Retirement Assets Payable to Trust: the Identifiable Beneficiary Issue

When naming a trust as beneficiary of an IRA or other retirement asset, it is critical that the trust be recognized as a “qualified trust.” This allows the trustee to stretch out payments from the IRA in a tax-efficient manner, namely over the life expectancy of the oldest beneficiary. If a trust is not a qualified trust, the IRA must be paid out in a tax-inefficient manner: within (a) 5 years or (b) the account owner’s remaining life expectancy, depending on whether the account owner died before or after age 70 1/2.

In order for a trust to be qualified, it must, among other requirements, have identifiable beneficiaries, all of whom are individuals. However, determining who the beneficiaries of a trust are for this purpose is not easy. The IRS does not just look at the current beneficiaries. It also looks at contingent beneficiaries; i.e., those who take upon the happening of a contingency, such as the death of a previous beneficiary.

At the same time, the regulations purport to draw a distinction between contingent beneficiaries and “successor beneficiaries.” Contingent beneficiaries are taken into account for purposes of determining whether a trust has identifiable individual beneficiaries; successor beneficiaries are not. The latter term refers to a “person who could become the successor to the interest of one of the [account owner’s] beneficiaries after that beneficiary’s death.” Thus the line between a contingent beneficiary and a successor beneficiary is blurry at best.

Accordingly, it is not clear how far down the beneficial line of succession one must look to determine who the beneficiaries of a trust are for qualified trust purposes. Remainder beneficiaries, contingent beneficiaries, beneficiaries who take in the event of a catastrophe, and eligible beneficiaries under a power of appointment could all be considered. If any of these are not individuals, the trust arguably does not have identifiable individual beneficiaries and thus fails as a qualified trust.

Fortunately, all of this uncertainty can be avoided by naming as beneficiary a trust with conduit provisions. In a conduit trust, the trustee is required each year, with respect to any retirement plan payable to the trust, to withdraw the minimum required amount and pay it within a reasonable time to the beneficiary or beneficiaries of the trust. Accumulation of payments from the retirement plan within the trust is not allowed. Under this approach, the IRS will not look for identifiable beneficiaries beyond the beneficiaries who are entitled to current distributions, and stretch out will be based on the life expectancy of the oldest beneficiary.

Source: Treas. Reg. § 1.401(a)(9)-5

Posted by Joel D. Roettger, JD, LLM, EPLS

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