Trusteed IRA – A quiet and powerful Client solution
A Trusteed IRA is a simple and powerful financial planning tool. To know the power of the Trusteed IRA it’s important to describe the IRA industry for all of us. The IRA market has grown substantially over recent years as the baby boomer generation prepares for retirement. With nearly 40.4% of all American households investing in at least one IRA, total IRA assets topped $8.5 trillion in the third quarter of 2017. This amount represents more than a 30% of the total $27.2 trillion retirement market in the United States and has grown at an average rate of 7.4% percent annually since 1990.. The IRS has accepted our Trusteed IRA solution which is called the SmartIRA™.
This rapid growth makes this asset class highly coveted by financial institutions and investment advisors. As more money continues to move into the retirement sphere, investment advisors can use IRA accounts to increase the size of their investment portfolio. This in turn will generate higher revenue for advisors through trading and investment advisory fees. However, the benefits of IRA accounts for advisors go beyond simply being a lucrative revenue source. Advisors are also able to make asset allocation decisions for their portfolios without the fear that the IRA funds will be withdrawn on a whim. Because there are punitive penalties for withdrawing the assets before the age of 59½ and tax incentives for waiting until 70½, IRA assets are a stable investment source that allow investment advisors to invest with a long-term horizon in mind.
However, current trends show that IRA withdrawals will increase significantly over the next decade, both in dollar amount and as a percentage of total retirement income, as the baby boomer generation enters retirement. Total IRA withdrawals increased to $189.8 billion in 2007 from just $23.7 billion in 1988. Similarly, although they held only 45.7% of IRAs nationwide in 2004, taxpayers aged 55 and older controlled 72.7% of the total IRA assets. It is evident that these withdrawals will only continue to increase as the retiring population begins to draw down on their accounts to pay for retirement. These trends pose a large potential problem for the investment advisors managing the IRA assets since funds withdrawn from accounts or passed on when account holders pass away are seldom kept with the same institution. In fact, recent studies by TD Ameritrade and Pershing have shown that roughly 80% of IRA assets will be lost when a client passes away. Increasingly, investment advisors and custodians are being forced to look for alternative methods to retain IRA assets and accounts.
Consider the Trusteed IRA as a possible remedy to counteract the current IRA withdrawal trends. This instrument helps investment advisors retain management and control of IRA deposits, generating fees for the duration of the IRA’s lifetime. It also is an attractive investment option for your client that provides increased customization of the terms of his or her IRA.
The Trusteed IRA
An Individual Retirement Account (IRA) may take one of two distinct legal forms: a Custodial IRA (IRC §408(h)) or a Trusteed IRA (IRC§408(a)). While both forms receive identical tax treatment, the Trusteed IRA combines the asset protection advantages of a trust with the ease and tax-deferral advantages of the IRA to create an effective, multifaceted estate planning instrument. With this instrument, the owner creates a trust within the IRA to serve as the beneficiary of the IRA assets upon the owner’s death and directs a trustee to distribute assets in strict accordance with the owner’s guidelines. Because the beneficiary has no power to pull or redirect the funds, the investment advisor and trustee can be confident that they will retain the IRA assets both during the client’s lifetime and after his or her death.
Although the overall effectiveness of the Trusteed IRA depends on the flexibility of the provider, there are many reasons your client may want to choose a Trusteed IRA over a more traditional IRA:
1) Maintain Control of the IRA Beneficiaries: Under a traditional, Custodial IRA format, your client’s primary beneficiary will gain control of the IRA assets upon his or her passing. The beneficiary is then free to designate his or her own beneficiaries for the assets, which may or may not correspond to your client’s wishes. For example, your client may designate his or her spouse as the primary beneficiary and children as the contingent beneficiaries of the IRA. Upon the client’s death, the spouse will receive the assets; however, he or she then has no obligation to leave the children as the next beneficiaries in line for the remaining assets. He or she could remarry and name a new spouse, or perhaps children from a past marriage, as the ultimate beneficiaries and your client’s children would receive nothing.A trusted IRA resolves this problem and maintains control of the chain of beneficiaries to the IRA assets. The trustee distributes the assets in strict accordance with your client’s guidelines, allowing your client to name contingent beneficiaries that cannot be changed by the primary beneficiary.
