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ira funding credit shelter trust


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Guest JBeck

Husband’s IRA is a significant part of his estate. It has been suggested that upon his death his trust should be the beneficiary of the IRA, with the trustee being given the ability to assign the IRA to either the marital trust or the credit shelter trust. Is this common or does the IRA have to be directly assigned to one of his trusts? Is is correct that required minimum distributions would be made over his spouse’s life expectancy (assuming the kids are the remainder beneficiaries) and if she has remining life expectancy at her death, over her remaining life expectancy to the kids?

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When "income in respect of the decedent" ("IRD") is a large part of the estate and there is a lot of money involved, then you generally want to do some planning with a knowledgeable tax advisor. IRA money (and qualified plan money) is generally "IRD." The owner (or participant) has not been subject to income tax yet, so the income tax will still be due after the owner s (participant's) death. But the issues of when the tax is due and who pays it depend a lot on the planning. E.g., there may be a big difference if the IRA itself is left to a specific person(s) versus a dollar amount is left to the person and the IRA is used to satisfy that bequest.

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I'm not sure what you mean by "his trust." If you mean a separate trust containing a marital/credit shelter formula, he could leave the IRA to that trust. But as Katherine hints at, there is a difference of opinion as to whether that might accelerate the income taxation of the IRA benefits. And it will sacrifice, or at least complicate, the rollover of the portion going to the marital share.

If his objective is to use his IRA to the extent necessary to fully fund the credit shelter trust, after using whatever other assets are available, he can accomplish this in the beneficiary designation. The tradeoff is the loss of the spousal rollover.

A simpler approach is to name the spouse as beneficiary, with a disclaimer/credit shelter trust as contingent beneficiary. The tradeoffs are (i) the decision becomes the spouse's rather than the IRA owner's, and (ii) a disclaimer trust is less flexible that a regular credit shelter trust.

I will be presenting a paper on this at the BNA Tax Management advisory board meeting in New York on September 18th. If your lawyer can make it, he/she may find it useful. If not, he/she should watch for a copy of the paper in his/her BNA Tax Management Memoranda.

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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Guest JBeck

I'm not sure what you mean by "his trust." If you mean a separate trust containing a marital/credit shelter formula, he could leave the IRA to that trust.

Yes.

But as Katherine hints at, there is a difference of opinion as to whether that might accelerate the income taxation of the IRA benefits. And it will sacrifice, or at least complicate, the rollover of the portion going to the marital share.

Could you expand on those two points?

.

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It's not enough that I kept you out of the soup. You want the analysis, too.

Some people (i.e., some experts) think that if you use an IRA to satisfy a preresiduary formula marital or credit shelter bequest, then the IRA is immediately taxable, notwithstanding the stretchout that would otherwise have been available. Others (i.e., other experts) think that this should not be a problem. Why take a chance?

If you leave the IRA to this trust, how is the spouse supposed to do a rollover? Obviously you can't for the portion that goes to the credit shelter. If the marital share passes in the form of a QTIP trust rather than outright, then obviously you can't for the marital share either. If the marital share passes outright, then you may be able to do the rollover for some or all of the portion of the IRA that will go to the spouse via the trust. This issue is far too complicated for a short answer. For a long answer, see my article on that subject in the October 1997 issue of Estate Planning. The lawyer who handles your estate planning should subscribe to this publication. But again, why look for a complicated solution that may work when there are simpler solutions that do not have these uncertainties?

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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I agree with Bruce's suggestion of naming the spouse as the beneficiary with the trust as a contingent beneficiary. There have been rulings where this was an effective way of completing the funding of a credit shelter trust. LTR 9630034 is an example.

In that ruling they avoided triggering all of the income tax upon funding by having the spouse disclaime "a fraction" of the IRA. It must be carefully done.

Even when the IRD is not triggered immediately upon funding, massive income taxes are possible. Each year the IRA custodian would pay the Minimum Required Distribution to the trust. The trustee would then follow the trust agreement. If the trust pays out income to beneficiaries, it will generally pay out trust accounting income. The IRA distribution may be all or mostly principal. IRA distributions paid to a trust that are not distributed to beneficiaries are subject to tax at the compressed income tax rates that apply to trusts.

When using an IRA to fund a credit shelter trust you're saving estate taxes while incurring income taxes, be sure to consider this fully in your planning.

Mary Kay Foss CPA

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