Using IRA Trusts in Estate Planning to Minimize Taxes and ...media.straffordpub.com/products/using-ira-trusts... · 9/12/2013 · Two-thirds of these states are opt-out states. 8
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Using IRA Trusts in Estate Planning to Minimize Taxes and Preserve Assets Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. THURSDAY, SEPTEMBER 12, 2013 Presenting a live 90-minute webinar with interactive Q&A Scott K. Tippett, Attorney, The Tippett Law Firm, Oak Ridge, N.C. Gregory Herman-Giddens, President, TrustCounsel, Chapel Hill, N.C.
The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
THURSDAY, SEPTEMBER 12, 2013
Presenting a live 90-minute webinar with interactive Q&A
Scott K. Tippett, Attorney, The Tippett Law Firm, Oak Ridge, N.C.
Gregory Herman-Giddens, President, TrustCounsel, Chapel Hill, N.C.
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business and investment assets. He also has $4 million in an IRA, which includes amounts rolled over from profit sharing and 401(k) plans. He currently receives RMDs and wants to leave as much as possible for the benefit of this three grandchildren Mckenzie (35), Kenan (22), and Cameron (20).
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Advantages of IRA Trusts Solution No. 1
Name grandchildren as multiple beneficiaries,
creating separate accounts for each. Each of the beneficiaries can then elect to receive RMDs over their respective life expectancies.
Only works if IRA custodian establishes separate accounts and the beneficiaries follow John’s wishes to only take the RMDs. Nothing prevents them from cashing out the entire IRA.
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Advantages of IRA Trusts
Problems With Naming Individuals as Benes. Most inherited IRAs are withdrawn almost
immediately, foregoing future benefits. Anecdotal evidence suggests that 80% to 90%
of IRAs that could be stretched are not. Short story, Stretch IRA likely will not happen.
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Advantages of IRA Trusts Solution No. 2 Establish a trust for the benefit of Mckenzie,
Kenan, and Cameron and name the trust as the beneficiary of John’s IRA.
So long as the trust qualifies as a designated beneficiary the trust can elect to receive only the RMDs and nothing more, thereby preventing the grandchildren from cashing out the IRA.
However, because Mckenzie’s life (as the oldest beneficiary) will be used to calculate RMDs for all three grandchildren.
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Advantages of IRA Trusts
Solution No. 3 Create a trust for the benefit of John’s
grandchildren with a separate sub-trust for each of Mckenzie, Kenan, and Cameron. Each sub-trust would be named as an equal beneficiary of the IRA. With this approach each sub-trust will use the respective sub-trust’s beneficiary’s life as the measuring life for RMDs for that sub-trust.
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Advantages of IRA Trusts Conduit Trusts – What Are They?
Four Requirements: 1. Trust Must Be Valid Under State Law 2. Trust must be irrevocable or will, by its terms,
become irrevocable upon the death of the participant.
3. The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit must be identifiable in the trust instrument.
4. Certain documentation must be provided to the plan administrator.
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Advantages of IRA Trusts
Conduit Trusts – The Fifth Rule 5. All beneficiaries must be individuals.
A conduit trust permits you to look through the
trust and treat the trust’s beneficiaries as if they were directly named as the Participant’s beneficiaries.
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Advantages of IRA Trusts
Conduit Trust Uses A. QTIP
1. A Stretch QTIP? If the surviving spouse
is the sole beneficiary and the QTIP Trust is structured as a conduit trust, it will last longer because the surviving spouse’s life expectancy is recalculated annually for RMD purposes.
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Advantages of IRA Trusts
QTIP as Conduit Trust cont’d 2. Deferral. Where the Participant dies
before the year in which the Participant attains the age of 70 ½ , RMDs can be deferred until the year in which the Participant would have attained 70 ½ , which allows a longer period of tax-deferred growth.
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Advantages of IRA Trusts B. Older Beneficiaries The Problem: If a beneficiary is named as a direct
beneficiary of an IRA, the beneficiary must take RMDs over their life expectancy, which in the case of an older beneficiary does not leave as much time for tax deferred growth.
The Solution: Use a conduit trust naming the older bene as
the remainder bene of the trust because under Treas. Reg. § 1.401(a)(9)-5,A-7(c), successor (remainder) benes of the trust will not be considered a bene for the purposes of determining who is the bene with the shortest life expectancy.
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Advantages of IRA Trusts PLR 201021038 shows how the typical provisions of a family revocable trust, inserted to obtain
maximum flexibility, can defeat the Participant’s goal to stretch the IRA. PLR 201203033 shows what must be addressed to enable a family trust to qualify as a conduit
trust to permit a spousal rollover and permit children to transfer their shares to inherited IRAs. This PLR also discusses the use of a disclaimer preserve the “stretch-out” of RMDs over a beneficiary’s life expectancy. This PLR provides a good road map for cleaning up a problem trust.
PLR 201210045 reinforces the necessity to comply with the “separate account” rule when naming
of the beneficiaries of an individual’s IRA account.
PLR 201203033 shows how retirement benefits payable to a trust can qualify for the stretch out notwithstanding a broad power of appointment exercisable in favor of a class of permissible appointees, along with a charity as the ultimate beneficiary.
Can a trust taxed as a grantor trust for income tax purposes be an IRA beneficiary? PLRs 200620025 (okay to transfer inherited IRA to a special needs trust) and PLR 200826008 (okay to transfer minor’s beneficiary share of decedent’s IRA to a grantor trust) say yes, but…
PLR 201117042 says no when the Participant wanted to transfer his IRA to a special needs trust
that was a grantor trust for income tax purposes.
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Advantages of IRA Trusts When Would You Want a Trust as Beneficiary, Just Not a Conduit Trust?
Mckenzie is going through a divorce. Her soon to be ex-husband hired Gloria
All Red who is trying to get all of Mckenzie’s assets in a divorce settlement. Kenan invented a process to use fiber optics in place of printed circuit boards in
all computers, thereby increasing their speed a thousand fold. He has more money than he can count.
Cameron is a financial nightmare. He not only spends money as soon as he
gets it, but before he gets it. While his siblings have lengthy good credit reports, the local courthouse has a lengthy judgment roll with numerous outstanding judgments against Cameron.
John also wants to help his nephew who has severe autism. See PLR 2011-
50037 for a novel approach.
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Advantages of IRA Trusts More Complications
John has a younger sister, Penn, who is 65 and
has never married. She rarely spends anything and manages to feed herself and her 33 cats on her Social Security income.
John’s current wife is his second wife, who he married late in life. They have no kids together, but John has two children from his first marriage.
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Advantages of IRA Trusts
What Do All These Situations Have In Common? All are situations where a conduit trust would
not be the best choice. A more flexible approach would be to use an
accumulation trust.
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Advantages of IRA Trusts
An “accumulation trust” is any trust that is not a conduit trust, which means the trustee has the power to “accumulate” plan distributions within the trust.
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Advantages of IRA Trusts Issues With Accumulation Trusts Some or all of the potential remainder beneficiaries
are not disregarded for RMD purposes, which means an accumulation trust should not include remainder beneficiaries older than the lifetime beneficiary.
Contingent beneficiaries may not include one or more charities or an undetermined surviving spouse, otherwise it may be deemed to have no designated oldest beneficiary.
An accumulation trust may not include a limited testamentary power of appointment in favor of charities, surviving spouses, or older beneficiaries.