2) Maintain Control over the IRA Distributions: Under a typical Custodian IRA format, the designated beneficiary gains total control of your client’s IRA assets upon his or her death. There is little to stop them from withdrawing any portion or all of the IRA assets at any time after the grantor’s death. This has indeed proved to be problematic: estimates show that approximately 80% of IRA assets are withdrawn from Custodian accounts by beneficiaries within two years of the grantor’s death. This almost certainly undermines the client’s intent, whether intentionally or unintentionally, to allow the IRA assets to accumulate on a tax-deferred basis for as long as possible and to provide the beneficiaries with an income stream for years to come.The Trustee IRA allows your client to limit the beneficiary’s access to the IRA funds by giving the responsibility to distribute assets to the trustee instead. While your client has no control over the payment of the required minimum distributions, he or she can determine whether the trustee should make any additional payments, whether to provide for the beneficiary’s health and support or to restrict distributions until the beneficiary reaches a certain age. In essence, the client can create a pension plan for his or her beneficiaries.
3) Avoid Legal Fees and Administrative Hassle: Depending on the Trustee IRA provider, your client can establish his or her trust specifications from a wide range of options. These options include designating the beneficiaries and the payment of funds upon his or her death. By choosing a set of pre-drafted options that are included in the IRA setup, your client may be able to avoid hiring a lawyer and paying legal fees to draft a separate trust agreement to serve as the beneficiary of the IRA assets. Similarly, a trusteed IRA allows for easier and less expensive accounting each year. Under a Trusteed IRA arrangement, the beneficiaries only need to submit a Form 1099-R annually. This is cheaper and less complex than if a separate trust was created, which would require Forms 1099-R, 1041, and K-1 each year.
4) Avoid Potential Problems with Naming a Separate Trust as Beneficiary: While it is possible to name a separate trust as the beneficiary of an IRA, there are many potential pitfalls that could undermine your client’s positive intentions. This type of instrument should be created in a manner so that all of the involved parties, including the IRA owner, investment advisor, custodian, trustee, and attorneys agree that the trust’s provisions comply with all applicable laws. Otherwise, any conflicting interpretations could cause the assets to be distributed before they have maximized their tax-deferred accrual.
For example, the IRS has “four minimum distribution trust rules” that must be closely followed in naming a trust as a beneficiary:
- 1) The trust must be valid under state law
- 2) The trust is irrevocable or will, by its terms, become irrevocable upon the death of the IRA owner
- 3) The beneficiaries of the trust are identifiable
- 4) A copy of the trust documents are provided to the IRA custodian by October 31 of the year immediately following the year in which the IRA owner died.
Furthermore, the Treasury Regulations stipulate that all trust beneficiaries must be individuals. Non-compliance with any of the aforementioned rules may cause the IRA to be distributed under the “five-year rule”, thus undermining your client’s intentions for the IRA to continue to be accumulated on a tax-deferred basis for as long as possible. 
A Trusteed IRA helps avoid these potential problems that would arise under naming a separate trust as the beneficiary because the pre-drafted trust terms have already been approved by the Custodian IRA and are already in compliance with the strict, often confusing, IRS regulations.
5) Provide Disability Protection
Under some types of Trusteed IRAs, the trust is created by the Custodian IRA as soon as it is named as the designated beneficiary. This may provide your client additional protection if they become disabled during his or her lifetime. Since the Trusteed IRA has a trustee already in place, this trustee can use and direct assets for the client’s benefit if he or she becomes incapacitated. The trustee is able to intercede on your client’s behalf, taking over the administration and distributions, and ensuring that your client does not get stuck in a financial gray zone. Without this provision, your client may need to go through a lengthy guardianship proceeding in the courts to gain durable power of attorney.
