Q.: I have a Roth IRA that I would like to leave to my sister. She has mental-health issues and I want to have a way to leave money to be distributed monthly without paying it all out in handling fees. Do you have any suggestions? Thank you.
Thanks for reading the columns and asking the question. Two basic options jump to mind.
Before I get to the two most common techniques I see that control the flow of money to a beneficiary, I want to emphasize that you should see a lawyer to determine what would work best for you and your sister. In order for your wishes to be carried out, you must have all the applicable documents drafted and executed properly.
In particular, if your sister gets or could be eligible to get any sort of assistance from state or federal programs, it is imperative you work with an attorney that specializes in “special needs” planning. This area of the law can get quite complex and additional assets or income from an inheritance can reduce or eliminate those benefits.
That said, probably the most popular option to provide a beneficiary a monthly income would be to leave the Roth IRA to a trust created for her benefit. The monthly payouts would be determined based on what directions are drafted into the trust document. You can also give the trustee some flexibility to pay additional sums at various times or in certain circumstances. Any funds left over upon your sister’s passing could be available the family, friends or charity.
Leaving the assets to a trust offers some protection from your sister’s own decision making as well as from creditors and scam artists. For instance, these trusts typically do not allow the trustee the ability to payout funds to pay off the student loans of the beneficiary’s new boyfriend or a boat for a neighbor’s birthday. Those are two scam attempts on inheritors I have seen that were thwarted by trusts.
While some flexibility can be written into the trust agreement, getting the trust language to work well with tax law and other rules like those affecting persons with special needs is tricky. Do not attempt to create a trust using over the counter software. Hire a qualified lawyer.
An obvious downside to using a trust is cost. It costs some money upfront to create the trust. When you pass and the trust collects the assets, there are ongoing asset management, tax, accounting and legal costs, so trusts tend to be better options with larger amounts or when special needs issues apply.
As an alternative to a trust, you could arrange to have an “immediate” annuity bought for your sister upon your passing. An annuity would provide a guaranteed monthly income. The checks come steadily for as long as you choose, up to her full lifetime no matter how long she lives. The annuity company issues a simple 1099-R that she can use to file her personal tax return. No accounting costs, legal fees or trust tax return needed.
The primary downside of an annuity for your sister is limited flexibility for her should her needs change. The checks will just keep coming and they cannot be altered. The funds are not invested as they would be in a trust so inflation can erode her purchasing power. Further, there is usually no access to additional funds beyond the payments and there are no funds left for anyone else upon her passing. Now, there are annuity contracts that address some of the limitations of traditional immediate annuities but those will pay a lower monthly amount.
The use of an annuity would not be as viable if this were a traditional IRA due to the taxation and SECURE Act rules for Inherited IRAs. An annuity might work for your sister because you are working with a Roth IRA and the account can be emptied right away after you pass, tax-free. This would satisfy the SECURE Act rules and make the funds available to purchase the annuity.
Even if the annuity approach is more along the lines of what you would want for your sister than the trust approach, you should still see a good estate planning attorney because based on your question, it sounds like it would be better to arrange your estate plan to compel the annuity purchase. Otherwise, you sister may have unfettered access to the funds.
If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.