Most people have a retirement account such as an IRA, 401(k), ROTH IRA, SEP, 403(b), 457, or another similar plan. If you own a retirement account, you are entitled to name a beneficiary who will receive the account upon your death. You can name an individual, a charity, a traditional trust, an IRA Stretch Trust, or a Charitable Trust.
Generally speaking, it is simple to name an individual beneficiary and it is often the most tax-efficient thing to do. However, many people do not wish to leave a retirement account outright to a beneficiary because they would prefer the funds to go into a trust for that person. (For example, perhaps the beneficiary is a minor or someone who is unable to manage the money.) Unfortunately, if you name a traditional trust as the beneficiary of a retirement account, it is not very tax efficient. This is why IRA Stretch Trusts were created.
An IRA Stretch Trust may be funded with any retirement asset, not just IRAs. However, for sake of simplicity, we generally refer to this type of trust as an IRA Stretch Trust
Naming an Individual Beneficiary
When an individual is named as the beneficiary of a retirement account, then upon the death of the account holder, the individual has many options regarding how to receive the funds. The beneficiary does NOT have to withdraw it immediately upon the death of the account holder. This is important as the immediate withdrawal of a large retirement account would cause a significant income tax.
Historically, after the account holder died, the beneficiaries were able to make an election to withdraw the funds over their life expectancies. In 2019, a new law, known as the Secure Act, was passed. Under the Secure Act, unless an individual beneficiary is a spouse, a disabled person, a minor, or someone the same age as the account owner, the beneficiary must withdraw the account over a 10-year period. Moreover, if the beneficiary is a charity, an estate, or a traditional trust, the account must be withdrawn over a 5-year period.
Benefits of an IRA Stretch Trust
If you wish to control how a beneficiary receives their inheritance, the easiest and most common method is to set up a trust for a person. A traditional trust allows the beneficiary to receive the funds over time at the discretion of the trustee (perhaps even giving the funds to the person outright once they reach a certain age). An IRA Stretch Trust is almost identical to a traditional trust, except it has extra language requiring the trustee to withdraw funds from the retirement account at least annually and there are special rules regarding the distribution of those funds.
By adding these special rules to an IRA Stretch Trust, the IRS allows the trust to be taxed like an individual, rather than a traditional trust. In other words, the 10-year withdrawal rule applies rather than the 5-year withdrawal. This allows the retirement account to grow for a longer period, tax deferred.
Who Should Consider Creating an IRA Stretch Trust
For individuals who have large IRAs, children with special needs, children with creditor problems, or individuals who want to name minor children as beneficiaries, an IRA Stretch Trust can be a vital part of an estate planning and tax planning strategy. Of course, a complete estate plan should also include a Will, Financial Power of Attorney, and an Advanced Health Care Directive.
If you have any questions about trust planning or IRA Stretch Trusts, please contact Wills Trusts and Estates Attorney Kevin A. Pollock, who is the head of the firm’s Trust Planning Department. Additionally, for more information, please visit our Blog Post entitled, “What is a Stretch IRA Trust“.