6) Ensure Professional Administration of IRA Assets
A Trusteed IRA reduces the risk of financial mismanagement by utilizing a professional corporate trustee. This not only removes the administrative burden from family members but also lowers the risk that mistakes would be made that could unintentionally cause the assets to lose their protected and tax-deferred status.
7) Create Greater Creditor Protection
There is currently some legal debate on whether inherited IRAs receive the same creditor protection that is rewarded to the initial IRA owner. Under the Internal Revenue Code, there are only two required elements for an IRA to be exempt from creditors (up to $1 million) :
1) The amount the debtor seeks to exempt must be in retirement accounts; and
2) Those retirement funds must be in an account that’s exempt from taxation under IRC 401, 403, 408, 408(A), 414, 457 or 501(a).
In re Nessa stipulated that inherited IRAs are protected, regardless of the fact that ownership has changed, because inherited IRAs still fulfill the above requirements in name and in substance. However, In re Chilton came to an opposite conclusion, stating that inherited IRAs are not the same as normal IRAs because holders of inherited IRAs can withdraw funds regardless of their retirement status and age. Because the funds are not necessarily intended to be used for retirement purposes, they lose their creditor protection. It is ultimately up to each state to determine whether ordinary inherited IRAs retain their exemption.
In light of this confusion, it could be advisable for owners in states with unfavorable or inconsistent inherited IRA rulings to utilize a Trusteed IRA. These instruments can provide stronger asset protection by including specific spendthrift language in the trust document that excludes the trust from any potential creditor claims. IRA trusts derive their protection from trust law rather than the specific exemption statutes of a state. The Trusteed IRA would also help protect your client if they later move to a state with unfriendly legal precedent.
Downsides to a Trusteed IRA
Although a Trusteed IRA can cement your client’s control over IRA beneficiaries and distributions while saving the cost and administrative hassle of having to prepare a separate trust, there are some downsides that must be considered before choosing this estate planning option.
1) Higher Fees and Required Minimums
In general, the Trusteed IRAs are more practical for IRAs with larger account balances. Due to the administrative requirements involved, Custodians / Trust Companies may require larger minimum balances (generally over $600,000) and charge higher service fees than for traditional IRAs. Depending on the size of your client’s IRA, the benefits of having a Trusteed IRA may or may not offset the additional cost.
However, it is important to note that the Trusteed IRA may still be cheaper than designating a separate trust as the IRA beneficiary. Your client will be paying distinct trustee and investment fee expenses. While the Trusteed IRA, like other trusts, can still utilize third-party investment managers, these responsibilities can often be combined to save cost with only one fee.
2) Can Be Unnecessary in Some Circumstances
Depending on the circumstances, a Trusteed IRA may not be the most efficient solution. The IRA assets may, for example, be needed to pay estate taxes or be better used to realize more immediate goals. In general, if the retirement plan needs to be withdrawn shortly after the owner’s death, there is little point in taking the administrative steps to set up the Trusteed IRA.
3) The Flexibility Depends on the Provider
There is no set standard or restrictions on the terms that a Trusteed IRA can contain. Each provider has its own set of provisions and modifications; however, the instrument is only as flexible as the provider allows. If customized terms are required, it may be best to draft them as a separate trust.
Similarly, since each provider creates its own unique set of dispositive terms, it may be difficult for you, the advisor, to move the IRA after the trust is created and find another provider that will accept the same trust terms. This could lock you into a financial institution for the duration of the trust’s life.
An alternate solution to this problem is to use an independent third party corporate trustee that creates the trust only upon your client’s passing. This enables you to advise your client to modify the terms of the trust during his or her lifetime and avoid being locked into a particular financial institution.
