You May Have a “Plain Vanilla” IRA When What You Really
                                 Need Is a Banana Split

Establishing an Individual Retirement Account is one of the easiest financial transactions a person can do, but in many cases it may be deceptively easy.  Whether it is starting an IRA with a percentage of your earnings, or a rollover of a retirement account from an employer’s 401(k) plan, setting up the IRA account can also be one of the most important financial transactions you will engage in, and one probably given the least thought.

An IRA Account is created by executing IRS Form 5305 (Traditional IRA Retirement Trust Account) or 5305-A (Traditional IRA Retirement Custodial Account).  Each form consists of twelve pages of text and two pages of instructions.  After speaking with several bank officers, and with numerous clients, it is clear that very little thought goes into the specific terms of an IRA plan.  We have seen accounts which have inaccurately set out the primary and contingent beneficiaries or have omitted a contingent beneficiary completely.  If the Account Agreement fails to name a contingent beneficiary, the death benefits would be payable to the IRA owner’s estate.  The potential for a tax disaster is tremendous.  Unfortunately, that’s just the beginning of the problems an estate’s attorney encounters during the administration of a decedent’s estate.  And, most of these problems could have been avoided with just a little care and planning.         

In addition to obvious errors in the account papers, the most prominent problem is that IRA owners have assumed all IRAs are the same.  After all, they are created by just filling out a printed form.  What can be changed?  Well, the fact is that the agreement setting up the IRA account leaves open several areas where specific elections can be made.  Besides that, IRA accounts permit additional terms to be appended to the printed forms.  Many times, these additional terms are critical if the IRA account is to make sense in light of the other estate planning documents, such as a client’s will or living trusts.  If a client does not coordinate the terms of the IRA with the rest of his estate planning, in the end the whole plan may make no sense and can be self-defeating.

Commencement of Distributions.  What types of changes can be made to a typical IRA account?  For example, Article IV.3 of the provisions of Form 5305 provide rules for when the Minimum Required Distribution (“MRD”) of an account holder is to begin.  Article IV.6 provides for an “alternative method” of making MRDs to be used at the election of the account holder.  But, the “alternative method” has been superseded by Proposed Regulations issued in January, 2001.  Generally these new proposed Regulations are simpler to follow than the previous proposed Regulations.  However, when it comes to taking MRDs from several IRA accounts, the new Regulations are less favorable to the IRA owner. So, the Account Agreement should be amended to permit the account holder to reserve the right to use the alternative method un-superseded by the January, 2001 proposed regulations.  

Amount and Duration of Distributions. The standard rules for distributions provide that they are to be made over a specified period not exceeding the IRA owner’s life expectancy, or the joint and survivor life expectancy of the owner and the designated beneficiary.  The IRA Account Agreement, translates these rules to provide for “equal or substantially equal annual payments.”  The Agreement form has a similar provision for distributions to beneficiaries.  But, suppose you want distributions to be made quarterly rather than annually.  An amendment to the IRA Account Agreement should clarify that more frequent distributions are permissible and that, at any time, the owner (and, if so desired, a beneficiary) may withdraw more than the minimum.  Where IRAs represent a principal source of cash flow for the beneficiaries, this kind of flexibility could be very important.

Owner’s Death Before the “Required Beginning Date.”  If the IRA owner dies before the RBD, the Account Agreement form provides that the beneficiary will elect the method of distribution, unless the owner has elected otherwise.  If the owner does not wish the beneficiary to have control over the distribution method, the election should be made by the owner.

These are just a few of the changes that can be made to the standard IRA Account Agreement form.  In subsequent articles, we will explore the very important use of trusts as beneficiaries of the plan, and how that can save both estate taxes and income taxes for the IRA account owner and his or her family. We will also discuss other opportunities for planning with IRA accounts, including creating separate and sub-accounts, post-death transfers of accounts, and options for the surviving spouse.  What is clear is the wide range of opportunities for planning with IRA accounts so that there is close coordination with one’s overall estate plan.  “Plain vanilla” may be your favorite ice cream flavor. But, when it comes to your IRA, you may prefer a Banana Split.

626 Reckson Plaza
Uniondale, NY  11556

Telephone
(516) 522-2575