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George F. Bearup, J.D. Senior Legal Trust Advisor

August 29, 2023

Applicable Multi-Beneficiary Trusts – Again!

Take-Away: Trusts for disabled or chronically ill beneficiaries can exploit the stretch distribution rules for retirement benefits made payable to the trust. Compliance with technical rules in the Tax Code and Proposed Regulations will be required, though, to attain the tax deferrals associated with stretch required minimum distributions from the inherited retirement account.

Background: Awhile back I mentioned in a couple of missives the change to applicable multi-beneficiary trusts, or AMBTs, in the SECURE Act 2.0. A couple of folks then asked me to to dig a bit deeper into AMBTs and explain why they are important when they receive distributions from inherited retirement accounts.

Basics: A quick preliminary review of some basic retirement plan distribution concepts will be helpful.

  • See-Through Trust:  Generally, in order to avoid the 5-year mandatory distribution rule for an inherited retirement account, the designated beneficiary must be an individual. However, Congress permits a trust to be treated as an individual if certain technical requirements are satisfied. These requirements where a trust is named as the retirement plan beneficiary are often referred to as see-through trusts, where the trust is essentially ignored, and the trust’s beneficiary is treated as the designated beneficiary.
  • Eligible Designated Beneficiary: The SECURE Act made most beneficiaries subject to the 10-year distribution rule. It created, however, 5 categories of beneficiaries who are entitled to continue to take required minimum distributions (RMDs) from the inherited retirement account using their life expectancy to calculate the annual required minimum distribution. These beneficiaries are called eligible designated beneficiaries. The 5 types of beneficiaries who are eligible for this stretch distribution include: (i) the decedent’s surviving spouse; (ii)the decedent’s minor child until that child attains age 21; (iii) a designated beneficiary who is less than 10 years younger than the decedent; (iv) a disabled individual; and (v) a chronically ill individual. It is these last two types of eligible designated beneficiaries, i.e., the disabled or chronically ill, that normally prompt the use of an ABMT. If the RMDs of the retirement benefits were paid directly to the disabled or chronically ill beneficiary, there is a good chance those RMDs would jeopardize that individual’s entitlement to governmental benefits. Consequently, rather than pay the RMDs directly to the disabled/chronically ill individual, the RMDs are paid to a see-through trust.
  • AMBTs: Thus, an AMBT is special type of see-through trust that is established for a disabled or chronically ill person that receives RMDs from the decedent’s retirement account. [IRC 401(a)(9)(h)(iv)(v).]

Types of AMBTs: There are two types of AMBTs, for convenience described as either Type I and Type II. A Type II AMBT is usually a special needs trust for one or more disabled/chronically ill beneficiaries.

  •  Individuals: The Proposed Regulations require that any ABMT be a see-through trust for one or more disabled/chronically ill beneficiaries. [Regulation 1.401(a)(9)-4(g).] At least one of the beneficiaries must be either disabled or chronically ill, and all trust beneficiaries must be designated beneficiaries which loosely translated means that the beneficiaries all must be individuals.
  • Charities: The recent change caused by the SECURE Act II is that charities are now allowed to be the remainder beneficiaries of a Type II AMBT.

Type I AMBT: As noted above, an AMBT must have at least one disabled or chronically ill individual beneficiary. The ABMT can either be revocable or testamentary.

  •  Immediate Division into Subtrusts: What is required with a Type I AMBT is that the trust terms must provide that the trust is immediately divided on the death of the account owner into separate shares (subtrusts) for each beneficiary. Therefore, each subtrust must exist after the account owner’s death and be a see-through trust with designated beneficiaries so that each subtrust will be considered the designated beneficiaries of the decedent’s IRA that is inherited.
  • Separate Accounts Rule: The Regulations allow a Type I AMBT, but not a Type II AMBT, to use the separate accounts rule. This rule is akin to naming the trust beneficiaries directly in an IRA beneficiary designation form. These separate inherited ‘IRAs’ for each trust beneficiary must be established by December 31 of the year that follows the death of the retirement account owner. This separate account rule is especially important when there is a large age difference in the beneficiaries of the trust. [Regulation 1.401(a)(9)-8(a)(1)(iii)(B).]
  • Flexibility: The separate accounts rule also provides flexibility in the trustee’s allocation of trust assets among the subtrusts, enabling the trustee to ‘pick and choose’ how trust assets are allocated among the subtrusts. For example, the trustee might allocate non-retirement trust assets to non-disabled/chronically ill beneficiary subtrusts with the decedent’s IRA that is payable to the trust allocated to the disabled/chronically ill beneficiary’s subtrust, i.e taking all of the beneficiaries’ health and life expectancies into account in making these asset allocations among the subtrusts for their respective trust beneficiary.

Type II AMBT: As a broad generalization, a Type II AMBT is a third-party special needs trust that is funded with assets by someone other than the special needs beneficiary. However, the Type II AMBT does not have to be a special needs trust that would enable the disabled/chronically ill beneficiary to qualify for governmental benefits like Medicaid and SSI. Again, the Regulations require that one or more of the trust beneficiaries must either be disabled or chronically ill. [Regulation 1.401(a)(9)(g)(3).]

  •  Only One Receives RMDs: A Type II AMBT requires that only one of the disabled/chronically ill beneficiaries are entitled to the trust’s retirement benefits during their lifetimes, until the death of the last of the disabled/chronically ill beneficiary.
  • Discretionary: The Type II AMBT may be a conventional discretionary trust for the disabled/chronically ill beneficiary with no special needs trust language needed.
  • Accumulations: Again, as a generalization, a Type II AMBT will be an accumulation see-through trust and will have only one disabled/chronically ill beneficiary.
  • Remainder Beneficiaries: The remainder beneficiaries of a Type II AMBT are disregarded if they are designated beneficiaries. However, starting this year, charities other than donor advised funds or most private foundations may be named as Type II remainder beneficiaries.
  • Calculating the RMD: To determine the applicable denominator used to calculate the RMD to the Type II AMBT, the age of the account owner will control. If the account owner died before his/her required beginning date (RBD) the disabled/chronically ill beneficiary’s age will be used. If there are multiple disabled or chronically ill beneficiaries, the older disabled/chronically ill individual’s life expectancy will be used. If the account owner died after his/her RBD then the longer for the account owner’s life expectancy or the oldest disabled/chronically ill beneficiary’s life expectancy will be used to determine the applicable denominator. Thus, the oldest beneficiary rule does not apply to the disabled/chronically ill beneficiaries of a Type II AMBT. Any payout from the inherited IRA will continue until the death of the last disabled/chronically ill beneficiary, or the IRA is exhausted.

Conclusion: While these AMBT rules are complicated, they definitely provide some flexibility in using retirement accounts to provide, long-term, for disabled or chronically ill beneficiaries. AMBTs also provide continued access by the disabled or chronically ill AMBT beneficiaries to government benefits while still being a discretionary beneficiary of the trust that receives RMDs. As time passes and we become more comfortable with these highly technical rules and distinctions, AMBTs may become the preferred beneficiary of an individual’s retirement account.