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Advantages of IRA Trusts Modified Accumulation Trust* Features of a Modified Accumulation Trust An A share and a B share; the A share receives
benefits from all qualified plans and IRAs, the B share is everything else
Testamentary appointees of the A share are limited to descendants of the primary current beneficiary in the same or younger generation as the primary current beneficiary.
If surviving spouse is permitted appointee of the A share, specify that surviving spouse is no older than a designated number of years older than the primary beneficiary.
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Advantages of IRA Trusts
Modified Accumulation Trust Provides that certain remaindermen are
deemed to be predeceased in the event the current beneficiary dies before the trust terminates. These remindermen can receive a preferential distribution of the B share. Can provide for an adjustment mechanism to offset any difference in tax consequences between the A share and B share beneficiaries.
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Asset Protection Benefits of IRA Trusts A. Two Issues
1. Exemption During Life of Participant
2. Exemption After Death of Participant
During the Life of the Participant-
25 states provide unlimited exemptions for traditional and Roth IRAs.
Two-thirds of these states are opt-out states. 8 states provide an unlimited exemption if the funds were contributed
outside a certain time frame (1 to 3 years, varies by state). 8 states limit the exemption to the amount reasonably necessary for
support 6 states provide a stated amount that is exempt.
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Asset Protection Benefits of IRA Trusts
During the Life of the Participant 4 states only exempt ERISA qualified plans or
do not protect SEP-IRAs (MI, OH, RI, WY). Puerto Rico, D.C., and the U.S.V.I. have no
statutory exemption for IRAs.
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Asset Protection Benefits of IRA Trusts After the Death of the Participant Of the courts that have examined the issue, the
clear trend is to hold “inherited IRAs” as exempt from the beneficiaries’ creditors. See In re Chilton,---F.3d---, 2012 WL 762924 (5th. Cir. 2012); In re Nessa, 426 B.R. 312 (8th Cir. BAP 2010); In re Kuchta, 434 B.R. 837 (Bankr. N.D. Ohio 2010); In re Tabor, 433 B.R. 469 (Bankr. M.D. Pa. 2010); In re Thiem, 443 B.R. 832 (Bankr. D. Ariz. 2011); In re Weilhammer, 2010 WL 3431465 (Bankr. S.D. Ca. 2010); In re Stephenson, 2011 WL 6152960 (E.D. MI. 2010); In re Clark , 2012 WL 233990 (W.D. Wis. 2012).
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Asset Protection Benefits of IRA Trusts
Solution to This Varied Landscape? An accumulation trust or modified accumulation
trust. With the power to accumulate, the trustee can
elect to accumulate the retirement benefits instead of passing the benefits out to the beneficiary.
Possible to draft trust that starts out as a conduit trust, but a triggering event turns it into an accumulation trust.
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Tax Issues With IRA Trusts If FET and GST taxes are in effect when
Participant dies, the value of the IRA will be included in the Participant’s gross estate for FET purposes. If the trust names a skip person as a beneficiary,
the Participant will need to allocate part (or all) of their GST exemption. Amounts received by beneficiaries are
considered IRD, therefore subject to income tax. A deduction is allowed for estate taxes
attributable to the IRA is allowed to the beneficiary as an income tax deduction.
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Estate Planning with IRA Trusts for Tax Savings & Asset Protection
September 12, 2013 Gregory Herman-Giddens, JD, LLM, TEP, CFP
Attorney at Law North Carolina ▪ Florida ▪ New York
• IRAs are not taxed until distributed (IRC § 402)
• Distributions must begin no later than one’s Required Beginning Date (RBD) – Generally, April 1 of the year following the year the owner
turns age 70½ is the RBD – Once at RBD, Required Minimum Distributions (RMD) must
begin
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Presenter
Presentation Notes
First, under Code Section 402, IRAs are not subjected to income tax until they're actually distributed. There may be one exception to that, and we have to be very careful in our legal documents to use fractional funding clauses, not pecuniary funding clauses. I'll come back to that when we talk about IRAs payable to trusts, but for the same reason you would always tend to use a fractional funding clause for items of IRD (Income Respecting a Decedent), you're going to want to use a fractional funding clause when dealing with a large IRA. Now, distributions must begin no later than one's Required Beginning Date (RBD). So, let’s understand what the RBD is. Normally, after someone turns 70½, distributions must be made by December 31st of each year. The only exception is for the very year in which I turn 70½ (“the date six calendar months after the 70th anniversary of the employee’s birth”). For that first year, the RBD is April 1st of the year following that year. Thereafter, we’re on a roll with December 31st, including December 31 of the year following the year I turned 70½. In other words, waiting until April 1st for the first distribution does not count for that year; it relates to the prior year in which I turned 70½. Now, can I elect to take a distribution in the very year that I turn 70½? Certainly, just like I could have been taking since age 59½. Is it required? No, not until April 1 of the following year. How about when I die? Here’s where the RBD becomes even more critical, because that date is a bright line on how post mortem distributions work. But before we go there, let’s review some distribution rules.
Basic RMD Concepts
• RMDs are calculated based upon prior year ending account balance divided by life expectancy factor
• Not applicable to Roth IRAs during original account owners life
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Expectancy Factor RMD =
Presenter
Presentation Notes
When we say Required Minimum Distribution, all we’re saying is how much money must come out of the IRA in any particular year. For example, if the IRA balance is $100,000 and the life expectancy factor is 10 years, I would simply take $100,000 divided by 10, which would require taking $10,000 out of the IRA. Or if the IRA is $100,000 dollars but the life expectancy factor is 50 years, you would take $100,000, divide it by 50, and you'd only be required to take $2,000 dollars out of the IRA. The exact same rule works in the context of both a Roth IRA and a traditional IRA, but one of the beauties of the Roth is that there is no RMD for the original owner’s lifetime, only for subsequent beneficiaries. In other words, distributions only occur from a Roth IRA either voluntarily by the original owner or mandatorily after the original owner’s death, when the beneficiaries must take the money out over a life expectancy.
Basic RMD Concepts • Death before Required Beginning Date
• If no Designated Beneficiary, five-year rule • If a spousal rollover, distributions depend on spouse • If an inherited IRA, begin December 31 of the year after
death using DB’s life expectancy (must also pay participant’s intervening RMDs, if any)
• Death on or after Required Beginning Date • If no Designated Beneficiary, participant’s ghost life • If an inherited IRA, begin December 31 of the year after
death using the longer of DB’s or participant’s life expectancy
• In any event, must pay participant’s RMD in and for year of death
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Presenter
Presentation Notes
So, we know what the RBD is and what the RMD is, but we need to understand what happens for the beneficiary after the participant’s death. That’s what this slide shows in outline form, based on whether the participant died before the RBD or after. (REVIEW SLIDE)
Basic RMD Concepts • Distribution Grid
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Five-Year Rule
Death Before Participant’s Required Beginning Date
Death On or After Participant’s Required Beginning Date
Designated Beneficiary
Non-Designated Beneficiary
P’s “Ghost” Life Expectancy with P’s SLT
DB’s Life Expectancy with Single Life Table
SS gets Uniform Lifetime Table
Life Expectancy choice (longer of DB’s or P’s) with respective SLT
SS gets ULT or P’s SLT
Presenter
Presentation Notes
This grid might be simpler to picture than the preceding slide. The most important part of your grid is whether the participant died before or after the RBD. Then, you have to ask, “Is there a designated beneficiary or a non-designated beneficiary?” And the answer to that tells us what kind of stretch we get. Now, what if the initial, inheriting, designated beneficiary then dies? Can we re-set the stretch based on the next beneficiary’s life expectancy? No. Once a distribution rule is determined for an inherited IRA, all subsequent beneficiaries are merely “successor beneficiaries” who step in the shoes of that initial, inheriting beneficiary and must continue to follow the same rule applicable to that first beneficiary for IRA RMD purposes. Of course, the subsequent beneficiary has the right to accelerate distributions, which is the same right the first beneficiary had.
