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Retirement Plan Guru Ed Slott Answers Reader Questions

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Q:
Ed—

I have many clients with young children. For ma

ny of them, their 401K/IRA is their largest asset. I know designating the estate as a beneficiary is problematic—re: the need to take all the money out within five years of death. But whenever I ask an estate planning attorney about writing the will, so any trust for the children would be a suitable beneficiary (without having to accelerate benefits), they all seem to concur that this is more trouble than it is worth. This seems to have something to do with the trust's classification of 401K/IRA income. Bottom line, I am confused about the best course of action. Any guidance would be appreciated.

—Bobbie D. Munroe, CFP
Fraser Financial
Atlanta, GA

A:
Bobby—

There is a significant difference between a 401(k) and an IRA with a trust as a beneficiary. An employer plan, such as a 401(k), many times does not allow a stretch for a non-spouse beneficiary and it may not allow the non-spouse beneficiary to do a direct transfer to a properly titled inherited IRA. The only option available to the beneficiary may be a lump sum distribution or the 5-year payout.

—Ed Slott

Q:

Ed—

When making a distribution from an IRA to an irrevocable trust, what is the protocol for allocation in the trust of the distribution to income and principal? Does the entire distribution from the IRA go to income and thus benefit the income bene of the trust—or is a portion allocated to principal? Since there may be opposing parties in the trust as income and principal benes, this is important to us.

—Laurie Dettelback
First American Trust
Santa Ana, California

A:
Laurie—

These first two questions touch on the same topic—income and principal in retirement distributions and trust distributions. All distributions from retirement accounts will be taxed as ordinary income, so these accounts do not account for principal and income separately. A trust, however, does need to track principal and income, as certain trusts require that income be distributed annually. A distribution that comes in from a retirement plan must then be allocated to eith

er principal or income. Most states have adopted the Uniform Principal and Income Act (UPAIA or UPIA) which says that funds like retirement distributions will be allocated 10% to income and 90% to principal. A trust can be drafted to override this provision. It could include language to the effect that retirement fund distributions are considered to be 100% income, for example.

—Ed Slott

Q:
Ed—

If the owner of an IRA has a slightly retarded adult child who is the only heir, what is the best way to name the beneficiary? She has established a trust for her taxable assets with a trustee who is her nephew and then a bank at the trustee's death.

—Jeff Neelon
LPL Financial
Lumberton, NC

Can a special needs trust be the beneficiary of an IRA? What are the considerations here?