While the following point is much less likely to occur due to the portability of exemption amounts between spouses it is still important to know the possibilty exists. It is also important to know just how easy this is to avoid by speaking with your advisor about your situation.
Let us assume that the beneficiary of the IRA was a revocable living trust (RLT) and that this trust states that upon the death of the first spouse, a new trust should be established and funded up to the current exemption equivalent. I have seen many cases where the attorney has “carved out” this exemption amount from the IRA in order to fund this exemption trust, and then suggested rolling over the difference into the surviving spouse’s IRA. Although this can be done, it has to be done properly!
I have seen countless examples where the exemption was in fact carved out and paid out directly into the exemption trust! One hundred percent of this money was subject to income taxation in one year, and if that isn’t bad enough, it was all taxed at the trust income tax rate brackets, which are usually much higher than individual income tax rates!
What should be done is to establish an Inherited IRA for the benefit of the exemption trust. Please remember that many attorneys and accountants have not heard of an Inherited IRA and believe that the exemption trust beneficiary would have to receive the money in order to have it funded. Please make sure that your financial advisor is aware of these complicated rules.
Again, this is an easy mistake to avoid based on new portabilty laws, but a situation involving funding of trusts for minors can come up. Remember that when people set up trusts for minors it is important the trust contains both the proper language to qualify for the stretch IRA and that the financial advisor properly titles the inherited IRA for the benefit of the trust established for the minor.
Information provided by MD Producer