Basic RMD Concepts
• Life expectancy tables • Single Life Table • Uniform Lifetime Table • Joint and Last Survivor Table
• Available where spouse is sole beneficiary and more than 10 years younger than the account owner. See IRS Publication 590
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Presenter
Presentation Notes
8:45 am Turn to the back of your Flowchart and look at the life expectancy rules for -- say, find someone age 30, age 50 and age 70. You can see the difference in life expectancy, so it's pretty easy to understand conceptually why we should be seeking to take distributions out over the youngest life expectancy possible. You can also see the difference it makes to use the different tables. So there might be several things you can do when someone dies, and I just want to emphasize how important it is for you to be on top of this.
Basic RMD Concepts
• Generally, if individual beneficiaries exist, post-death RMDs are based upon oldest designated beneficiary’s life expectancy under the Single Life Table
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Presenter
Presentation Notes
Generally, if individual beneficiaries exist, post mortem distributions are going to be based upon the oldest beneficiary's life expectancy. If you name four children as beneficiaries, unless you can and do separate that account by December 31 of the year following the decedent’s death, you’re going to be using the oldest beneficiary's life expectancy for all the children, including the youngest. So, if I name children, and the oldest is 17 and the youngest 11, and I leave my IRA to those children but all in one IRA account without separation, then the distributions are going to occur over my oldest child's life expectancy. On the other hand, if we can break them up, then each would be able to use their own life expectancy with regard to his distributions. Now, from ages 17 to 11, does it matter? Does it matter if the children are between 50 and 56? You can look at the tables on the flowchart and see how little impact half a dozen years has. But what about if one child is 20 and the other child is two? Then it matters. Then the life expectancy rules become very critical. So, in those situations, you want to separate the IRA accounts by December 31st following the year of death. If you do that, then you're going to be able to take distributions out over each individual beneficiary's life expectancy.
Basic RMD Concepts
• Post-death RMDs based on whether “designated beneficiary” exists • Only “individuals” with quantifiable life expectancy can be
“designated beneficiaries”
• If trust qualifies, can “look through” to underlying trust beneficiaries • Simply distributing out of trust to beneficiary does not make the
beneficiary the “designated beneficiary”
• An estate is not a designated beneficiary
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Presenter
Presentation Notes
Now, only individuals can be a designated beneficiary, so you name your Aunt Mary. That's easy. We'll use her life expectancy; we'll take the money out over her life expectancy. Generally, for trusts which qualify, we can look through the trust to the oldest beneficiary of the trust and then we take distributions out on that oldest beneficiary's life expectancy. But if the trust contains a poisonous beneficiary, we have to do more than simply distribute out among the various beneficiaries. For instance, a charity is a poisonous beneficiary. Say I leave my IRA 90% to my children, 10% to my favorite charity. That charity is going to poison the IRA unless we eliminate the charity from the IRA before September 30th of the year following the year I die. An estate is also a poisonous beneficiary. If I leave my IRA to my estate, I'm either going to end up with what's called the "five-year rule" or the "ghost life expectancy rule.” Remember the grid in an earlier slide (Slide 11)? Say I die at age 65, my IRA is payable to my estate. We are going to end up with the five-year rule. On the other hand, say I die at 75 and my IRA is payable to my estate. Then the funds are going to come out over my remaining theoretical ghost life expectancy. Now remember, a spouse can do something that no one else can…and what’s that? A spouse can roll over an IRA. So let’s look at the rollover rules.
Critical Dates • Age 55 Withdraw from Qualified Plan without penalty [IRC 72(t)]
• Age 59½ Withdraw from IRA without penalty [IRC 72(t)]
– Inherited IRA might start earlier without penalty
• September 30 of the year following the year of death
– Date at which the beneficiaries are identified
– Date by which to “strip out” poisonous beneficiaries, if possible
• October 31 of the year following the year of death
– Date by which trust documentation (in the case where as trust is named as a designated beneficiary) must be filed
• December 31 of the year following the year of death
– Date by which the first distribution must be made by each IRA beneficiary
– Date by which separate shares must be created
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Presenter
Presentation Notes
Before we tackle this slide, I’ll let you stand up, take a deep breath or two, and stretch for 30 seconds, which does not give you time to go anywhere. If you leave the room, we’ll likely be starting back without you. Okay, let’s look at some critical dates and how they relate to some choices we might have. Using the Traditional IRA Distribution Flowchart, let's start in the far left and let's talk about the options that are available when I have a spouse, trust, charity, my estate, a child or grandchild. Let’s look at my spouse. First of all, when I name my spouse as the beneficiary of an IRA or qualified plan, my spouse can do something no one else can do. She can roll that IRA over into her own name or she can leave it as an Inherited IRA. Now, why is that important? I come to see you, my wife died and she was 49 years old when she died. And, say, I’m about the same age—hypothetically, of course. Now, at the heart of this, let's think about what you would tell me. You'd say, “Joe, one choice you have is you can roll all the money over into your own name.” And I say, “Okay. That's a good idea, but can I get to it?” You say, “No, there's this little rule called ‘Section 72(t)’ and it imposes a 10% penalty when you take money out of an IRA before age 59½ or a qualified plan before age 55, an exception being death.” So let's look at this. I roll the money into my own IRA, Joseph H. Mitchiner, and at that point in time, I cannot take the money out because I'm not 59½. In the alternative, I leave the money back in my wife's IRA. If I want to take money out of that IRA, that's fine. That's called an “Inherited IRA.” I can take the money out without the imposition of the 10 percent penalty. Let's go through another example. Mrs. Smith comes to see you; her husband, a doctor, just died. He was 50 years old. They have little children, and he's got 2 million dollars in his IRA. If that's the case, what you'd probably want to do is roll over a portion of that, say $900,000, into an IRA in her name, leaving a million and one back in the Inherited IRA. But there’s another issue: creditor protection! If Mrs. Smith is intended to receive the entire principal and income of the IRA, then naming her as outright beneficiary guarantees the ability for rollover, which in turn allows greater deferral, while also affording creditor protection under State law [N.C.G.S. § 1C-1601(a)(9)]. Your own IRA, which includes a spousal rollover, is a creditor protected asset. But an inherited IRA is not. Big difference! So, it’s all about the facts and numbers, and depends on what Mrs. Smith’s attorney and financial advisors say she needs to live on before she turns 59½ versus how much creditor protection she might need. So, that’s important when looking at the ages of 55 and 59½. What about September 30 of the year following the year of death? (READ SLIDE) Then, there’s October 31. (READ) Finally, there’s December 31 . (READ)
September 30th Determination Date
• Designated Beneficiary not determined until September 30 of the year following the year of the IRA owner’s death
• Treas. Reg. § 1.401(a)(9)-4, Q&A 4(a)
• Allows for disclaimer planning (discussed later)
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Presenter
Presentation Notes
Let's talk more about what the September 30th Determination Date means. Basically, this is called a "shakeout period." It’s a very important thing in your planning process, because an estate administration may come into your office, and it may not be working right; but under the regulations, you have until September 30th following the year of death to correct bad IRA beneficiary designation forms or to reform trusts that do not work. What about the September 30th date in the context of a disclaimer? Say my IRA is payable to my wife, but -- within the regular disclaimer period of 9 months, she disclaims, and now it passes to my children. Whose life expectancy do we use? Under the Treasury Regulations, we would use my children's life expectancy, not my wife's life expectancy. This is a wonderful thing to be able to use my children's life expectancy.
