Monthly Archives : August 2010

Potential Adverse Tax Consequences when Trust is the Beneficiary of an IRA

Potential Adverse Tax Consequences when Trust is the Beneficiary of an IRA

A parent may want to require that assets be retained in a single trust for their children or separate trusts, one for each child.  While a trust for a child can be designated as a beneficiary of an IRA, special care must be taken to assure that the trust will be able to utilize the child’s life expectancy when determining required minimum distributions under the inherited IRA rules. 

A recent private letter ruling, PLR 201020138, discussed the consequences when a charity is named as a remainder beneficiary of a trust. Upon the death of the parent, assets were required to be retained in trust for the benefit of the children.  The Trustee had discretion to pay income and principal for the benefit of the children and to accumulate income not paid.  Upon the trust termination, the trustee was directed to distribute the balance to descendants of the children as well as charities.

A trust must have a “designated beneficiary” in order to take advantage of the inherited IRA rules.   If the trust has a “designated beneficiary”, the trustee will be permitted to take required minimum distributions over the actuarial age of the oldest trust beneficiary. 

Under the trust in question, there was no requirement that the IRA distributions be paid to the children.  Accordingly, the IRS rules require that the remainder beneficiaries be considered in determining whether the IRA has a “designated beneficiary.”   Code Section 401(a)(9)(E) defines a designated beneficiary  as any ”individual” as long as the individual is identifiable.  If a charity is named as a beneficiary, the IRA is treated as having no beneficiary even if individuals are also named as trust beneficiaries.  

In determining designated beneficiaries under a trust, the IRS does not look at “successor beneficiaries”, those who could become a successor to the interest on the beneficiary’s death, but this exception does not apply to “contingent beneficiaries.”

 In a trust that allows the Trustee to accumulate income and principal, the IRS states that the remainder beneficiaries must be considered “contingent beneficiaries, rather than successor beneficiaries for purposes of determining who is the designated beneficiary.  Since charities were contingent beneficiaries, the trust was deemed not to have a designated beneficiary as of the decedent’s date of death.  A court order reforming the trust was ineffective to correct this problem.  Accordingly, the trust was unable to use the more favorable measuring life for determining future required minimum distributions, (the actuarial age of the oldest trust beneficiary).  In this case, the Trustee was required to use the IRA owner’s remaining life expectancy at the time of death reduced by one each year for determining future required minimum distributions.   

 With the advent of the inherited IRA rules, it is incumbent upon clients to review their trusts to make sure that their beneficiaries will be able to take advantage of the tax favored treatment available the inherited IRA rules.

 This is particularly relevant in special needs trust planning when the parents have significant IRA assets.   Some parents may want to benefit the non-profit agency that provided services to their child and desire to name that organization as the remainder beneficiary or among the remainder beneficiaries when the child with disabilities passes away.    In those cases, perhaps a different strategy will need to be considered in order to preserve the better tax-favored treatment accorded to trusts that have a “designated beneficiary.”