Part II: Naming an Accumulation Trust as the Beneficiary of an IRA

Last month we discussed the benefits of naming a Conduit Trust as the beneficiary of an IRA.  A Conduit Trust allows the IRA to remain tax deferred thereby stretching the Required Minimum Distributions over the lifetime of the trust’s beneficiary which could be a young child or grandchild.  The ability to continue tax-deferred growth over a long period is a key benefit.  As a Conduit Trust is also the named beneficiary, minor children who become beneficiaries will not require a guardianship proceeding.

However, while a Conduit Trust affords these advantages, there are some notable drawbacks.  First, a Conduit Trust requires that all Required Minimum Distributions be distributed immediately outright to the beneficiary.  In cases where the beneficiary is a spendthrift, is at risk for divorce or is in a litigious profession such as physicians, the forced distributions are left wide open and unprotected from creditor claims. Second, a Conduit Trust cannot withdraw retirement account proceeds and accumulate them inside the trust.

Accordingly, a second option is to name an “Accumulation Trust” as the beneficiary of the IRA.  An Accumulation Trust allows  to receive the Required Minimum Distributions and then use their ultimate discretion in making distributions.  This way, distributions from the IRA can be kept within the trust and accumulated rather than being immediately distributed to the beneficiary.  As such, the trust assets have added protection against creditors. This is especially helpful where the beneficiary is a spendthrift and protects against inexperience.

In drafting the trust, special attention must be paid to the governing provisions. Specifically, in order to be able to use the principal beneficiary’s life expectancy for Required Minimum Distribution calculations, the trust agreement must prohibit trust distributions to anyone who is older than the person whose life expectancy is used to calculate the Required Minimum Distributions.  This can be quite limiting as typically named contingent beneficiaries such as spouses or older siblings cannot be so designated.  The trust assets can never pass to any older sibling or relative which may be contrary to the owner’s wishes.  Perhaps equally limiting, only individuals can be beneficiaries which prevents one from designating a charity.  If any of these requirements is not satisfied, the trust will not qualify for stretching.  As such, an Accumulation Trust is probably useful only for certain, older, beneficiaries.

New Congressional Update:   Congress’ Senate Finance Committee recently proposed legislation eliminating the beneficial tax “stretch” and replacing it with a mandatory 5-year liquidation rule for non-spousal beneficiaries.  Under the proposed legislation, an inherited traditional IRA would have to be liquidated generally within 5 years of the original owner’s death.  It will be interesting to see whether any of this legislation is approved.  Stay tuned.

For more information or if you have any questions about estate planning and taxation, please contact Judson M. Stein, Chair of the Trusts & Estates Practice Group, at 973-230-2080 or or John A. Grey and Lauren M. Ahern, Associates in the Trusts & Estates Practice Group.

21st Century Cures Act Remedies Longstanding Special Needs Trust Issue

On December 13, 2016, President Obama signed the 21st Century Cures Act.  One of the more relevant aspects of the law to estate and special needs planning is found in Section 5007 of the Act, which is called “Fairness in Medicaid Supplemental Needs Trusts.”  The purpose of this section is to amend 42 U.S.C. Section 1396p d(4)(a) to add the words “the individual” to the list of persons who may establish a first party or self-settled special needs trust (SNT) for a disabled individual.

In 1993 Congress enacted the Omnibus Budget Reconciliation Act of 1993 (commonly referred to as OBRA 93).  As part of this larger Medicaid overhaul, 42 U.S.C. Section 1396p d(4)(a) was enacted which allowed a parent, grandparent, guardian or a Court to establish a first party, or self-settled, SNT for a disabled individual under the age of 65 to be funded with that individual’s own assets.  The self-settled SNT has since become an important estate planning tool by allowing disabled individuals to receive certain government assistance while still enjoying the benefit of their own assets to supplement their living expenses.  The tradeoff being that upon the death of the disabled individual or the termination of the trust, the benefits received during the disabled individual’s lifetime must be repaid from trust assets.  Curiously, though, the OBRA 93 language did not provide a mentally competent disabled person the ability to establish his or her own self-settled SNT.  This became particularly onerous when a disabled person had no parent or grandparent to establish such a trust for them, forcing them to petition a Court for approval of their SNT; a costly and time consuming process.

With the passing of the 21st Century Cures Act, however, this issue is rectified.  Now, disabled persons with the requisite mental capacity may establish their own self-settled SNTs without the need for assistance from other parties or Court approval.  It is important to note that the disabled individual must still be under the age of 65 when creating the trust and the trust must still contain a payback provision for government assistance.  Also, it is important to distinguish the self-settled SNT from the third party SNT, a different type of special needs trust which is established and entirely funded by a third party but exists for the benefit of a disabled individual.  These third party SNTs do not require a payback provision and are not affected by the new law.  Special Needs Trusts are an important and powerful tool when considering estate planning for the disabled or individuals with disabled beneficiaries.  Care should be taken to receive appropriate advice regarding the use of special needs trusts as part of a broad, comprehensive estate plan.

For more information or if you have any questions about estate planning and taxation, please contact Judson M. Stein, Chair of the Trusts & Estates Practice Group, at 973-230-2080 or or John A. Grey and Lauren M. Ahern, Associates in the Trusts & Estates Practice Group.