Retirement Benefits Planning Update provides information on developments in the field of retirement benefits law. The editors of Probate & Property welcome information and suggestions from readers.

 

The Final Section 401(A)(9) Regulations—Four Years Later

The final regulations under Code §§ 401(a)(9) and 408 increased the opportunity for stretching out the payment of plan and IRA benefits made during the participant’s lifetime (and through the year of the participant’s death) by adopting the longest payout period that was permitted under the 1987 proposed regulations with neither of the prior gateway requirements that the old rules imposed (naming a spouse as beneficiary on the required beginning date and affirmatively electing recalculation of benefits). Post-death deferrals also were extended by the new tables based on 2000 mortality factors. By delaying the date on which a participant’s designated beneficiary is determined to September 30 of the year following the participant’s death (the designation date), the regulations allow a nine- to 21-month period (the window period) between the participant’s date of death and the designation date during which actions may be taken to avoid the pitfalls that the definition of designated beneficiary presents.

If a participant designates multiple individuals as beneficiaries, the individual with the shortest life expectancy will be the measuring life for purposes of determining the applicable distribution period under the single life expectancy table. Treas. Reg. § 1.401(a)(9)-5, A-7(a). If a non-individual—an estate or a charity—is one of a group of multiple beneficiaries, there is deemed to be no designated beneficiary. Treas. Reg. § 1.401(a)(9)-4, A-3. Under the minimum required distribution (MRD) rules, having no designated beneficiary curtails the stretch-out payment of benefits. Depending on whether the participant dies before or after the required beginning date (RBD), which is generally April 1 of the calendar year after the year the participant attains age 70¹/², the benefits must (1) be paid out in full by the end of the calendar year in which the fifth anniversary of participant’s pre-RBD death occurs or (2) be paid out over the participant’s fixed life expectancy if the participant died after the RBD. Code § 409(a)(9)(B); Treas. Reg. § 1.401(a)(9)-3, A-3(a).

Window Period Changes

During the window period, a potential member of the pool of designated beneficiaries who is living on the participant’s death and who must otherwise be taken into account to determine the payout period can be eliminated before the designation date deadline if that beneficiary is entitled to an identifiable percentage or fractional share of the benefits. The final regulations identify three methods by which the effect of the otherwise applicable multiple designated beneficiary rule can be altered. Treas. Reg. §§ 1.401(a)(9)-4, A-4(a); 1.401(a)(9)-4, A-4(c).

 

1. A beneficiary’s entire benefit may be withdrawn before the designation date.

2. A beneficiary may disclaim his, her, or its benefit, in whole or in part, before the designation date.

3. Separate accounts may be established for the shares of each of the beneficiaries or for groups of beneficiaries if those accounts are set up before December 31 of the year following the participant’s death and the pre-establishment earnings and appreciation of the combined account are identified and proportionately allocated.

 

The supplementary regulations issued on June 15, 2004 (69 Fed. Reg. 33,288) cleared up the confusion under the initially issued final regulations as to whether (and how) separate accounts that were established in the final three months of the year following the year of the participant’s death (that is, after the designation date had already occurred) would affect the determination of the year-after-death payment. The new regulations provide that the establishment of separate accounts on or before the December 31 deadline relates back to the participant’s date of death. Treas. Reg. § 1.401(a)(9)-8, A-2.

To comply with the final regulations, a disclaimer of benefits must meet the Code § 2518 qualified disclaimer requirements and thus, inter alia, must be made within nine months of the date on which the beneficiary’s entitlement to benefits first arises—the date of the participant’s death or, if a successor beneficiary disclaims following a predecessor beneficiary’s disclaimer, the date on which the prior disclaimer occurred. Note that the receipt by a beneficiary of an MRD payment required to be made for the year of the participant’s death (because no pre-death payment to the participant had been made for that year) will not be considered an acceptance of benefits that would otherwise foreclose a disclaimer of the balance of the benefits if the rules of Rev. Rul. 2005-36 are followed. Rev. Rul. 2005-36, 2005-26 I.R.B. 1368. That ruling requires that plan or IRA account income attributable to the MRD payment received also be distributed to the disclaiming beneficiary before the designation date.

