The Tradeoffs When Protecting A Spouse’s IRA

A client came to me concerned about her spouse. His memory was failing and if he survived her, then he might not have the capacity to properly invest the account or withdraw the proper amounts for his living expenses and care. She was also worried that he’d be vulnerable to gold diggers.

Part of this can be alleviated by naming someone as a Durable Power of Attorney who will have the husband’s best interest at heart if he turns out to be the surviving spouse. While the holder of the power can help with investments and withdrawals, it doesn’t do much to protect the account against a gold digger.

Normally we name our spouses as the primary beneficiary to an IRA account. WHen that happens, the spouse becomes the account owner, subject to required minimum distributions upon attaining age 72. Assume, for example, the spouse is 80 years old when he inherits the IRA account of #1 million from his deceased spouse. He rolls over that account and makes it his own.

This year, the IRS issued a new Uniform Life Table that is used to calculate Required Minimum Distributions (RMDs). Under those tables, an 80-year-old’s divisor is 20.2.. Which results in a RMD of $49,505 – calculated as the $1,000,000 account balance divided by the table divisor of 20.2. The next year, the divisor is 19.4 – if, because of interest and dividends, the account remained at $1 million, then that next year’s RMD would equal $51,546.

Wife feels like with social security, some other income and the RMDs, the IRA account is likely to last the husband for quite some time, providing for him for the rest of his life. It doesn’t, however, solve the problem of his vulnerability due to his failing mental state.

Let’s assume that wife, instead of naming husband as the primary beneficiary, creates a marital trust as the beneficiary. She can name a trusted family member or a bank or trust company as the trustee. Now, the account isn’t vulnerable to a gold digger. The problem, however, rests with a more aggressive distribution schedule.

After the SECURE Act that was enacted in 2017, most beneficiaries that can’t roll over an IRA must withdraw the entire balance within 10 years. Spouses are one of the limited exceptions who may calculate the RMDs on an inherited IRA account over the spouse’s life expectancy. In order, however, for the IRS to “look through” the trust to the beneficiary ( the surviving spouse) for purposes of determining the RMD table to use (the life expectancy as opposed to the 10-ear requirement), it must comply with the “identifiable beneficiary” IRS Treasury Regulations.

That topic is beyond the scope of today’s column, but let’s assume that the marital trust share and beneficiary designations are properly drafted to so comply. The tradeoff, as I mentioned, is a more aggressive distribution requirement.

Instead of a $49,505 RMD at age 80, for the same #1 million account, the trust must withdraw $89,286 because the divisor is 11.2 rather than the more generous 20.2. The next year, the divisor is 10.5 You can therefore see that routing an IRA through a trust for the spouse is much more likely to deplete it quickly over the spouse’s remaining lifetime.

Aside from gold digger worries, individuals who want their IRA to benefit spouse for his or her life then go to children often believe that a marital trust is a strategy that holds promise. As you can see, if a spouse lives out to a normal life expectancy, the account will rapidly drain, leaving little or nothing for the children.

Suppose the spouse creates a trust that does not distribute the entire RMD to the spouse, but reinvests some part of it? There, the income taxes will likely consume more of the distribution. ROMDs that are distributed to the spouse/ beneficiary will be taxed at his marginal rate. Amounts that reman in the trust are subject to a compressed tax rate schedule, where amounts above $13,000 are taxed at the highest federal marginal rate of 37 percent.

There are strategies that can be used to reduce the tax rate that applies. In any event, this planning requires a skill set of understanding income taxation of estates and trusts, along with up-to-date knowledge of IRA distribution rules, including new regulations enacted as recently as a few months ago.

©2022 Craig R. Hersch – The Sheppard Law Firm.

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