September 30th Determination Date
• If death occurs before the September 30 date without disclaiming, such beneficiary continues to be treated as a beneficiary in determining the designated beneficiary
• Treas. Reg. § 1.401(a)(9)-4, Q&A 4(c)
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Presenter
Presentation Notes
What if my wife died very shortly after me? We'd be stuck with my wife's life expectancy unless we can get her estate to execute a disclaimer. If we can get her estate to execute a disclaimer, then, again, we're going to be back to my children's life expectancy.
September 30th Determination Date Example
• Jane names a trust as beneficiary of her IRA. 90% of the trust is payable to her children over their lifetimes. 10% of the trust is payable to Jane’s favorite charity.
• If the charity’s 10% is separated and paid out of the trust by September 30th of the year following the year of Jane’s death, the charity’s interest will not taint the rest of the trust.
• See PLR 200218039 (Michelle L. Ward and Robert S. Keebler)
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Presenter
Presentation Notes
9:15 am Here's an excellent example of a shakeout, or what some call “stripping”. Keebler had a client who named a trust as a beneficiary of her IRA. 90% of the trust was payable to her children over their lifetimes and the remainder of the trust went to her favorite charity. What he did was reform the trust to create two separate shares, one share for the charity and one share for the children. The share for the charity was paid out immediately under the five-year rule, but the 90% share for her children was taken out over the children's life expectancy. Let's take a side trip to talk about reformations. Keebler has had half a dozen-plus Private Letter Ruling requests where he’s gone to the government and said, “What if we can reform the trust? Will you let us change the trust to have the proper language so that we become a designated beneficiary trust?" Courts have been gracious across the country in granting his clients these reformations, which will allow compliance with the 401(a)(9) rules. Now -- what about debts, expenses and taxes? There are also Private Letter Rulings that would allow an IRA to be payable over someone's life expectancy provided we pay all our debts, expenses and taxes by the September 30th cutoff date, just like we can do to strip out a charity. And again, this is something where you need to very quick on your feet. Immediately after a person dies, the first question you have to ask is: Is this trust a designated beneficiary trust? You run it through the tests and decide, “This is probably not a designated beneficiary trust. Now what am I going to do?" Then you ask, “Can I have someone execute a disclaimer? Can I cash out beneficiaries? Can I reform the trust?” But when thinking about reformations, beware that under what’s known as the Bosch Doctrine (that’s B-o-s-c-h), the federal government is not required to respect a state law reformation. And that's why you must ask for a Private Letter Ruling, first. Or, at least, make sure that your state court order makes the reformation conditional upon obtaining a favorable PLR. You don’t want to get into a situation where the government later comes back and says the trust was not a designated beneficiary trust. Here’s what I mean. Let’s say you go ahead and you do the reformation without a Private Letter Ruling; the government then comes back and says, “You're still not a designated beneficiary trust and we need a 50% penalty for the million dollars you were supposed to take out of the trust." The reason you see so many Private Letter Rulings in the area of disclaimers, charitable cash outs, other shakeouts and pure reformations is that the penalties are overwhelming. For example, say I have an IRA is payable to a trust. You tell me I get life expectancy payouts, but I'm truly under the five-year rule. I fail to follow that five-year rule. Then I am going to be stuck with a 50% penalty for failing to withdraw proper distributions, and we would have to ask for a waiver. Now, Keebler says that the government is generally pretty genteel with granting waivers, but that’s not where you want to find yourself.
September 30th Determination Date Example
• John names his wife as primary beneficiary of his IRA and his grandchild as contingent beneficiary.
• If John’s wife executes a qualified disclaimer by September 30th of the year following the year of John’s death, RMDs can be calculated based on the grandchild’s life expectancy.
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Presenter
Presentation Notes
Let's talk about the next example. John names his wife as primary beneficiary of his IRA and his grandchild as contingent beneficiary. In that context, if his wife disclaimed, then basically, distributions could be calculated over the grandchild's life expectancy.
September 30th Determination Date Example
• John names his sister as primary beneficiary of his IRA and his nephew as contingent beneficiary.
• If John’s sister dies before September 30th of the year following the year of John’s death without performing a qualified disclaimer , RMDs are still calculated based on the sister’s life expectancy.
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Presenter
Presentation Notes
Another example, very similar: John names his sister as primary beneficiary and his nephew as contingent beneficiary. John's sister dies before September 30th of the year following the year of John's death. No disclaimer. In that context, Required Minimum Distributions are still based on the sister's life expectancy, but if her personal representative had properly disclaimed, then we could use the nephew’s life expectancy.
Disclaimer Planning
Disclaimer must be “qualified” (IRC § 2518) • In writing • Within 9 months • No acceptance of the property interest or any of its
benefits * • Interest passes without any direction on the part of
the person making the disclaimer * Rev. Rul. 2005-36 allows disclaimer of the IRA balance even though, prior to
disclaimer, the beneficiary receives the RMD for the year of the decedent’s death.
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Presenter
Presentation Notes
Let's look more closely at disclaimers. First of all, a disclaimer must be in writing. Next, it has to occur within nine months. There can be no acceptance of the property interest or any of its benefits, with this one exception noted; and the interest must pass without any direction on the part of the person making the disclaimers.
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Disclaimer Planning
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IRA Spouse Must be Qualified Disclaimer
Life Expectancy of Oldest Beneficiary of Trust
Trust FBO Children
Spouse Disclaims
Presenter
Presentation Notes
Now, how do we use disclaimers? Maybe my IRA is payable to my spouse and she says, “I don't need that money. Let me disclaim in favor of a trust for my children." Once we have a qualified disclaimer, we have to follow the beneficiary form. This means that all this planning needs to be in place before a person does a disclaimer. So while a person is still alive and healthy, we need to put all the planning in place so we can have choices, if that’s what we want.
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Disclaimer Planning
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IRA Spouse Must be Qualified Disclaimer
Life Expectancy of Oldest Beneficiary of Trust (i.e., spouse)
Useful for funding unified credit amount while still benefiting spouse
Trust FBO Spouse and Children
Spouse Disclaims
Presenter
Presentation Notes
9:25 am Let’s look at this in another context. Maybe my IRA is payable to my wife, but there's also a special IRA trust for my wife and children. In that case, the IRA would go to my wife because it’s payable to her. But she can disclaim it into a trust for herself and for our children. I think that's a very important part of this concept – that my wife can disclaim into a trust where she's still a beneficiary, while keeping it out of her own estate at her death. Now, keep in mind that even though the children are also beneficiaries, distributions are going to occur over my wife's life expectancy, because there’s no separation going on here. More about separate shares later.
