IRA See-Through Trusts

Take-Away: In something of a surprise, the IRS recently ruled that an irrevocable trust which was named as the beneficiary of several retirement plan accounts and IRAs qualified for see-through treatment so as to enable the life expectancy of the sole trust beneficiary to be used to calculate required minimum distributions (RMDs) from all of the retirement accounts. The surprise was because the beneficiary of the trust was given a testamentary general power of appointment over the trust corpus which permitted the beneficiary to appoint the trust’s assets, including the retirement accounts possibly to a charity. The key take-away is that the beneficiary’s testamentary general power of appointment was disregarded for purposes of identifying all of the beneficiaries of the see-through trust.  PLR 108823-17 (Released Dec. 15, 2017)

Background: Normally in order to qualify as the beneficiary of a retirement plan or IRA (collectively I will only refer to them as an IRA) the beneficiary must be an individual who may take distributions from the inherited IRA. Usually those taxable distributions are taken over the beneficiary’s life expectancy. [IRC 401(a)(9)(B)(iii)] If the designated beneficiary is not an individual, e.g. it is a charity, estate, trust, then the retirement assets must be distributed over a period no longer than 5 years from the IRA owner’s death. [IRC 401(a)(9)(B)(ii)] If a beneficiary other than an individual is designated as a beneficiary of the IRA, the IRA will be treated as having no designated beneficiary for purposes of the required minimum distribution (RMD) rules, even if there are also individuals who are designated as part of the group of IRA beneficiaries, leading to a 5-year payout of the entire IRA.

See-Through Trust Exception: A major exception to the non-individual beneficiary trap is that if a trust is named as beneficiary of an IRA and certain conditions are met, then the trust will be ignored for purposes of determining the IRA beneficiary, i.e. it will be treated as a see-through trust and its oldest beneficiary will have their life expectancy control the RMD’s taken by the trustee from the inherited IRA that is payable to the trust. [Treas. Reg. 1.401(a)(9)-4, Q&A-5] One of the conditions that must be satisfied for the trust to be ignored as the IRA beneficiary, i.e. it is seen-through, is that the IRA custodian must receive documentation with regard to the trust in order to enable the custodian to identify all of the beneficiaries of the IRA, apparently in a search that non-individuals might be beneficiaries forcing, in turn, a 5 year payout of the inherited IRA.

The Problem: If the trust beneficiary could exercise the testamentary general power of appointment given to her under the trust instrument and appoint the trust assets to a charity, arguably there could be a non-individual as one of the beneficiaries of the trust, which would result in a mandatory pay-out of the IRA to the trustee over no more than 5 years. This had been the worry of many attorneys who draft trusts that are intended to receive qualified plan and IRA payments; the settlor desires was to build in flexibility to the trust by giving an individual lifetime trust beneficiary a general power of appointment over the trust assets, which could be exercised arguably either in favor of older beneficiaries (whose older ages might dictate the required minimum distributions from the IRA) or exercised in favor of a charity, a non-individual beneficiary of the trust,  which would then force all taxable distributions from the IRA over a period of no more than 5 years. The Hobsen’s Choice was a stretch IRA paid to the trust or giving the lifetime beneficiary maximum flexibility over the trust assets with a power of appointment.

IRA Analysis: The IRS was asked if the trust before it was a see-through trust. Thus, it had to determine if the IRA custodian could identify all of the beneficiaries of the trust and if those beneficiaries were identifiable from the trust document to satisfy the see-through requirements. What was critical to the IRS’ analysis was that it read several provisions of the trust instrument together to reach the conclusion that the trust was what is called a conduit trust  that required the annual distribution of all retirement benefits paid to the trust to, in turn,  then be paid to the income beneficiary of the trust, which results in no accumulation of the retirement benefits in the trust. In short, it was a see-through trust because it was also a conduit trust.

“The determination of whether the subtrust qualifies as a see-through trust depends on whether the beneficiaries of the subtrust can be identified at the time of Decedent’s death. Article 6.4.4 of the Trust provides Daughter with a testamentary general power of appointment. This power of appointment generally applies to any accumulation of Retirement Account distributions that will accumulate in the subtrust. However, when read together, Articles 6.1 and 6.4.1 of the subtrust require the trustee to pay to Daughter any and all funds in the subtrust withdrawn by the trustee, including the minimum distributions required under IRC 409(a)(9) during Daughter’s lifetime. Therefore, there can be no accumulation of Retirement Account distributions in the subtrust for the benefit of any other beneficiary. Because Daughter is the only beneficiary named in the subtrust, all beneficiaries with respect to the subtrust’s interest in the Retirement Accounts are identifiable within the meaning of Reg. 1.401(a)(9)-4, Q&A-1 from the trust instrument. Accordingly, the subtrust satisfies the requirement of a see-through trust under Regulation 1.401(a)(9)-4, Q&A-5.”

Had the trust instrument permitted the accumulation of retirement benefits paid to the trust without a corresponding direction to distribute those same retirement benefits to the settlor’s Daughter who was the sole current beneficiary of the trust in the same year, what is called an accumulation trust, then the presence of the testamentary general power of appointment held by the Daughter would have forced the trustee to take the IRA assets over a much shorter 5 year period, since a charity could have been appointed as a beneficiary of the trust upon the Daughter’s death and her exercise of the testamentary general power of appointment, such that the charity could have received by virtue of the exercise of that appointment, all of the accumulated IRA distributions from the trust.

Conclusion: In conclusion, there were two pieces of good news in the past 10 days with regard to IRA distributions. First, Congress did not repeal the stretch-IRA rules for inherited IRAs as many thought would be the case as part of the promised ‘tax reform.’ Second, this helpful IRS ruling eliminates the worry of many lawyers who drafted see-through trusts intending to maximize the stretch-IRA rules, who also wanted to give the trust beneficiary a general  power of appointment to add flexibility to alter trust distributions to respond to changes in the needs of the remainder beneficiaries of the trust. We now know that a general power of appointment can be given to the current trust beneficiary without risking the loss of stretch-IRA distributions. The key is that the trust must be a conduit trust in order for the Service to ignore the general power of appointment that could otherwise be exercised to ultimately direct the trust assets to older beneficiaries or to charities.