Retirement Benefits Planning Update provides information on developments in the field of retirement benefits law. The editors of Probate & Property welcome information and suggestions from readers.
Recent Rulings Confuse Benefit Payments to Trusts
Many of the rules governing required minimum distributions are set forth in Proposed Treasury Regulations § 1.401(a)(9)-1 issued in 1987. Some rules, including those that permit the distribution of qualified plan or IRA benefits payable to a trust to be made over a period equal to the life expectancy of certain trust beneficiaries, were formulated to allow these complex payout pro-visions to be integrated into an employee's estate plan.
Revisions to the regulations, proposed on December 30, 1997, further help to mesh the distribution rules with estate plans. By (1) allowing the individual beneficiaries of a revocable trust named as a plan or IRA beneficiary to be counted in determining the payout period commencing on an employee's required beginning date (RBD) and (2) streamlining the four part test that trusts must meet to obtain this "look through" treatment, the IRS has recognized that the common practice of using a revocable trust as a central estate plan vehicle will not prevent the minimum distribution rules from operating effectively.
Private letter rulings issued over the past year for plan and IRA distributions to trusts having "contingent" beneficiaries indicate, however, that making the complex minimum distribution rules user friendly is likely to be an ongoing process.
When applying the minimum distribution rules to a trust named as beneficiary, the proposed regulations treat certain beneficiaries of the trust as "designated beneficiaries" if the trust meets the four part test in the regulations. Prop. Treas. Reg. § 1.401(a)(9)-1, D-5 & D-6. The identity of the designated beneficiaries is significant because:
1. To determine the period over which benefits may be paid, commencing with the employee's RBD, the eldest designated beneficiary's life expectancy (together with the employee's life expectancy) is taken into account.
2. If a beneficiary is not an individual, then (a) on the employee's death before the RBD, all benefits must be distributed by the end of the fifth calendar year after the employee's death or (b) if the employee reaches the RBD, only the employee's life expectancy may be used to determine the payment period.
In general, for purposes of the designated beneficiary determination, the "beneficiaries" of a trust appear to include all trust beneficiaries, even those whose interests are contingent on an event other than the employee's death (for example, the death of another beneficiary). Prop. Treas. Reg. § 1.401(a)(9)-1, D-5(a) & E-5(b).
if the regulation is read broadly, beneficiaries would include current and future beneficiaries, income and remainder beneficiaries, discretionary distributees and
potential appointees under a power of appointment that a beneficiary holds.
The Contingent Beneficiary Exception
The proposed regulations provide:
If a beneficiary's entitlement to an employee's benefit is contingent on the death of a prior beneficiary, such contingent beneficiary will not be considered a beneficiary for purposes of determining who is the designated beneficiary with the shortest life expectancy . . . or whether a beneficiary who is not an individual is a beneficiary.
Prop. Treas. Reg. § 1.401(a)(9)-1, E-5(e)(1).
One meaning of "contingent" is "dependent for effect on or liable to modification by something that may or may not occur." In the regulation's phrase "if a beneficiary's entitlement to an employee's benefit is contingent on the death of a prior beneficiary," it would appear that, because the death of a prior individual beneficiary will in all events occur, the entitlement, at least in the case of a successor individual beneficiary, must be contingent on whether or not the successor beneficiary survives the predecessor beneficiary. Most practitioners have assumed that the regulatory language means that remainder beneficiaries (those having no entitlement to receive distributions at either the employee's date of death or RBD, as applicable) could be disregarded.
The IRS Interpretation of "Contingent"
In PLR 9820021, plan benefits were payable to a marital trust providing the employee's spouse with a right to trust income for life and principal invasions under an ascertainable standard. Three charitable organizations were named as remainder beneficiaries. The IRS held that, because a portion of the benefits received by the trust from the qualified plan could be retained in trust and not distributed by the trust to the spouse, the charities' entitlement to benefits was not solely contingent on the spouse's death and the charities could, therefore, not be disregarded as beneficiaries in determining the minimum required distribution period. Because the trust had an entity beneficiary, the employee was deemed to have no designated beneficiary.
