Trust Accounting for IRAs
What is Trust accounting and why is it important for an IRA account?
Trust accounting is determined by State law, and the applicable state law is driven by the trust account’s situs. For the purposes of this article, I am going to focus my attention on the State of Delaware’s trust accounting laws because FSTC is a Delaware trust company. This Delaware law can be found under Title 12 of the Delaware Code, § 61-409.
Proper trust accounting is done through an income and principal accounting ledger. Although this is a two-ledger system, it is very different than the double-entry bookkeeping that one finds in corporate accounting.
Trust accounting is how income and expenses are allocated between these two ledgers. This is important for IRAs because it affects how an IRA RMD withdrawal is treated within a trust account. Under Delaware law, trust accounting for IRAs can be broken up into two buckets: Trust accounting for IRAs found within marital trusts and trust accounting for IRAs in all other accounts.
Brief Overview of IRA RMDs
RMD stands for “required minimum distribution”. This is the minimum amount that the IRS requires to be distributed out of the IRA each year. RMDs are calculated following IRS’ instructions. Historically, the size of the RMD is based on your age and the calculation is carried through your lifetime. However, in 2020, the SECURE Act modified the calculation so that the amount to be withdrawn may be limited to a ten-year period.
To discuss all of the intricacies of RMDs fall outside of the scope of this article. However, it is important to note that for this 2020 tax year, the CARES Act waived the requirement to take a RMD distribution.
Trust Accounting for an IRA Within a Marital Trust
In order for a trust to qualify for a marital deduction (meaning that no gift/ estate tax needs to be paid or gift/ estate tax exemption needs to be used when being established for a spouse), it has to meet certain accounting requirements. One of these requirements is that it has to pay out all net income to the spousal beneficiary.
Another requirement for a trust to qualify for a marital deduction is that the trust has to have productive property within the trust, or the spouse has to have the power to get rid of unproductive property.
Both of these requirements back into the intention that the trust must currently benefit and support the spouse during his/ her lifetime, or until the trust terminates. As a result of these requirements, Delaware has issued special accounting principles when dealing with a marital trust that has an IRA embedded within it.
Under Delaware law, there are two methods to determine the income/ principal breakdown for a marital trust.
Method 1: Count all of the income from the IRA as income in the trust. The RMD amount that is in excess of the IRA’s net income is deemed to be principal. Additional draws from the IRA in excess of the RMD are also considered principal.
Method 2: Calculate 4% of the yearend IRA value and deem this to be income. This 4% calculation is based off of the 12/31 IRA value, not 4% of the RMD. (This 4% calculation comes directly from the Delaware State statue and is described in more detail in Title 12 of the Delaware Code, § 61-409 (g)). Any part of the RMD in excess of this 4% calculation (or any additional IRA distributions in excess of the RMD) is deemed to be principal.
Out of the two methods, FSTC utilizes method 2, where we calculate 4% of the IRA value as the income of the trust. The reason we use method 2 is because it enables the IRA to be invested for total return. In addition, the calculation is less prone to error, which leads to more accurate accounting.
Trust Accounting for all other Trusts
Trust accounting for IRAs on all other accounts is rather simple. Per 12 Del. C. 61-409(c), all RMDs (aside from the carved out marital calculations referenced above) are deemed to be 95% principal 5% income. Any IRA draws in excess of the RMD is also considered principal.
If you have questions about this article, you can contact Jordan Wolff at 302-573-5821. If you have any questions about your trust account, please contact your Trust Officer whose contact information you can find on your trust statement. If you are not an FSTC client and would like to learn more about FSTC, please contact our Director of Business Development, Jacqui Jenkins at 561-515-6156.
Jordan Wolff, Director of Personal Trust Services
The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only. FSTC does not offer tax or legal advice, professional counsel should be sought for tax or legal advice.