Partial Release of Power of Appointment Allows Use of Minimum Distributions to Extend Payout from Qualified Plan and for Rollover to Inherited IRA

A ruling with request to a set of trusts that were the beneficiary of a qualified retirement plan provides a good starting point for a review of some of the key rules involving the use of trusts as vehicles to receive retirement fund distributions as beneficiaries upon the death of the covered employee.  In PLR 201203033 the taxpayer was asking for the IRS to rule that the trusts involved would qualify to allow the inherited plan balances to be distributed over the shortest life expectancy of the individuals involved.

The situation involved a retirement plan in which the decedent had an interest.  The decedent had indicated a Marital trust to be created upon his death as the beneficiary of his interest in the plan.  The Marital trust provided that the spouse was to receive all net income generated by the trust and that the trustee could invade principal to provide for the health, support and maintenance of the spouse during her life.  However the trust did not require that the entire amount of any minimum distributions received by the spouse be distributed to her during her life.

Upon her death, the balance in the Marital Trust would be divided into two sets of trusts.  The first, referred to as the Exemption trusts, would receive property equal to the spouse’s remaining unused GST exemption.  The beneficiaries of the trust would be the husband’s (but not the spouse’s) two children.  The trustee may distribute from these trusts amounts deemed by the trustee to be necessary for each child’s health, education, maintenance and support.  Each child has the right at their death to designate the disposition of any assets remaining in the trust, but only to lineal descendants of their father.  If the power is not exercised, the remaining balance would be distributed to lineal descendants of the father per stirpes.

Another set of trusts were the “Primary Trusts” and would receive the balance of the funds from the Marital Trust.  The trustee of these trusts is directed to distribute all trust income to the children annually, plus any amounts necessary for each child’s health, education, maintenance and support, as well as other designated purposes.  Each child could withdraw ½ of the balance upon reaching age 30 and the entire principal upon reaching age 35.  If the child died with a balance remaining in the trust, wide discretion was granted to appoint all of the principal and income to, among other options, persons and organizations.

At the death of the plan participant, his daughter was age 35 (and thus could withdraw the entire balance upon receipt of an interest in the Primary Trust) and thus was, per the ruling, treated as the sole beneficiary of her trust.  However, the son was over 30 but not yet 35, thus having a testamentary power to appoint the remainder to a large pool of potential beneficiaries, including ones that were not natural persons.  Therefore that pool would be considered, at this point, in determining the potential beneficiaries of the Marital Trust.

Under Reg. §1.401(a)(9)-4 Q&A 5, a trust can qualify as a designated beneficiary of the retirement plan, allowing for distributions over the life expectancy of the beneficiary with the shortest life expectancy, if the following four criteria are met:

• (1) the trust is valid under state law or would be but for the fact there is no corpus.
• (2) the trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.
• (3) the beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit are identifiable from the trust instrument.
• (4) relevant documentation has been timely provided to the plan administrator.

The son’s ability to appoint a virtually unlimited category of individuals and organizations to receive the remaining balance of his trust would cause that group to be considered beneficiaries for the third point above.  However, prior to September 30 of the year following the year of the plan participant’s death the Son executed a partial release of his testamentary power of appointment, restricting his right to appoint the balance at his death to only a natural person who was born after his step-mother.

Under Reg. §1.401(a)(9)-4, Q&A4, we have a two step process to determine beneficiaries.  First, for purposes of counting as a qualified designated beneficiary for purposes of using the ability to stretch out distributions, the individual must have been a beneficiary as of the date of the participant’s death—that is, a beneficiary added after that date will not be a designated beneficiary.

Second, the actual beneficiaries as of September 30 of the year after the year of the participant’s death will be used in the final determination of beneficiaries—thus, “problem” beneficiaries can be removed between the date of the participant’s death and September 30 of the year following the year of the participant’s death so that only eligible designated beneficiaries remain at the September 30 measuring date.

In this case, while at the date of the participant’s death the son’s right of appointment brought a virtually unlimited number of potential beneficiaries into the mix, including some who would not be natural persons (and thus have no life expectancy, removing any right to distribute over the shortest life expectancy of the beneficiaries), the partial release of the son’s power of appointment prior to the September 30 measuring date served to remove the problem beneficiaries.

Thus the IRS ruled that the required distributions would be determined based on the shortest life expectancy in the revised potential pool of beneficiaries.  In this case, no beneficiary could end up with a shorter life expectancy than the spouse, thus her life expectancy would be used for computing minimum distributions.  As well, the IRS also ruled that the balance from the employer sponsored retirement plan could be transferred to an inherited IRA established for the purpose of receiving the balance on behalf of the Marital Trust.

The case serves as a reminder that when retirement plan assets are involved in an estate, there are steps that may need to be considered prior to September 30 of the year following the year of death that can allow for an extended distribution—and that if not taken may force funds out of the account much more quickly.  As well, it serves as a reminder of some of the unique issues that arise in using trusts in such planning.  Since trusts are often used generally in estate planning, it’s important that consideration be given to how the trusts should (or if they should) receive qualified plan assets.

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