In PLR 9846034, IRA benefits were made payable to a trust that provided for income distributions to trust income for life and principal invasions under an ascertainable standard. Three charitable organizations were named as remainder beneficiaries. The IRS held that, because a portion of the benefits received by the trust from the qualified plan could be retained in trust and not distributed by the trust to the spouse, the charities' entitlement to benefits was not solely contingent on the spouse's death and the charities could, therefore, not be disregarded as beneficiaries in determining the minimum required distribution period. Because the trust had an entity beneficiary, the employee was deemed to have no designated beneficiary.
In PLR 9846034, IRA benefits were made payable to a trust that provided for income distributions to the deceased account owner's spouse during the spouse's lifetime with principal invasions for the spouse (presumably under an ascertainable standard). On the spouse's death, any undisposed trust property was to be distributed to the deceased employee's then living descendants (six of whom were living at the time of the employee's death and all of whom were younger than the spouse) or, if there were none, to those persons who would be the employee's heirs under state intestacy laws (presumably the employee's siblings, who may or may not have been older than the spouse).
After observing that some portion of the required minimum distributions could accumulate in trust during the surviving spouse's lifetime, the IRS concluded that the descend-ants were designated beneficiaries. Adapting an apparent actuarial test, the IRS also stated that the takers under the "intestacy" provision could be disregarded because no benefit would be received unless all of the descendants of the deceased employee predeceased the employee's spouse. Thus, distributions could be made over the spouse's (the eldest designated beneficiary's) lifetime.
Application to Special Spousal Distribution Rule
In PLR 9847022, a spouse was the "current" beneficiary of a trust named as an IRA beneficiary and five children were named as successor beneficiaries, each to receive a share on the current beneficiary's death (the nature of the spouse's current interest in the trust was not indicated). The ruling holds that the special commencement date (the date on which the employee would have attained age 70 1/2) in Code § 401(a)(9)(B)(iv) did not apply because the spouse was not the sole designated beneficiary of the trust. Prop. Treas. Reg. § 1.401(a)(9)-1, C-3(a). Apparently, the fact that the trust was not a conduit was sufficient to prevent the children remainder beneficiaries from being treated as contingent beneficiaries who could be disregarded.
The position taken in PLR 9820021 would appear to be correct under a literal interpretation. If one assumes that a charitable organization has perpetual life, there is no survivorship contingency involved and entitlement is only a matter of timing. In the case of PLRs 9846034 and 9847022, the children, as successor beneficiaries, must survive their mother to be entitled to any benefits retained in trust. Clearly, the IRS did not view the fact that the children must survive their mother to benefit as a contingency in either ruling. In PLR 9846034, the IRS did conclude that the interest of the "intestate" takers is contingent on the death of the prior successor
(presumably younger) beneficiaries.
To simply pass through to the trust beneficiary plan and IRA distributions payable to a typical accumulation trust benefiting a spouse would defeat the purposes of having a trust--beneficiary protection, property management and property disposition. The regulations expressly affirm that "a trust which receives a payment from a plan after the death of an employee need not distribute the amount of such payment to the beneficiaries." Prop. Treas. Reg. § 1.401(a)(9)-1, H-7. Moreover, contemporary trusts frequently grant beneficiaries powers of appointment that may permit other persons (including entities or individuals older than the appointing beneficiary) to receive benefits and may contain a "clean-up" clause benefiting charities or older persons.
The principal function of identifying the designated beneficiary (setting aside the entity beneficiary issue) is to establish the length of the minimum required distribution period. From administrative and tax policy viewpoints, it is difficult to perceive the value of construing the contingent beneficiary exception narrowly. If, instead, the regulation is interpreted to disregard (as a contingent beneficiary) any beneficiary who, as of the employee's date of death or RBD, is not currently entitled to receive benefits (and may not receive distributions until the death of a prior beneficiary), practitioners could avoid the need for customized, rigid trusts to receive plan and IRA benefits.
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