The Trusteed IRA is becoming increasingly common as the market becomes more aware of its existence and advantages. This instrument is currently offered many large custodians and trustees, including Merrill Lynch, TD Ameritrade, Northern Trust, KeyBank, and USAA. Other custodians may also provide the Trusteed IRA when teamed with a non-custodial trust services provider. Furthermore, because the Trusteed IRA complies with Federal tax laws under IRS Code 408(a) and Treasury Regulation 1.401(a)(9)-4, it can be created in any state around the country. However, it is important to note that the trust still must comply with the specific trust laws in the state where it was created. Because each state has different legislative, reporting, and duration provisions, special care should be taken in selecting the trust’s situs to ensure favorable trust laws given your client’s circumstances.
Although estate planning does not have a one-size fits all solution, the creation of the Trusteed IRA is a beneficial for both the client and the advisor. As soon as your client opens the Trusteed IRA, a revocable management trust is created that can be altered during the client’s lifetime. This allows the client to customize his or her to estate planning goals while reducing legal fees and administrative hassle. Upon your client’s passing, the trust becomes a testamentary irrevocable trust, thereby cementing the beneficiaries and distribution provisions according to your client’s wishes. The Trusteed IRA also helps retain IRA assets with the financial advisor since the beneficiaries cannot pull or redirect the assets all at once. Therefore, the advisor mitigates the potential problem of IRA withdrawals as the baby boomers begin to pass away and provides continuity for IRA management during the client’s lifetime. In essence, the client is creating a pension plan for future beneficiaries and you retain your advisory role for years to come.
 Sarah Holden and Daniel Schrass, “Appendix: Additional Data on IRA Ownership in 2012,” ICI Research Perspective 18, no. 8A (December 2012): [Page #], accessed August 23, 2013, http://ici.org/pdf/per18-8_appendix.pdf; & ICI Global, “Release: Quarterly Retirement Market Data, Third Quarter 2017, Dec 20, 2017”, accessed January 16, 2018, https://www.ici.org/research/stats/retirement
 Frequently Asked Questions about Individual Retirement Accounts, last modified May 2013, accessed August 23, 2013, http://www.ici.org/faqs/faq/faqs_iras & ICI Global, “Release: Quarterly Retirement Market Data, Third Quarter 2017, Dec 20, 2017”, accessed January 16, 2018, https://www.ici.org/research/stats/retirement
 Planning John Sabelhaus and Daniel Schrass, “The Evolving Role of IRAs in U.S. Retirement Planning,” Investment Company Institute Research Perspective 15, no. 3 (November 2009): 15, accessed August 23, 2013, http://www.ici.org/pdf/per15-03.pdf.
 John Sabelhaus and Daniel Schrass, Most IRA Assets Are Held by Taxpayers Aged 55 or Older, chart (Washington DC, USA: Investment Company Institute, 2009), http://www.ici.org/pdf/per15-03.pdf.
 Pershing, LLC and TD Ameritrade Institutional
 Pershing, LLC and TD Ameritrade Institutional
 Pershing, LLC and TD Ameritrade Institutional show 80% and 83%, respectively
 Morrow, Edwin P., III. “Trusteed IRAs: An Elegant Estate-planning Option.” Trusts and Estates, September 2009, 53-59.
 Determination of the Designated Beneficiary, 26 C.F.R. § 1.401(a)(9)-4
 Required Distribution Where Employee Dies Before Entire Interest is Distributed, 26 C.F.R. § 1.401(a)(9)(B)(ii)
 Exemptions, 11 U.S.C. § 522(b)(3)(C) (2012).
 Gene W. Doeling v. Nancy A. Nessa, No. 10-6009 (8th Cir. Apr. 9, 2010) (LexisNexis).
 Chilton v. Moser, No. 11-40377 (5th Cir. Mar. 12, 2012) (Lexis Nexis).
 Ward, Michelle, and Mark Merric. “Creditor Protection for IRAs.” Trusts and
Estates, June 2012, 49-53.