Financial advisors can generate new business and fees by focusing on IRA trusts

Financial advisors can generate new business and fees by focusing on IRA trusts

Now that big financial institutions are advertising zero-fee services, financial advisors need to justify their charges more than ever. One of the best ways to do this is to offer advice and guidance that simply isn’t available elsewhere. One of the biggest opportunities — for generating new fees and new business — is in the area of IRA trusts.

This is where the big retirement account money is. Clients with the largest IRAs are the ones most likely to name a trust. These clients want that money protected for their heirs — and sometimes from their heirs.

Don’t assume only lawyers need this expertise. Yes, I understand you are probably not an attorney and cannot give legal advice. Neither am I. But you are a financial planner who can identify big money areas where clients’ assets are at risk. You can possibly save clients a fortune in excessive and unnecessary taxes, IRS fees, court costs and pricey legal disputes among family members.

While attorneys may be the ones who draft these trusts, they are often never followed up on once the client leaves the attorney’s office. These documents generally only surface after death, but by then many planning options or corrections are off the table and the legal and tax problems begin.

This is where financial planners can step up and provide real value.

2018 brought us reminders of how valuable and needed these services are. There were several Tax Court cases and IRS rulings on IRA trusts with decisions focusing on bankruptcy creditor protection and IRA trust beneficiary planning.

In several recent cases, the courts ruled that inherited IRAs are not protected in bankruptcy. This worries clients who worked a lifetime accumulating these funds and don’t want the money lost when inherited by their children. The IRAs now being inherited are often in the hundreds of thousands or millions of dollars. There’s a lot at stake.

Advisors could suggest that a trust be named as the IRA beneficiary for children who may have financial problems, divorce issues or other lawsuits. A trust can also be used to shield a surviving spouse from financial predators or even the monetary risks of a future marriage. Some beneficiaries may need extra protection and guidance, such as those who are still minors, are disabled or are unsophisticated in financial matters. The biggest reason for naming a trust as the IRA beneficiary is post-death protection and control.

An IRA trust is not a “set it and forget it” affair. Financial planners can review the trust periodically to make sure everything still fits the client’s current situation. Future expensive tax and legal problems can generally then be averted with quick and easy fixes.

Within the last few months, the IRS released two private letter rulings where poor IRA trust planning needed to be undone after death. These cases show how difficult this can be.

First, a PLR is an expensive and time-consuming way to fix an oversight. The cost of these PLRs, including IRS and professional fees, can easily exceed $20,000. The average wait is six to nine months.

PLR 201844004 was the latest of many rulings where a trust was the IRA beneficiary but this wasn’t what the surviving spouse wanted. In this case, the spouse wanted to do a spousal rollover. But since the trust was the named beneficiary, the spouse couldn’t get that done without requesting a PLR.

The IRS granted the PLR request (as it often does) and allowed the surviving spouse to roll over inherited IRA assets to her own IRA as a spousal rollover. The IRS ruled that the surviving spouse will be treated as having acquired her deceased husband’s IRA directly from the decedent and not from the trust that the IRA assets passed through.

Because the deceased IRA owner’s surviving spouse was “the sole trustee of the trust” and had the sole right to amend or revoke the trust and to distribute all income and the entire corpus for her own benefit, the IRA funds essentially belonged to her.

But a spousal rollover could have been easily accomplished in advance by reviewing the beneficiary form and changing the beneficiary from the trust to the spouse. This could have been done in a few minutes and at probably little or no cost. This is a service that every advisor should provide — and charge for.

In addition, a contingent beneficiary should always be named on the IRA beneficiary form, even if the trust is the primary beneficiary.

In this particular case, if there was any doubt about leaving the IRA directly to the spouse, the client could have still named the trust as primary beneficiary and named the spouse as contingent. Then, if after death, the spouse no longer needed or wanted the trust (as is often the case) the spouse as sole trustee of the trust could have disclaimed the trust as the beneficiary and then the funds would pass directly to her. This would allow the spousal rollover without the need for a PLR from the IRS.

