Listener Questions: IRAs and Trusts, and Special Social Security Rules

This week, Devin and John continue working their way through some of the listener questions that have been coming in. John has a question about making a trust the beneficiary of an IRA, and then Devin has a question about Social Security benefits for public employees who have not contributed to Social Security.

Trusts and IRAs

John has a question about using a trust as a beneficiary of an IRA. The questioner had set up a revocable trust and was going through the process of re-titling his assets. He contacted his IRA custodian and they sent him a notice, warning him that he may not want to do that. He was asking John if he should make the trust the beneficiary of the IRA. Like many of John’s answers, the answer to this question is “maybe.”

It depends on the trust.

Here’s the background: If someone has an IRA, and they die, the beneficiary has some options. They can pay all the taxes at once, they can pay the tax over five years, or, in some cases, they can roll the IRA over into an inherited IRA, and they can spread the taxes out over the beneficiary’s actuarial life expectancy. There are some additional rules based upon on the age of the deceased IRA holder and whether or not they were already taking distributions. There are lot of variations.

The big question here is that most people don’t want to pay the taxes all at one time. They want to pay over the longest period of time possible. That’s something that you might be able to do, if you are a qualified beneficiary. One of the requirements to be a qualified beneficiary is the person/entity has to have a life expectancy. Trusts generally don’t have a life expectancy, which means they aren’t a qualified beneficiary. Because the trust is not a qualified beneficiary, you don’t have the option extend the taxes over the life expectancy.

John keeps saying “usually,” because it is possible to draft a trust so that it can get around the rules. First, the trust has to become irrevocable if it isn’t already irrevocable. Then you have to instruct that the trust will continue on for a designated person. With a designated person, they have a life expectancy. You can even have two or more beneficiaries, as long as you designate that any life expectancy determination is based on the oldest beneficiary.

Why would you want to do this? Control and asset protection.

Putting an IRA into a trust can let you control how the money is disbursed, including designating the order of beneficiaries and giving instructions to the trustee on how the money can be distributed. Also, an inherited IRA does not have the same asset protection as a personal IRA. Putting that money into a trust can protect it from third parties like creditors, spouses, or lawsuits.

The key is making sure that your trust has the right language in it, and then making sure that you follow the rules based upon the way that the trust is written. This is complicated trust-making, and it is easy to mess up. If you are thinking about designating a trust as a beneficiary, it makes sense to review the entire plan up front by submitting the trust to the IRA custodian when you write the trust. Have them look at it to ensure that it is correct.

Social Security Benefits When You Don’t Pay Into Social Security

One of the questions that Devin gets is, “how Social Security benefits are calculated for teachers and other public servants who do not pay into the Social Security system?” Devin has written an entire book on this, called The Hero’s Penalty, and you can find it on Amazon.

On the surface, it may seem like they shouldn’t receive benefits, but you have to remember that many people are eligible for benefits on not only their own work record, but also on the work record of their spouse. Alternately, they may have a mix of covered work history and non-covered work history. It can get pretty complicated if you have a pension from work where you did not pay Social Security, but you are also eligible for benefits either on your own work that did pay into Social Security, or from spousal or survivor benefits based upon the work history of your spouse.

What’s extra difficult is that your Social Security benefits estimate is probably wrong. They send you this estimate not knowing that you have a pension from work that didn’t pay into Social Security. When you go to retire, the Social Security Adminstration will re-calculate your benefit, and you’ll get a smaller amount.

The Windfall Elimination Provision (WEP) decreases the amount of Social Security benefits available to those who have a pension from work that was not covered by Social Security and who have also contributed to Social Security through other work.

There are ways to work around the WEP. One of the more popular ways you can sidestep the WEP is with 30 years of “substantial” earnings that were covered by Social Security. Between 20 and 30 years of service, the reduction decreases, and after 30 years, it is eliminated.

The other thing that it is going to hit you with is the Government Pension Offset (GPO.) The GPO only applies to a spousal or survivor benefit – it does not apply to a benefit for work that you have performed and paid into Social Security. The GPO reduces the amount of spousal or survivor benefits by an amount equal to 2/3 of the beneficiary’s pension amount.

One of the best ways to sidestep the GPO is to find a way to meet the 60 month rule. Under this rule, if you worked the last 60 months of your pension in a job where you pay into both the same pension plan and Social Security, then the GPO doesn’t apply.

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