Building the Modern-Day Stretch IRA: Proceed With Caution

While most advisors and clients were always aware that the benefits of an IRA could be “stretched” over future generations, the Supreme Court’s recent finding that nonspousal inherited IRAs do not qualify as protected retirement assets has generated renewed interest in how to properly structure the IRA as a wealth transfer vehicle.

The easy answer has been to name a trust as IRA beneficiary in order to secure the asset protection benefits that can now otherwise be eliminated upon inheritance, but this strategy can create complexities that are often overlooked. In fact, one misstep can eliminate the benefits of the stretch IRA entirely—making this one area where competent guidance is essential to avoiding the pitfalls that abound and ensuring that the value of the stretch IRA is maximized for the next generation.

See-Through Trust Protection

A see-through trust (also referred to as a “look-through trust”) is one that meets certain IRS requirements so that the IRS will “look through” the trust and treat the individual trust beneficiaries as the IRA’s designated beneficiaries for purposes of determining the timing of required distributions after the original IRA owner’s death.

Generally, if IRA proceeds pass to a trust beneficiary that does not qualify as a see-through trust, the IRS prohibits the “stretch” treatment that would allow an individual designated beneficiary to take distributions from the inherited IRA based on his life expectancy. Instead, the nonqualifying trust is required to exhaust the account assets over a five-year period if the original owner had not begun taking required minimum distributions (RMDs). If the original owner had already begun taking RMDs, the IRA assets may be distributed over the remaining life expectancy of the original owner.

In either case, if the trust does not qualify as a see-through trust, the trust beneficiaries will typically be required to exhaust the inherited IRA assets more rapidly than if no trust intermediary was used. Trusts that do qualify as see-through trusts, however, are permitted to stretch IRA distributions over the life expectancy of the oldest trust beneficiary.

In order to qualify as a see-through trust, the trust must satisfy the four basic requirements imposed under the Treasury regulations: the trust must be valid under state law, the trust must be irrevocable (or must become irrevocable upon the death of the IRA owner), the trust beneficiaries must be identifiable as of the date of the IRA owner’s death, and a copy of the trust must be provided to the IRA custodian by October 31 of the year after the IRA owner’s year of death.

Making the Most of a See-Through Trust

Simply achieving see-through trust status does not eliminate all planning concerns in using a trust as IRA beneficiary. The IRA account owner must also consider whether he will require the trust to distribute all of the RMDs to the trust beneficiaries immediately (a “conduit” trust), or whether the trust will be permitted to accumulate assets over time for future distribution (an “accumulation” trust).