In PLR 201840007, a poorly drafted trust required some major post-death altering. Here, the IRS approved the stretch payout to discretionary trust beneficiaries after they executed a release limiting their own ability to name successor beneficiaries. This case serves as an important reminder of how successor, or remainder, beneficiaries in a trust can impact eligibility for stretch payments when that trust is the beneficiary of an IRA or qualified plan.

The original taxpayer was a participant in a workplace 401(k) plan. He created an irrevocable discretionary living trust and named it as the beneficiary of his 401(k) account. When he died, he was survived by five children. Since PLRs do not provide details, we’ll call them Chase, Danielle, Eric, Frank and Gina. The trust itself was rather complicated. Upon the taxpayer’s death, the trust split into six separate discretionary trusts, two each for Chase, Danielle and Eric.

A discretionary trust is one where a trustee can determine access to funds. In addition, the trust also prohibited Chase, Danielle and Eric from naming their own beneficiaries until they reached age 30. Instead, the trust named Frank and Gina as the remainder beneficiaries for each of the discretionary trusts. However, after reaching age 30, Chase, Danielle and Eric were free to name any beneficiary they wanted, including a charity, estate or even a creditor! That alone should have sent up a red flag. A trust is set up for the beneficiaries, not for creditors. In addition, the possibility of a charity or an estate being named as a trust beneficiary would mean the loss of the stretch IRA because these are not individuals and have no life expectancy. A knowledgeable financial advisor might have picked this up.

It appears that after death, someone did let these beneficiaries know that this trust would not work. It would not qualify for a stretch IRA through a “see-through trust” because there was no designated beneficiary.

Being advised on this, these three beneficiaries convened on or before Sept. 30 of the year after the original taxpayer died. The timing is important because that is the deadline to determine the designated beneficiary for an inherited IRA. At this meeting, they each executed a release which limited their ability to name a successor beneficiary. Under the terms of the release, they could only name a successor beneficiary that was (A) a natural person, and (B) younger than Chase. That’s important because among these three beneficiaries, Chase was the oldest and thus had the shortest life expectancy.

Even after securing the release, the beneficiaries still needed the blessing of the IRS so they had to request this PLR. The IRS issued a favorable ruling. First, the IRS explained that since the beneficiary trusts were discretionary, it was necessary to look at the life expectancies of any potential remainder beneficiaries. Under these instruments, there was no requirement that the 401(k) assets be paid out during the life of the primary beneficiary. Therefore, that leaves a real possibility that remainder beneficiaries will inherit the retirement plan money.

This is where the release becomes important. Under the Tax Code, a beneficiary group that can contract or expand is treated as identifiable (and therefore entitled to the stretch) as long as it is possible to identify the class member with the shortest life expectancy. The release Chase, Danielle and Eric executed not only removed potential non-designated beneficiaries (i.e., charity, estate or creditors), but it also solidified Chase as the oldest beneficiary. As a result, the IRS held that the trust beneficiaries can be considered designated beneficiaries entitled to post-death RMDs based on Chase’s life expectancy.

Since the IRS concluded that the trust beneficiaries were designated beneficiaries, they were also eligible to rollover the 401(k) assets to inherited IRAs. Therefore, the direct transfers into inherited IRAs controlled by the trust would not result in taxable income to the trust.

While the outcome ended up favorable, it was still expensive, time-consuming and, most likely, stressful for the family. They may certainly have wondered why this was so poorly handled.

If a knowledgeable financial advisor checked this trust ahead of time, the provision allowing the beneficiaries to name a charity or a creditor of the estate as beneficiary would have stood out and could have been more efficiently corrected. In fact, the beneficiary form could have easily been changed to name the children as direct beneficiaries. Or, if the trust was still needed, a new trust containing the proper provisions could have been done.

Financial planners should identify every client who has named a trust as their IRA beneficiary and check that it is still the right choice and that the trust contains the right provisions for the client. Also check that the trust is actually named on the IRA beneficiary form and that a contingent beneficiary is also named. This leaves post-death planning options open.

And yes, this means knowing the IRA trust rules, but that is where your enhanced value lies.

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