The regulations are clear, but there is doubt.
Check out Natalie's downloadable Special Reports at her Web site. There are five reports, including The 194 Best & Worst Planning Ideas for Your Client's Retirement Benefits, Retirement Benefits and the Marital Deduction (Including Planning for the Noncitizen Spouse), Making Retirement Benefits Payable to Trusts, The Estate Administrator's Guide to Retirement Benefits, and her newest, Charitable Giving with Retirement Benefits, plus two free shorter articles. The price of each report includes three downloads, so you can get updated versions free as they appear.
Question: "Mark" wants to leave his $2 million IRA to a trust for his three grandchildren, who are 12, 10, and 8 years old. He wants the trust to be a "family pot" trust, under which the trustee would have discretion to distribute income and/or principal each year to the grandchildren or for their benefit. Mark wants the trustee to have discretion to distribute based on the grandchildren's relative needs rather than based on strict equality. The trust would terminate when all the grandchildren have reached age 35, and whatever is left would be distributed to them equally at that time. If all the grandchildren die before reaching that age, without issue, the trust would pass to a charity.
To be sure that the trust qualifies as a "see-through trust" for purposes of the minimum distribution rules (so that the IRA can be paid out over the life expectancy of the oldest grandchild), Mark plans to use a "conduit trust." Can there be a conduit trust with more than one beneficiary? Or does Mark have to create a separate trust for each grandchild (which would defeat his intent to give the trustee discretion to distribute based on need)?
Natalie: Like most people who are leaving assets to young beneficiaries, Mark wants the property to be protected by a trust until those beneficiaries reach a more mature age. The problem with leaving an IRA or other retirement benefits to a trust is that doing so makes it more difficult for the benefits to qualify for the "life expectancy" or "stretch" payout after the participant's death--and qualifying for a stretch payout (meaning that distribution of the inherited plan is spread out over the beneficiary's life expectancy) is especially important when the intended beneficiaries are so young.
The problem is that a trust is not an individual, so a trust doesn't have a "life expectancy." The IRS has tried to solve that problem with its "see-through trust" regulation. The regulation says that benefits paid to a trust can be paid out over the life expectancy of the oldest trust beneficiary, if the trust complies with various rules. One of the rules is that all beneficiaries of the trust must be individuals.
Mark plans to name a charity as the contingent remainder beneficiary of the trust for his grandchildren. Because a charity is not an individual, Mark's trust would not qualify as a "see-through" trust, unless that charity can somehow be ignored. And the IRS regulations say you CAN ignore a remainder beneficiary if the trust is a conduit trust. (The IRS doesn't use that word; practitioners have adopted "conduit trust" as the nickname for a type of trust described in the IRS regulations.)
Under the example of a successful conduit trust in the regulations, a retirement plan is payable to a trust for the life benefit of "B," and "all amounts distributed from [the plan] to the trustee while B is alive will be paid directly to B upon receipt by the trustee." The regulations explain that, because no amounts distributed from the plan during B's lifetime are accumulated in the trust for the benefit of any later beneficiaries, B is considered the sole beneficiary of the trust for minimum distribution purposes. So far so good.
But what if there are multiple conduit beneficiaries, as in Mark's proposed trust for his three grandchildren? My conclusion, based on the clear language of the regulations, is that you can have as many conduit beneficiaries as you want. The only requirements are that:
1. All distributions the trust receives from the retirement plan must be immediately passed out to one or more of the conduit beneficiaries; and
2. As long as any member of the group is living, no plan distributions can be accumulated in the trust for later distribution to other beneficiaries.
So my opinion is that Mark can write his trust the way he wants it. As long as it meets those two requirements, the charity "doesn't count" as a trust beneficiary, and the trust passes the "all beneficiaries must be individuals" test. The oldest trust beneficiary is the oldest grandchild.
But you should know that a prominent West Coast estate planning attorney and benefits expert disagrees with me on this. In a private conversation, an IRS official told him that a conduit trust could have only one beneficiary. Which illustrates a lot of what is wrong with our crazy system of tax laws dealing with retirement benefits: When you finally find a rule that is actually clear, some anonymous IRS agent comes along and casts doubt on it!
For my money, I'll rely on the clear language of the regulations. We have a system for creating rules in the tax area, and private phone conversations with IRS agents are not part of that system. Under Mark's proposed trust, no amounts distributed from the IRA during the lifetimes of his three grandchildren can be accumulated for later distribution to any other beneficiary. Therefore, beneficiaries other than the three grandchildren are disregarded for purposes of determining who are the beneficiaries of Mark's trust, according to Treas. Reg. § 1.401(a)(9)-5, A-7(c)(3), Example 2.
If Mark is uncomfortable with the idea of hoping that the trust his attorney has drafted qualifies as a see-through trust, he might want to consider using a "trusteed IRA" instead. These are offered by only a few financial institutions. Under a trusteed IRA, Mark would not have a separate trust (drafted by his attorney) that was named as beneficiary of the IRA. Instead, the IRA itself is a trust (pre-approved by the IRS), and Mark could set conditions and terms on the beneficiaries' right to withdraw from the account (as long as the minimum required distribution was paid out each year). The IRA provider would be the trustee and enforce the restrictions on distributions to the grandchildren.
Also, be sure Mark understands the generation-skipping transfer tax implications of leaving money to his grandchildren. If Mark's child who is the parent of these grandchildren is still living when Mark dies, then there is a limit on how much Mark can leave the grandchildren without their having to pay a stiff 45% GST tax. The total GST exemption for someone who dies in 2009 is $3.5 million, but that is scheduled to drop to $1 million for deaths in 2010 and later. So Mark needs to keep a close eye on the ever-fluctuating exemption amounts and on how much he transfers to his grandchildren (both from his IRA and in the rest of his estate plan).
Resources: For discussion of the IRS's "see-through trust" rules, see Chapter 6 of the author's book Life and Death Planning for Retirement Benefits (6th ed. 2006; www.ataxplan.com).
The purpose of this column is to provide general educational information for investment professionals. Natalie cannot give advice regarding specific clients or actual matters. Thus, only hypothetical questions, seeking general information, can be answered. Questions that involve real people or real matters will not be answered. E-mail your questions to firstname.lastname@example.org.