Under Code § 2518, the disclaimed benefits also must pass to the successor beneficiary without any direction by the disclaimant. Unplanned disclaimers may go awry if the beneficiary designation does not provide a disclaimer ladder identifying the successor beneficiary or beneficiaries. Most standard issue IRA beneficiary designation forms provide two boxes—one to name a primary beneficiary or beneficiaries who receive or share the benefits if they survive the participant and a second to name successor beneficiaries who receive benefits only if all of the primary beneficiaries named predecease the participant. If multiple primary beneficiaries are named on such a beneficiary designation, a disclaimer by one primary beneficiary will generally cause the remaining primary beneficiaries to share the disclaimed benefit unless the beneficiary designation form is customized.

For example, if a participant designates a spouse, a child, and a charity, each to receive a percentage of the benefits as primary beneficiaries, the taint of having a nonindividual beneficiary can be removed if the charity withdraws its benefits before the designation date. If the spouse then decides it would be preferable to have the spouse’s benefits pass to the son for distribution over the son’s much longer life expectancy period and disclaims the benefits after the charity has withdrawn its share of the benefits, the disclaimed benefits would be shared by the son and the charity—the beneficiaries as of the participant’s death, the effective date of the disclaimer.

Finally, for the purposes of determining the oldest beneficiary as of the designation date, a beneficiary who dies during the window period without having disclaimed benefits is deemed to have survived until the designation date for purposes of determining the participant’s oldest beneficiary (even though, under the IRA, the deceased beneficiary’s interest in the benefits will pass to the beneficiary’s estate or the beneficiary’s designated beneficiaries under the IRA agreement’s provisions). It is not yet clear whether a disclaimer of the benefits made before the designation date by the executors of a deceased oldest beneficiary, if authorized to disclaim and able to act within nine months of the participant’s date of death, will cause the deceased beneficiary’s life expectancy to be disregarded. Treas. Reg. § 1.401(a)(9)-4, A-4(c).

Trusts Named as Beneficiaries—Overview

When the final MRD regulations were issued on April 17, 2002 (67 Fed. Reg. 18,988), most planners were disappointed that the IRS failed to delineate the rules for naming trusts as beneficiaries in detail. Despite the receipt of a barrage of well-thought-out advice from practitioners, the final regulations contain only two examples (carried over from the proposed 2001 regulations) of trusts named as beneficiaries—one a conduit QTIP trust example and the other an example of a QTIP trust for a surviving spouse and minor children that perplexingly stipulates that there are no alternative or cleanup beneficiaries. Treas. Reg. § 1.401(a)(9)-5, A-7(c)(3), exs. 1 and 2.

To make matters worse, the final regulations seemed to eliminate options that the proposed regulations and prior private letter rulings appeared to offer. First, the final regulations provide that if a trust accumulates the plan or IRA benefits it receives, all trust beneficiaries, however remote, must be taken into account in determining whether or not the trust has a designated beneficiary and, if so, the identity of the oldest designated beneficiary over whose life expectancy benefit payments may be stretched out. Treas. Reg. § 1.401(a)(9)-5, A-7(c)(1). Second, the final regulations state that separate accounts cannot be created for the beneficiaries of a trust for the trust’s interest in the IRA or plan benefits, taking away the ability to use the post-death window period to segregate the shares of non-individual and older beneficiaries in a participant’s benefits. Treas. Reg. § 1.401(a)(9)-4, A-5(c) (overriding PLR 200234074).

