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Common Estate Planning Mistakes

Natalie Choate reviews two of the most common trust-drafting mistakes and misconceptions.

Natalie Choate, 01/11/2013

I am frequently called upon to review a trust that has been named as beneficiary of retirement benefits and comment on whether it will work for its intended purpose. Here are two of the most common trust drafting mistakes and misconceptions I encounter.

Question: The decedent's IRA is payable to a trust that doesn't even mention the "minimum distribution rules." Does this mean the trust cannot qualify for a life expectancy "stretch" payout and must take a lump sum distribution of the IRA?

Answer: Good news: The trust does not need to mention minimum distributions or retirement benefits.

A little background: In most cases the most favorable form of distribution for an inherited IRA is "annual installments over the life expectancy of the designated beneficiary." This is called the "life expectancy payout method" or the "stretch" payout. Though the life expectancy concept can apply only to an individual, the IRS allows a trust named as beneficiary of a retirement plan to qualify for the stretch payout. The trust must comply with various rules set by the IRS, including a requirement that all beneficiaries of the trust must be individuals. A trust that meets these requirements is called a "see-through trust," and can take distributions over the life expectancy of the oldest trust beneficiary.

The tests for qualifying as a see-through trust can be complicated and sometimes tough to comply with. But the tests depend on the substantive terms of the trust--not whether the trust instrument contains some magic language. A trust that meets the IRS' tests qualifies for the stretch payout even if the instrument never mentions minimum distributions or retirement benefits at all.

When drafting a trust, it is usually considered advisable to mention the retirement benefits and the minimum distribution rules because this shows the grantor's intent and alerts the trustee to the requirements. But the trust may still qualify even if it does not mention those things.

Question: The decedent's IRA was left to a marital deduction trust. The trust provides that the decedent's surviving spouse receives all income of the trust for life. On the spouse's death, the principal passes to the decedent's issue then living. The trust has a provision dealing with "stub income" of the marital trust: Any income the trust receives during the surviving spouse's life that has not yet been distributed to the spouse at the time she dies must be distributed to her estate. Does that provision leaving "stub income" to the surviving spouse's estate destroy qualification of the trust as a see-through trust for minimum distribution purposes?

Answer: Yes, it does.

Natalie Choate practices law in Boston, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is fast becoming the leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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