An AB trust, commonly referred to as a bypass trust, can be an effective estate planning tool for wealthy married couples. Instead of leaving assets to the surviving spouse, property is left to the bypass trust, which is irrevocable. The survivor gets to use the trust's income but has limited rights to the trust's assets. Making your AB trust the beneficiary of your IRA has pluses and minuses.
Many IRA owners make an AB trust the beneficiary of their IRA because it allows them to say with certainty what will happen to the money after one or both spouses die. For example, according to Nolo.com, if the beneficiary cannot accept responsibility for the IRA's ownership, an AB trust could be useful. This can occur if the anticipated beneficiary has special needs or is a minor; minors can't legally inherit assets. If you're an IRA owner who has concerns about how the funds will be used after you pass on, you could leave detailed instructions in the trust.
Bypassing the Estate Tax Exemption
In 2011, the federal government was not imposing taxes on estates valued at less than $5 million. If you elect to fund a bypass trust, you can rest easy knowing that you have funded a trust and made "optimum use" of your exemption, according to Nolo. Keep in mind that even if you fund an AB trust with an IRA, the IRA's distributions are still taxable at the beneficiary's current income tax rate. However, the trust could dictate how much in distributions the beneficiary would be allowed to take out at one time.
Although the federal government doesn't generally impose taxes on heirs who receive inheritances, IRAs are a notable exception. IRA beneficiaries must pay income tax at their current rate, and they must continue taking distributions based on life expectancy. As a result, if you decide to fund an AB trust with an IRA, you're not funding the trust with the full amount of your account; you're funding it only with pre-tax money. If you fund the trust with cash instead, the trust is worth more.
Rollovers Not Allowed
Perhaps the biggest disadvantage to naming an AB trust as your IRA's beneficiary is that the surviving spouse can't roll the account balance over into a new account in her own name. Giving your spouse the right to roll over your IRA balance into her own account gives her greater flexibility, and she can do this only if she is the IRA's named beneficiary and not the trust. Keep in mind that AB trusts are usually used only by the very wealthy. If you are serious about establishing a bypass trust and you want to fund it with you IRA, consult an estate planning attorney and tax adviser.
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