Other potential roadblocks to naming trusts as beneficiaries have surfaced in private letter rulings interpreting (or misinterpreting) the Code and final regulations. For example, if benefits paid to a trust are used to pay the participant’s estate expenses or transfer taxes, those payments “benefitting” the estate may be deemed to make the estate (a non-individual) a trust beneficiary. Practitioners have suggested that the use of IRA benefits to pay estate expenses and transfer taxes should not cause the benefited estate to be treated as a trust beneficiary if none of these payments can be made after September 30 of the year following the participant’s death—the date on which the identity of the oldest designated beneficiary is determined.

Another roadblock arises if benefits are paid to a terminating trust (such as the participant’s revocable trust) that, effective as of the participant’s death, divides into separate continuing irrevocable trusts according to a direction or formula in the revocable trust agreement. If the separate resulting trusts have differing beneficiaries (especially those in different generations such as the participant’s spouse on the one hand and children on the other), the goal is to have each trust separately tested under the designated beneficiary rules without reference to the other trusts’ beneficiaries. Private letter rulings have held that, if the benefits are considered to “pass through” the original terminating trust, then the beneficiaries of all of the trusts must be taken into account in determining the oldest beneficiary (and whether there is a non-individual beneficiary) in measuring the payout period for all of the separate trusts. PLRs 200317041, 200317043, and 200317044. Practitioners have suggested that, if the division into shares occurs in the beneficiary designation and the separate shares are expressly payable to the separate resulting trusts (rather than to the terminating original trust), each of the resulting trusts should stand on its own feet in determining the payout period.

Four years after the issuance of the final MRD regulations, there appear to be four different kinds of trusts that, depending on the participant’s circumstances, may be named beneficiary of plan and IRA benefits with predictable results under the look-through rules. Specifically, three of these trusts avoid the five-year rule in the case of a participant’s pre-RBD death and all four provide for the deferral of minimum required distributions over the life expectancy of an identifiable look-through beneficiary or the deceased participant. It further appears that the two roadblocks to naming trusts of any kind as beneficiaries are moving toward workable solutions.

Private Letter Rulings Still Rule

The regulations have now been in place long enough that private letter rulings interpreting the final regulations have begun to appear. The efficacy of two of four kinds of trusts discussed below—trusts having a foreseeable termination date and trusts benefiting younger individuals only—are only confirmed in private letter rulings. The third kind of trust, a conduit trust, is described as an example in the regulations but benefits from private letter ruling elaboration. The final choice, the post-required-beginning-date trust with no designated beneficiary, which is based on ignoring the look-through rules altogether in those limited circumstances in which this alternative may apply, is the only option described below that does not rely, in part, on private letter rulings. The lifting of the two roadblocks to using the look-through rules depends entirely on private letter ruling guidance.

Unfortunately, private letter rulings are unreliable. In one sense, they are not reliable because they may not be relied on by taxpayers other than the taxpayers to whom they are issued as precedent except for the limited purposes of showing a reasonable basis for a position taken if faced with tax penalties. Second, private letter rulings may reflect the IRS’s policy du jour and numerous examples of reversals in ruling policy, even under the MRD rules, can be cited. A third problem with private letter ruling guidance is that the factual description of the transaction that is the subject of the ruling is often abbreviated and the significance of facts stated is not always indicated in the discussion of issues or the ruling’s conclusion. Finally, a particular ruling may well be a product of negotiations between the taxpayer’s representatives and the IRS that settle issues not stated in the ruling (or result in the taxpayer dropping requests that were a part of the original ruling request) in order to obtain rulings on those issues that are specifically addressed.

As a consequence of the minimalist provisions in the final regulations that address the naming of trusts as beneficiaries, practitioners are working in the familiar (if unwelcome) environment that preceded the regulations project. Fortunately, some private letter rulings are better than others, at least in terms of the delineation of the facts of a transaction, the scope of the discussion, and the integration of the pertinent facts into the statement of the rulings made. On balance, PLR 200537044 (issued on Sept. 21, 2005) is one of those letter rulings. This ruling adds to our information about conduit trusts, trusts for younger individuals only, the scope of changes that may be made during the window period, and one of the two roadblocks to naming trusts as beneficiaries.

