IRA Designated Beneficiary Trust (“IRA DBT”)
IRA DBT Advanced Planning Overview
The IRA DBT is a Trust that is arranged specifically for IRAs/Retirement plans and is separate and apart from your revocable living trust. The key to this arrangement is that the IRA DBT, rather than an individual, is designated as the IRA beneficiary. The two main purposes of setting up the IRA DBT is to take full advantage of the “stretch” IRA rules to minimize taxes, and to protect the IRA funds from creditors of beneficiaries.
Maximizing the IRA Funds and Minimizing Taxes
This trust is specifically designed as a recipient of IRA funds to be distributed to the trust beneficiaries with extended life expectancies.
If you were to name your revocable living trust as your IRA beneficiary, and the trustee is required to immediately distribute all IRA funds received by the qualifying revocable trust, it is considered to be a “Conduit” Trust. As a result, only the life expectancies of the primary beneficiaries are taken into consideration regarding the shortest life expectancy issue and the amounts that are distributed from the trust. However, if the Trustee is given the authority to accumulate IRA funds, all potential beneficiaries are taken into consideration. This would include the primary, contingent and any beneficiaries who could be designated through the exercise of powers of appointment by a beneficiary in the revocable living trust. This could result in a drastic reduction in the period of distribution and, consequently, loss of IRA funds to taxes upon withdrawal.
Instead, the IRA DBT includes separate sub-trusts for each beneficiary of the IRA. Your beneficiary form with your IRA or qualified retirement plan custodian would then nominate the individual sub-trusts within the IRA DBT as the IRA beneficiaries in the proportion you see fit. This, of course, benefits a younger beneficiary who is, as a result of establishing the IRA DBT, not subject to the shorter life expectancy of an older beneficiary. An IRA owner cannot do this with a revocable living trust.
Importantly, the IRA DBT provides another advantage to your estate plan: asset protection.
Advanced Planning and Creditor Protection
In 2014, the U.S. Supreme Court held that inherited IRAs are no longer protected or exempt from creditors of the IRA beneficiary or beneficiaries. So what is an Inherited IRA? These are IRAs inherited by non-spouse beneficiaries. Typically, spouses rollover IRAs and become the IRA owner if they are designated as the beneficiary. But non-spouse beneficiaries do not have that option.
If the IRA DBT beneficiaries were threatened by creditors or were required to file for bankruptcy, the Inherited IRA, payable to the IRA DBT, would be protected from those creditors. If your IRA or other qualified retirement plan beneficiaries are lacking in money management skills, have existing creditor issues or are likely to incur debts before your death, an IRA DBT is an excellent advanced planning asset protection strategy that will help your beneficiaries.
Irrevocable Life Insurance Trust (“ILIT”)
Currently, the Federal Estate Tax Exemption is set at $5.43 million dollars per person ($10.86 million for a married couple) and will increase with inflation each year. This means that if you do not have in excess of $5.43 million dollars at your death, you will not incur estate taxes. However, for those of you who have accumulated wealth in excess of this exemption amount, an ILIT can be used to finance your eventual estate tax bill and provided needed liquidity to your estate.
Without delving into the technical features, the ILIT is established to own an insurance policy on your life. The ILIT is irrevocable, thus, because the ILIT owns the policy, and you, as the insured, do not, the death benefit proceeds from the policy will not be included in your gross estate at your death. Consequently, the death benefit proceeds can be a fast source of liquid assets to pay the trustor’s last debts, expenses, and taxes, including estate taxes.
Any remaining portion of the death benefit from the life insurance policy, assuming all of the benefit was not used to pay your estate tax bill or other expenses, can be distributed to the named beneficiaries of the ILIT.
Qualified Personal Residence Trust (“QPRT”)
A QPRT is an irrevocable trust to which you transfer real property. The purpose of the trust is to remove the real estate from your taxable estate, but retain the right to occupy or enjoy the property for a defined period of time. By removing the property from your taxable estate, you decrease the value of your estate that may be subject to estate taxes. These trusts become particularly valuable when you have a property that is of a high dollar value or if the value of a property is appreciating rapidly.
At the conclusion of the time specified in the trust for the trustor to use and enjoy the property, the trust’s beneficiaries become the owners of the property. These trusts, and the funding of them, can be highly technical. To discuss whether your estate would benefit from such a trust, call our firm to schedule a consultation with advanced planning strategies.
A dynasty trust is another irrevocable trust that is used to benefit generations of family members free of estate and gift taxes. These trusts are typically reserved for families with wealth in excess of the Federal Estate Tax Exemption, or who anticipate the value of their estate to grow in excess of the exemption by the time they die.
The trustors make lifetime gifts to the Dynasty Trust of significant value. To avoid paying gift taxes at the time, the trustors use their annual gift tax exclusion amount, lifetime unified credit from estate taxes, and generation skipping transfer tax exemption to transfer property to the trust free of tax at the time of the gift. The trust is then administered over multiple generations, making distributions to children, grandchildren, and other lineal descendants as defined in the trust.
In California, there is a law called the Rule Against Perpetuities that prevents a trust from remaining open in perpetuity. Thus, the dynasty trust, if established under California law, will have to terminate at a specified future date. However, for wealthy families, these trusts can be utilized to achieve significant tax savings for your family for generations. Contact our firm to discuss whether you may benefit from a Dynasty Trusts and to learn more about advanced planning.