In my last article, I discussed some things to consider as you decide about giving in retirement. I touched on leaving a legacy (inheritance) as a form of giving and discussed it (biblically) relative to spending and giving. However, I didn't detail the mechanics of doing so, should that be your desire.
As I mentioned in that article, many people will want to leave a financial legacy for their family, church, or other organization such as a para-church ministry.
This article will focus on the major legal and tax considerations involved when conveying financial assets to families, which may also partially apply to gifts to organizations. (For those interested, I may do an article about charitable annuities, advisor-managed giver accounts, and charitable remainder trusts in the future. But I need to do a lot more research in that area.)
I'll mainly be talking about IRA financial assets (where most retirement savings are kept). However, other assets, such as homes, cars, land, businesses, and other types of personal possessions and financial assets, can come into play. These are not addressed specifically in this article but could be included as part of your residual assets that you could bequeath via either a will or a trust.
As with anything of such importance, you would be wise to consult with estate planning professionals before deciding and committing to one conveyance method over another.
A personal concern
When our children were younger, my wife and I set up a Revocable Living Trust to ensure that they would be taken care of in the unlikely event we both were to die before they were grown. The trust would have been mostly funded via term-life insurance proceeds (I had a personal policy and one through my employer) and, to a lesser extent, by financial assets such as our home equity, 401(k), and IRAs.
Our kids are now grown, and when we reevaluated our situation a few years ago, we didn't see a compelling need for a trust as we no longer needed to name guardians for our children or decide what to do with life insurance proceeds. As I wrote in an article titled "Estate Planning and Your Will," we revoked the trust and set up everything in a simple will. (Although it's a little dated, I would encourage you to read that article before this one if you haven't already.)
We recently needed to update our wills and wondered whether we should reconsider the trust question. We no longer have any term life insurance, but we have IRA savings and a paid-for house, and some of those assets may be available as a bequest once we're gone.
The emphasis is on may be since one or both of us may live another 20-plus years, and a lot can happen in that much time that we can't anticipate (Prov. 27:1).
We thought a trust would give us more "control," especially now that we have a handful of grandchildren and perhaps offer tax benefits to our heirs.
In this article, I'll tell you what I learned about inherited IRAs, taxes, and other things that could apply to our situation and why. But keep in mind that what applies and makes sense for us may not be right for you. That's why it's a good idea to do your homework and consult with a financial planner/advisor and estate/tax planning attorney if necessary (especially if you have a complex financial situation).
It's wise to plan
Having an estate plan is wise—think of it as "stewardship of your estate."
Why is estate planning wise? Because if you ignore it altogether, you run the risk of negatively impacting your surviving spouse's lifestyle (and others who are dependent on you), and you may lose the ability to direct what should happen to your assets when you die. It's something you should not set aside or postpone if you want to be a responsible spouse, parent, or grandparent.
Having an estate plan can help accelerate the probate and estate settlement process. Probate is a necessary legal process as it can protect the deceased's interests and their families when the deceased does not have a written plan.
If the deceased leaves behind a last will and testament, it's then submitted to the probate court so that the court can name (or verify) the executor and then ensure that the deceased's last wishes are fulfilled.
There is ample biblical wisdom in the form of principles that support the need for estate planning and provide guidance on how to go about it:
We must first remember that God has staked his claim as the owner of everything (Lev. 25:23; Dt.10:14; Ps 50:11; Hag.2:8). God created all things and retained ownership of all he has made. He owns them for his good pleasure, so anything we possess has been entrusted to us by God, which includes any residual assets we leave at our passing. Therefore, we as stewards have a responsibility to have a plan for distributing the assets he has entrusted to us according to his Word and the guidance and leading he gives to us.
We are responsible for those who are dependent on us (1 Tim. 5:8). That's more applicable to parents with young children and less of a factor when it comes to adult children (who are, hopefully, independent) and grandchildren (who are dependent on their parents until they're grown). But this is not to say that we can't (or shouldn't) assist them financially in certain ways as an expression of love and care.
Leaving a financial legacy is not a commandment but can be virtuous (Prov. 13:22; Prov. 13:11; Prov. 20:21; ). The Bible does not require you to leave an inheritance. However, leaving an inheritance to your children or grandchildren and churches and other ministries can be virtuous if it helps them in constructive ways. But if they have not proven to be wise stewards of what they already have, it may do them more harm than good.
The ultimate motivation for all giving, even in death, is love (1 Cor. 13; 1 John 4:19). Because of the love of God toward us, we love our families, our churches, and others. We also desire to see God's Kingdom expanded for his glory and the benefit of the poor and oppressed. People are always more important than dollars, so a goal of our giving by leaving an inheritance is to express the love of God toward others.
