Most clients who have revocable trusts believe that there won’t be a probate opened upon their passing. I’ve written in the past how your trust won’t avoid the probate process if all of the assets that would have otherwise been subject to probate haven’t been transferred into the trust. But there’s another issue for those that own retirement accounts that you need to know about.
“Wait a minute!” You might say. “IRAs have a beneficiary designation. Like a life insurance policy there shouldn’t be a probate!”
You’d be right about that.
Moreover, IRAs and similar accounts such as 401(k)s aren’t usually not transferred into your trust anyway. You don’t transfer those accounts into your trust during your lifetime because if you were to do so bad income tax consequences result. You’d have to withdraw the account balance that causes income recognition, and hence tax. You’d also lose the tax deferred growth that otherwise would have occurred had you left the amounts in the IRA.
What you may not realize, however, is that a traditional IRA could cause a probate if you are older than your “Required Beginning Date” (RBD) which is the April 1st following your 70½ birth date. As most of us know, once you have past your RBD you are required to take “Required Minimum Distributions” (RMD) from the IRA account.
So how could your RMD cause a probate?
Suppose the Ed is 82 years old and his RMD for 2017 is calculated to be $82,000. Ed has no other assets subject to probate because he has already funded all of his other accounts into his revocable living trust. Assume, however, that Ed dies before taking his RMD for this year.
The RMD amount ($82,000) is an asset of Ed’s estate that will be subject to probate. The IRA custodian (usually a bank or investment firm) won’t make a distribution to the IRA beneficiary of the RMD because it is his estate’s asset. The estate may have a different beneficiary than that designated on his IRA beneficiary form. Even if the beneficiaries are one and the same, the custodian will only make distribution to Ed’s estate.
Because the $82,000 RMD is above the threshold for a Summary Administration in Florida, Ed’s personal representative (executor) must open the probate administration to collect the $82,000.
There is nothing that the estate can do to avoid this outcome. But there was something that Ed could have done.
Ed could have withdrawn his RMD from his IRA account early in the year. Not one of us knows which will be our last day on this earth, so it’s really not Ed’s fault that the RMD for the year is a probate asset. Many of my clients, however, who realize this issue, choose to take their RMD distribution early in the year. Some do so on the first business day of the year for this very reason.
What about those that inherit the IRA account as the designated beneficiary? A spouse can roll over the account. Once the account is rolled over, then the spouse is treated as the account owner and her RMDs are based upon her lifetime. A spouse’s RMD in my example here would begin the year after Ed’s death. But that doesn’t change the probate issue on Ed’s last RMD.
Anyone other than a spouse who inherits the IRA would not be able to roll over the account. Instead, the IRA becomes an Inherited IRA account. The beneficiary will also have RMDs, but like a spouse who rolls over the IRA, the beneficiary’s RMDs begin in the year following Ed’s death. It’s important to note that with a non-spouse beneficiary, the RMDs begin whether or not the beneficiary is older than 70½.
A toddler who is an IRA beneficiary would have RMDs in the year following the account holder’s death.
Which brings up yet another important point. You should never name a minor or incompetent person as the beneficiary to an IRA. A custodian can’t make a distribution to a minor or incompetent. Instead, the IRA custodian will insist on a court-ordered guardianship account be opened in which to make the distribution. This causes a great deal of unnecessary expense.
If you nevertheless wish to make a minor or incompetent person as the beneficiary of an IRA account, you should instead establish a trust for that person. It’s important to note that for the beneficiary’s trust to qualify for the stretch out of the RMDs over that beneficiary’s lifetime some very specific requirements must be satisfied under IRS rules.
Here it’s always wise to visit with a competent estate planning attorney to ensure that the planning surrounding your IRA or 401(k) accounts is sound. Most people simply complete their beneficiary designations without much thought as to these issues.
But as you might see, proper planning is important.
The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.
© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.