The Trust Lawyers Blog

Senior citizens and low-income taxpayers beware: there's a new tax refund scam making the rounds that has already been responsible for thousands of fraudulent tax returns.

If you have a significant amount of money in an IRA, you may be concerned about what happens to it when you die. Until recently, an IRA was simply cashed out within five years after death of the account-holder, incurring very large tax brackets in your estate. Further, the longer the IRA lasts, the more money it earns, so it's in the best interests of your family to keep your IRA around for as long as possible.

One solution to this is turning your IRA into a stretch IRA, and guaranteeing its long-term viability with an IRA stretch trust.

Before we get to the IRA stretch trust, however, we should define a stretch IRA. When an IRA is set up, you name a person as its beneficiary after your death, usually your spouse. Once this happens, they then name a new beneficiary, usually a child. At that point, they can either cash out the IRA, accepting the tax loss and receiving a large lump sum, or they can choose to stretch it out by only taking out the minimum yearly amount required by the IRS life expectancy tables to avoid excess accumulation penalties.

With the latter option, this becomes a “stretch” IRA, allowing the IRA to grow for decades. Later, once your spouse dies and your child inherits control of it, they have the same option. They can cash it out, taxes and all, or keep taking out the minimum amount for the length of their lifespan.  Plus, they can then name their own spouse or children as beneficiaries, and so on, continuing to stretch it over the course of generations.

The problem with this is, what if your child decides to take all the money at once rather than allowing it to grow? While they'd have this right, for your IRA to provide to generations to come, you'd need to prevent this. By designating a trust as the beneficiary for your stretch IRA, and providing detailed instructions to the trustee on how the money is to be paid out to your descendants, you can help prevent this sort of short-sighted action.

Creating an IRA stretch trust also can better shield it from many types of legal action, such as bankruptcy and divorce settlements, protections that may or may not be available with a personally-inherited IRA . Further, the trustee can still be allowed leeway to disperse more funds in the case of emergency or any other good reason.

Basically, by naming a properly drafted IRA stretch trust as beneficiary, you can guarantee that the money you earned and saved can be put to work for your family for generations to come. It can potentially pay out millions to future generations that it never could have otherwise.

If you have a large amount of wealth and are planning for the future of your estate, you probably want to ensure that the largest possible amount can pass to your descendants. Unfortunately, estate taxes can be punishingly high. Currently the top estate tax tier is 35%, and unless Congress acts soon, in 2013 that will rise to 55%. That's potentially over half of your wealth gone, before your family sees it. For those interested in avoiding this fate, dynasty trusts are a possible answer.

A dynasty trust is a form of irrevocable trust where the grantor (that's you and possibly your spouse) transfers a large portion of wealth into a trust, to be overseen by a trustee. Under current 2012 rules, you and your spouse can both contribute up to $5 million dollars each tax-free. There are further, more complex methods of transferring additional assets at substantially reduced tax rates that your financial adviser may be able to help you consider. The funds can be transferred either while you are alive or upon your death, although for long-term growth, the former option is better.

Once the trust is established, it can continue to invest its assets and grow in perpetuity, allowing future generations to benefit from it, even ones not yet born. As the grantor, you can set up detailed rules on who is allowed to benefit from it, and under what circumstances. You could, for example, mandate that future generations are not allowed access to it until after they graduate college, to prevent them from becoming “trust fund kids.”

Furthermore, imposing these sorts of spendthrift restrictions will also protect the trust from the beneficiaries' creditors or divorcing spouses. Properly established, a beneficiary cannot give up his claim in the dynasty trust either voluntarily or involuntarily. This makes dynasty trusts a reliable source of income for your descendants for decades and generations to come.

Perpetual trusts are not legal in all states, but several, such as Delaware or Nevada, merely require that the trustee have a presence there, but not the grantor or beneficiaries. Plus, there are few drawbacks, aside from the inevitable dilution of benefits that occurs as the generations pass. With an established corporation as trustee, a dynasty trust could last as long as your legacy.

If you are interested in dynasty trusts, now is definitely the time to act. Besides the real possibility of 2010's tax cuts expiring soon, President Obama's new budget is attempting to end dynasty trusts after 90 years. Trusts established today, however, would still be shielded from those rule changes. If you believe this could be an asset in your estate planning, contact a qualified financial adviser sooner rather than later.