The Problem: Trusts as Beneficiaries of Retirement Accounts, IRAs, 401(k)s, etc.
THE ISSUE IN A NUTSHELL If you have a small retirement account and all of your beneficiaries are close in age then this is not a significant issue. If however you have a sizeable retirement account and there is a great difference in the ages of your beneficiaries (i.e. beneficiaries who are ten years of age and beneficiaries who are forty years of age), then this could have a significant income tax effect for your beneficiaries. This would mean that the required minimum distribution from each account will be based on the life of the oldest beneficiary, rather than each beneficiary using his own life expectancy. RECENT LAW CREATED SEVERAL PROBLEMS IRS regulations issues in the year 2002 made required minimum distribution rules for IRAs and qualified retirement plans simpler and more favorable to taxpayers in every instance except one: When trusts are beneficiaries of retirement plans and separate account treatment is desired for each beneficiary. Problem 1. In 2003, a series of taxpayer-adverse private letter rulings made things even worse for trusts, holding that beneficiaries who receive their interests through a trust could not use the separate accounts rule. The separate accounts rules of the IRS permit a retirement account to be divided into separate accounts, one for each beneficiary after the participant’s death. Certain 2003 IRS private letter rulings held that beneficiaries who receive their interests through a trustcould not use the taxpayer friendly separate accounts rule to determine their respective distribution periods, even if the trust terminated immediately upon the death of the participant. This would mean that the required minimum distribution from each account will be based on the life of the oldest beneficiary, rather than each beneficiary using his own life expectancy. Problem 2. Before the final minimum distribution regulations (in 2002) and PLR 2002-28025 were issued, many practitioners believed that a remainder beneficiary could be ignored when applying the minimum distribution trust rules, if the trust terms required distribution of the entire trust corpus to the income beneficiary at an age that was well within that beneficiary’s life expectancy. For example, we thought we could safely ignore the contingent remainder beneficiary of a typical minor’s trust that would terminate when the minor reached age 25, 30, or 35, with all trust assets then distributed outright to him. We now know that the IRS does not share this view. Problem 3. If the participant’s estate is a beneficiary of the trust, that trust will flunk the rule that “all beneficiaries must be individuals” because an estate is not an individual. The typical trust provision requiring or permitting the trustee to make payments to the participant’s estate to cover debts, expenses or taxes can cause a trust to violate this rule. THE SOLUTIONS Solution to Problem 1. If the separate accounts treatment is desired for any group of multiple beneficiaries, then you will need to modify the retirement plan beneficiary designation forms to include certain wording. Merely leaving benefits to a funding trust (such as your revocable living trust) that splits up into separate shares or trusts will not achieve the desired result. Solution to Problem 2. If you want your retirement benefits to be payable to your trust over the life expectancy of the income beneficiary, you must be sure that the remainder beneficiary of the trust (whether vested or contingent) is younger than the income beneficiary. Solution to Problem 3. The easy way to avoid this problem is to specify in the appropriate documents that retirement benefits cannot be used for debts, expenses or taxes. WHAT TO DO In view of the significant changes discussed above, all persons would be well advised to review your trusts and your beneficiary designations. You likewise should periodically check back with the retirement plan custodian to make sure that they have not misplaced your beneficiary designation form. By: Anthony B. Ferraro Attorney – CPA *This document is for discussion purposes only and is not intended to be construed as legal advice. You should never attempt estate planning without the advice of competent legal counsel. Please feel free to contact our offices if we may assist you.** Copyright 2007 THE LAW OFFICES OF ANTHONY B. FERRARO, Rosemont, Il.