The main concerns
People who use trusts as an estate-planning solution tend to be most concerned about the following:
1) Guardianship and provision for children
This is an important consideration for younger couples. Retirees may not have this concern unless they are caring for an adult child with special needs. In that case, a Special Needs Trust may be a wise choice.
2) Avoiding probate
Wills have to be submitted for probate and can be contested. However, probate isn't a huge issue except in cases of no will or if a will is being contested. The main problem is that it can take a while, which delays the beneficiaries' receipt of their inheritance even with a verified will. Meanwhile, the assets (IRA accounts, house, cars, other belongings, etc.) have to be looked after.
Trusts reduce or eliminate the need for probate if all assets are held in the trust as they are not part of your "probateable" (is that a word?) estate upon your death. But in states with simple probate laws, trusts can be an overly expensive and complex solution.
A better answer may be to use financial account beneficiary designations and Transfer on Death (TOD) or Payable on Death (POD) provisions, depending on what types of accounts you have. You can use them to arrange for certain accounts to go immediately to heirs without any need for probate.
Some good examples are that my wife was the designated primary beneficiary of my term-life insurance and is now the designated primary beneficiary of my IRA (our other accounts are jointly held). As such, they would automatically pass to her upon my death.
3) Minimizing taxes
This isn't necessarily a big deal regarding estate taxes, at least not in many states. My state (NC) repealed its estate tax laws in 2013. There is still a Federal Estate Tax, but in 2021, it only applies to estates valued at $11.7 million or more for an individual, and it doubles to $23.4 million for a couple. It won't be a concern for the vast majority of people, including my wife and me.
Income taxes are a more common concern for, as we shall see, what you do with taxable-upon-withdrawal assets like a Traditional IRA can have big tax implications to your heirs.
4) Management of assets
This is where trusts can provide a big benefit. A will can't hold any assets, but it can name beneficiaries and amounts. However, assets can be placed in a trust and professionally managed (for a fee) for an extended period. You can simultaneously use it to manage distributions from the trust to designated beneficiaries.
5) Controlling distribution of assets
This is another benefit of a trust, especially if there is a desire to do it over time (and under certain conditions) to heirs such as children, grandchildren, or an organization (such as a church or ministry). This can be a wise way to extend your stewardship of the resources God entrusted to you after you're gone. You may not want to give a large financial gift to a wayward grandchild who may squander it like the prodigal son did (Luke 15:11–31).
It's the last two categories that my wife and I have been most focused on. Should we set up a trust to hold, manage, and distribute whatever residual assets we have after we're both gone, or is a simple will sufficient for that purpose?
We'll return to the asset management and distribution question shortly. But first, let's look at the matter of income taxes, specifically, the tax laws governing the distribution of taxable IRA assets to beneficiaries.
In the 2016 article, I included a section about Stretch IRAs. I bring this up because (surprise, surprise) the congress and IRS have changed the rules.
Under the old Stretch IRA provisions of the tax code, a non-spouse beneficiary (such as a child or grandchild) who inherited an IRA had to take required minimum distributions (RMDs) over their remaining life expectancy. The younger they were, the less they had to take each year and pay taxes on, and consequently, the more money left in the Stretch IRA account to continue to grow tax-deferred.
The main benefits were that the money could stay longer in the account, and the Stretch provision was a fairly generous tax treatment of an inherited IRA.
But the rules changed when the SECURE Act was enacted in late 2019—there are now two sets of rules. The ones that will apply depend on 1) the age of the original IRA account owner at their passing and 2) the relationship of the listed beneficiaries to the original owner.
For an owner who passes after December 31, 2019 (which would apply to me since I am, obviously, still alive), the new rules apply if the beneficiary isn't an "eligible beneficiary" as defined by the IRS. Eligible beneficiaries include:
- my spouse (got one—for 49 years and counting!)
- a minor child (I currently have none—they're both grown)
- a disabled or chronically ill beneficiary (none)
- a beneficiary who is not more than ten years younger than me (I have grandchildren, but they aren't that old, nor could they be, LOL)
So, in my case, my only "eligible" beneficiary is my wife. Therefore, if I should predecease her (God is sovereign, but it is a statistical probability), the old rules (as described above) apply. That means that she can continue to invest the account on a tax-deferred basis for the remainder of her life like it was her own. She will still be required to take normal RMDs, but the tax consequences are less than if she were an ineligible beneficiary under the new rules.
But the new rules aren't as favorable to any ineligible beneficiaries.
Since neither my adult children nor grandchildren would be eligible beneficiaries, they would also be under the new rules. Consequently, if they inherit assets from the IRA account after my wife and I are gone, it must be completely distributed (withdrawn and all the taxes paid) within ten years.
