Trust as an IRA Beneficiary

Submitted by Jack Smith on Sat, 2019-02-16 03:26

1. Consider John who leaves his IRA to his trust which benefits only his daughter Jane. The trust is a discretionary/accumulation trust, but otherwise qualifies for “look-through” status, allowing RMDs to be taken from the IRA based on Jane’s lifetime. The trust directs that all income (including IRA distributions) be accumulated until Jane attains the age of 40, and then directs that all trust property including accumulations be distributed to Jane outright. In this scenario, when Jane turns 40 can the trustee of John’s trust ask that the inherited IRA benefiting the trust be transferred to a new inherited IRA benefiting Jane directly, and if so, would Jane then be able to specify a successor beneficiary for the new inherited IRA account?

2. In addition, consider the same scenario but where the trust gives Jane a limited testamentary power of appointment to name any of her lineal descendants as contingent beneficiaries of the trust should she die before the age of 40. In this alternative scenario, can distributions still be stretched out over Jane’s life expectancy on account of the fact that of the class of all possible successor beneficiaries, Jane is guaranteed to have the shortest life expectancy?

I’m hoping the answer to (1) is “yes” and “yes” because that seems logical, and for (2) I am thinking the answer should be yes based on § 1.401(a)(9)-4 A-1 which as I understand it, explains what it means for beneficiaries of a trust to be identifiable for the purposes of qualifying for “look-through” status, stating in part: “[t]he members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible, to identify the class member with the shortest life expectancy.” https://www.law.cornell.edu/cfr/text/26/1.401(a)(9)-4



Submitted by Alan - IRA critic on Sat, 2019-02-16 03:38

  1. Yes, the remaining balance in the inherited IRA can be assigned by the trustee to Jane. She will have full control and be able to name her successor beneficiary. Her RMD divisor will continue to be reduced by 1.0 each year as before. Of course, this control of the IRA distributions comes with a cost of higher trust tax rates on the IRA distributions and accumulated earnings in the trust. In return, the inherited IRA will be protected against her creditors while the trust remains beneficiary.
  2.  Yes.

Submitted by Jack Smith on Sat, 2019-02-16 13:21

  • Thanks much Alan. Some follow-on questions:
  • 1.  Can the look through requirements be met for a discretionary trust if in addition to individual, identifiable beneficiaries (say the trustor’s children) the trust also allows discretionary distributions (generically) to any other discretionary trust meeting the look-through requirements and benefiting a class of younger beneficiaries (say the trustor’s grandchildren). 
  • In other words, is the look-through property transitive, such that a second trust can be named as a beneficiary of the first, and the second trust will also be “looked through” to identify the full set of ultimate individual beneficiaries, or alternatively, does the analysis stop as soon as the non-individual beneficiary (the second trust) is reached, causing the main trust to not qualify as a look through trust?
  • The primary reason I would be interested in something like this is to provide future flexibility, e.g., allowing trustor’s children to setup trusts tailored to meet the needs of their children, needs which may be difficult or impossible to foresee during the original trustor’s lifetime.
  • 2.  A related question: John funds trust A naming as discretionary beneficiaries his daughter Jane outright and (generically) any trust benefiting jane. Trust B is then setup as a grantor trust with Jane as its discretionary beneficiary and Jane being given the power to substitute trust property (in an attempt to trigger grantor trust treatment with Jane as “grantor”). Jane however only funds the trust with a nominal amount, say $10. If the trustee of A then distributes out trust A’s income to trust B, is that income treated as Jane’s income for income tax purposes, even though she never held the property or otherwise had a right to demand it be paid to her outright under the terms of trusts A or B? 
  • The reason for considering such a scenario would be to avoid having trust A’s income taxed at trust rates, while allowing said income to accumulate and be managed for and kept out of reach of, e.g., a financially irresponsible beneficiary.

 

Submitted by Bruce Steiner on Sat, 2019-02-16 23:42

  • What is “his trust?”  John can’t leave his IRA or anything else to a trust for his own benefit, since he’ll be dead.
  • Mandating distribution of Jane’s trust at age 40 is poor drafting.  It throws the assets into Jane’s estate for estate tax purposes, and exposes them to Jane’s creditors and spouses.  It would be better to give Jane effective control over her trust at age 40.
  • You can have other beneficiaries, either present or future, so long as nothing can ever go to anyone older than Jane, or to anyone other than an invididual or another trust subject to the same restrictions.  Drafting for this can be tricky the first few times you do it.
  • Bruce Steiner

Submitted by Jack Smith on Sun, 2019-02-17 16:18

  • Thanks Bruce. It was a contrived example, but point taking regarding estate inclusion and exposure to creditors. 
  • Regarding including other trusts as beneficiaries where said trusts also meet the look-through requirements: how common is this? Any reason to think plan administrators would raise any issue with this due e.g. to unfamiliarity?
  • Finally, what are your thoughts regarding my question (2) above? (Perhaps an equivalent question is: if Jane sets up a grantor trust with herself as “grantor” and discretionary beneficiary, but her father John funds the trust, is the trust’s undistributed income still taxed to Jane?)

Submitted by Bruce Steiner on Sun, 2019-02-17 17:09

  • Almost every trust allows other trusts as beneficiaries.  In your example, Jane could, by her Will, appoint the balance of the trust at her death in further trust for her children.  You have to make sure that none of the IRA benefits may ever go to anyone older than, say, Jane, or to anyone other than an individual or another trust in which none of the IRA benefits may ever go to anyone older than, say, Jane, etc.
  • Having a nominal grantor won’t work for tax purposes.  John, not Jane, will be treated as the grantor for tax purposes.
  • Bruce Steiner

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