Estate Planning for Tax-Deferred Investments


By Alexandra Smyser​

Next to the family home, IRAs often represent the bulk of a middle-class family’s wealth. It is no surprise that clients want to preserve balances in their retirement accounts for their families. Ironically, due to federal regulations, IRAs are some of the most difficult assets to plan for, so it’s incumbent on us to advise our clients on the various planning methods.

If a surviving spouse is named as beneficiary of an IRA, there are two options. Option one allows the spouse to roll over the IRA into his or her own name. The rollover allows the surviving spouse all the protections and privileges provided to the original owner. A straight rollover is perfect for the long-term married couple who are approximately the same age. The surviving spouse is considered the owner of the rollover plan, so any withdrawal before the age of 59 ½ will carry a penalty.

The second option would be to inherit the IRA as a non-spouse beneficiary would, which allows the beneficiary to take a required minimum distribution annually from the IRA and let the remainder grow tax-deferred. This option may be a better choice if the surviving spouse is younger and may want to access the funds in the IRA before she reaches 59 ½. There is no penalty (other than income tax owed) for taking out the annual distribution or a greater amount. The downside is that the full balance of the IRA is not growing tax deferred or the surviving spouse’s retirement.

Naming a surviving spouse as a primary beneficiary is wise as long as the couple is on the same page as to who should inherit the IRA after the surviving spouse passes away. However, if, for example, the original owner wants to secure the remainder for his children after the surviving spouse passes away, it may be prudent to provide the added protection of naming a trust as the beneficiary of the IRA.

If the original owner wants more control over the IRA asset, then the client should name the trust as the beneficiary of the IRA; however, disaster can result if the trust is not drafted properly. The stretch out only works if the trust qualifies as a “designated beneficiary” under the IRS code. This must be done with care.

Additionally, it is a wise decision to name a trust as the beneficiary if the beneficiary is a minor, a person with special needs or a spendthrift.

Clients should be aware that IRAs that are inherited by a non-spouse beneficiary are subject creditor’s claims and are NOT protected if the beneficiary files for bankruptcy. In recent years, practitioners have been developing trusts that are specifically designed to be a beneficiary of an IRA and to distribute the assets, all while preserving the tax benefits, providing creditor protection and controlling the distributions to beneficiaries.

A retirement trust, in addition to the traditional revocable living trust, is advisable for clients who have a significant amount of wealth in qualified plans and who want to provide for their beneficiaries with the maximum of protection from creditors, and for underage or irresponsible beneficiaries.

This story is part of a 30-day series on wealth management strategies.

Alexandra Smyser is an Associate Attorney at Schweitzer Law Partners in Pasadena, Calif. She handles all areas of estate planning including trusts, wills, probates, general and limited conservatorships, and special needs trusts.