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In PLR 201203033, a trust qualified as a designated beneficiary after a trust beneficiary released certain portions of a power of appointment. The trustee of the trust was also allowed to transfer the inherited qualified plan to an inherited IRA for the benefit of the trust.
“Alex” died at age 62 after establishing a trust that became irrevocable at his death. Alex was survived by his wife, “Lydia”, and his two children, “Nicholas” and “Melissa.”
The trust provided for the creation of a marital trust for the benefit of Lydia. The marital trust was named as primary beneficiary of Alex’s qualified defined contribution plan. The marital trust was to be funded by (in addition to other amounts) the value of any employee benefit plans made payable to the marital trust.
The trust also provided for the creation of "Primary Trusts" and "Exemption Trusts" for each of the two children. The Exemption Trusts receive equal shares of Alex's remaining GST exemption. The Primary Trusts receive the balance of the assets of the trust after all other distributions or allocations under the trust.
Lydia receives all income from the marital trust and discretionary distributions of principal. Upon Lydia’s death, any remaining property in the marital trust passes in this manner: (1) from the marital trust property includable in Lydia’s gross estate, a share equal to Lydia’s remaining GST exemption, to be divided equally between each Exemption Trust, and (2) the
remaining balance, divided equally between each Primary Trust.
During the term of each Exemption Trust, the trustee may distribute to each child the income and principal the trustee considers necessary for the child's health, education, maintenance and support. Upon the death of each child, the child may appoint the remaining principal and accumulated income among Alex’s lineal descendants. To the extent the child does not exercise this power, the remaining principal and income are to be distributed to the child's lineal descendants, per stirpes, and if there are none, to Alex’s lineal descendants, per stirpes.
During the term of each Primary Trust, all net income is paid to the child, plus discretionary distributions of principal. The child may withdraw up to one half of the principal upon reaching age 30, and the entire principal upon reaching age 35. Melissa had already reached age 35 at the time of Alex’s death.
A child who dies before receiving the entire principal of their Primary Trust may appoint any or all of the principal and income by will among one or more persons or organizations; however, the child may not exercise this power of appointment over any portion of the trust in favor of the child, the child's estate, or the creditors of either unless a federal GST tax would be payable.
To the extent that the child does not exercise this appointment power over their Primary Trust, the remaining principal and income are to be distributed to the child's lineal descendants, per stirpes, and if there are none, to Alex’s lineal descendants, per stirpes.
The trust provides that any property not effectively disposed of under the provisions of the trust is to be distributed to a charity.
After Alex’s death but before September 30 of the year following the year of Alex’s death, Nicholas executed a "Partial Release of Power of Appointment". The Release irrevocably released Nicholas’ right to appoint at his death any portion of the Primary Trust in his name to any beneficiary who is not a natural person or who was born before Lydia. Nicholas had no children as of September 30 of the year following Alex’s death.
An individual’s designated beneficiary is determined by September 30 of the year following the year of the plan participant’s or IRA owner’s death. In order for a trust to be considered a designated beneficiary under the IRC Sec. 401(a)(9) regulations governing RMDs from plans and IRAs, the following requirements must be met:
The trust is a valid trust under state law, or would be but for the fact that there is no corpus.
The trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.
The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit are identifiable within the meaning of Treas. Reg. Sec. 1.401(a)(9)-4, A-1 from the trust instrument.
The documentation described in Treas. Reg. Sec. 1.401(a) (9)-4, Q&A 6 has been provided to the plan administrator (this requirement can be satisfied by providing a copy of the trust to the plan administrator by Oct. 31 of the year following the year of the owner’s death).
If these requirements are satisfied, the beneficiaries of the trust (and not the trust itself) will be treated as having been designated as beneficiaries for purposes of determining the distribution period. Accordingly, the life expectancy of the oldest trust beneficiary can be used to determine RMDs. If the trust does not meet the above requirements, the owner is considered to have no designated beneficiary and the retirement plan must be distributed in five years if the plan owner died, as did Alex, before his required beginning date.
Requirements 1, 2 and 4 are easily met. Most trusts fail to qualify as designated beneficiaries because of the third requirement. While at first blush it may appear simple to identify the beneficiaries of a trust, the analysis is not that straightforward.
One must look at all potential beneficiaries of a trust to determine (1) if such beneficiaries can be identified by September 30 of the year following the year of the plan owner’s death and (2) if such beneficiaries are all individuals with an ascertainable life expectancy.
