Take-Away:  One of the challenges in directing an IRA to be paid to an irrevocable trust on the IRA owner’s death is how to identify the oldest beneficiary of the trust whose life expectancy governs the required minimum distributions the trustee must take from the decedent’s IRA. Even more of a challenge is if there is a non-individual beneficiary of the trust, such as an estate or charity, which could cause the entire IRA to be ‘emptied’ by the trustee over a period of no longer than 5 years. Figuring out which trust beneficiaries to count, and which to ignore, frequently trips up trustees and lawyers. Finally, there is a helpful analytical tool to use to identify which beneficiaries can be ignored in identifying the IRA’s applicable distribution period.

Background: An inherited IRA can be taken over the beneficiary’s life expectancy. If the IRA is paid to a trust, then the life expectancy of the oldest trust beneficiary controls the required minimum distributions from the inherited IRA. If the trust instrument directs that the entire required minimum distribution taken by the trustee from the IRA is paid out to the beneficiary, using the oldest trust beneficiary’s life expectancy for that calculation, it is often called a conduit trust. If, however, the trustee of the trust is permitted to accumulate trust income, including the distributions taken from the inherited IRA, then the trust is called an accumulation trust. If there are non-individual trust beneficiaries of the trust, e.g. a charity, a decedent’s estate, then with a conduit trust, those non-individual trust beneficiaries can be ignored, permitting required minimum distributions over an extended period of time (permitting assets inside the IRA to continue to grow during that extended period.) If, however, the trust is an accumulation trust, then all trust beneficiaries, including non-individual beneficiaries must be taken into account. For example, if one of the trust beneficiaries is a charity, and the IRA owner was under the age of 70 ½ at death, then the entire IRA must be paid to the accumulation trust over a period of no longer than 5 years [Treas. Reg. 1.401(a)(9)-3, Q&A-2]; if the IRA owner was older than that age at the time of death, then the IRA must be emptied by the trustee through withdrawals over the deceased IRA owner’s ‘normal’ life expectancy, perhaps longer than 5 years, but not nearly as long as the life expectancy of a younger trust beneficiary.

  • Example: Dad, age 69,  dies owning a $1.0 million IRA that is made payable to the trust that Dad created prior to Dad’s death. Dad’s Son, age 41,  is the lifetime beneficiary of Dad’s trust. The trustee is given the discretion to distribute trust income and/or principal to Son for his lifetime. On Son’s death, the trust instrument directs the trustee to distribute the remaining trust assets to Son’s sons, Cain (age 21)  and Able (age 18). However, if Cain or Able are under the age of 35 years at the time of Son’s death, their share continues to be held in trust until they reach that age of 35 years. If, by chance, either Cain or Able does not survive until age 35, then the trust share that was created for Cain or Able is to be distributed, 50% to that grandson’s then living descendants (Dad’s great-grandchildren, if any), and the other 50% is to be distributed directly to Dad’s church. This trust is an accumulation trust. A charity is a named contingent  trust beneficiary. Can the church-as-trust-beneficiary be ignored when the trustee determines the applicable distribution period (ADP) for the IRA distributions to the trust, which would normally be Son’s life expectancy (Son’s two sons Cain and Able being younger than Son, as well as Cain and Able’s descendants?)
  • Filtering Process: In short, the trustee must filter multiple trust beneficiaries to identify which beneficiary creates the ADP, and which named trust beneficiaries can be ignored, a task easier said than done.
  • General Rule: If the trust instrument only has individual beneficiaries, called the designated beneficiaries, the oldest beneficiary’s life expectancy will create the ADP, which governs how fast the IRA will be emptied through distributions to the trust. If the trust instrument has non-individual beneficiaries, like an estate or charity, the presence of those non-individual beneficiaries will disqualify the use of all individual beneficiaries life expectancies, thus accelerating the payment of the IRA’s assets to the trust and accelerating the income tax liability associated with the IRA distributions.
  • Unhelpful Regulations: ‘Mere Potential Successor Beneficiary:’ However, a beneficiary with a contingent interest in the trust further complicates this filtering process by the trustee. The Regulations initially provide that a beneficiary’s contingent right under the trust’s terms factors into the ADP’s determination [Treas. Reg. 1.401(a)(9)-5, Q&A-7(b).] But another part of the same Regulations imply that another contingency will exclude certain trust beneficiaries from consideration, by using the terminology that some trust beneficiaries are mere potential successor beneficiaries which can be excluded in the ADP filtering process. Not helping matters any is that while the mere potential successor beneficiary concept was first identified by Treasury back in 2003, no regulations have ever been provided since then to clarify the meaning of mere potential successor beneficiary. In short, no one has a real good handle on when a beneficiary is a contingent beneficiary who/which must be counted for ADP purposes, and when the contingent beneficiary is only a mere potential successor beneficiary, whose presence in the trust instrument can be ignored for ADP purposes.
  • Restating the Question: Clearly the trustee can identify the present lifetime income/principal beneficiary of the trust and quickly ascertain his/her age(s). The following question then is: what is the effect if a primary remainder holder dies before taking an outright distribution, and a secondary remainder beneficiary succeeds to this interest?  Using the above example: We can identify Cain an Able and ascertain their ages (both younger than Son, so they are ignored for ADP purposes), but if either Cain or Able does not survive until age 35 years, then Dad’s church will receive one-half of Cain or Able’s trust share. Will the presence of Dad’s church as a contingent beneficiary in Dad’s trust force the IRA to be emptied into the trust within 5 years since Dad was under his required beginning date (age 70 ½) at the time of his death?  Does the presence of Dad’s church as a named contingent trust beneficiary prevent the trustee from taking required minimum distributions from the IRA over an extended period of time (Son’s life expectancy?)If this was the result then a lot of deeming  goes on: the IRS would deem that Son died immediately after Dad, followed one minute later by the deaths of both Cain and Able, the Dad’s grandsons, after which one- half of their trust shares will then be distributed to Dad’s church. In the absence of clarifying Regulations, how does the trustee proceed?