Conduit Trusts

For IRA or plan benefits payable to successive individuals, successor beneficiaries are disregarded in determining the payout period, and the initial beneficiary’s life expectancy is used to determine MRDs. The successor beneficiary is considered to be a “mere successor” because, if the initial beneficiary lives out his or her life expectancy, the successor will receive no benefits. Treas. Reg. § 1.401(a)(9)-5, A-7(a)(1).

A conduit trust requires the trustee to immediately distribute any IRA or plan benefits received by the trust (whether as minimum required distributions or otherwise) to the trust beneficiaries. MRD payments are determined by the single life expectancy of the trust’s conduit beneficiary but trust distributions may be sprayed to other beneficiaries younger than the conduit beneficiary as well.  PLR 200227059. Because all of the benefits will be distributed by the trust if the conduit beneficiary whose life expectancy is the measurement of the payout period lives out his or her life expectancy, any successor older or non-individual beneficiaries who might receive benefits following the conduit beneficiary’s death can be characterized as mere successors and can be disregarded by applying the rule that applies to successive individual beneficiaries. Following the conduit beneficiary’s death, the trustee may accumulate IRA and plan benefits received and the conduit beneficiary may hold a broad power of appointment exercisable in favor of non-individual or older individuals if the power is exercisable only on the beneficiary’s death.

A conduit trust serves a partial spendthrift purpose because the trustee (rather than the conduit beneficiary) controls withdrawals from the IRA of amounts in excess of the minimum required distribution amounts. For example, a conduit trust for a young beneficiary, perhaps distributing the MRD pass-through amount to an UTMA account, affords the beneficiary time to gain maturity because the pass-through distributions will be a small percentage of the IRA account for a significant number of years unless the trustee withdraws (and passes through) amounts in excess of MRD amounts. Similarly, if a surviving spouse has money management challenges, a conduit QTIP trust that distributes only MRD amounts over the recalculated single life expectancy of the spouse will effectively provide payments for the balance of the surviving spouse’s lifetime. A conduit QTIP is the only kind of trust that recognizes the spouse as the sole beneficiary and permits the MRD payments to be based on the redetermined or recalculated single life expectancy of the spouse. Treas. Reg.§ 1.401(a)(9)-5, A-7(c)(3), ex. 2(ii).

The Snapshot Approach If a Trust Has a Foreseeable Terminating Event

Contrary to the broad statement in the final regulations that, if a trust may accumulate plan and IRA benefits, all trust beneficiaries, however remote, must be taken into account for purposes of the designated beneficiary determination, it now appears that some remainder beneficiaries may be disregarded. For example, in the case of a marital/bypass trust plan in which the trusts will continue for the surviving spouse’s lifetime and then terminate in favor of children, the IRS now seems willing to disregard older contingent beneficiaries who might receive benefits in the unlikely event that the children predecease the spouse. In effect, the ability to disregard successor beneficiaries as mere successors because they will take nothing if the primary beneficiary lives out his or her life expectancy is applied on an extended basis by recognizing that the actuarial probability that certain successor beneficiaries will receive benefits only if a prior successor beneficiary or beneficiaries of the participant should die prematurely is minimal.

In PLR 200438044, the participant created a QTIP trust and a nonmarital bypass trust for the surviving spouse. Each trust was to pay income to the spouse with discretionary invasions for the spouse’s welfare. On the spouse’s death, the trust assets were to be held in separate trusts for the participant’s descendants, per stirpes, with outright distributions to occur when each descendant attained age 30. The ruling holds that the trust is a look-through trust that can distribute benefits over the surviving spouse’s fixed single life expectancy. In what has been called the “snapshot” approach, the IRS concluded that, because each of the participant’s three children had already attained age 30 at the time of the participant’s death, they had “an unrestricted right to a portion of the remainder interest” if the spouse’s interest were to terminate at that time. Under the logic of the ruling, the possibility that the children could predecease the spouse is ignored. The ruling states in the description of facts that the trust agreement had a provision for the disposition of trust assets if neither the spouse nor the participant’s lineal descendants were living but does not identify the remote contingent beneficiaries (a group that presumably may have included non-individual beneficiaries or beneficiaries older than the spouse).

