Planning for the Dementia Factor in Retirement

Question: A practicing attorney asks, "I work with many seniors and often need to address dementia issues. Here is a typical situation:

John wants to name his wife Susan as the primary beneficiary of his IRA and to name their children as contingent beneficiaries. The expectation is that, upon John's death, Susan, as surviving spouse-beneficiary, would roll the IRA over into her own IRA, and name the children as beneficiaries of the rollover IRA.

But both spouses are concerned that following John's death Susan might have dementia, and not be legally competent to roll over the inherited IRA or file a new beneficiary designation. Is there a way that Susan can, now, prior to John's death, pre-elect the spousal rollover and name the children as beneficiaries of her (not yet created) rollover IRA? If that cannot be done, can John at least designate that benefits still in his IRA after Susan's death will pass to their children?"

Answer: Unfortunately, neither of these approaches will likely work.

IRS regulations specify that the spousal election to treat an IRA inherited from the deceased spouse as the surviving spouse's own IRA may not be made until after the death of the first spouse.

Furthermore, most IRA custodians will not allow the participant to name a "successor beneficiary." Once the participant dies, the primary beneficiary owns the inherited IRA absolutely, assuming he or she survived the participant and did not disclaim the benefits. The primary beneficiary is the only one who can name a successor beneficiary to take the account if the primary beneficiary, having survived the participant, dies while there is still money in the account. If the primary beneficiary fails to do that, the IRA documents' default beneficiary provisions would apply. Typically the IRA provider would have no way to go back to the original participant's account documents to see what he or she would have wished.

Here are the other ways to deal with a potential anticipated mental disability:

The Bronze Plan: Guardianship If John and Susan do no advance planning to deal with the disability risk, and John dies at a time Susan is legally incompetent, a guardian could be appointed by the applicable state court to act for her with respect to the inherited IRA and her other property. That should enable the guardian to use the IRA assets for Susan's benefit.

But guardianship has serious limitations. The state court process may be public and costly. The court might or might not appoint the person Susan would have chosen as her legal guardian. Depending on state law, the guardian might not be able to take certain actions (such as "rolling over" the account) without court permission. It would be unusual for a guardian to have the power to name beneficiaries on Susan's behalf. Essentially, guardianship is the way to deal with disability--for people who didn't plan for that eventuality.

The Silver Plan: Power of Attorney Susan could sign a durable power of attorney appointing a trusted person to act for her. Ideally I would like to see a separate power of attorney just dealing with retirement benefits. Whether it's a separate document or not, it should enumerate powers with respect to any retirement plan, including the powers to: withdraw from, contribute to, change the investments inside, receive all information regarding, and make all tax elections with respect to the account. The power should specify that the attorney can roll or transfer funds into or out of the account from or to another retirement account or plan. The power should direct the attorney to name John, if living, otherwise the children as beneficiary for any account.

While John and Susan are both alive and competent, they should make sure John's IRA provider will accept the power of attorney. Some financial firms require you to use their particular form or have other guidelines on this subject.

The Gold Plan: Trusteed IRA Most IRAs are in the legal form of a "custodial account." A custodian has no power to make decisions about the account. A custodian merely safeguards the assets, keeps necessary records, and files required tax returns.

Alternatively, an IRA can be in the form of a trust--though this is less common, the trusteed IRA is perfectly legal and has exactly the same tax characteristics as a custodial IRA. If John's IRA were in the form of trusteed IRA (also called an "individual retirement trust" or IRT), there would be several advantages from the point of view of potential disability of either spouse:

1. If John were disabled, the trustee could use IRA assets directly to pay bills on John's behalf and make sure the annual required distribution is distributed. An IRA custodian, by contrast, will only act on instructions with respect to any distributions.
2. After John's death, if beneficiary Susan is disabled, the IRA trustee can perform the same services on her behalf--pay expenses directly and distribute the required minimum distribution.
3. The trustee of the trusteed IRA can assume full investment responsibility for the IRA assets. A custodian will never do this.
4. Finally, John could provide in the trusteed IRA document for a "successor beneficiary" to Susan, if she should survive him and then later die while there was still money in the account. As noted, few if any custodial IRAs allow the participant to name a successor beneficiary.

The only step the IRA trustee cannot complete is a spousal rollover on Susan's behalf. For that, Susan herself or her guardian or power-of-attorney holder would have to act. So the "gold plan" is to have a trusteed IRA plus a durable power of attorney ("dialed down" to make it clear the power of attorney is subordinate to the trusteed IRA document).

The Platinum Plan: Transfer IRA to a Living Trust? For non-retirement assets, the best way to deal with potential mental decline is (before disability strikes) to place assets in a living trust, where a successor trustee can smoothly take over the management if the donor becomes disabled. Unfortunately, as of right now, it appears the IRS may be hostile to placing an IRA in such a trust. Until the tax path is clear, the platinum plan is not available!

For a senior or anyone else concerned about potential future mental decline--either his or her own or that of his or her beneficiary--for now, the trusteed IRA provides the best possible protection, especially when combined with a well-drafted durable power of attorney to close any gaps a trusteed IRA cannot fill.

Where to read more: Regarding the spousal election to treat an inherited IRA as his or her "own" IRA, see Treas. Reg. § 1.408-8, A-5(a).

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