Thursday April 18, 2024

4.6.4 IRA to Trust for Surviving Spouse

IRA to Trust for Surviving Spouse

IRA to QTIP Trust:  Many estate plans include creation of a bypass trust equal to the exemption amount at date of death, with the balance of the estate transferred to a marital deduction trust for the surviving spouse.

IRA to Unitrust for Spouse:  Another planning strategy is to transfer an IRA to a testamentary unitrust for a surviving spouse.

Bypass IRA Unitrust:  If an estate holds a substantial IRA in proportion to the other assets, it may be necessary to transfer the IRA either to the bypass trust or a QTIP trust when the first spouse passes away.

IRA to QTIP Trust

Many estate plans include creation of a bypass trust equal to the exemption amount at date of death, with the balance of the estate transferred to a marital deduction trust for the surviving spouse. The most popular spousal trust is a qualified terminable interest property (QTIP) trust. If the IRA or other retirement plan is transferred to a QTIP trust, the distributions will be based on the Single Life Table. This will result in much larger distributions and greater income tax than would be applicable if the IRA was rolled over by the spouse and he or she could use the Uniform Lifetime Table.

To insure qualification under the QTIP marital deduction provisions, most counsel draft a provision that indicates that the spouse will be entitled to all income. The IRA then distributes the greater of the income or the required minimum distribution to the QTIP trust and it is paid to the surviving spouse. See Rev. Rul. 2000-2, 2000-31 I.R.B. 305 (1/4/2000).

For a donor who desires to benefit spouse and charity, the transfer of an IRA to a QTIP trust for the spouse could result in little or no gift to charity. The required distributions from the IRA to the spouse over his or her life expectancy may result in distribution of all or most of the IRA to the spouse. He or she would also have increased income taxes with the larger distributions.

IRA to Unitrust for Spouse

Another planning strategy is to transfer an IRA to a testamentary unitrust for a surviving spouse. The unitrust is tax exempt and is able to receive the IRA without paying income tax. In addition, there is an estate tax marital deduction. Sec. 2056(b)(8). This spousal unitrust option is excellent when other assets provide sufficient liquidity for the surviving spouse.

The unitrust may be a standard trust, usually paying out 5% or 6% for life. Potentially, the trust may earn more than 5% or 6% total return. In this case, the trust will pay out the income and, as the trust principal grows, trust income can grow for the lifetime of the spouse. This is a significant improvement over plans that could result in payment only for the life expectancy of the spouse. Some spouses, especially women, may outlive the projected Treasury table's expectancy by five to 15 years.

Another option is to create a Type II or net income plus makeup unitrust. With a net income plus makeup unitrust, the trustee has the flexibility to invest for growth or for income. This flexibility can enable a spouse to reduce current income and current income taxes.

Example 4.6.4A IRA to Unitrust for Emery Wilson

Harold and Emery Wilson have an estate of $3 million. Harold rolled over his retirement plan into an IRA when he was 70. The IRA is now valued at $1 million.

After Harold passes away, Emery desires control over the IRA income and potentially the ability to reduce income taxes. Emery and Harold had signed a two-life unitrust. Under their state law, the unitrust is valid without being funded. Since they are in a community property state, Emery also signed a consent and waiver to allow the $1 million IRA to be distributed to the spousal unitrust. Harold changed the beneficiary designation and made Emery as trustee of the unitrust, the designated beneficiary of the IRA. When Harold passes away, the IRA flows to the unitrust for the life of Emery. There is no income tax payable by the trust and it qualifies for a marital deduction. Emery then may choose to invest for growth and reduce the income or may choose to invest for income and receive the 6% unitrust amount. The income payouts will be taxable as ordinary income, since the trust was funded with an IRA.

Since the approximate $2 million balance of the estate is sufficient to provide income security, Emery chooses to invest the unitrust assets for growth. The unitrust pays out approximately 2% and accrues a deficit. If Emery later needs higher income, the trust may be reinvested for maximum income. The trust then could pay out the 6% unitrust amount, and any excess earnings could also be distributed to make up the prior deficit. Emery enjoys income control, lower income taxes and potential increased income at a future time.

Bypass IRA Unitrust

If an estate holds an IRA that is substantial in proportion to the other assets, it may be necessary to transfer the IRA either to the bypass trust or to a QTIP trust when the first spouse passes away. However, both options have unfavorable income tax results. Under the provisions of most bypass trusts that pay to spouse and children, IRA minimum distributions will be made using the life expectancy of the spouse. The IRA payments to the bypass trust will be taxed at a very high rate if retained in the trust. Alternatively, if paid out to the surviving spouse, the bypass trust is greatly diminished and the IRA (less income taxes) may be subject to estate tax in the estate of the spouse. Both the IRA-Bypass trust or the IRA-QTIP trust present a very unfavorable double tax problem.

A better solution that may preserve the IRA for family and also minimize both income and estate tax for the surviving spouse is to create a bypass IRA unitrust. This bypass trust is a charitable remainder unitrust. The unitrust may be payable to spouse for life and then to children for their lives or a term of years. The life to spouse plus term of years for children is the lowest-tax option. After the term of years to children, the balance is distributed to charity and all further income tax is avoided.