The snapshot approach expands Example 1 in the final regulations and reconciles previous private letter rulings relating to trusts that were to terminate on the initial beneficiary’s death. For example, PLR 9846034, issued under the proposed 1987 regulations, seemed to apply the snapshot rule in the case of a trust that was to benefit the participant’s surviving spouse and terminate in favor of the participant’s (and spouse’s) minor children on the spouse’s death by disregarding the participant’s older brother, who would have received trust benefits only if the minor children predecessor beneficiaries were to die prematurely. Then, in PLR 200228025 (issued under the proposed 2001 regulations), the IRS refused to apply the premature death exception to a discretionary trust established for the participant’s two minor grandsons. In that situation, each grandson could withdraw his interest on attaining age 30. If a grandson died before age 30, his interest went to his descendants or, if none, to the other grandchild. If both grandsons (and all their descendants) failed to attain age 30, a 67-year-old aunt became the trust beneficiary. The IRS ruled that the aunt was the oldest trust beneficiary over whose life expectancy payments were to be made. In light of the snapshot ruling, it appears that, had either grandchild attained age 30 at the time of the participant’s death or had the trust agreement contained no age attainment requirement, the older aunt would have been disregarded because a grandchild would have had an unrestricted right to the remainder interest.

For the snapshot approach to be successful, the younger generation beneficiaries must be living on the snapshot date—the participant’s date of death—and the trust agreement must not require the children to attain an age (not already attained at the time of the participant’s death) before the trust terminates. Thus, any “trusts for minors” clause that would permit the trustee to defer the termination of the trust until a minor attains majority would have to be restricted in application to generations below that of the children or be eliminated if there are minor children.

Younger Individual’s Only Trust

One of the four threshold requirements that a trust must meet to be treated as a look-through trust (in addition to the requirements that the trust be valid under state law, that the trust be irrevocable as of the participant’s death, and that a copy of the trust agreement or list of beneficiaries be delivered to the plan administrator by October 31 of the year after the participant’s death) is that the beneficiaries of the trust for the trust’s interest in the IRA or plan benefits must be identifiable. The final regulations’ rules for defining a designated beneficiary provide that if the participant names a class of beneficiaries that is capable of expansion or contraction, there is still a designated beneficiary if the oldest member of the class can be identified. Treas. Reg. § 1.401(a)(9)-4, A-1. Based on this rule, it has been suggested that a trust, such as a dynasty trust, can qualify under the look-through rules if the trust’s dispositive provisions restrict distributions to a class that consists of the oldest trust beneficiary and all individuals in the world that are younger than that oldest beneficiary. Because the threshold look-through qualification requirement is that the beneficiaries entitled to receive plan benefits be identifiable from the trust agreement, it has not been clear whether or not an expansive class that meets the designated beneficiary definitional requirement also will pass the threshold requirement when there are unborn and unascertained members of that class. Treas. Reg. § 1.401(a)(9)-4, A-5.

Drafting a trust that benefits only individuals younger than the beneficiary whose measuring life is targeted to govern MRD distributions may distort the normal dispositive provisions of a family trust. For example, spouses of beneficiaries who may be older than the oldest beneficiary must be excluded (or the older spouse must be made the measuring life). Charities that would otherwise be named as cleanup beneficiaries if the participant has no descendants must be deleted from the trust. Frequently, the oldest lineal descendant will be the measuring life of all separate trusts, even those created for younger siblings and their families, because the trust agreement will provide that separate trust assets will pour over, in part, from a younger family member’s trust to the separate trust for the oldest beneficiary if a younger family member’s lineal line fails.