Treasury Decision to the Rescue: In its 2002 Treasury Decision No. 8987, its preamble explains the rule to be applied in determining the ADP for the inherited IRA paid to a trust. The preamble creates an “exception form the multiple beneficiary rules for death contingencies” that otherwise count in measuring the ADP.

Filtering Rule: This filtering rule in the Treasury Decision can be summarized as follows: If a primary remainder beneficiary survives the creation of the trust at the IRA owner’s death, but he/she should die before receiving an outright distribution of the trust’s assets, the successor to this trust interest is not a trust  beneficiary for purposes of measuring the ADP.

  • Included: In effect the IRS has created its own definition of contingencies a trustee must consider for purposes of determining the ADP. An includible contingency will exist when the trust’s terms conditionally or unconditionally delay the primary remainder beneficiary’s access to the trust’s principal until the lifetime trust beneficiary’s death.
  • Ignored: In contrast, an excluded contingency, or a mere potential successor beneficiary, arises if a primary remainder beneficiary’s successor has no independent beneficial interest in the trust, and that beneficiary takes solely due to the primary remainder beneficiary’s death.
  • Example: In our example the IRS will treat Cain and Able as primary remainder beneficiaries, even though their interest in outright distribution from Dad’s trust depended completely on Son’s untimely death.  Dad’s church has no independent beneficial interest in (right to) Dad’s trust assets. If Dad’s trust instrument had provided a lifetime interest for Son, followed by lifetime trust interests, for Cain and Able, and upon Cain or Able’s death one half of their trust share was to then be distributed to Dad’s church, then the presence of the church (it possessed a right to receive trust assets, just delayed in its receipt) would change the outcome, and the trustee of Dad’s trust would have an ADP period of only 5 years from Dad’s death.

Conclusion: Admittedly the above discussion is opaque if not entirely irritating. But it is nonetheless important when a trustee administers a trust to which the settlor’s IRA is made payable. To exploit the income tax savings by using the ADP with the longest period possible, the trustee must identify the individual beneficiary with the shortest life expectancy, i.e. the oldest trust beneficiary. While the presence of non-individual trust beneficiaries can forfeit or greatly reduce that ADP, some non-individual trust beneficiaries can be ignored if they are mere potential successor beneficiaries  of the trust. While that concept not formally defined, the best way to describe a mere potential successor beneficiary, is a secondary remainder beneficiary which has no significance in determining the ADP, and which takes only because the remainder beneficiary standing ahead of them in the trust dies prior to an age or event when they are entitled to take what has been set aside for them. Thus, focus should be on the first set of remainder beneficiaries with the question when (if ever) will they have a right to take the trust principal- if they die prior to that required age or event occurring the secondary remainder beneficiaries that stand behind them are ignored for ADP purposes. If the primary remainder beneficiary never has a right to take the trust principal (e.g. it’s a continuing lifetime trust for the named remainder beneficiary) then the identity of the following remainder beneficiary cannot be ignored for ADP purposes.