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Combine ILITs With IRA Trusts to Maximize Inherited IRA Benefits

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Estate planning for IRA assets can become a complicated business—in addition to maximizing the tax-preferred aspects of IRAs, clients are often torn in searching for ways to allow multiple beneficiaries to reap the benefits of these assets. 

While it may initially seem wise to name the surviving spouse as beneficiary, or funnel the account into a QTIP trust established for that spouse’s benefit, these strategies can have repercussions that will diminish the value of the IRA assets for the owner’s children after the death of the inheriting spouse.  On the other hand, in providing for the account owner’s children, advisors must remember that inherited IRAs are no longer entitled to the creditor protection benefits afforded to IRAs generally. 

To properly provide for both a surviving spouse and children, therefore, clients must seek out more innovative planning strategies—and combining an irrevocable life insurance trust with an IRA trust can provide a tax-savvy solution for clients looking to provide for both surviving spouses and children through the inherited IRA.

The Irrevocable Life Insurance Trust (ILIT)

An irrevocable life insurance trust (ILIT) is an irrevocable trust that is funded with life insurance (in this case, insurance on the life of the IRA account owner).  Rather than leaving an IRA to the client’s surviving spouse, the client can fund an ILIT for the benefit of that spouse—upon the account owner’s death, the life insurance policy proceeds are paid to the ILIT, which will provide income to the surviving spouse for his or her life.

As noted by Julius Giarmarco, Esq., partner and head of the Trusts & Estates practice group at Giarmarco, Mullins & Horton, P.C., “[t]he IRA owner can use his/her RMDs to pay the premiums by making cash gifts to the ILIT.”  This strategy essentially ensures that the surviving spouse is entitled to a portion of the IRA assets sufficient to provide income for his or her life, while allowing the remaining IRA assets to be stretched over the lifetime of the client’s children.

The remaining IRA assets themselves can be left directly to the children as designated beneficiaries, or to a trust established for the benefit of those children (as discussed below). 

Adding an IRA Trust

As most advisors are aware, late in 2014 the Supreme Court held that IRAs inherited by non-spouse beneficiaries do not qualify as protected retirement assets and, as such, are not entitled to traditional IRA creditor protection. 

(See Enhancing Creditor Protection of IRA Funds, and Building the Modern-Day Stretch IRA: Proceed With Caution.)

Because of this, clients looking to maximize the value of an inherited IRA for their children may wish to name a trust as beneficiary, and the children as beneficiaries of the trust—the trust vehicle can provide creditor protection, and can also allow the client to leave IRA assets to a minor beneficiary without an appointed guardian or conservator.

Assuming the trust qualifies as a “see through” or “look through” trust, 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. 

The IRA account owner must also decide whether to require the trust to distribute all of the RMDs to the trust beneficiaries immediately as they are received (a “conduit” trust), or whether the trust will be permitted to accumulate assets over time for future distribution (an “accumulation” trust).

With a conduit trust, the process of determining whose life expectancy will be used for calculating RMDs is simplified if there are contingent and successor beneficiaries, because the only relevant beneficiary for this purpose is the primary income beneficiary who receives the distributions immediately. In this case, the original IRA owner can name a younger beneficiary as income beneficiary in order to maximize the period over which the tax-deferral benefits of the IRA are stretched.

If the trust is permitted to accumulate RMDs, any contingent or successor beneficiaries must be considered in determining the oldest beneficiary because there is a possibility that the IRA funds will eventually be distributed to these remainder beneficiaries. Further, if an entity (rather than an individual) is named as a remainder beneficiary of an accumulation trust, the trust may lose its see-through status entirely because a non-individual beneficiary does not have a life expectancy for purposes of the RMD rules.

Further, using an accumulation trust will generally require that the funds be taxed at the trust’s tax rate, which reaches 39.6 percent if the trust earns $12,400 in 2016. Conversely, a conduit trust can minimize the tax liability because it pushes taxation to the individual level, where the tax rate does not reach 39.6 percent until a single taxpayer’s income reaches $414,050 in 2016.

However, the potential downside of using conduit trust to minimize taxes is that it eliminates the asset protection that an accumulation trust can provide, which may be the exact reason that a client is using a trust beneficiary in the first place.


Combining two trust vehicles—an ILIT and a see-through IRA trust—can provide the compromise solution that clients are seeking when attempting to split the benefit of inherited IRA assets between generations, while at the same time maximizing the value of these accounts and providing otherwise unavailable creditor protections. 

Originally published on Tax Facts Onlinethe premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.    

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