Stretch IRA Trust By Ward J. Wilsey, JD, LLM 3655 Nobel Dr. Suite 345 San Diego, CA 92122 (858) 764-2672 [email_address]

Circular 230 Notice Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

The Problem Trillions of Dollars in Wealth held in Qualified Retirement Accounts “ Qualified Retirement Account” means any account with a tax deferral benefit IRAs, 401Ks, 403(b), etc. For the purposes of this presentation, I’ll lump these together under the term “IRA” With the recent increase in the estate tax exemption, the likely real future “estate tax” will reside with IRA owners Income Tax Opportunity Cost on Lost Deferrals

Trillions of Dollars in Wealth held in Qualified Retirement Accounts

“ Qualified Retirement Account” means any account with a tax deferral benefit

IRAs, 401Ks, 403(b), etc.

For the purposes of this presentation, I’ll lump these together under the term “IRA”

With the recent increase in the estate tax exemption, the likely real future “estate tax” will reside with IRA owners

Income Tax

Opportunity Cost on Lost Deferrals

Estate Taxes on IRAs Upon Death, IRAs constitute “Income in Respect of Decedent” (Internal Revenue Code 691) Withdrawn amounts are taxable as ordinary income See IRS Publication 559 for more information When IRAs are inherited, they become taxable immediately absent proper planning Once distributed, and once taxes, you lose the opportunity for tax free growth in IRA “wrapper”.

Upon Death, IRAs constitute “Income in Respect of Decedent” (Internal Revenue Code 691)

Withdrawn amounts are taxable as ordinary income

See IRS Publication 559 for more information

When IRAs are inherited, they become taxable immediately absent proper planning

Once distributed, and once taxes, you lose the opportunity for tax free growth in IRA “wrapper”.

Taxes on IRAs If state and federal taxes apply, the result is a great deal of lost IRA wealth Example 1. John Doe dies, leaving his son Kyle Doe with a $500,000 IRA. If this IRA is subject to immediate taxation, there would be a 35% federal tax and a 9.3% California state tax. The result is a tax of approximately $205,225.00 Net Distribution is only $294,775 About 41% of the IRA is gone, right away

If state and federal taxes apply, the result is a great deal of lost IRA wealth

Example 1. John Doe dies, leaving his son Kyle Doe with a $500,000 IRA. If this IRA is subject to immediate taxation, there would be a 35% federal tax and a 9.3% California state tax. The result is a tax of approximately $205,225.00

Net Distribution is only $294,775

About 41% of the IRA is gone, right away

Solution is deferral “ Stretch” IRA The process of a Beneficiary taking only the Required Minimum Distribution from an Inherited IRA each year, allowing the remainder to compound in a tax free environment. Why does it work? Compound interest in a tax free “wrapper” (only distributions are taxes) capital gains, dividends, etc. are not taxed each year Extra gain Deferral is not indefinite Required Minimum Distribution (“RMD”) must be taken each and every year. Even on Roth

“ Stretch” IRA

The process of a Beneficiary taking only the Required Minimum Distribution from an Inherited IRA each year, allowing the remainder to compound in a tax free environment.

Why does it work?

Compound interest in a tax free “wrapper” (only distributions are taxes)

capital gains, dividends, etc. are not taxed each year

Extra gain

Deferral is not indefinite

Required Minimum Distribution (“RMD”) must be taken each and every year.

Even on Roth

Results for a Stretch IRA Example 2. John Doe dies, leaving his $500,000 IRA to his son Kyle, who is 50 Years old Growth 8% growth plus a 2% premium for tax deferral 10% real growth Over $4.6 million of distributions by the time Kyle is 85 years old $2.9 million net of tax Almost 10 times the amount if Kyle takes lump sum distribution

Example 2. John Doe dies, leaving his $500,000 IRA to his son Kyle, who is 50 Years old

Growth

8% growth plus a 2% premium for tax deferral

10% real growth

Over $4.6 million of distributions by the time Kyle is 85 years old

$2.9 million net of tax

Almost 10 times the amount if Kyle takes lump sum distribution

Stretch for a Grandchild Deferral benefits for younger generations are much greater Ex. 3. Assume that John Doe leaves his $500,000 IRA to his grandson Larry. Same growth of 10% real growth. Result is over $42 million of distributions by the time Larry is 85 Over $25 million net of tax Almost 100 times the benefit had a lump sum distribution occurred at death Main rule…the younger the Beneficiary, the more wealth passes via the Stretch

Deferral benefits for younger generations are much greater

Ex. 3. Assume that John Doe leaves his $500,000 IRA to his grandson Larry. Same growth of 10% real growth.

Result is over $42 million of distributions by the time Larry is 85

Over $25 million net of tax

Almost 100 times the benefit had a lump sum distribution occurred at death

Main rule…the younger the Beneficiary, the more wealth passes via the Stretch

Comparison of Approaches for Distributing $500,000 IRA Approach Distributions Tax Rate Net Distributions Immediate Distributions $500,000 41% $294,775 Kyle, 50 years old $4,629,935 41% $2,731,662 Larry, 20 years old $42,609,134.35 41% $25,139,389

IRA “Blowouts” (Non-Stretch) Immediate Withdrawal 5 year rule All IRA amounts must be withdrawn within 5 years of IRA owners death No Designated Beneficiary Death of IRA owner prior to age 70.5 Stretch Over Life Expectancy of IRA owner You may “Stretch” the IRA over what the deceased IRA owners distribution schedule would have been had he or she survived No Designated Beneficiary Death of IRA owner after age 70.5 Or if oldest Designated Beneficiary older than the IRA owner

