by Vanessa Kanaga
I would like to start this post with a potentially controversial statement: When planning for qualified retirement plans and IRAs (which I will sometimes refer to as "retirement benefits"), achieving the longest "stretch-out" period for distributions is not always the most important goal. I know this may be met with a certain amount of deserved skepticism, but I hope you will bear with me, and allow me to state my case.
Planning for retirement benefits has become an increasing component of estate planning in recent years. Many clients now have sizable retirement plans that constitute a large portion (in some cases, a majority) of their assets. Given the significance of these assets, and the decreased importance of planning to avoid federal estate tax (due to the large exemption amount), it is not surprising that estate planners and their clients have shifted their focus to planning for retirement benefits.
A key component of planning for a client's retirement benefits is ensuring that the beneficiaries after the client's death are able to take distributions over the longest period permitted under the terms of the plan and the Internal Revenue Code (the "Code"). In general, returns on investment within a retirement plan are allowed to accumulate, income-tax free, while distributions from a retirement plan (with the exception of a Roth IRA) are taxed as ordinary income in the hands of the recipient. Accordingly, in purely economic terms, it is best to defer distribution from a retirement plan as long as possible.
If permitted by the terms of the retirement plan, a beneficiary may "stretch out" distributions over his or her life expectancy, but only if the beneficiary is a "designated beneficiary" as defined in the Code. If the beneficiary or beneficiaries will receive their interests in trust (as is often desirable, if not imperative), the trust must be structured so that there is a "designated beneficiary" within the meaning of the Regulations. This type of trust is often referred to as a "see-through" trust, and comes in two forms: a "conduit trust," in which all distributions from the retirement plan flow through the trust and are distributed immediately to the beneficiary; and an "accumulation trust," which allows distributions to be accumulated within the trust, provided the trust meets certain requirements, generally relating to the identity of the trust beneficiaries. (For an additional discussion of see-through trust requirements, see Natalie Choate's book, Life and Death Planning for Retirement Benefits, now available online at https://retirementbenefitsplanning.com/.)
Incorporating see-through trusts into an estate plan can effectively achieve a client's goal of protecting the family's inheritance by leaving assets in trust, while still allowing a stretch-out of retirement plan distributions. In many cases, see-through trusts will fit seamlessly into the estate plan, and will provide the best outcome for the beneficiaries. However, in some circumstances, the see-through trust requirements may prove detrimental to the over-all structure of the plan, and may produce a result that is contrary to the client's goals.
For example, if the client has a child with special needs, creating a conduit trust for that child may affect the child's eligibility for Medicaid or other forms of government assistance, due to the mandatory distributions required by a conduit trust. This could result in a substantial loss of assistance otherwise available to the child, the value of which may exceed the benefit of stretching out the plan distributions over the child's life expectancy. Conduit trusts can create similar difficulties if the beneficiary has creditor problems.
As an alternative, the beneficiary's share may be placed in an "accumulation trust," which does not require distributions to the beneficiary, but still allows for the plan distributions to be stretched over the beneficiary's life expectancy. However, in order to achieve the longest stretch-out period possible, no potential beneficiary may be older than the primary beneficiary. This could result in a distribution contrary to the client's wishes if, for example, the primary beneficiary is survived only by his or her older sibling. In that case, the older sibling will be excluded as a remainder beneficiary of the trust. Furthermore, depending on the terms of the trust, it may not be possible to determine the remainder beneficiaries.
In order to avoid this scenario, some planners may require distribution of the trust assets to the beneficiary, outright, if at any time there are no potential remainder beneficiaries living. This may help to ensure that the trust qualifies for see-through trust treatment, and achieves the longest stretch-out for distribution of plan benefits. However, it could have disastrous consequences for a beneficiary with special needs or creditor issues, as described above.
In some cases, it may be possible to reach a happy medium, and obtain the longest stretch-out that is still consistent with the over-all estate plan. For example, the accumulation trust provisions in InterActive Legal are structured to obtain the stretch-out over the life expectancy of the oldest individual beneficiary of the client's estate plan. This may not achieve the longest stretch-out period possible with respect to each beneficiary, but it seeks to maximize the stretch-out while still achieving the client's goal of keeping assets in trust for his or her family.
Planning to maximize the potential of a client's retirement benefits is a worthy endeavor, and shows forethought on the part of the estate planner. However, in planning to achieve the longest stretch-out period for retirement plan distributions, it is important not to lose sight of the end goal. The maximum stretch-out may not be worthwhile if it stretches the over-all estate plan to the point of breaking.