Trust Beneficiary of Qualified Plan Benefit
Doug H. Moy
January 29, 2008 — 1,864 views
Copyright © 2007 by Doug H. Moy. All rights reserved
Clients and their advisors have inquired of me whether a surviving spouse can make the election to treat the surviving spouse as the owner of the decedent spouse’s IRA (including qualified plan benefits) when the trustee of a trust (e.g., revocable living trust or testamentary trust) is named beneficiary of the IRA. As a general rule, in order to make the election, the surviving spouse must be the sole beneficiary of the decedent spouse’s IRA and have an unlimited right to withdraw amounts from the IRA. If a trustee is named beneficiary of the IRA, this requirement is not satisfied, even if the surviving spouse is the sole beneficiary of the trust [Treas. Reg. § 1.408-8, Q&A-5(a)]. In this regard, if a decedent spouse’s IRA passes through a third party, e.g., a trust, and then is distributed to the decedent’s surviving spouse, the surviving spouse will be treated as acquiring the IRA from a third party and not from the decedent spouse. Thus, under such circumstances, a surviving spouse would not be eligible to effect a tax-free rollover of the decedent spouse’s IRA into his or her own IRA.
However, where neither the trustee nor the decedent spouse’s personal representative has any discretion as to the allocation of assets to a trust for the benefit of the surviving spouse, and the surviving spouse can appoint (i.e., give) those trust assets to himself/ herself, such assets may be transferred via a trustee-to-trustee transfer to an IRA maintained in the name of the surviving spouse; i.e., the surviving spouse becomes the owner of the IRA [Priv. Ltr. Rul. 9533042 (May 25, 1995)]. As the owner of the IRA, the surviving spouse can designate the beneficiary of the IRA. This planning strategy is commonly known as effecting a “stretch” IRA. Moreover, if the surviving spouse has the power to revoke the trust, then, for the purposes of IRC Section 408(d), the surviving spouse will be treated as having acquired the IRA proceeds from the decedent spouse and not from the trust [Priv. Ltr. Ruls. 200708084 (Nov. 27, 2006); 200304037 (Oct. 29, 2002); 200245055 (n.d.); 200242044 (July 23, 2002); 9751042, ¶s  and  (Sept. 24, 1997)]. Moreover, the IRS acknowledges the reality that, if the surviving spouse is the sole beneficiary of the IRA (including a qualified benefit plan) under a revocable living trust, then, the surviving spouse receives “from and by reason of the death of [his or] her [spouse]” the qualified plan benefit and may elect to treat the [qualified plan benefits or] IRA as his or her own and roll the benefits over tax-free into his or her own IRA [Priv. Ltr. Ruls. 200242044 (July 23, 2002); 200245055 (n.d.); 200304037 (Oct. 29, 2002)].
A potential disadvantage of naming the trustee beneficiary of the IRA (or qualified plan benefits) involves the separate account rule. In this regard, the separate account rules are not available to beneficiaries of a trust with respect to the trust’s interest in an employee’s qualified plan benefit [Treas. Reg. § 1.401(a)(9)-4, Q&A-5(c); Priv. Ltr. Rul. 200708084 (Nov. 27, 2006)]. Whether a planning strategy is a perceived or real disadvantage must be thoroughly explored before a determination is made as to the efficacy of the planning strategy.
A nonspouse beneficiary of the IRA designated by the surviving spouse may elect to treat the IRA as an inherited IRA [IRC § 402(c)(11)(A)(ii)]. However, to do so, the nonspouse beneficiary would have to know about the availability of the nonspouse beneficiary direct rollover provisions under IRC Section 402(c)(11) and not have received a distribution from the IRA upon the death of the surviving spouse; or the nonspouse beneficiary’s advisor would have to alert the nonspouse beneficiary of the direct rollover provisions. In this regard, if the designated beneficiary receives a distribution from the IRA before a direct trustee-to-trustee transfer of any portion of such distribution is made to an IRA for the nonspouse beneficiary, then, the distribution is not eligible for rollover [See Notice 2007-7, 2007-5 I.R.B. 1, Q&A-15]. Hence, a more secure approach would be to have the surviving spouse name the trustee of the revocable trust beneficiary of the IRA. Under the revocable trust, the trustee would direct the custodian or trustee of the IRA to effect a trustee-to-trustee direct rollover of the IRA to an inherited IRA for the child. The custodian or trustee of the IRA would then make required minimum distributions (“RMDs”) to the trustee of the revocable trust who, in turn, would make all amounts of the RMDs to the nonspouse beneficiary. Moreover, the RMDs would have the protection of the revocable trust if the nonspouse beneficiary were to become physically or mentally incapacitated. In this regard, the trustee could make the RMDs available [See IRC Section 402(b)(2)] to or for his/her health care, education, support and maintenance. Furthermore, by naming the trustee of the revocable trust beneficiary of the IRA upon the surviving spouse’s subsequent death, the remainder value of the IRA may be shielded from a property settlement agreement if the nonbeneficiary and his or her spouse were to divorce.
Bottom Line: Can a stretch IRA be accomplished if the trustee of a revocable living trust is named beneficiary of the IRA? Answer: (1) we know that the surviving spouse could effect a tax-free rollover of the decedent spouse’s IRA into the surviving spouse’s own IRA, even if the trustee of the trust is the named beneficiary [Priv. Ltr. Ruls. 200708084 (Nov. 27, 2006); 200304037 (Oct. 29, 2002); 200245055 (n.d.); 200242044 (July 23, 2002); 9751042, ¶s  and  (Sept. 24, 1997)]; (2) we know that, if the surviving spouse names the trustee of the revocable trust beneficiary of his or her rolled-over IRA, then, the trustee can direct the custodian or trustee of the IRA to effect a trustee-to-trustee direct rollover of the IRA on behalf of the a nonspouse beneficiary. Under IRC Section 402(c)(11), the IRA would be an inherited IRA; and the RMDs would be based on the nonspouse’s life expectancy [Treas. Reg. § 1.401(a)(9)-5, Q&A-5(c)(1); Notice 2007-7, 2007-5 I.R.B., Q&A-17(c)]; and (3) thus, the answer to the question is "Yes."
Doug H. Moy
Doug H. Moy is a nationally recognized author, consulting specialist, seminar instructor and educator. He has an undergraduate degree from Willamette University and a Masters degree from Washington State University. Since 1979, Mr. Moy has consulted to attorneys, tax practitioners and their clients, as well as assisted practitioners representing clients before the IRS Conference of Right and Appeals Division and Settlement Conference Negotiations. He is noted for his ability to communicate his unparalleled knowledge and experience to practitioners at all levels in his field of expertise; namely, estate/gift taxation and planning, with special expertise in living trusts; community property; lottery prize winnings; structured settlement trusts; extricating clients from abusive trust tax shelters; designing effective estate plans; and preparation of Form 706 Estate Tax Returns and 709 Gift Tax Returns. He offers particular assistance and exceptional skill designing creative, practical solutions to challenging and difficult estate planning situations.