The IRA Contract

Pioneered by Ettinger Law Firm, the IRA Contract solves a technical problem that arises when a spouse in a second marriage wishes to leave their IRA, or other qualified plan, to the husband or wife but also wants the unused funds to go to their children from a previous marriage after the spouse dies.

Many lawyers recommend a trust for this purpose. For example, husband dies and leaves the IRA to a trust which names the wife as beneficiary for her lifetime and, after her death, to his children from the previous marriage. Although leaving an IRA to a trust is perfectly legitimate and solves the problem, it has one major drawback. Since a trust has no “life expectancy” on which the IRS can calculate the required minimum distribution (RMD), when you leave an IRA to a trust, the Service looks through the trust to find the oldest trust beneficiary. They then calculate the RMD based on the life expectancy of that person, usually the second wife. The first issue is that even if the wife is under 70 1/2, the age at which you are required to start withdrawals, she cannot wait until then. Since the IRA was left to a trust, it is not a spousal rollover and does not become the wife’s IRA. As such, she cannot defer taxes until 70 1/2 but must start withdrawing the year following her husband’s death. The larger problem is that the IRS will establish a “term certain” for the payout based on her life expectancy which may be two decades or more less than the husband’s children. In other words, when she dies, his children must continue to withdraw based on her life expectancy, instead of based on their own life expectancies. Two decades or more of deferred taxes on the IRA are lost.

To solve this problem, we prepare a fairly simple contract. Wife agrees, in consideration of husband’s naming her as beneficiary on his IRA, to name husband’s children irrevocably as her beneficiary when the IRA rolls over to her. She also agrees not to take any more than the RMD, except on consent of the attorneys appointed by the husband. This prevents someone perhaps unduly influencing the wife in her later years to simply withdraw all the funds and give them to her children or others.

The net effect of The IRA Contract is this. Husband’s IRA now rolls over to his wife. She may continue to defer taxes on it until she reaches 70 1/2. She names his children as beneficiary on her IRA so that upon her death they may each take a distribution based on their individual life expectancies. The IRA’s get two or more decades of additional tax deferral. The value of all of those extra years of tax deferral may easily be worth double what it would be without the benefit of The IRA Contract.

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