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Leaving Benefits to a See-through Trust

Even the best estate planners can get off the track when it comes to leaving an IRA to a trust.

Natalie Choate, 04/17/2009

Natalie Choate will be speaking at a location near you if you live in Charlotte, N.C. (Apr. 21); Leawood, Kan. (Apr. 23); Palo Alto, Calif., or San Francisco (Apr. 28); Iowa City (May 1); New York  (May 6); Newton, MA, (May 14), Boston (May 21), or Waltham, MA, (June 12); Bucks County, Pa. (May 19); Indianapolis (June 18); Lombard, Ill. (Sept. 21); Atlanta (Oct. 23 and Nov. 3); or Baltimore (Oct. 3). See all of Natalie's upcoming speaking events at www.ataxplan.com.

Good estate planning usually requires creating trusts for the client's spouse, minor children, and/or special needs beneficiaries. What happens when a trust is named as beneficiary of the client's IRA?

If the trust qualifies as a "see-through trust" under the IRS' rules, then distributions from the IRA to the trust after the participant's death can be "stretched out" over the life expectancy of the oldest trust beneficiary. Unfortunately, even the best estate planners can get off the track when it comes to the IRS' rules for leaving an IRA to a trust. The lawyer who sent me the following questions had three strikes.

Question from "Frank": Hi Natalie. Here is my fact pattern, followed by my three questions. Husband (H) died before reaching age 70½, leaving his IRA to a trust. The trust provides that all of the trust's income is to be paid to Wife (W) (age 45) for her life. On her death, the remaining trust assets pass into separate trusts for H's two children. Each child's trust is held and used for the child's benefit until he or she reaches age 30, at which time it is distributed to the child outright.  If a child dies before reaching age 30, the deceased child's trust passes outright to the deceased child's issue. If there are no such issue living, the deceased child's trust is added to the share of the other child (or the other child's issue), but if no one survives, the assets pass to H's heirs-at-law. Right now H's heir-at-law would be (if his wife and children had not survived him), H's brother, who is age 67. The children are now age 15 and 17, and have no issue. Am I correct in the following points:

Frank: The trustee must start taking distributions from the IRA when W reaches age 70½, right?

Natalie: Wrong. If the surviving spouse is the SOLE beneficiary of a trust, then minimum required distributions are delayed until the deceased participant would have reached age 70½ (not until the spouse reaches that age). The surviving spouse is considered the "sole" beneficiary of the trust only if all distributions the trust receives from the IRA during her lifetime must be immediately paid out to the spouse. In your case, the spouse is entitled only to the "income" of the trust--not to all IRA distributions the trust receives. So in your case the trust must start taking distributions by the end of the year after the year of H's death (or by the end of 2010, if later).

Frank: During W's lifetime, the trustee must take annual required distributions computed based on W's life expectancy, right?

Natalie: No, wrong again. Under the IRS' view, this trust has four beneficiaries: W, the two children, and  H's 67-year-old brother. Since the brother is the oldest member of the group, the brother's life expectancy is the Applicable Distribution Period for the benefits.
 
The IRS basically "counts" all potential beneficiaries of the trust as "beneficiaries" of the IRA. Under the IRS rules, a beneficiary can be "disregarded" only in certain very limited circumstances.

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