Post-Required-Beginning-Date Trust with No Designated Beneficiary

The fourth option applies to a not uncommon circumstance and depends on the MRD rule that, if the participant dies after the required beginning date without a designated beneficiary, benefits may be paid out over the participant’s remaining fixed single life expectancy. Treas. Reg. § 1.401(a)(9)-3, A-3(a). The divisor for the age the participant attained (or would have attained) in the year of death is reduced by one year to determine the initial payment for the year after death and by an additional year for each payment year thereafter.

If the participant’s surviving spouse is a beneficiary of the trust or trusts named as beneficiary (as is often the case if transfer tax planning is indicated and a marital trust/bypass trust arrangement is called for) and the spouse is near in age to the participant, the participant may choose to forego compliance with the look-through rules. If the look-through rules were met (by complying with the rules for a snapshot, conduit, or younger individual’s only trust) and the surviving spouse were the oldest look-through beneficiary, the initial payment made for the year after the participant’s death would be based on the single life expectancy table divisor for the spouse’s attained age in the year after the participant’s death. Thus, if the spouse is the same age as the participant, only a portion of a year is trimmed from the payout period by instead using the participant’s life expectancy. If the spouse is one year older than the participant, the payout period is the same. Because none of the look-through rules need to be met, the terminating revocable trust may be named as beneficiary and may contain the formula for dividing the IRA benefits between the marital and bypass trusts.

IRAs that an individual holds as a beneficiary of the same decedent and are being distributed over the same period are aggregated. Treas. Reg.§ 1.408-8, A-9. The 2004 Treasury regulations provide that, except to the extent separate shares are established, all separate accounts “will be aggregated for the purposes of section 401(a)(9).” Treas. Reg. § 1.401(a)(9)-8, A-2(a)(1). For benefits payable “through” a participant’s revocable trust, no separate share treatment is permitted and separate IRA accounts established in the deceased participant’s name for the marital trust and for the bypass trust must be aggregated. The annual MRD amount for the entire inherited IRA (both shares) is thus determined by reference to the oldest beneficiary, the surviving spouse, of each separate IRA based on the entire account balance of both IRAs. Can the MRD for the aggregate IRA be paid from the marital trust IRA, permitting the bypass IRA account to grow? It would appear to be the case. The same aggregation of IRAs benefitting marital/bypass trusts of which the spouse is the oldest beneficiary also would apply to trusts established under the individual’s only or snapshot approaches.

Roadblock—Payment of Taxes and Expenses

Several private letter rulings have cited trust agreement restrictions that prohibited the use of trust funds to pay expenses of the participant’s estate (such as transfer taxes) in the factual portion of the ruling (without discussion in the body of the ruling). PLRs 9820021, 199912041, and 200010055. If trust funds can be used to pay estate tax, the implication is that the estate (a non-individual) will be treated as a trust beneficiary. Under the final regulations, it would seem that if amounts cannot be distributed to or for the benefit of a participant’s estate after the designation date, the distributions before that date (even if they are considered to have been made to a non-individual) should be ignored.

In PLRs 200432027, 200432028, and 200432029, the trustee of a trust named as an IRA beneficiary withdrew funds to pay estate, last illness, funeral, burial, and administrative expenses as well as estate tax—all before the designation date. The taxpayer’s representative asserted that the withdrawn amounts covered all expenses, that any additional estate taxes would be paid from non-IRA assets first, and that the IRA would be tapped only if required by Code § 6324(a)(2), which provides for IRS liens. The rulings hold that the participant’s estate is not a trust beneficiary because the withdrawals were made before the designation date and the remote possibility that IRA assets would be used in the future to pay tax did not change that result.

Two other private letter rulings issued in 2004 concern trusts that provided that all trust assets that were exempt from creditors were not to be used to pay estate expenses. In PLR 200433019, no IRA assets were, in fact, used to pay expenses. The ruling holds that the estate is not a beneficiary because a state court would hold the IRA exempt from creditors. In PLR 200440031, a trust prohibited the use of plan assets exempt from creditors to pay expenses but a state court ordered that the benefits nonetheless be used in the absence of other trust assets. The IRS ruled the estate was not a beneficiary and recognized the oldest individual trust beneficiary as the look-through beneficiary.

