April 9, 2012
Authored by: Kathy Sherby and Stephanie Moll
When a trust is named as the beneficiary of retirement benefits, there will be a designated beneficiary for purposes of the required minimum distribution (“RMD”) so long as the trust is a “look-through” trust, a trust that complies with the requirements set out in Reg. § 1.401(a)(9-4, A-5(b). If a trust is a “look-through” trust, the oldest countable beneficiary will provide the measuring life for purposes of the RMD. Determining the countable beneficiaries of a trust, and drafting to make sure the desired person is the oldest countable beneficiary, is complex and necessitates precise drafting. Most recently in PLR 201203033 the IRS has provided a detailed roadmap to be followed in making this determination.
In PLR 201203033, the decedent, whom we’ll call Bob, had created a revocable trust that created a Marital Trust, an Exempt Trust and a Primary Trust. Then in his beneficiary designation form, Bob named the Marital Trust as the beneficiary of his qualified plan benefits. After Bob’s death, the trustee of the Marital Trust sought this ruling in order to confirm (1) that the trustee could arrange for a trustee to trustee distribution from the plan to an inherited IRA in a “non-spousal rollover”, as only a “look-through” trust is entitled to complete a non-spousal rollover, and (2) that Bob’s surviving spouse Carol would be the measuring life for determining the RMDs.
In order to determine whether the Marital Trust was a “look-through” trust, the IRS began its testing with the easy tests, setting out that the taxpayer represented that (i) the trust was valid under state law, (ii) the trust became irrevocable on Bob’s death and (iii) the taxpayer had provided the plan administrator with a copy of the trust prior to 10/31 of the year following Bob’s death.
The IRS then began testing the Marital Trust to determine where the benefits would end up as of 9/30 of the year following Bob’s death. The Marital Trust provided that Carol would receive all the income and the trustee could make discretionary distributions of principal. The IRS then stated that Carol was not the “sole” beneficiary of the Marital Trust because the trustee was not obligated to distribute the entire RMD to Carol, citing Example 1(iii) of Reg. §1.401(a)(9)-5, A-7(c)(3). (While Carol is not the sole beneficiary under this Example, the requirement of the cited Reg. is that the trustee would have to be required to make immediate direct distributions to Carol of all distributions from the plan in order for Carol to be the “sole” beneficiary of the Marital Trust.) Since Carol was not the sole beneficiary of the Marital Trust, the IRS then followed the money to determine the other beneficiaries of the Marital Trust on Carol’s death. The Marital Trust provided that on Carol’s death, the amount of her generation skipping exemption would fund the Exempt Trust and the balance would fund the Primary Trust.
The IRS then traced the disposition of the Exempt Trust assets. The Exempt Trust provided that the trust would continue for the life of Bob’s two children, Debbie and Ed. On the death of each child, each had the special power to appoint his or her share to her or his descendants, and if a child did not exercise the power of appointment, his or her share of the Exempt Trust assets would go to her or his descendants, but if there were none, to Bob’s descendants. Ed had no descendants, but his share would pass to Debbie on his death. Debbie had one child who would receive Debbie’s share.
There was no discussion of a possibility of a continuing trust for Ed and Debbie’s descendants or of the possibility that Ed’s share would be added to Debbie’s continuing trust or whether there was a possibility of exercising the power to appoint in further trust for descendants, which would have been important to consider, as then the ultimate contingent beneficiary, a charity, would have been countable and would have caused the trust not to be a “look through” trust. Perhaps such possibilities did not exist, as the IRS ignored the Charity and determined that the Exempt Trust as a beneficiary of the Marital Trust was a “look-through” trust with beneficiaries who were individuals all younger than Carol.
The IRS then turned to the Primary Trust to trace the disposition of the benefits once in this trust. The Primary Trust provided that each child would have the power to withdraw the assets of his or her share of the trust, half at age 30 and the balance at age 35. Debbie was over age 35, so her share would go outright to her. Ed was over age 30 but under age 35, so the IRS needed to determine where the balance of his share would flow. Ed had had a general power of appointment over his share, and had “released” the general power to the extent it permitted appointment to anyone other than individuals younger than Carol. The IRS assumed that this release was valid under state law, but did not discuss whether the release was a qualified disclaimer. Since Ed’s power of appointment was limited to individuals younger than Carol, this power no longer posed a problem of the identity of the permissible appointees. The IRS then considered where the funds would flow if Ed did not exercise his power. In that event, the Primary Trust provided that the half share would flow to Ed’s descendants, but since there were none, it would flow to Debbie, and Debbie could withdraw the funds, so the Primary Trust was likewise a “look-through” trust.
Since all of the beneficiaries of the Marital Trust, the Exempt Trust and the Primary Trust were all identifiable and individuals, and the trusts were “look-through” trusts, the trustee of the Marital Trust was permitted to rollover the benefits from the qualified plan to an inherited IRA held for the benefit of the Marital Trust and the RMDs would be taken out over Carol’s life expectancy, as the oldest beneficiary with the shortest life expectancy.
This same detailed tracing of where the funds would go as of 9/30 of the year following the decedent’s death must be completed in drafting any trust that is to be named as a beneficiary of any retirement funds, to make sure that the desired result will be accomplished after the death of the employee/owner of the retirement plan.