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Disclaimer Planning
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IRA
Standalone IRA Trust F/B/O Spouse and Children
Contingent = Mother Age 88
DB Status – Trust is Irrevocable
No Separate Share Treatment (as Master Trust)
Life Expectancy of Oldest Beneficiary
Mother and Spouse Disclaim 100%
Oldest Child is DB
Presenter
Presentation Notes
Let's look carefully at what happens here. I have an IRA payable to a standalone IRA trust with accumulation provisions for the benefit of my wife and children. The contingent beneficiary of this trust is my mother, who is age 88. Without proper conduit provisions, even with a standalone IRA trust, as opposed to a regular RLT, the IRA would have to be paid out over my mother's life expectancy. So, if we can get my mother and wife to disclaim their interests in that trust…do qualified disclaimers…then the distributions would occur over my oldest child’s life expectancy. That's the moral of the story on this slide. By the way, we’ll be talking about accumulation vs. conduit provisions later.
Naming a Trust as a “Designated Beneficiary”
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Presenter
Presentation Notes
9:40 am Moving from general retirement planning rules and regulations, let’s talk about naming a trust as a designated beneficiary. This is a difficult issue. Why? Because the government wants its money as soon as possible and has set up a number of very stringent rules that you need to follow. Remember something I think I said earlier: These plans were designed for retirement purposes, but they’ve become inheritance devices. So, basically, we’re trying to put square pegs in round holes.
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Naming a Trust as a “Designated Beneficiary”
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An IRA Can Be Payable to a Trust
See PLRs 200410019, 200433019 (both obtained by Robert S. Keebler’s office)
IRA distributions over the life expectancy of the oldest beneficiary
Trust for Spouse and
Children
IRA
Beneficiary Designation Form
Presenter
Presentation Notes
There’s no question that an IRA can be payable to a trust and that the trust can then take and pay the funds out over the life expectancy of a designated beneficiary. But to make that happen, the trust itself needs to be a designated beneficiary trust. To learn more about this, you may want to take a look at PLRs 2004 10019 and 2004 33019, both received by Keebler’s office regarding IRAs payable to trusts. So, let’s look at this slide. When an IRA is payable to a trust, it's very important to understand that the IRA never gets re-titled to the trust like you would re-title a bank account into a trust, but instead it's simply a beneficial interest. And that beneficial interest is controlled by 2 things: the beneficiary designation form and the terms of the trust.
IRAs Payable to Trusts
Benefits of Using a Trust • Spendthrift protection
• Creditor protection
• Divorce protection
• Special needs
• Investment management
• Estate planning
• “Dead-hand” control
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Presenter
Presentation Notes
What are the benefits of using a trust to receive IRA benefits? Here is a list that you’re all probably already familiar with.
IRAs Payable to Trusts
Disadvantages of Using a Trust • Trust tax rates
• Legal and trustee fees
• Income tax returns
• Greater complexity
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Presenter
Presentation Notes
What about disadvantages? Trust tax rates: but compare to the individual’s top marginal rate for a better comparison. Legal and trustee fees: worth the protection. Income tax returns: a relatively insignificant bother or expense. Greater complexity: if clients don’t understand trusts, they can’t be trusted to handle things like the Code 691(c) deduction, 1041 returns, RMDs, or principle and income allocations.
Standard Issues with Revocable Living Trusts
• Fractional vs. Pecuniary clauses – Recognition of income (IRC § 661)
• No separate share treatment (as Master Trust) • Payment of debts, taxes and expenses
– Apportionment language / Firewall provision – PLRs 9820021 and 9809059
• Powers of appointment (PLRs 200235038-41) • Adoption of older individuals •
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Presenter
Presentation Notes
Let's talk about some of the more difficult issues when an IRA is payable to a standard revocable living trust. First of all, we have to be aware of the fact that most revocable living trusts will not qualify as designated beneficiary trusts. And we’ve seen how that can be a tax problem. A big question to ask is: Do you have a fractional or pecuniary funding clause? There’s contention between the IRS and taxpayers about the interplay of various Code sections and rules. The recognition of income rules under Code Section 661 say that a pecuniary assignment is deemed to be a sale or exchange. But the IRA rules under Code Section 402 say that tax is payable only upon actual distribution. So, if the recognition of income rules under Code Section 661 trump the IRA distribution rules under 402, then when you fund a bypass trust, legacy or charitable bequest with a pecuniary funding clause, you're going to trigger gain or accelerate income. So, the concern is, if a pecuniary funding clause is used, like to fund the bypass trust or even to fund legacies or charities, there's a very strong possibility that gain or otherwise deferred income is accelerated upon the death of your client or upon the funding of the pecuniary clause. This can be a disaster if you could have been looking at a very long payout. And regarding charities, it could be worse: you won’t get an offsetting deduction if the use of IRD to fund the pecuniary charitable bequest is not directed or required in the trust instrument. What this means is that you shouldn’t have specific pecuniary clauses in your documents. Next, with the standard trust, there's going to be no separate share treatment. Basically, if my IRA is payable to a trust for the benefit of my mother, my wife, my children and my grandchildren, then distributions are going to occur over my mother's life expectancy, which is clearly a disaster because she's older than all the other parties. If you want to have separate share treatment or use everyone's life expectancy, we're going to have to draft separate share treatment in the beneficiary form, not just in the trust. Next, it’s very important in our trust to have provisions that carve out the payments of debts, expenses and taxes. I think that's critical to the whole planning technique. What we're talking about here is my IRA cannot be responsible for the payment of debts, expenses and taxes after September 30th of the year following the year of my death. Most documents are going to contain language that just says, “Thou shalt not pay debts, expenses and taxes from my IRA proceeds.” But this raises apportionment issues—very important. For any estate tax plan you design for someone with a large IRA, you need to say who is going to bear the burden of the federal estate tax. Will it be carried by the individual receiving the IRA, or will it be carried by the residue of the estate? For example, an IRA is payable to my son and has a value of $4M; and I leave to my daughter the residue of my estate, which is also $4M. Simplistically, I’m thinking that everything is going to work fine. Both children will get $4M. In some states, what will happen is the IRA will pass to my son without the imposition of the estate tax, while my daughter will receive the residue of my estate, less estate taxes. In other words, my son receives $4M; but my daughter receives $4M minus the estate tax. This might be a problem. Under NC law, any retirement plans includible for estate tax purposes and not part of the marital deduction are subject to apportionment and recovery by the personal representative unless specifically stated otherwise; and a general direction in the Will that taxes shall not be apportioned but shall be paid from the residuary may not be specific enough to protect retirement plans. The reason I say “may” is that the relevant statute in this regard (N.C.G.S. § 28A-27-2) specifically mentions certain types of assets not protected by a mere, general, residuary direction, but fails to mention retirement plans. So, it’s best to be specific, either way. Next, it’s very important to understand how adoption provisions play into a trust document. Let's say that my IRA is payable to a trust for the benefit of my grandchildren as a class subject to open. On the day that I die, my oldest grandchild may be 4 years old, but there remains a possibility that one of my children might adopt a child who’s a year and a day older than that oldest child. Because of that mere possibility, I cannot identify the oldest beneficiary of the trust. Accordingly, we need very, very precise language that says that an adopted child will not be a beneficiary if they are older than my oldest natural grandchild and if they're adopted after my date of death.
IRAs Payable to Trusts
Other Considerations • Older or unidentifiable contingent beneficiary • Estate as contingent beneficiary • Failure of beneficiaries clause • Failure to provide trust document to custodian by October 31 of year following year of death • Making lump sum IRA distribution to trust
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Presenter
Presentation Notes
These should be self-explanatory, so I won’t belabor these points. Plus, we’ll see some of them mentioned in later slides.
