Roth in Bypass Trust

[Guest DAW]

Understand if husband dies with Roth, wife can adopt/inherit and no distribution required until her demise. Also understand she can disclaim to the Bypass Trust as beneficiary of Roth. On portion retained by wife, can she still withhold taking distribution? On the portion going to Bypass, can the three children each receive a tax free distribution based on their life expectancy, or does if defer to the age of the oldest child? Any problems I should be aware of in funding the Bypass and setting up the required Roth distributions?

[Guest EAS]

If someone had a ROTH and listed their spouse as the primary beneficiary, then yes the surviving spouse can move the assets into a standard ROTH or a Beneficiary/Inherrited ROTH. This is a non-reportable and non-taxable action. Since the decedant had a ROTH there was no RMD (Required Minimum Distribution) requirement, therefore the surving spouse is not required to take distributions.

Yes, the surviving spouse does have the option to disclaim either all or part of the inherrited assets withhin 9 months from the date of death. If it is past 9 months the primary beneficiary cannot disclaim any assets. If it is still withhin the 9 month period then the spouse can request to disclaim all or a portion of the inherrited assets. However, the spouse cannot determine who is to receive the assets they disclaimed. Instead the disclaimed assets pass onto other primary beneficiaries, if none then onto contigent beneficiaries if none then onto surviving children if none then onto the estate of the the decedant. The assets the spouse did not disclaim can remain in her ROTH, and still not be required to take distributions.

In your case the assets would go to the immediate children. Yes each child would only have the option of setting up a Beneficiary/Inherrited ROTH (not a standard ROTH). The assets would be moved from the original deceased ROTH into the Inherrited ROTHs for each child (non-reportable, and non-taxable). Since there are no RMDs for ROTHs each non spouse beneficiary must fully distribute the assets withhin 5 years of the DOD or take distributions based upon their own life expectancies, not the oldest.

[Guest DAW]

So if I understand you correctly, if spouse is going to possibly disclaim on the husbands Roth, she should be set up as the Primary Beneficiary, and the Bypass as the Contingent Beneficiary.

Couple things I'm not quite getting:

1. Can the Bypass exist before there is a death? (I guess it could with nothing in it if one were to get a TIN awaiting the first death).

2. Doesn't the Roth stay in the Bypass until the wife's demise and we have a distribution of the trust estate of both Trust A & B? (Upon the liquidation of Trust B, then I imagine each child would have their own inherited Roth). Please enlighten.

Really do appreciate you help. Don't want to do anything for this client that I might regret or misunderstand the repercussions.

[Guest EAS]

In responding to your inquiry, I am not sure what you mean by "Bypass" account. Are you talking about the husband naming a trust as the Primary beneficiary?

I assume now your are indicating the Husband who is the owner of the ROTH is still alive. In that case the wife cannot decide who the beneficary will be on her husband's ROTH as long as he is still alive.

Does the husband want his wife want to remain as 100% primary beneficiary? Once her husband dies she will solely inherrit and have the ability disclaim the assets to whomever the contigent beneficiary is.

The only way the "bypass" can exist prior to the husband's death is for the husband to clearly indicate all the primary beneficiaries with their percentages (e.g. wife is 50% primary, one child 25% primary, and one child 25% primary). This will ensure the surviving wife will receive 50% of her husband's ROTH and the 2 children will split the remaining 50%.

Please advise.

[Guest DAW]

Want the husband to convert IRA to Roth. Want the wife to be 100% primary beneficiary, but want her to be able to disclaim as much as she wishes to a Credit Shelter Trust that would be setup with 9 months of his demise. Want the three children to then start receiving 33% tax free distributions from the CST based on their life expectancy. Maybe this is a matter of just working with the financial custodian to make sure we structure beneficiary language correctly to allow this to occur.

Sure do appreciate your assistance!!!!!!!!!!!!!!!!!!!!!!!

[Guest EAS]

I would agree with you. If the wife does not know exaclty how much she plans to disclaim after inheriting her husband's ROTH, then for now she should be set up as 100% Primary Beneficiary, and the "CST" (is this considered a "living trust"?) as the contigent Beneficiary.

Now in this situation when the husband dies 100% will go the spouse. At that point the spouse can disclaim how ever much she wants, and what she disclaims will automatically go to an inherited ROTH set up under the name and TAX ID of the CST. The distributions that will be taken from the Beneficiary ROTH in the name of CST will be based upon the life expectancy of the oldest beneficiary within the CST.

