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In my earlier posts we talked about how to set up a living Trust properly in order to be the pay-on-death beneficiary of an IRA. That is all well and good if you are actually setting up the IRA and have the opportunity to do it right. What happens if you discover that a deceased relative has made you a Trustee of his or her Trust, made the Trust the beneficiary of an IRA, and did not plan appropriately?

Due to the complexity of the regulations, there are many ways that a Trust can “flunk” the test for being a beneficiary of an IRA. The good news is that some mistakes can be fixed—even after the Settlor of the Trust passes away.

By way of review, a Trust that leaves IRA benefits to a beneficiary that is not an individual—will flunk the test. For example, if the Trust leaves benefits to a charity, the Trust is not an authorized beneficiary of the deceased person’s IRA. The good news is that the Successor Trustee, (who is also likely the executor of the deceased person’s Will) has until September 30, of the year following the year that the decedent died, to clean up any unauthorized beneficiaries. If the unauthorized beneficiary is paid in full before the September 30 date it will not count for purposes of the regulations and the IRS will treat the Trust as if it had never named the unauthorized beneficiary to begin with. For example, if the Trust leaves a lump sum—such as $20,000.00, to the deceased person’s church, the Successor Trustee can clean up the problem by making sure that this request is paid before the deadline.

This grace period can also be used to weed out individual beneficiaries that are older than the person who is supposed to receive the bulk of the retirement assets. Under the rules, it is perfectly ok to have several individuals who are beneficiaries of the Trust. But, the IRS will require the Trust to take minimum distributions using the life expectancy of the oldest beneficiary. For example, assume that the Trust has two beneficiaries—one is 70 years old and one is 20 years old. Under the usual rules the Trust would have to take the usual distributions using the life expectancy of the 70 year old beneficiary. This will limit the tax benefit that the 20 year old beneficiary could have received if he or she had been the only beneficiary. Under the IRS rules, a person that is 20 year old can take much smaller minimum distributions than the person that is 70 years old. This allows the money to grow inside the IRA—tax free, for much longer.

Fortunately, our grace period can help here as well. If the Trustee is able to pay off the older beneficiary before the deadline, the Trust will be able to take minimum distributions using the 20 year old beneficiary’s life expectancy. The potential tax savings could be huge.

The rules are—in my opinion—more complicated than they need to be. That being said, it is important to realize that: 1.) proper Trust planning can save a lot of tax dollars, and 2.) it is sometimes possible to achieve real tax savings through “post-mortem” planning.

This is a general overview and not to be confused as legal advice. If you would like to speak to Jonathan about estate planning, legal, business or tax matter, please email him at jcw@eastbaybusinesslawyer.com or call him at (925) 217-3255.

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