Immediate Withdrawal

5 year rule

All IRA amounts must be withdrawn within 5 years of IRA owners death

No Designated Beneficiary

Death of IRA owner prior to age 70.5

Stretch Over Life Expectancy of IRA owner

You may “Stretch” the IRA over what the deceased IRA owners distribution schedule would have been had he or she survived

No Designated Beneficiary

Death of IRA owner after age 70.5

Or if oldest Designated Beneficiary older than the IRA owner

Creating the Stretch You need a Designated Beneficiary to Stretch an IRA or 401K The younger the Beneficiary, the more the wealth transfer What is a Designated Beneficiary Individual Not a Charity Not an Estate Properly Designed Trust

You need a Designated Beneficiary to Stretch an IRA or 401K

The younger the Beneficiary, the more the wealth transfer

What is a Designated Beneficiary

Individual

Not a Charity

Not an Estate

Properly Designed Trust

What about the Spouse??? Generally, a spouse should be the primary beneficiary of an IRA They will rollover the inherited IRA and be responsible for naming future beneficiaries Blended Families If you want to leave the IRA to a spouse, but ensure that it then goes to your kids, you must use a Trust You will lose much of the Stretch Benefit if your spouse is significantly older

Generally, a spouse should be the primary beneficiary of an IRA

They will rollover the inherited IRA and be responsible for naming future beneficiaries

Blended Families

If you want to leave the IRA to a spouse, but ensure that it then goes to your kids, you must use a Trust

You will lose much of the Stretch Benefit if your spouse is significantly older

Naming Individuals You can name individuals as designated beneficiaries over a percentage of IRA Example John Doe can leave his IRA 50% to his son Kyle and 50% to his grandson Larry Each will be able to Stretch their ½ over the course of their lifetimes Their stretch will be according to their age Kyle will receive less in total distributions than Larry

You can name individuals as designated beneficiaries over a percentage of IRA

Example

John Doe can leave his IRA 50% to his son Kyle and 50% to his grandson Larry

Each will be able to Stretch their ½ over the course of their lifetimes

Their stretch will be according to their age

Kyle will receive less in total distributions than Larry

The Problem with Naming Individuals Stretch IRA will (likely) not happen Most inherited IRAs are withdrawn almost immediately, foregoing future benefits Anecdotally, estimates are that 80% to 90% of IRAs that are potentially “stretchable” are not stretched Bottom Line: IRAs left outright to individuals will likely not be Stretched. The result is a loss of about 90% to 99% of the possible IRA distributions OPPORTUNITY COST

Stretch IRA will (likely) not happen

Most inherited IRAs are withdrawn almost immediately, foregoing future benefits

Anecdotally, estimates are that 80% to 90% of IRAs that are potentially “stretchable” are not stretched

Bottom Line: IRAs left outright to individuals will likely not be Stretched. The result is a loss of about 90% to 99% of the possible IRA distributions

OPPORTUNITY COST

Solution: Stretch IRA Trust Benefits of the Stretch IRA Trust Guarantee that a Stretch will occur The option to direct how Distributions are made Protect the Inherited IRA from Creditors, Divorce, and Government (Special Needs) Protect IRA from the Generation Skipping Transfer Tax

Benefits of the Stretch IRA Trust

Guarantee that a Stretch will occur

The option to direct how Distributions are made

Protect the Inherited IRA from Creditors, Divorce, and Government (Special Needs)

Protect IRA from the Generation Skipping Transfer Tax

Stretch IRA Trust INHERITED IRA STRETCH IRA Trust Annual Required Minimum Distributions drop each year into Stretch IRA Trust, to be distributed according to the terms of the Trust. Annual RMD Distributed to Beneficiaries RMD each year go to Stretch IRA Trust Terms of Trust state how distributions made IRA is protected from creditors, divorce, and government Result is that family wealth though Stretch IRA is guaranteed, rather than an improbable possibility

RMD each year go to Stretch IRA Trust

Terms of Trust state how distributions made

IRA is protected from creditors, divorce, and government

Result is that family wealth though Stretch IRA is guaranteed, rather than an improbable possibility

What about the Revocable Living Trust? Stretch IRA Trust is a different animal A Standard Living Trust is absolutely requires for non-qualified assets, but does not work well for inheriting IRAs Designated Beneficiary Rules Issues with older beneficiaries Any person with an IRA over $250,000 should have both (1) a Living Trust and (2) a Stretch IRA Trust

Stretch IRA Trust is a different animal

A Standard Living Trust is absolutely requires for non-qualified assets, but does not work well for inheriting IRAs

Designated Beneficiary Rules

Issues with older beneficiaries

Any person with an IRA over $250,000 should have both (1) a Living Trust and (2) a Stretch IRA Trust

Summary Without properly Stretching an IRA, you would lose 90% to 99% of the potential inherited IRA distributions You must name a Designated Beneficiary to “stretch” an IRA Individual Designated Beneficiaries will generally not “stretch” an IRA A Stretch IRA Trust will ensure that an IRA is Stretched Protect IRA from creditors, ex-spouses, and government Provide distribution instructions

Without properly Stretching an IRA, you would lose 90% to 99% of the potential inherited IRA distributions

You must name a Designated Beneficiary to “stretch” an IRA

Individual Designated Beneficiaries will generally not “stretch” an IRA

A Stretch IRA Trust will ensure that an IRA is Stretched

Protect IRA from creditors, ex-spouses, and government

Provide distribution instructions