The IRS began pulling your strings in 1974 when the United States Congress established traditional IRAs in section 219 of the Internal Revenue Code. Added Pub. L. 93–406, title II, § 2002 (a)(1), Sept. 2, 1974, 88 Stat. 958. Congress sought to encourage individuals to save for retirement. Saving for retirement using a traditional IRA has advantages and disadvantages. The advantages are generally deducting a certain amount from yearly taxable income. Traditional IRAs give individuals an incentive to save for retirement by allowing a tax deduction for the amount set aside and deferred taxes which allow the amount to grow tax free. The disadvantages are generally that the IRS wants to tax someone, someday on the amount distributed from an IRA. You might want to talk to a Georgetown estate planning attorney, San Antonio estate planning attorney, or New Mexico estate planning attorney to discuss what the unintended side effects of your IRA will be on you or your beneficiaries.

Over the last ten years, I have seen clients and heard the problems that IRAs have had on estate planning goals, qualifying for government benefits to help pay the high cost of long term care, starting up a new business, and paying a decedent’s federal income taxes for the year of death on the final return. One of the most commonly neglected topics in estate planning is how much of an IRA is paid to federal income taxes when a beneficiary inherits an IRA and withdraws a large portion of the IRA.

Strings Attached to Inheriting IRA

Federal regulations pull your strings by allowing you to name beneficiaries to receive unspent IRA funds after the you pass away. Many beneficiaries take distributions much larger than the required minimum distributions, often consuming this “found money” in only a couple of years. Once the beneficiary spends this “found money,” the beneficiary must report all the money spent as taxable income in the year that it was spent. This is how the IRS collects federal income taxes on the once deducted retirement savings in the IRA.

One way to prevent a beneficiary from spending too much of the IRA all at once because of the “found money” phenomenon, is to name a trust as the beneficiary of your tax-qualified plans. Setting up a sophisticated stand-alone retirement trust will ensure that the beneficiary defers the income and that these assets remain protected from creditors or a former son or daughter-in-law. A stand-alone Retirement Trust (separate from your revocable living trust and other trusts) can help ensure that it accomplishes your objectives while also ensuring the maximum tax deferral permitted under the law. This trust can either pay out the required minimum distribution to the beneficiary or it can accumulate these distributions and pay out trust assets pursuant to the standard you set in advance (e.g., for higher education, etc.) Naming a trust as a beneficiary is done to gain control over distributions, to asset protect proceeds, to allow for alternative beneficiary planning in the event of the death of a beneficiary or a disclaimer, and for other non-tax reasons. Setting up a Retirement Trust accomplishes non-tax related goals and helps to reduce federal income tax liability for beneficiaries. Tax reasons include continuation of an opportunity for tax-deferred growth.

A Retirement Trust is designed to provide opportunities for tax-deferred growth, consistent with the Internal Revenue Code and Regulations that can also provide asset protection or beneficial enjoyment guidelines. The key to accomplishing optimal tax-deferral is that the trust qualifies as a designated beneficiary, meaning that a life expectancy can be used as a measure for required minimum distributions. The smaller the required distribution to a beneficiary, the less assets subject to current income tax, the more assets that remain growing tax-deferred. Of course, a beneficiary (or the Trustee) may take larger distributions than required but should only do so after looking at the cost of the possible tax liability. In addition to calculating the cost of a possible tax liability, Georgetown Medicaid attorneys, San Antonio Medicaid attorneys, and New Mexico Medicaid attorneys should advise their clients about the shocking truth that some IRAs are not countable for Medicaid applicants.

Fiduciary administration of the conduit or accumulation trust. In a conduit retirement trust, the fiduciary would likely have the discretion to decide how the distributable year income would be spent. In an accumulation retirement trust, the fiduciary would likely have the discretion to decide whether, to distribute annual mandatory required distributions, and if so, how to spend the distributed income. Determining how, whether, and when to distribute IRA assets to beneficiaries is one of the many side effects of IRA regulations.

Strings Attached to Saving Certain IRAs and Qualifying for Nursing Home Medicaid

In one way, the tangled strings give chronically ill and disabled nursing home patients an advantage. The shocking truth is that certain IRAs are not currently countable resources by Texas Health and Human Services Commission. Under the current regulations an institutionalized person applying for Medicaid benefits to help pay the high cost of extended, long term, nursing home care can save significant wealth through the proper strategic use of certain IRAs.

Purchasing certain IRAs will not always be an available strategy for tax-efficiently protecting and preserving assets for nursing home Medicaid applicants. This strategy is subject to change at a moment’s notice and should not be the only reason for investing in IRAs and we strongly recommend that you invest in IRAs only after consulting with your financial adviser. You should engage in Medicaid asset protection planning only with the advice and counsel of a Texas elder law attorney and the advice and counsel of a trusted financial adviser. IRAs can be useful for starting a new business just like IRAs can be useful for saving money if an individual applies for Medicaid to pay for nursing home care.

Strings Attached to Investing IRA in a New Business

When can I use an IRA to start a new business? IRS regulations allow individuals to rollover IRAs to start-up a new business. You must be careful because there are strings attached to this permitted strategy. The consequences for making mistakes when investing an IRA into a business are the entire balance of the IRA in question is treated as distributed to the participant and the account is no longer treated as an IRA account. Ellis v. Commissioner, TC Memo 2013- 245, TC Memo 2013-245. Peek v. Commissioner, 140 TC No. 12. Edward K. Zollars, CPA, Nichols Patrick CPE, Inc. In addition to the strings controlling a business owner’s use of his own IRA, there are strings attached to the duties and obligations an executor, personal representative, or trustee has.

Strings Attached to Administration of Estate or Trust

What are the executor’s, personal representative’s, or trustee’s obligations regarding traditional IRA minimum required distributions of the deceased person for the year of death? If the deceased person died before taking his or her minimum required distribution (hereafter referred to as MRD), the executor, personal representative, or trustee must distribute the MRD to a beneficiary in the year of the death. If the deceased person died after taking his or her MRD, the executor, personal representative, or trustee is not required to distribute the MRD in the year of death. The commencement date for the beneficiary could be as late as December 31st of the year following the deceased person’s death. Treas. Reg. 1.401(a)(9)-3, A-3. Once the Georgetown executor, San Antonio executor, or New Mexico personal representative determines when the commencement date is, he or she then should determine whether the distributions should be made outright, annually as part of a conduit retirement benefits trust, or distributed per his or her discretion as part of a retirement benefits accumulation trust.

Ask Your Attorney about Strings Attached to Beneficiaries, Business Investments, Nursing Home Medicaid Applicants, and Administration of Estates or Trusts

Talking through the issues and looking at the possible consequences with an attorney in Georgetown, Texas, San Antonio, Texas, and New Mexico is what a good steward would do. You should call, schedule a consultation, and decide whether we are the right law firm for you whether you are planning your last will and testament, your trust, your business start-up or business succession, or exercising your fiduciary duties as executor, personal representative or trustee.

Educational and Informational Only

This information does not constitute a legal opinion and does not constitute legal advice. Legal opinions and legal advice can only be given after a qualified attorney has reviewed your specific facts and circumstances, has analyzed the current law and applicable regulations, and has applied the law to your unique case. Marquardt Law Firm, P.C. provides this information only for those who know full well that relying on newsletters and internet information should not be the sole basis for saving for, spending, naming a beneficiary, transferring, or investing in IRAs.