Another option (but as you indicated check with the custodian first) after the spouse disclaims what she wants would be to set up three separate beneficairy ROTH's all still in the name of the CST and using the CST Tax ID. In this case each of the three children (beneficiaries listed within the CST) will have their own beneficiary accounts, and in this case can take out distributions from their own Beneficiary ROTH. But remeber even though there would be three seperate Beneficiary ROTHs accounts they would all be registered exactly the same way and reflect the name and tax ID of the CST (for tax purposes). I do not believe this would be creating "separate accounts" (pub. 590 pg. 36) where each child has a Beneficiary ROTH set up under their own name and SS#.

I have seen custodians separate a trust listed as a beneficiary into separate beneficiary accounts (all still registered to the trust all using the tax ID of the trust) for each of the beneficaries listed within the trust itself. Any distribution from any of these accounts will reflect for tax purposes under name and TAX ID of Trust. You usually see this done if the beneficaries within the trust do not get along and want to control their portion of the inherited assets in a separate beneficiary account.

Hopefully this helps

[Guest DAW]

Helps tremendously. Yes, this is a ABC Revocable Living Trust. Given that, the contingent beneficiary could be the Trust (Johnson Family Trust Dated 1-15-2001), we wouldn't have to name the CST (B Trust) until demise. As I understand it, don't really have the pertinant data until a death to properly apply for the TIN for the CST, so naming the Trust in my mind should be sufficient until a death occurs.

Again, your opinion is very welcome.

By the way, my responsibilities as a financial planner involve a lot of these CST decisions and the ramifications of transferring/funding life insurance, annuities, and IRAs to the B or C (QTIP) Trusts. Hope you are OK with my getting some feedback from time-to-time. I/my company has clients throughout the Midwest and Eastern States, and maybe we can even develop a consulting basis fee once we get down the road a bit.

[Mary Kay Foss]

You asked if the Bypass Trust can be named as a beneficiary if it doesn't exist as of the date of death. In defining a *qualified trust* (aka see-through trust) for IRA stretch out purposes, a trust that is legal can be unfunded and still qualify.

I often see people name the Family trust (which will be split upon the first death) as the contingenet beneficiary. Some others that want to be more specific will name as a contingent beneficiary "the Bypass trust to be created from the X Family Trust..." as the beneficiary.

When a Bypass Trust is the beneficiary of a traditional IRA we worry about the stretch out to minimize income taxes payable by the trust. With the Roth IRA, the income taxes are not a factor but if you qualify as a see-through trust you will maximize the time period that the Roth can grow tax-free.

[Guest DAW]

Appreciate your information. I think the Family Trust as the contingent beneficiary to the Roth is the route I'm going to go. With that scenario if the primary (wife) so decides, she can disclaim all or a portion of her share to fund the Bypass Trust (CST). If in fact we do fund the CST, the estate I'm working with will mostly be comprised of qualified funds, since qualified money are 75% of the overall estate.

Am I correct in feeling that the Roth is a much better vehcile in the CRT for tax and distribution reasons? I've used the Brentmark Pension/Roth Analyzer and it makes a very compelling case for the Traditional IRA to Roth conversion. When I bring in the logic of funding the CST, I think it is a "no brainer."

What am I overlooking or issues that might throw a wrench in this plan?

Not being a CPA or Attorney, I'm grateful for your opinion and knowledge.

Thank You!!!!!!!!!

[Mary Kay Foss]

The Roth is by far the better vehicle for funding the CST. The only difficulty with the Roth is the income tax burden up front. Clients are reluctant to convert so much that they will acheive a higher income tax bracket in that one year that in any future years. It could be that only $50-60,000 a year in conversion will keep them within a reasonable tax bracket.

In 2005 when RMDs are not considered in determining if a couple has less than 100k in Modified Adjusted Gross Income for Roth conversion purposes there should be many more conversions.

[mbozek]

Whether the Roth conversion is advantageous depends the clients age and marginal tax bracket on the date of the conversion since the amount of after tax income used to pay the taxes will result in lost investment income. Example: If taxpayer is in 25% bracket then 40k conversion to Roth will result in loss of 10k of income for future investment. If taxpayer is 50 years old 10k would compound to 32k in lost income over 20 years assuming an AT return of 6%. In other words conversion to a Roth account will result in lost investment income on the funds used to pay taxes which will cancel out the advantage of having non taxable income on the Roth account.