Private Letter Ruling 200537044

To the extent that a private letter ruling can be used as a guideline, PLR 200537044 is a good one because it affirms both the conduit trust and the individual’s only trust approaches to planning for IRA benefits in a single ruling. It also illustrates a possible method of “toggling” between the two forms of trusts during the window period. The participant died before his required beginning date, having created an irrevocable “inheritance” trust before his death that established nine separate conduit trusts, each for a different named beneficiary. Each beneficiary held a broad special power of appointment, exercisable effective on death in favor of anyone except the beneficiary, his estate, or the creditors of either, over one-half of the conduit trust and the other half (or all, if the power was not exercised) was to pour over to the other continuing conduit trusts on the beneficiary’s death. The trust agreement terms granted a designated trust protector the power to modify each conduit trust by deleting the required pass-through of IRA benefits. If the pass-through clause were eliminated, trust provisions that were otherwise only to apply to non-IRA assets were activated for the IRA benefits as well. These provisions gave the trustee the power to accumulate all income and make distributions to the trust beneficiary under an ascertainable standard.

Within nine months of the participant’s death, the trust protector eliminated (voided) the conduit clause for one of the nine subtrusts. Under a specific power given to the trust protector, the protector also limited the permissible appointees of the beneficiary’s special power of appointment to beneficiaries younger than the subtrust’s beneficiary and required that the beneficiaries of the one-half of the subtrust not subject to appointment be younger beneficiaries as well.

The IRS ruled that all nine of the separate subtrusts were look-through trusts with MRDs to be measured by each subtrust’s beneficiary’s fixed single life expectancy. The IRS recognized that the trust protector’s actions were in conformity with the trust agreement and were effective under the trust agreement as of the participant’s death and, therefore, treated the trust protector’s exercise of discretion as a part of the trust agreement. The IRS noted that the protector’s actions were taken within nine months of participant’s death “and are treated as a disclaimer under the laws of State X.” A beneficiary could not have made a qualified disclaimer of the right to receive conduit distributions under Code § 2518 because no beneficiary except for a participant’s surviving spouse can both disclaim the right to receive conduit distributions and retain the right to be a beneficiary of a trust that receives those disclaimed benefits. But a disclaimer by the trustees of a trust who have no beneficial interest in the trust, like the “disclaimer” by the trust protector, is permissible even though the beneficiary of the recipient trust is the same as the beneficiary of the disclaiming trust.

A simpler method of providing for a change from a conduit to an accumulation trust would be to permit an independent trustee of the conduit trust to disclaim the benefits in favor of an individual’s only trust under a properly ordered beneficiary designation. In PLR 200537044, the trust agreement provisions did not require the trust protector to convert a conduit trust to a younger individual’s only trust within nine months of the trust grantor’s death (although the power was, in fact, exercised within that time frame). According to hearsay reports, one of the conditions of issuing the ruling (that is not stated in the ruling itself) was that the trust protector renounce the right to alter the dispositive provisions of the subtrusts after the designation date.

Other PLR 200537044 Nuggets

One of the practical concerns in drafting a conduit trust is how trust administrative expenses (even if the trust administration involves only the pass-through of IRA benefits and the filing of tax returns) can be funded without also placing other assets in the trust or having the conduit trust be a subtrust of a trust funded by other assets for the same beneficiaries. In PLR 200537044, the trust provided for the deduction of trust expenses from the pass-through amount “if the deduction does not disqualify the status of the trust as a conduit trust.” Although such a bootstrap clause may be of questionable validity generally, the IRS held that “the provisions of each conduit trust that mandate that all withdrawals from retirement assets be distributed to the trust beneficiary as soon as possible after trust expenses are deducted will not cause the trust to be treated as if there is an accumulation of distributions from retirement assets.” While not stated, the payment of trust expenses is conceptually similar to the ability to spray benefits in a conduit trust among the conduit beneficiary and younger trust beneficiaries—the key being that no retirement benefits are retained that could be enjoyed by an older or non-individual contingent beneficiary.

