I have written this article for information purposes, and I hope you learn something from it. Though I would like to state it is current and up to date, in all candor, I can't. In most cases, the concepts are relatively accurate (except for obviously old and dated materials, primarily related to taxes). You should confer with your own lawyer about issues that affect you and your family.
IRAs, Wills and Trusts
Never ending questions: When will the Social Security Trust Fund run out of money? And isn't Congress going to deal with this?
We won't attempt to answer the first question, but you might be interested to learn that Congress "solved" the second problem in 1974. Here's what happened. Even though payroll taxes were increased so as to fund social security and Medicare costs, it was obvious a retiree would not be able to live on social security payments. With this in mind, Congress passed the Employee Income Retirement Security Act, in the hope that employees would save towards their own retirement (such action would also relieve employers of funding pension plans, if they were so inclined). There were income tax lures to the employees: if the employee invested in an IRA, he or she would get an "above the line" tax deduction.
Banks, brokerage houses, and insurance companies got to work, and devised all sorts of investment packages, to induce working Americans to invest in IRAs. All of this helped the financial industry. And those who invested in an IRA had a nest egg for use in retirement years.
Since there were tax benefits given to the employee who invested in an IRA, Congress reasoned that when withdrawals were made from the IRA, the employee should pay taxes on the withdrawals. But there were limitations and restrictions placed on withdrawals: if withdrawals were made before age 59.5, the employee would have to pay a penalty (an extra 10% tax). Second, if an employee failed to make a withdrawal at age 70.5, or did not withdraw the proper amount, the employee would be taxed an additional 50% for that year (YIPES!).
There were more surprises in store for those investing in IRAs, mainly dealing with beneficiary designations. Let's start with the question, when you die, how are the IRA proceeds taxed?
First, if you name "my estate" as beneficiary of your IRA, then your personal representative (named in your will) receives the balance in your IRA account in a lump sum, but will pay 39.6% income tax (at the federal level, for amounts over $11,950) plus applicable state income taxes. Thus, your heirs could lose about half of your IRA in income taxes, if you designate "my estate" as your death beneficiary.
Second, should you name "my trust" as beneficiary of the IRA, you might reach the same result. If the trust is properly drawn, and the custodian of the IRA is a reasonable company -- not all custodians fall in this category -- then the trustee of the trust might take steps, to permit your beneficiaries to reduce the income tax impact.
Third, if you name sentient beings as IRA beneficiaries (i.e., human beings), they can elect to stretch payments over their life expectancies (yes, even new born babies can do this). Each year they will receive a sliver of your IRA, based on their age (they receive larger payments each year, as they age).
Final topic: the great veto power. Unless your spouse agrees to receive less than his or her statutory share of your estate, or you have a prenuptial agreement, you cannot disinherit your spouse from your IRA. The spouse will have to sign your beneficiary designation form, if he or she is to receive less than 100% of your IRA.
Technically, your spouse is entitled to receive no more than the share he or she is guaranteed to receive, under the statute of descent and distribution (or community property rules, if applicable). The general rule of thumb is, the spouse is guaranteed a 50% share of your IRA.
The rules and regulations and articles on this topic are massive, and what we have stated is not all inclusive. But it is enough to warrant quoting the Bard of Stratford on Avon:
"Income taxes, wills, trusts and IRA Beneficiary Designations make strange bed-fellows." Shakespeare, The Tempest (paraphrased).
©2014 James H. Beauchamp