I generally recommend that persons with IRA or qualified plan assets of at least $200,000 should consider a Standalone IRA/Retirement Plan Trust.
There are many reasons that justify creation of a separate trust just to receive retirement plan assets. Though most attorneys think it can be done with only one master trust, there are various drafting problems and post-mortem administrative problems that are lessened by using a separate trust for retirement benefits alone. Many of the benefits of a separate trust(s) established to solely hold retirement plan or IRA assets after death are included below.
This posting is adapted from a presentation by Ed Morrow, J.D., LL.M.
The Inexperienced Attorney
A separate trust increases the likelihood that the trusts will survive later planning by another attorney who does not understand or appreciate the complexities of estate planning with IRAs. Attorneys routinely revoke, restate or amend old trusts, but would take more care in doing so with a specially labeled trust.
The Inexperienced Trustee
A separate trust increases the likelihood of a successor trustee appreciating the complexities of administering separate trusts with IRAs and retirement plan assets. This is especially true of individual trustees where this is more of a problem.
Those Pesky Required Minimum Distributions (“RMD”)
A separate trust increases the likelihood of the successor trustee not overlooking RMD issues, especially when the decedent was already in pay status.
Inadvertent Loss of Designated Beneficiary Status
A separate trust increases the likelihood that debts, taxes and expenses will not and cannot be paid from the retirement plan trust, which helps to avoid losing Beneficiary Designation status. For the majority of attorneys who do not often customize their tax payment and apportionment clauses, this is an advantage.
Simplification of General Estate Plan
A separate trust allows the Will and/or Living Trust to be simpler and less confusing to the client. This is especially true for the engineers and other clients who insist on understanding every word and paragraph of the trust.
Segregates the Retirement Plan from Unintended Tax Consequences Attributable to Choices Made in General Estate Plan
A separate trust allows the main Will and/or Living Trust to easily name older beneficiaries, charitable beneficiaries and allow for normal marriage and adoption provisions. It allows the main trust to contain broad general and limited powers of appointment, and other clauses that permit great flexibility – clauses that are problematic in a trust designed to hold retirement plan assets.
Grantor Has More Flexibility in General Estate Plan
A separate trust allows the living trust to have the broadest spendthrift, in terrorem, incentive/disincentive or other clauses that act to restrict or eliminate income payouts to a beneficiary, which would be problematic in a trust designed to hold retirement benefits.
Simplified Fiduciary Accounting
A separate trust simplifies the fiduciary accounting issues after death involving division between income/principal and separate share rules.
Prevention of Co-mingling of Qualified Assets with Non-Qualified Assets
A separate trust simplifies tracing of the immediate payout of RMDs out to the beneficiary that is required in a conduit trust.
Easier Income Tax Filing
A separate trust can simplify income tax filing and planning for the trust and beneficiaries because it becomes much easier to plan exactly how much IRD is left trapped in the trust at potentially higher brackets and where the IRC 691 deduction will be used.
Maintained Flexibility for Tax Election Planning
A separate trust might prevent the executor/trustee from commingling retirement plan assets in a conduit trust from making a Section 645 election to use a fiscal year, which may jeopardize a conduit trust from qualifying as a Designated Beneficiary.
Greater Likelihood of Effective Utilization of GST Exemption
A separate trust might simplify and/or make more efficient use of the GSTT exclusion, as it is usually wise to use GST exemption for the non-IRD assets left in the standard living trust. Generally, but not always, GSTT exemption would be less valuable to a separate retirement plan trust and more valuable to a trust holding other assets. Moreover, a separate trust can more easily segregate Roth IRA/401(k) assets that have completely different tax planning involved. For instance, the GSTT allocation issue noted above involves quite different considerations for Roth assets. Coinciding with the last points about GSTT, the related issues surrounding the granting limited and general powers of appointment are also clearer with separate trusts. This is because it may be desirable to grant a general power of appointment via formula to avoid a generation skip as to some assets and not others, or, in the event that an accumulation trust is used, it is impermissible to use either a general or broad limited power of appointment. In other words, the criteria and use of LPOA/GPOAs are different and using separate trusts makes the practitioner and client see them as such. In addition, the trustee administering the trust would have clearer guidelines.
Greater Likelihood of Tax Efficient Use of Income Taxable Assets
A separate trust allows clearer directions to trustees to exhaust assets in order of tax preferred priority without worrying about diversification rules overriding tax preferences. For instance, discretionary distributions come out of the trust holding ordinary assets first, then retirement plan assets, then IRAs, then Roth IRA/401(k) trust assets. It would avoid the tremendous danger of having a pecuniary bequest in a master trust triggering IRD in such plans. See IRS Chief Counsel Memorandum (CCM) 200644020.
Retention of Greater Flexibility in Adapting to Future Tax Law Changes
A separate trust makes later amendments when tax law or retirement asset mix changes the dynamics of the planning. Especially where trusts are designed to potentially accumulate retirement plan assets (aka accumulation trusts) – the state of the tax law is ever evolving with PLRs still coming out to explain the 2002 Regulations. Changing just the beneficiary designation or separate trust years later when things change is easier than reworking the entire master trust.
Many of the problems noted above are also solved through using a trusteed IRA, which as noted above can have even greater administrative simplicity and advantages. But trusteed IRAs are only available for larger accounts through a handful of wealth management firms. They cannot be of help when working clients have significant retirement plan assets that cannot be rolled over. Nor are they a solution when a client does not want to change IRA custodians or their current investment advisor. Nor do they provide the maximum restrictions on beneficiaries needed for special needs trusts or other extreme situations. For these situations you need a separate trust. Consider a separately drafted trust apart from the master living trust for the reasons noted above.