Most financial professionals interpreted the Secure Act to mean that distributions don't have to be even. For example, an heir could take little or no distributions for five years and then liquidate the account fully over the next five years. However, recent guidance from the IRS in Pub 509-B interprets the new law differently. It says that non-eligible beneficiaries must take a distribution in each of the ten years following the IRA owner's death. But they may have done this in error, so look for further clarification in the future.
In either case, you can see what the IRS is up to. Once the original IRA owner is gone, the rate at which the taxes are paid on the residual assets is accelerated versus the old rule, which allowed beneficiaries to spread them out much longer.
In our situation, which would be similar to many couples our age, our children and grandchildren will be considered ineligible beneficiaries under the new rules. Further, they are what the IRS calls "successor beneficiaries" if they inherit IRA assets from my wife or me before the account has been fully distributed.
As already noted, based on the new rules, successor beneficiaries will have to take distributions over ten years. Still, it will be a new 10-year period beginning with either my or my wife's death (whichever was the original beneficiary) rather than the date of the original owner's death, which is me.
To trust or not to trust?
This brings us back to the original question: Is there any benefit, then, to making a trust the beneficiary of an IRA instead of children and grandchildren? Does the new law or IRS rules make a big difference?
What if, instead of naming beneficiaries in my will, I name a trust the beneficiary with instructions on how much to distribute to each designated (ineligible) beneficiary and under what conditions? (That is, after all, one of the most significant benefits of a trust—the ability to control asset distributions to beneficiaries out into the future.)
A trust as beneficiary
The beneficiary of an IRA can be a person or entity (such as a charitable organization) of the IRA owner's choosing. However, a trust can't technically be a "designated beneficiary" in the same way an individual or entity can, so the trust's beneficiaries are used to determine how distributions will be taxed and not the trust itself.
A trust that identifies specific beneficiaries to receive distributions from an IRA account is known as a "Conduit Trust." With this type of trust, it's almost as though the trust doesn't exist to determine the classification of the beneficiaries. Thus, the IRA is considered either eligible or ineligible beneficiaries, as described above. The respective rules apply based on the beneficiaries' classification (eligible or ineligible) and relationship to the original IRA owner.
There may be no clear tax advantages to naming a trust as the beneficiary, except that the trustee may optimize the tax implications to the beneficiaries by though timing and amounts distributed.
A trust to reduce estate taxes
Many people think the main reason to create a trust is to possibly reduce estate tax costs. The strategy is to move assets to an irrevocable trust (which effectively removes them from your taxable estate) while continuing to receive income from it for some number of years.
But when assets are transferred to a trust, taxes will be due, but they will be based on the trust's value at the time (rather than a potentially higher value later on). There are some variations of this, so setting things up this way will require the help of a tax accountant and an attorney. (As mentioned earlier, it won't be a factor unless your estate is very large.)
What to do?
Absent any compelling tax benefits, the main reason for us to create and then designate a trust as the beneficiary of the IRA would be to have more control over the distribution of the IRA assets after we are both gone. (This would also be true for any other financial and non-financial assets, such as houses and cars, as long as they are also held in the trust.)
This is where we put the focus back on wise stewardship. We wouldn't want a beneficiary to squander an inheritance (Prov. 20:21). Instead, we might prefer that the IRA assets be distributed on a set schedule and only under certain conditions (such as education expenses or to purchase a first home) instead of handing out lump-sum payments.
Although we have faith for our children and grandchildren, it's impossible to know the situation when they (the grandchildren) are grown.
On the other hand, both of our adult children are grown and have proven to be reasonably responsible managers of their affairs. Not perfect (none of us are), but we trust them.
Therefore, rather than take on the cost and complexity of setting up a trust, we could just update our will and entrust our adult children with the responsibility of distributing assets to their children as they see fit. If they want to give one child a distribution to pay tuition or pay off a student loan or some money to help them with a down payment on a first house, they would have the freedom to do that.
Of course, we can still make our wishes known in our will and associated documents, but it would be up to them to make wise decisions after we are both gone. Both in terms of how they use whatever residual assets they receive and how they share them with their children (as they would their other assets).
It's a lot to consider, so we're going to take our time deciding what the best route would be.
Consider these matters carefully and prayerfully. And, as always, since I'm not a licensed financial advisor or estate attorney, and nothing in this article should be taken as specific advice for your situation, you should consult with a professional on complex estate planning matters.
Also, a tax professional (such as a CPA) can help you more fully understand the advantages and disadvantages of different approaches from a tax-planning perspective.
And above all else, pray and seek godly wisdom for these decisions (Prov. 4:5–9).