Structuring IRA Trusts
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Structuring IRA Trusts
Four Requirements of All IRA Trusts 1. Trust is valid under state law
2. Trust is irrevocable upon death of owner
3. Beneficiaries of the trust are identifiable from the trust instrument
4. Documentation requirement is satisfied
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Presenter
Presentation Notes
9:50 am There are four requirements to have a designated beneficiary trust. Here they are. Let’s talk about each one.
Four Requirements for ALL Trusts
Number One • Trust is valid under state law
• Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(1)
• Easily met
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Presenter
Presentation Notes
First requirement: The trust is valid under state law. Very easy. If it's drafted by a licensed attorney in a particular state, very rarely will that trust not be valid under state law.
Four Requirements for ALL Trusts
Number Two
• Trust is irrevocable upon death of owner
• Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(2)
• Difficult to satisfy when using joint revocable trust
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Presenter
Presentation Notes
The second thing: The trust becomes irrevocable upon the death of the owner. I die, my trust becomes irrevocable. Now, this is sometimes difficult with a joint trust, and the next slide shows how to do this.
Irrevocable Requirement IRA to RLT
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IRA Payable to Family Trust under RLT
Joint RLT
Joint RLT does not get DB Status, because Survivor’s Trust is not Irrevocable
IRS views trust as one trust (See PLRs 200317041, 200317043 & 200317044)
Survivor Trust Irrevocable Family Trust
Presenter
Presentation Notes
The text on this slide states the problem, and the boxes show the solution. Bottom line: Name the Irrevocable Family Trust, not the Joint Trust, as the beneficiary on the custodian’s beneficiary designation form, so that the appropriate irrevocable trust is funded directly. We’ll talk more about separate shares in later slides, but you might want to take special note here of some issues with separate shares raised by these PLRs: According to these PLRs, a trust must be in existence at the account-owner’s date of death to receive separate share treatment. This means that it may not be possible to create trusts with a Will and expect to receive separate share treatment, because the trusts will not be in existence as of the date of death. This is any excellent reason for drafting a standalone retirement trust, even if funded with only nominal consideration prior to death, in what would otherwise be a Will-based estate plan (that is, no regular, revocable living trust). Because each share must be identified in the custodian’s beneficiary designation form, division of accounts can be by formula but the division, itself, in terms of where the IRA money goes, cannot be discretionary. Each separate share must be funded directly.
Four Requirements for ALL Trusts
Number Three • Beneficiaries of the trust are identifiable from the
trust instrument
• Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(3)
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Presenter
Presentation Notes
Requirement number three: The beneficiaries of the trust are identifiable from the trust instrument. On the four corners of the trust instrument, do we know who the beneficiaries are? If you look at Treas. Reg. 401(a)(9)-4, question 5, you'll understand that requirement a little bit better. This is the hardest requirement that most attorneys and advisors stumble over. Without proper identification, plus proper designation in the plan documents, the trust will fail to qualify as a designated beneficiary trust. And that means that distributions are going to occur either over the five-year rule or over the ghost life expectancy rule, not over the 20- or 30- or even 50-year life expectancy the decedent was hoping for.
Four Requirements for ALL Trusts
Number Four • Documentation requirement is satisfied
The last of the 4 requirements is about documentation. By October 31st – we’ve seen that date in another slide (Slide #24) – by October 31st, we need to make sure that we provide a copy of the plan document to the plan administrator. This means that the actual trust needs to be provided. This doesn't seem like much of a requirement, but it is. And this is something you don't want to overlook. You ought to go ahead and do it immediately after a person dies. Even if a copy was previously furnished during the participant’s life as part of the beneficiary designation form, do it again to be safe. You don’t want to risk being tripped by a technicality.
IRAs Payable to Trusts
Separate Shares • In proper circumstances, the IRS allows the division of
the IRA into separate shares per beneficiary
• In the case of an individual beneficiary, this must be determined by December 31 of the year following the year of death
– Separate shares established when divided
• No separate shares available for estates
• Disclaimers are permitted
• Death by September 30
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Presenter
Presentation Notes
10:00 am Before we get into more details about separate shares, let’s take a break. 10:15 am (resume) Here are the things we need to consider when talking about separate shares. We’ve already talked a little bit about this issue, but we’ll go into some more detail with the next few slides.
IRAs Payable to Trusts
Separate Shares
If the IRA is payable to a single trust
And no separate shares are identified in the beneficiary designation form
Then the IRA must be paid over the oldest life expectancy
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IRAs Payable to Trusts
Separate Shares
If the IRA is payable to multiple sub-trusts
And each sub-trust is named in the beneficiary designation form
Then the IRA is paid over each
sub-trust beneficiary’s life expectancy
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PLR 200537044
• Attorney Phil Kavesh and CPA Bob Keebler obtained the IRS’s “blessing” on the use of standalone IRA trust with separate share treatment for each beneficiary
• Four Primary Rulings • Exhibit A
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IRA Trust PLR Rulings • Ruling 1: Each Beneficiary’s Trust Share Qualified for
Maximum Stretch. – Upon the death of the Settlor, the IRA standalone trust creates
separate shares for each beneficiary (in this case, separate shares for 9 beneficiaries), each trust share “treated effective ab initio to the date of the Decedent’s death” and each share functioned as a “separate and distinct trust” for the beneficiary.
– The beneficiary designation form named each separate share as a primary beneficiary of the IRA.
– Before the December 31st deadline, the IRA was divided into separate accounts for each share.
– Held: Separate account is treatment permitted; MRD of the IRA for each separate trust share is measured by the life of its sole beneficiary for whom the share was created.
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– PLR 200537044
Presenter
Presentation Notes
Keebler obtained this PLR for a high profile WealthCounsel attorney, Phil Kavesh. This PLR has 4 parts . Let’s look at it in detail. Here’s the 1st ruling, dealing with getting separate trust-share treatment for IRAs.
IRA Trust PLR Rulings
• Ruling 2: Allowance of One-Time “Toggle” from Conduit Trust to Accumulation Trust. – Each separate share in the IRA standalone trust had language
structuring the separate share as a conduit trust. – The trust provided for an independent 3rd party, as “trust protector”
to transform each sub-trust to an accumulation trust in the protector’s sole discretion by voiding the conduit provisions ab initio.
– Trust Protector had the authority to limit the initial trust beneficiary ab initio.
– After Participant’s date of death, Trust Protector exercised “toggle” and converted one share to an accumulation trust.
– Held: Each share can use the life expectancy of its initial beneficiary to measure the RMD for that share.
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Separate Shares – PLR 200537044
Presenter
Presentation Notes
10:20 am Here’s the 2nd ruling, dealing with the option for a one-time toggle from a conduit trust to an accumulation trust.
IRA Trust PLR Rulings
• Ruling 3: Payment of Expenses from IRA not considered an accumulation. – The trust provided that “Trust expenses may be deducted prior to
any such payment to or for the benefit of the beneficiary of the trust share if the deduction does not disqualify the status of the trust as a conduit trust. This paragraph may be rendered void, ab initio, by the Trust Protector. . .”
– Held: Each share can use that the life expectancy of its initial beneficiary to measure the RMD for that share.
Why? Even with the deduction for payment of trust expenses, no amounts distributed to the trust during the beneficiary’s lifetime would be accumulated in the trust, and thus would not be kept in the trust for the benefit of any future beneficiaries. Treas. Reg. § 1.401(a)(9)-5 Q&A 7(c)(3), Example 2.