The question of whether a younger individual’s only trust that benefits a class of beneficiaries as broad as all individuals younger than the oldest beneficiary sufficiently identifies the beneficiaries entitled to receive benefits within the meaning of the threshold look-through qualifications is answered affirmatively in PLR 200537044.

Finally, PLR 200537044 addresses the question of whether or not separate subtrusts created as of the participant’s death can be recognized as independent of one another for MRD purposes if each subtrust is designated in the beneficiary designation as the beneficiary of a percentage share of an IRA’s benefits. The IRS noted that the IRA had been divided into nine separate IRAs before the end of the year following the year of the participant’s death. The IRS recognized that the participant’s beneficiary designation did not name the “master” trust as beneficiary but separately named each subtrust as beneficiary of a portion of the benefit and that the trustees of the master trust were directed by the trust agreement (that is, had no discretion) to divide the master trust into separate subtrusts as of the participant’s date of death. By naming the subtrusts directly in the beneficiary designation, it was noted that the deceased participant took specific action to assure that the benefits would not pass through the master trust. The IRS then concluded that “for the purposes of Code § 401(a)(9), the Service will not apply the rule found in Section 1.401(a)(9)-4 of the Final Regulations, Q&A-5(c), to the fact pattern presented here.” Accordingly, because the prohibition against separate shares for trusts does not apply, each of the separate subtrusts is separately recognized for MRD purposes.

Conclusion

In deciding whether to recommend that plan and IRA benefits be made payable to a trust, planners have to balance (1) the benefits of maximizing the income tax deferral of benefits, (2) the participant’s dispositive plan and the vicissitudes that a well-adopted trust covers, and (3) the goal of minimizing transfer taxes. If the family’s net worth permits IRA beneficiaries to take full advantage of income tax deferral, naming a surviving spouse as a trust beneficiary (even a conduit QTIP trust beneficiary) substantially reduces the income tax deferral opportunity compared to naming the spouse as the individual beneficiary of the participant’s IRA. By rolling over the IRA to the spouse’s own IRA (an option that is not available if a trust for the spouse is named as beneficiary), a spouse who is younger than the participant may defer the commencement of distributions until the spouse’s own RBD, receive lower MRDs during the spouse’s lifetime under the substantially more generous Uniform Lifetime Table, and designate younger generation beneficiaries to receive benefits after the spouse’s death. Often the fixed single life expectancy divisor that applies to a younger generation beneficiary will cause MRD distributions for a number of years to be less than the annual increase in value of the account, permitting the account to continue to grow in value before the crossover point is reached and the IRA gradually diminishes in value. Planners may wish to consider having the portion of the IRA not needed to top off the credit shelter trust pass to the spouse rather than to a marital trust.

Naming trusts for younger generation beneficiaries does not substantially accelerate MRD distributions. Depending on how prolific the younger generation beneficiaries appear to be, the limitation of successor beneficiaries to younger individuals may be an appropriate restriction. Otherwise, a conduit trust may preserve the cleanup provisions that the participant’s overall estate plan employs. Compared to naming younger generation beneficiaries as individual IRA beneficiaries, a trust provides protections that IRA agreements cannot provide, including a shelter from estate tax and probate, protection against spendthrift tendencies or addiction, the management of benefits if incapacity occurs, and a comprehensive dispositive plan in the event of the beneficiary’s death. Because the industry pattern for IRA agreements generally places the younger generation beneficiary in full charge of investments, withdrawals, and the designation of successor beneficiaries, naming a younger generation individual as beneficiary of an IRA is often comparable to an outright bequest.