In addition, the bypass IRA unitrust can be a net income plus makeup trust. The IRA is distributed from the first estate to the bypass IRA unitrust. There is avoidance of income tax at that time, since the unitrust is tax exempt. If the surviving spouse does not need current income, the net income plus makeup trust may be invested for growth. The unitrust percent plus additional makeup income may eventually be distributed to the children. This trust has the advantage of lower income taxes and preservation of the IRA for the family. In addition, there will also eventually be a substantial charitable gift.

Example 4.6.4B Bypass IRA Unitrust for Ryan Lee

Bill and Ryan Lee have an estate of $3.5 million. $2 million of that is in an IRA. $1.5 million is composed of the home, CDs, stocks and bonds. Bill and Ryan create an unfunded two-life plus term of years trust, which is permitted under their state law. Ryan signs a consent form to the designation and Bill selects that unitrust as the beneficiary of his IRA. He includes a zero-estate-tax formula clause in the IRA beneficiary designation. This clause limits the distribution to the lesser of the IRA date of death value or the federal estate tax exempt amount, plus the charitable estate tax deduction for funding the unitrust. Any excess IRA amounts will be transferred to Ryan and she will roll the excess over into her IRA.

When Bill passes away, the 5% unitrust is funded for the life of Ryan plus their two children. The 5% net income plus makeup unitrust receives almost $1.9 million. The balance of the estate is transferred to Ryan. Ryan decides to take income from the trust and receives the 5% unitrust earnings. In addition, Ryan receives income from the balance of the estate. If Ryan does not need the full income from the unitrust, it is possible to invest for growth and later make larger distributions of income to the children.

The unitrust initially pays out ordinary income. However, over the lifetimes of the beneficiaries the unitrust will pay out approximately four times the initial value. Therefore, after the first payout is distributed as ordinary income, the remaining years permit the trust to pay out mostly dividend income or long-term capital gain.

Example 4.6.4C Bypass IRA Unitrust for Clara Wilson

Harold and Clara Wilson have an estate of $3.5 million. They decide that it would be good to create a bypass trust funded with Harold's IRA. Harold has approximately $2 million in his IRA. Harold and Clara sign a trust for two lives plus a term of 20 years. Under their state law, the trust does not have to be funded. Clara signs a waiver and consents to transferring Harold's IRA to the trust. Harold then changes the IRA designated beneficiary to Clara as trustee of the 6% unitrust. When Harold passes away, the formula clause in the beneficiary designation transfers the exemption equivalent plus the charitable deduction to the unitrust. The unitrust is funded with approximately $1.94 million.

The unitrust 6% income is paid to Clara for her lifetime. After she passes away, the trust income is paid for a term of 20 years to the Wilsons' two children. During her lifetime, Clara receives the income from both the unitrust and the balance of the estate. After the payments to Clara for life plus the 20-year income term to the children, the trust principal is distributed to favorite charity.

Case Studies on IRA to Trust for Surviving Spouse

Saving Taxes on Savings Bonds:   Ethel Peters is an 80-year old grandmother and has an estate valued at $2 million. She has one son, age 55, who is married with three children. Her estate consists of her home valued at $750,000, an IRA with a current balance of $100,000 and United States Savings Bonds (Series EE) with a current value of $250,000. The balance of the estate is invested in securities. Ethel primarily lives on her Social Security income, the IRA distributions and a small pension inherited from her husband.

Death and Taxes - The Madison Era of Giving, Part 6 of 7:   While George Madison, Jr., repeatedly demonstrated his willingness to give, his younger brother Frank Madison, 75, was another story. In short, Frank was never the "giving" type. He believed only the super-rich, like his brother George, gave to charity, since they were the only ones well off enough to "throw money away." Frank did not consider himself rich because his estate was valued at a mere $3,000,000. Consequently, Frank had never made any kind of charitable gift. Frank's unshakable and outspoken beliefs about giving had not surprisingly earned him the nickname Ebenezer. However, even Ebenezer Scrooge had a change of heart when given the right circumstances.

Transferring the Family Business:   Wayne and Kristine Caldwell, both age 70, have developed a fine 101 Flavors Ice Cream business. This business has been built up over the past 30 years and they now have a number of stores located in outlet malls throughout the southern portion of the state. Their estate is currently valued at $6 million, with the ice cream business valued at $2 million and their IRA accounts valued at $3.5 million. Because of Kristine's savvy investment skills, the IRAs have done extremely well and now are the major assets in their estate. Other estate assets include their home and approximately $250,000 in various stock and bond investments.

Private Letter Rulings

PLR 199901023 IRA or Pension Plan to Unitrust, No Sec. 691(c) Income Tax Deduction:   When a qualified retirement plan is transferred at death to a unitrust, there is a charitable estate tax deduction. If the unitrust does not have unrelated business taxable income (UBTI), the transfer is not subject to income tax for the estate or the unitrust. When payments are received, there is Sec. 664 tier one ordinary income to recipients but no Sec. 691(c) income tax deduction for the estate tax attributable to the income interest.

PLR 201242002 IRS Allows Trust Severance, Reverse QTIP Election:   Decedent died, survived by Spouse, Son and grandchildren. Article IV of Decedent's will provided that upon her death the residue of the estate should pass to Trust.

PLR 9634019 IRD to Testamentary Unitrust:   One of the most attractive planning devices is the transfer of an IRA, pension plan or other income in respect of a decedent (IRD) asset to a testamentary charitable remainder trust.

Quiz-Basic

� Copyright 1999-2024 Crescendo Interactive, Inc.