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Separate Shares – PLR 200537044
Presenter
Presentation Notes
Here’s the 3rd ruling, allowing payment of expenses not to cause a conduit trust to be characterized as an accumulation trust.
IRA Trust PLR Rulings
• Ruling 4: The trust assets of the primary beneficiary’s separate share will not be included in that beneficiary’s estate upon that beneficiary’s death. – Each trust share would accumulate the net income of the trust, and
the trustee had discretion to distribute accumulated income and principal to the primary beneficiary only for his or her health, education, maintenance and support.
– The document did not grant any beneficiary a general power of appointment over his or her share.
– Held: Upon the death of the primary beneficiary of each separate trust, the trust assets will not be included in such beneficiary’s estate.
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Separate Shares – PLR 200537044
Presenter
Presentation Notes
Here’s the 4th and final ruling, allowing an accumulation IRA trust not to be included in the primary beneficiary’s estate at that beneficiary’s death.
Two Types of Trusts
• Accumulation Trusts • Conduit Trusts
• Treas. Reg. § 1.401(a)(9)-4, Q&A 5
Requirements apply to both types
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Presenter
Presentation Notes
Now, let’s shift gears. Under the regulations, there are two separate types of trusts. One is called an "accumulation trust" and one is a "conduit trust." When we have a conduit trust, it's very easy to qualify it to obtain designated beneficiary status. Remember, above all, an IRA stretch is going to be obtained within a trust when you meet what's called "designated beneficiary status." If my trust is simply a conduit, I will pretty much automatically meet that status. But a conduit IRA Trust comes at a price. In a conduit IRA trust, all distributions from the IRA must be immediately distributed to the trust beneficiaries. No retention. No discretion. Now, let's say that the beneficiaries are my four children. Can that be sprayed among those children? If there’s no separate share treatment, absolutely. We use the life expectancy of the oldest child. But what if one child has a substance abuse problem? Or is a spendthrift? At least part of the distribution must also go to that child. See, this is where we get into an area where the conduit trust may not be quite as efficient as we need it to be.
Conduit Trust
• A trust in which all distributions from the IRA are immediately distributed to the trust beneficiary/beneficiaries.
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Presenter
Presentation Notes
10:30 am (READ) First of all, if you have a child who has drug or alcohol abuse problems, you would never consider doing that. But a conduit trust is basically a good technique for someone who does not need a lot of asset protection but simply wants to slow the game down so that children do not receive all that money at once. Why would someone do a conduit trust? Because none of the difficult rules of meeting the designated beneficiary trust rules exist. They simply will not come into play like you would have with an accumulation trust. In a conduit trust, all the distributions from the IRA – minimum or not --- must be immediately paid to the trust beneficiary.
Accumulation Trust
• A trust in which distributions from the IRA are allowed to accumulate within the trust.
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Presenter
Presentation Notes
(READ) In an accumulation trust, the trustee is allowed discretion to retain the IRA distributions. And the beauty of that is you interpose a trustee between the IRA distributions and the beneficiary. And all of us have seen situations where that makes a tremendous amount of sense for non-tax reasons, like for pure property law or protection reasons, such as special needs, a child who has an alcohol or drug problem, a child who's simply a spendthrift, a child who we're hoping will someday get through college and we don’t want them to have money before they reach a certain age of maturity.
In the conduit trust, the distribution to the beneficiary is always, at least, the total of withdrawals from the IRA
Presenter
Presentation Notes
This slide shows cash flow examples for an accumulation trust versus a conduit trust. In the conduit trust context, all the distributions are going to flow immediately out, and one of the nice things about that is you’re not going to have income taxation at the trust level. On the other hand, in the accumulation trust context, you will sometimes have income tax to pay at the trust level. Now, can you distribute the dollars out of an accumulation trust? Yes. And if you distribute those dollars out, you will receive what's call a “DNI Deduction.” Simply put, that means the trust won’t pay income tax at the trust level, but the beneficiaries are going to pay the tax. Now, when we think through all this, we also have to worry about whose life expectancy we are measuring. Remember, in an accumulation trust, you're going to measure the oldest beneficiary, including contingents. And when we're dealing with the oldest beneficiary in the trust, sometimes that may be my mother as a contingent beneficiary. When you look at these trusts, you can’t just ask, “Who are the obvious beneficiaries?” You need to ask, “Who are all the beneficiaries? Who are the beneficiaries with even a small, remote possibility of receiving distributions from this trust?" Because that's really what you want to know -- and that's when you begin doing disclaimers, doing other shakeouts, doing reformations, doing charitable payouts. So what I want to challenge you to do is to study this material and to really focus on improving the process in your office both in drafting trusts for new clients and in the administration process, as well as recognizing these issues when you review a client’s existing documents. If you are going to try to get separate share treatment -- for example, a trust for my wife and a trust for my children --then the separate shares have to be established both in the trust and in the designated beneficiary form. Remember that, especially you financial advisors who are on the front lines of filling out beneficiary designation forms. Please work with your people to do what the attorney is asking to be done here. Now, in the estate administration process, once someone dies, your job is to quickly identify whether or not the trust will be a designated beneficiary trust. So the first thing to do after death, if not before, is review whether or not the trust is indeed a designated beneficiary trust and if it is, great; if it isn't and death has already occurred, then you must try to do a reformation. Or do charitable payouts. Or do disclaimers. Somehow, try to cure that situation.
Accumulation Trust
• The key issue in analyzing an accumulation trust is to determine which beneficiaries are “countable.”
• All beneficiaries are countable unless such beneficiary is deemed to be a “mere potential successor” beneficiary.
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Presenter
Presentation Notes
Under the accumulation trust, identifying the beneficiaries is the hard part. So a key issue in analyzing an accumulation trust is to determine which beneficiaries are countable. Which beneficiaries do I have to count and which are mere potential successor beneficiaries? That's the language in the regulation. But how do we know the difference? “Countable” means anyone or any entity who might be a beneficiary by some act of choice. “Mere potential successor” means anyone or any entity who might become a beneficiary by no one’s actual choice, like a beneficiary’s estate or natural issue in the event of the beneficiary’s death. Let’s look at examples of countable beneficiaries.
Accumulation Trust – Example #1
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Mother Age 80
Trust
Discretionary Distributions
Entire Trust outright upon Children reaching age 30
If Children die before reaching age 30
Mother is “countable” for determining applicable life expectancy
See PLR 200228025 and Treas. Reg. § 1.401(a)(9)-5 Q&A 7
Child – age 28
Child – age 28
IRA
Presenter
Presentation Notes
In this example, we have a trust for the benefit of two children, twins age 28, and it pays out to them outright when they're 30. In the event that they die before reaching age 30, then it’s going to go to their mother, who is currently age 80. The government's position is that the mother is countable when we're determining the applicable life expectancy.
Accumulation Trust – Example #2
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IRA
Sister Age 67
Grandchild
Trust
Discretionary Distributions
Grandchild
Entire Trust outright upon Grandchildren reaching age 30
If Grandchildren die before reaching age 30
Sister’s measuring life for determining Required Minimum Distributions
Facts essential same as PLR 200228025
Presenter
Presentation Notes
This Example focuses specifically on the facts of Private Letter Ruling 2002 28025. We have this IRA for these two grandchildren. They're very young, like 10 and 12 years old. In the event they die without issue, regardless of how remote that is, this property goes to their aunt, who is age 67. Now, most people would logically say, you know, unless those boys are killed in some type of tragic accident before they have children, it's never going to go to the aunt. Well, the government doesn't care about probabilities. There’s no de minimis test, no 5% chance rule or anything like that. By choice, we’ve named the aunt as a contingent beneficiary, so the mere possibility of something like that happening is enough to make us use the aunt's life expectancy, not the children’s life expectancy. Very critical to understand that. Bottom line, with an accumulation trust, we must take the money out over the oldest beneficiary’s life expectancy; but you have to be careful with your analysis of who that is.
