From The Wall Street Journal: (click for article)
My wife and I are both over 65 and are
doing some estate planning. Can I transfer funds from a traditional IRA
to a trust without immediately being taxed? What would be the tax
consequences of making the trust the beneficiary of my IRA?
Ken Hartmann
Omaha, Neb.
The reader's best bet would be the second strategy -- making the
trust the beneficiary of his individual retirement account, says
Natalie Choate, an estate-planning lawyer at Nutter McClennan &
Fish LLP in Boston.
Still, there is a caveat we will get to in a moment.
To take the questions in order: Transferring funds from an IRA to a
trust would "invariably cause immediate taxation," because the transfer
would be considered an IRA distribution, Ms. Choate says.
Note: Investors might encounter a technique espoused by some
estate-planning experts, which in theory would allow for a transfer
without triggering taxes. But the Internal Revenue Service has never
specifically "blessed" the technique, Ms. Choate says. So, "most
estate-planning lawyers would say you shouldn't try it without getting
a ruling from the IRS, which would be quite expensive."
Instead -- and here we turn to the second question -- the reader
could name the trust as a beneficiary of his IRA. It is a popular
estate-planning move for people who want to use a trust to avoid estate
taxes or protect beneficiaries, such as children who are too young to
manage the money themselves, or adult children with special needs, Ms.
Choate says.
You would need to make sure that the trust is written to follow
strict IRS guidelines known by estate planners as "see-through" or
"conduit" trust rules. Also, the income-tax rates that trusts pay are
generally higher than income taxes paid by individuals. But your heirs
can avoid paying the high trust rate if the trustee can pass all the
IRA distributions out to the individual trust beneficiaries. "So, you
need to be sure, if you name a trust as beneficiary, that the trustee
has the latitude to do this, and the IRA distributions won't get
trapped inside the trust," Ms. Choate says.
There are drawbacks to leaving an IRA in a trust for your spouse, as
opposed to other beneficiaries. A trust would have to draw down the IRA
in installments every year over the life expectancy of the oldest trust
beneficiary. In contrast, if you name your spouse outright as
beneficiary, instead of using a trust, he (or she) can roll your IRA
into his or her own IRA -- and possibly defer distributions and taxes
for many more years, Ms. Choate says.
So, you may want to combine the strategies so that your IRA goes to
your spouse upon your death, and then to a trust on behalf of your
other heirs upon your spouse's death.
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