Spendthrift trust provisions may encourage fiscal responsibility

Although retirement accounts may not be the most common form of inheritance, they are undeniably a type of asset. As such, they can pass to beneficiaries.

However, not all assets receive the same type of treatment. In the case of a traditional individual retirement account, the funds have been contributed tax-free and preserve that status until withdrawal, when income tax obligations attach. A parent who is concerned about a child’s retirement planning may want to include an IRA as an inheritance.

However, an attorney that focuses on estate planning would likely recommend a spendthrift trust as a better means for accomplishing that goal. The reason: current law does not permit a beneficiary to use an inherited IRA as his or her retirement savings account. Instead, the funds in an inherited IRA must be withdrawn within five years after the date of inheritance. The rationale is to impose a limitation on passing tax-free assets between generations.

Yet a spendthrift trust may satisfy many of the same goals as an inherited IRA -- without the time constraint. This type of legal estate planning instrument is considered an irrevocable trust with a designated trustee. Only that trustee has the full control to determine how the trust’s funds will be spent on the designated beneficiary’s behalf. Consequently, those funds may also be insulated from the beneficiary’s creditors.

If an individual is concerned about setting up inheritance instruments while still having enough liquidity for retirement, an attorney may recommend a combined approach involving wills, revocable and irrevocable trusts. A will can incorporate specific trusts in its wording, specifying how they are to be funded and actions that will occur at the time of the grantor’s death.

Source: Courthouse News Service, “Inherited IRAs Aren't Creditor-Safe, Court Says,” Barbara Leonard, June 12, 2014