Accumulation Trust – Example #3
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Trust IRA
To Red Cross
Discretionary Distributions for Child
At Child’s death
Contingent beneficiary must be counted.
Non-individual contingent beneficiary.
No designated beneficiary status.
Treas. Reg. § 1.401(a)(9)-5 Q&A 7
Presenter
Presentation Notes
Now, let's look at one more example. That's a very easy example which I want you to take to heart and understand. Right out of the regulations, when an IRA is payable to a trust, and a child is a beneficiary, you'd think, “Well, I can use the child's life expectancy." But when the American Red Cross is a contingent beneficiary, the contingent beneficiary needs to be counted. In this case, because you have a non-individual contingent beneficiary, then distributions are going to occur not over that child's life expectancy, but over the five-year rule. So, in this case, if a person died at age 70 before their Required Beginning Date with this structure in place, the funds would need to be withdrawn over the five-year rule. In the alternative, if they died after their Required Beginning Date, then distributions would occur over the life expectancy -- remaining ghost life expectancy -- of the decedent.
Conduit Trust
Allows for Easier Identification of Beneficiaries
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Presenter
Presentation Notes
What a conduit trust does is plain and simple—it allows for easier identification of the beneficiaries. In other words, because I only have to measure the first-tier beneficiary, a conduit trust is not going to be hard to implement. Let’s look at some examples.
Conduit Trust – Example #1
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Mother Age 80
Trust
Entire Trust outright upon Grandchildren reaching age 21
If G’children die before age 21
Neither Mother or any Grandchild is “countable” for determining applicable life expectancy
Treas. Reg. § 1.401(a)(9)-5 Q&A 7
IRA
Child – age 30 for life
Child – age 30 for life
Discretionary Distributions, but no less than total withdrawals from IRA
Presenter
Presentation Notes
10:50 am If my IRAs are payable to a trust and it's a conduit trust and it's for the benefit of two 30-year-olds, you do not need to look beyond those two 30-year-olds. You only need to measure those two 30-year-olds.
Conduit Trust – Example #2
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Trust IRA
To Red Cross
All distributions from IRA to Child
At Child’s death
No need to count contingent beneficiary
See Treas. Reg. § 1.401(a)(9)-5 Q&A 7
Presenter
Presentation Notes
Here's a very easy example which I want you to take to heart and understand. Again, right out of the regulations, when an IRA is payable to a trust and a child is a beneficiary, you'd think, “Well, I can use the child's life expectancy." And you can— IF the trust is structured as a conduit trust.
Conduit Trust – Example #2
All distributions from the IRA are required to be distributed to the beneficiary. If Child lives to life expectancy, the entire IRA will be distributed to Child. Therefore, Child is the only “countable” beneficiary, and the Red Cross can be ignored.
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Presenter
Presentation Notes
So, when we have a conduit trust, all distributions from the IRA are required to be distributed to the primary beneficiary, so if the child lives to his or her life expectancy, the entire IRA will be distributed to the child. Therefore, the child is the only countable beneficiary and, in that case, the Red Cross can be ignored. The problem, of course, is that you now have money being paid to a minor child or to a child who, for some other reason, ought rather be protected from outright distributions of anything.
Conduit Trust – Example #3
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Trust
To my lineal descendants as appointed by Child in
his/her Last Will
Child All distributions
from IRA
At Child’s death
IRA
Presenter
Presentation Notes
Here’s a slight variation. Assume the IRA is payable to a trust, all distributions go to a child, and the trust says "to my lineal descendents as appointed by my child in his or her Will or Last Testament." Now, if that's the case, that's fine. Because we have a conduit trust, lineal descendants can be ignored because all distributions are paid through the trust to Child. We do not have to look to that Will or to that limited or general power of appointment. Everything works just fine. This might have very important strategic implications when we're dealing with a generation-skipping transfer tax situation and we want to use a general power of appointment.
“See-Through” Trust – Example
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Whoever, Whatever
Trust
Discretionary distributions until age 45, then Outright If child dies before
reaching age 45
Ages at participant’s death preclude accumulation; thus, contingent beneficiaries are not “countable”
Oldest child is the determining applicable life expectancy
PLR 200708084
IRA
Child – age 46
Child – age 50
Discretionary distributions until age 45, then Outright
Other Assets Enough to satisfy all other distributions, and terms of trust prohibited using IRA to pay any disqualifying expenses
Presenter
Presentation Notes
Here’s a trust that may not have qualified as a designated beneficiary except for the fact that each child had attained the age of 45 prior to the participant’s death.
Other Drafting Considerations
• IRA Trusts can contain Credit-Shelter and QTIP Trusts for benefit of surviving spouse
• Proper structuring of Beneficiary Designation allows disclaimer planning by spouse and other beneficiaries
• No further stretch allowed after death of spouse with regard to IRAs in CST or QTIP trusts
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Other Drafting Considerations
• Beneficiary Designations – Custom drafted forms required to allow proper
disclaimer planning and separate share treatment • Generally – 1) spouse; 2) if spouse disclaims, IRA Trust
(for funding of CST/QTIP); and 3) if spouse is deceased, to the separate shares for descendants, per stirpes
• Children can disclaim to allow grandchildren to stretch
– Some custodians will not accept custom forms, especially for “smaller” accounts (under $500k)
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Fine Tuning Use of Exemption Amount Through Disclaimer
Example: Alex dies at age 70. Spouse disclaims amount of Alex’s estate tax exemption amount to bypass trust for benefit of spouse and children
• Disclaimer must occur within nine months • Disclaimer served on IRA custodian • Disclaimer must be fractional
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Presenter
Presentation Notes
Now, picture this. Alex dies at age 70. His wife disclaims the amount of Alex's unified credit to a bypass trust for the benefit of herself and their children. We know the rules. Within nine months, a disclaimer must occur. A disclaimer must be served on the IRA custodian, and the disclaimer must be fractional. Now, the fractional disclaimer -- very important that your disclaimer not be drafted on a pecuniary basis. You don’t want to say, “I disclaim that dollar amount with no tax." If you do that, the government may take the position that it accelerates gain. That is the last position you want; because if gain is accelerated, then you're recognizing income up front and you're going lose the stretch-out. More about fractional clauses later (Slide 45). So she disclaims the IRA, it goes to a trust with her as a beneficiary, while basically saving the estate tax on the bypass amount that likely would have been payable by her estate.
Other Drafting Considerations
• Revocable vs. Irrevocable – Revocable
• Allows easy changes to trust • May open IRA to account owner’s creditors at death
(Commerce Bank v. Bolander, 2007 WL 1041760, Kan. App. 2007) – UTC state
– Irrevocable • May not be changed, but a new trust can be drafted
and the beneficiary designation simply changed • Protects against Commerce Bank case problem
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Resources on IRA Rules
• Life and Death Planning for Retirement Benefits by Natalie Choate 2011- 7th Ed. www.ataxplan.com
• www.irahelp.com (Ed Slott, CPA) • Robert Keebler, CPA