Accordingly, in PLR 201203033, the potential beneficiaries of the trust upon the death of Lydia needed to be considered in determining if the trust qualified as a designated beneficiary.
A person will not be considered a beneficiary for purposes of determining who the beneficiary with the shortest life expectancy is, or whether a person who is not an individual is a beneficiary, merely because the person could become the successor to the interest of one of the employee’s beneficiaries after that beneficiary’s death. Such beneficiary is referred to as a “mere potential successor.
The above rule does not apply to a person who has any right (including a contingent right) to an employee’s benefit beyond being a mere potential successor to the interest of one of the employee’s beneficiaries upon that beneficiary’s death. Therefore, if benefits will not accumulate in trust for a particular beneficiary under the facts existing at the plan owner’s death, any contingent beneficiary taking as a result of such beneficiary’s death is disregarded. In essence, one would keep going down the beneficiary line to determine the oldest potential beneficiary until there comes a point when the trust would be distributed outright given the facts that exist at the owner’s death.
Because of this “mere potential successor” rule, the potential remainder beneficiaries of Melissa’s Primary Trust did not need to be considered because Melissa was already age 35 at Alex’s death and therefore her Primary Trust would be distributed outright to her if she were living at Lydia’s death.
Nicholas, however, was not age 35 at his father’s death and therefore contingent beneficiaries of his Primary Trust had to be taken into account. If Nicholas were to die before the entire principal of his Primary Trust was distributed, he had the power to appoint the trust among one or more persons or organizations. In addition, to the extent the GST tax would otherwise apply, his power of appointment expanded to include himself, his estate, and the creditors of both. In other words, Nicholas had the power to appoint his Primary Trust to a non-individual or to an individual who is older than Lydia (whose identity could not have been known as of September 30 of the year following the year of Alex’s death).
Nicholas’ power of appointment would disqualify the trust as a designated beneficiary because, as of September 30 of the year following the year of Alex’s death, not all beneficiaries were identifiable and those that were included non-individuals. This situation
was rectified by Nicholas releasing, before September 30 of the year following the year of Alex’s death, his right to exercise his power of appointment in favor of any non-individual or anyone older than Lydia.
Under Treas. Reg. 1.401(a)(9)-4, Q&A 4 (except as provided in Treas. Reg. Sec. 1.401(a)(9)-6) any person who was a beneficiary as of the date of the employee's death but is not a beneficiary as of that September 30 of the year following the year of the employee’s death is not taken into account in determining the employee's designated beneficiary for RMD purposes. As a result of Nicholas’ release, the class of potential beneficiaries as of September 30 of the year following the year of Alex’s death contained only individuals and the beneficiary with the shortest life expectancy was identifiable (Lydia). Accordingly, the trust qualified as a designated beneficiary under the IRC Sec. 401(a)(9) regulations.
The potential charitable beneficiary that would take if there was a total failure of beneficiaries did not need to be considered because the trust would pay outright to a beneficiary at the death of Nicholas. The charity, therefore, was a “mere potential successor”.
Regarding the trustee’s desire to have the qualified plan transferred to an inherited IRA, IRC Sec. 402(c)(11) allows the post-mortem transfer of qualified retirement plans to inherited IRAs by non-spousal beneficiaries when such transfer is done via direct trustee to trustee transfer. As long as the trust qualified as a designated beneficiary, the trustee was entitled to have a direct trustee-to-trustee transfer made of the inherited qualified plan to an inherited IRA. Because the IRS ruled that the trust did qualify as a designated beneficiary, the IRS further ruled that such a transfer would be allowed.
Along with being a good example of how a trust is analyzed to determine if it qualifies as a designated beneficiary, this ruling also shows a post-mortem technique (i.e. a release or disclaimer) that can be utilized to save the designated beneficiary status of a trust. It highlights the fact that even if the plan owner has died and the trust does not qualify as a designated beneficiary as drafted, the advisor can explore options such as disclaimers or cashing out a beneficiary to allow the trustee to stretch out required minimum distributions for as long as possible.
CONTRIBUTOR: Michelle Ward, J.D.
TECHNICAL EDITOR: Barry Picker
CITE: PLR 201203033 (January 20, 2012).
CITE AS: LISI Employee Benefits and Retirement Planning Newsletter #594 (February 1, 2012) at http://www.leimbergservices.com Copyright 2012 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission is Prohibited. The Ultimate Estate Planner, Inc. has received permission from Leimberg Information Services, Inc. to repost this newsletter.