tax-free – but taxes are assessed when withdrawals are taken. To minimize those taxes and maintain protection against creditors, the IRA needs to be passed on using a different method than the Last Will and Testament.
Using a Living Trust
With the living trust, there are different benefits – and a critical drawback – that must be kept in mind. When you use a trust to distribute your IRA assets to your heirs, it can provide you with greater control over how the money is distributed. You can set specific criteria that must be met before an heir can receive his or her distributions, or simply set terms to provide smaller distributions over time. That can be a useful way to ensure that spendthrift heirs are not given a windfall to squander all at once.
When your trust pays out IRA distributions in smaller increments over a longer period of time, that can allow the trust to continue to grow in value – maximizing the inheritance value for all heirs receiving those distributions. That can be a great way to fund a special needs trust for a disabled loved one, or to provide ongoing support to minor children as well.
That drawback that we mentioned can be a troublesome thing, though. Since the trust is technically a non-person, the law requires that all of the money in the IRA be completely dispersed no later than five years after you die. Still, that can be avoided if the trust is set up in a way that meets the IRS’ exacting standards for treating the beneficiaries as though they are actually the IRA’s direct beneficiaries – essentially ignoring the trust. In that case, the funds can remain in the IRA and be distributed over time without regard to that five-year time limit.
You may find this to be the single greatest advantage that a trust can offer when leaving and IRA to heirs. As long as the trust meets the IRS requirements, the agency often views IRA monies left to the trust as thought they were directly bequeathed to the heirs.
Which is the Better Option?
Again, the decision about which option is right for you is something that comes down to a matter of perspective. If you simply want to pass on the IRA to your spouse, then you don’t really have to be concerned about issues like distribution time limits or managing how much money can be taken at any given time. Your spouse can simply roll over the IRA and make it his or her own. On the other hand, if you have concerns about creditors or other legal judgments against beneficiaries, or otherwise want to exercise greater control over distributions, then a living trust is probably the best option.
Can a Lawyer Help?
A competent estate planning attorney can indeed help you evaluate your individual circumstances and determine which option will work best for your needs. That attorney can also help you make sense of how your selection of beneficiaries impacts distributions and other aspects of the inheritance process. More importantly, though, a lawyer can help you to avoid the types of mistakes that could create serious complications for your beneficiaries after you pass away.
Obviously, there are a lot of factors to be considered when it comes to an important decision like this. How you choose to pass on your IRA to loved ones can be critically important in determining the ease with which they can access those funds and how vulnerable they might be to judgments and other creditors. At the Law Offices of Mary A. Miller, P.C., we can help you make sense of those issues and choose the option that works best for your estate planning needs. If you’d like to know more about the benefits of choosing either a will or a living trust as the vehicle for passing on your IRA, contact us online or give us a call at (914) 939-6565.