Trusts and Annuities to Protect Non-Spouse IRA Beneficiaries
If you are remarried and have children from an earlier marriage to whom you want to leave what's left in your IRA when you die, you will need to do more than to simply name the children from your first marriage as contingent beneficiaries. The reason for this is that upon your death, your current spouse can roll over your IRA into his/her own. Once this is done, the surviving spouse controls the beneficiaries of the remaining money. Another obvious potential concern is that if you suspect that your spouse may be less than fiscally provident, he/she could easily withdraw all the money from the your IRA, leaving nothing for the children. (This article continues below the table...)
This is a table illustrating today's top interest rates for deferred annuities. The table lists the name of the insurance company, annual effective yield, and the number of years for which the yields are guaranteed. To learn more about deferred annuities click any line in the chart or call 800-872-6684 for quick answers.
Deferred Annuity table
|Company / Product||Rate||Years|
|Sentinel Security LifePersonal Choice Annuity 10||3.45 %||10 yrs.|
|Midland National LifeGuarantee Ultimate 9||3.05 %||9 yrs.|
|Midland National LifeGuarantee Ultimate 8||2.85 %||8 yrs.|
|Sentinel Security LifePersonal Choice Annuity 7||3.20 %||7 yrs.|
|Midland National LifeGuarantee Ultimate 6||2.30 %||6 yrs.|
|Sentinel Security LifePersonal Choice Annuity 5||2.95 %||5 yrs.|
|Midland National LifeGuarantee Ultimate 4||1.90 %||4 yrs.|
One way to solve these problems is to use a trust. A recent private letter ruling shows how a taxpayer who has already reached his required beginning date can use a trust without upsetting the required minimum distribution rules that would otherwise apply when a spouse is an IRA's designated beneficiary. (IRS Letter Ruling 9846034)Facts. A taxpayer we'll call Xavier turned age 70½ during 1991, and began taking required minimum distributions (RMDs) from his IRAs on April 1, 1992, his required beginning date. His spouse, Denise, was the designated beneficiary of the IRAs, and Xavier's RMDs were based on his and Denise's joint life expectancies. Xavier then rolled over some of his IRA proceeds into new IRAs that named the Xavier Trust as beneficiary. The trust document provided that the Xavier Trust, which had independent trustees, was irrevocable and couldn't be amended, and carried the following payment provisions:All trust income would be paid to Denise at least quarterly during her life. Additionally, the trustees were empowered to pay her principal from the trust if they determined that Denise's income from all sources was insufficient for her comfort.
Section 3.4 of the trust provided that upon Denise's death, the remaining trust property would be distributed to Xavier's then living descendants.
Section 3.5 of the trust provided that if at any time after Xavier's death, any portion of the trust property otherwise not disposed of, the trustees would "distribute such undisposed property to the then living persons who would have been entitled to receive the personal property of [Xavier] under the laws of the [applicable] State in effect on the date of the trust determined as if [Xavier] had died intestate with no surviving spouse upon the date immediately following the date such trust property first became undisposed of..."
The last clause was intended to provide for a situation where all of Xavier's descendants predeceased Denise. Colleen, Bertrand, Everhart, Francis, Gordon, and Harry, were Xavier's sole descendants and all were alive when the trust was established.
Thus, the trust was designed to assure that what remained of Xavier's IRAs after Denise's death would be paid to his descendants. Although the ruling doesn't specifically say so, it appears that Colleen, Bertrand, et al were Xavier's children (and possibly grandchildren as well) from an earlier marriage.
When Xavier died, his authorized representative asked IRS whether for purposes of the RMD rules Denise could continue to be treated as the designated beneficiary of the IRAs naming the Xavier Trust as beneficiary.
The IRS dealt favorably with the three potential obstacles to the taxpayer's ruling request.
(1) Trust as beneficiary.
An IRA owner can change the account's beneficiary after his required beginning date. But if the new beneficiary is not an individual or a qualifying trust, the IRA owner is treated as not having designated a beneficiary. (Prop Reg § 1.401(a)(9)-1, Q&A E-5¢)(2))
If there is no IRA beneficiary, RMDs must be paid out over the IRA owner's life or life expectancy. Under Prop Reg § 1.401(a)(9)-1, Q&A E-8(a), depending on how the IRA owner chooses to take payouts, the balance remaining in his IRA when he dies would either have to be paid out over the years remaining of the distribution term (if he used the term certain method) or distributed by the end of the calendar year following the year of the IRA owner's death (if he used the recalculation method).
The IRS ruled that the Xavier Trust was a qualifying trust because it met the conditions enumerated in Prop Reg § 1.401(a)(9)-1, Q&A D-5:
(a) the trust is valid under applicable state law;
(b) the trust is irrevocable, or the trust contains language to the effect that the trust becomes irrevocable
(c) the trust beneficiaries are identifiable from the trust's language, and(d) the necessary documentation is provided to the IRA administrator.
(2) Measuring life for purposes of RMDs.
Where two or more individuals are designated as beneficiaries of an IRA, the designated beneficiary with the shortest life expectancy is the designated beneficiary for purposes of determining RMDs. (Prop Reg § 1.401 (a)(9)- 1, Q&A E-5(a)(1)) Xavier wound up in this situation by naming the Xavier Trust as the beneficiary of his IRAs. Reason: The Xavier Trust doesn't provide that Denise, during her life, would receive all amounts distributed from the IRAs which are intended to satisfy the Code Sec. 401(a)(9) required distribution rules using her life as the measuring life. Thus, distributions from the IRAs may accumulate during her life and may subsequently be paid to the remaindermen of the Xavier Trust (Colleen et al). As a result, the life expectancies of Colleen and her fellow remaindermen had to be compared with Denise's to determine the Code Sec. 401(a)(9) distribution period. Because Denise was older than any of the remainder persons (Colleen et al), the IRS concluded that the life expectancies of the remaindermen didn't have to be considered for purposes of determining the IRAs' required payout period.
(3) Effect of contingent beneficiaries.
Under Section 3.5 of the Xavier Trust, if all of Xavier's descendants predeceased Denise, the trust was to pay out undisposed property to other persons, such as, possibly, Xavier's brother or sister. If these other persons were treated as beneficiaries, and one of them had a shorter life expectancy than Denise's, that person would be treated as the designated beneficiary for RMD purposes. However, if they were only contingent beneficiaries, these other persons could be ignored for purposes of determining the distribution period. (Prop Reg § 1.401(a)(9)-1, Q&A E-5(e))
The IRS ruled that the persons referred to as potential beneficiaries under Sec. 3.5 of the trust were only contingent beneficiaries. They could take the trust's remainder interest only if any portion of it was undisposed of when Denise died, and, under Sec. 3.4 of the trust, that could happen only if every descendant of Xavier predeceased Denise. As a result, these potential beneficiaries were disregarded for purposes of determining the designated beneficiary of Xavier's IRAs.
Depending on the IRA owner's potential estate tax situation, he can protect children of a first marriage by using either a QTIP trust that qualifies for the estate tax marital deduction (see Rev Rul 89-89, 1989-2 CB 231), or a credit shelter trust to preserve the IRA owner's unified credit.
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