Take-Away: The SECURE Act’s Proposed Regulations provide a safe harbor when a trust is named as a retirement account beneficiary and one beneficiary holds a power of appointment over the trust assets.

Background: Earlier missives have summarized some of the key changes that appear in the SECURE Act’s Proposed Regulations, including the surprise that if the deceased account owner died after his/her required beginning date (age 72) that the inheritor must continue to take annual required minimum distributions (RMDs) from that inherited retirement account. What is of interest is that the Proposed Regulations provide this ‘new’ interpretation of the SECURE Act, yet 2022’s IRS Notice 590 continues to use the ‘old’ interpretation that no RMDs need to be taken by the inheritor until December 31 of the 10th anniversary of the account owner’s death. So much for clarity and consistency from the IRS!

See-Through Trusts: Other proposed changes in the SECURE Act’s Proposed Regulations are not so draconian. One area of the SECURE Act Proposed Regulations which provides some relief is with regard to identifying all of the beneficiaries of a see-through trust. Recall that in order for a trust to qualified as a designated beneficiary, the trust must satisfy several conditions, so that the beneficiaries of the trust are treated as the designated beneficiary of the retirement account and not the trust (which is otherwise not a person, thus leading to the application of the 5-year distribution rule.)

Identifiable Beneficiaries: One of those see-through trust requirements is that the all beneficiaries of the see-through trust must be identifiable by September 30th of the calendar year following the calendar year of the account owner’s death, called the Determination Date. A trust will satisfy the identifiability requirement “If it is possible to identify each person eligible to receive a portion of…the plan through the trust.” 

Power of Appointment: Previously, the presence of a power of appointment held by a trust beneficiary was considered to frustrate such identification requirement because the failure of the person who holds the power of appointment (the powerholder) to exercise or restrict such power that results in the inability to determine the identity of the trust beneficiaries by the Determination Date.

Safe Harbor: The Proposed Regulations provide a safe harbor with respect to the exercise or restriction of a power of appointment, which is separate and apart from the ablility to reform or modify a trust.

Example: Doug died in 2022 at the age of 60. Doug named a see-through trust as beneficiary of his IRA. Under the terms of his trust, all trust income is payable to Doug’s wife, Millie. Millie also has a testamentary power of appointment to redirect the trust assets upon her death. The testamentary power of appointment provides that if Millie does not exercise the power of appointment, then upon Millie’s death,  Doug’s descendants are entitled to the remainder interest in the trust, in separate shares (per stirpes). At the time of Doug’s death, Doug has two adult children, Jack and Jill.

Before the Determination Date, Millie irrevocably restricts her testamentary power of appointment under the trust so that Mille may only exercise the power to appoint in favor of Millie’s siblings (all of whom are less than 10 years younger than Doug, and thus all siblings are eligible designated beneficiaries. Because Millie timely restricted the testamentary power of appointment so that she may exercise the power only in favor of Millie’s siblings, the only designated beneficairies are Millie and Millie’s siblings, even though Jack and Jill are the ‘takers-in-default’ under the trust instrument. Because all of the designated beneficiaries are eligible designated beneficiaries, payments made to the trust may be made over Millie’s life expectancy.

However, if Millie had not timely restricted the testamentary power of appointment, then Millie, Jack and Jill would all be considered designated beneficiaries, and the SECURE Act’s 10-year distribution rule would apply, since not all designated beneficiaries are eligible designated beneficiaries.

Ability to Amend, Modify, and Reform a Trust: The Proposed Regulations also contain a welcome position as they permit the amendment, modification and reformation of trusts on or before September 30th of the calendar year following the calendar year of the account owner’s death, so that trust beneficiaries, creditors, charities and other entities can be added or removed. If a trust beneficiary is added after the Determination Date, however, the addition of the new beneficiaries to the trust will affect the life expectancy calculation. In addition, if a beneficiary is added to the trust in a calendar year in which a full distribution is not required, and after the addition of such beneficiary full distribution would have been required, the full distribution will not be required until the end of the calendar year following the calendar year in which the beneficiary was added to the trust.

Conclusion: More ‘modern’ trusts are being drafted these days to include powers of appointment to add flexibility to the administration and distribution from the trust. The concern was that the presence of a broad power of appointment would disqualify the trust from meeting the see-through trust requirements, triggering the 5-year distribution rule. Now, it will be possible to limit any power of appointment through a restriction or disclaimer prior to the Determination Date and enable the trust to continue to qualify as a see-through trust, perhaps as the Example demonstrates with a life expectancy distribution of RMDs.