ALI-ABA Course of Study. Estate and Distribution Planning With Qualified Plans & IRAs

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1 1 ALI-ABA Course of Study Estate and Distribution Planning With Qualified Plans & IRAs Encore Presentation with Live Q & A November 10, 2008 Live Video Webcast Preserving the "Designated Beneficiary" If a Trust is Named as Beneficiary of a Qualified Plan or IRA By Virginia F. Coleman Ropes & Gray LLP Boston, Massachusetts Copyright Virginia F. Coleman. All Rights Reserved.

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3 3 SUMMARY OF CONTENTS Page Section One: Trust as Beneficiary-Preserving the Designated Beneficiary... 1 Conduit Trust... 6 Circle Trust... 9 Flat Earth Trust Snapshot rule Powers of appointment Post mortem amendment Payment of estate obligations from trust Allocation to a specific trust Self-help measures after the fact Penalty tax for underdistributions i-

4 4 PRESERVING THE DESIGNATED BENEFICIARY IF A TRUST IS NAMED AS BENEFICIARY OF A QUALIFIED PLAN OR IRA Virginia F. Coleman Ropes & Gray Boston, Massachusetts I. Who is a trust beneficiary for purposes of IRC 401(a)(9) framing the issue A. The 1987 proposed regulations stated that if a trust was named as beneficiary of a plan or IRA and certain conditions were satisfied, a look-through rule would apply to determine whether there was a designated beneficiary and if so the identity of the designated beneficiary. These regulations were substantially revised in 1997, and have been carried forward largely unchanged in the 2001 proposed regulations, issued in January 2001, and now in the 2002 final regulations. 1. The identity of the designated beneficiary remains crucial to the payout period for post-mortem minimum distributions, although in most instances, under the 2002 regulations, it will be irrelevant to the determination of minimum distributions during life. 2. After the participant reaches his required beginning date, when at a minimum post-mortem distributions may be made over his life expectancy, if his primary real beneficiary is his spouse (or other individual) of roughly the same age, it will be of little or no consequence even with respect to post mortem distributions if a trust for the spouse or other individual is named as beneficiary and gives rise to no designated beneficiary. In either case the payout period (participant s nonrecomputed remaining life expectancy or spouse s (or other individual s) recomputed (or nonrecomputed) remaining life expectancy) will be much the same. 3. If the real beneficiary is of a younger generation (child or grandchild), the existence or not of a designated beneficiary

5 5 if a trust for child or grandchild is named as beneficiary will make a major difference in the distribution period for post-mortem distributions. In addition, regardless of the identity of the real beneficiary, if death occurs before the required beginning date, it is necessary to have a designated beneficiary to avoid the 5-year rule. B. If the conditions for application of the look through rule are satisfied at the relevant time(s), the beneficiaries of the trust who are beneficiaries with respect to the trust s interest in the employee s benefit will be treated as the employee s designated beneficiaries. Reg (a)(9)-4, A-5 (2002). Prop. Reg (a)(9)-4, A-5 (2001). Prop. Reg. 401(a)(9)-1, D-5(a) (1997). Assuming there are multiple beneficiaries, absent separate accounts the payout period will be determined in accordance with the life expectancy of the beneficiary with the shortest life expectancy. Reg (a)(9)-4, A-5(c), 1.401(a)(9)-5, A-7 (2002). 1. The four requirements that a trust must satisfy, per 1.401(a)(9)-4, A-5, are: a. The trust must be a valid trust under state law, or would be but for the fact that there is no corpus. b. The trust must be irrevocable or will, by its terms, become irrevocable on the death of the participant. The italicized language was new with the 1997 proposed regulations. c. The beneficiaries of the trust who are beneficiaries with respect to the trust s interest in the participant s benefit must be identifiable from the trust instrument. d. The documentation described in 5. below must be provided to the plan administrator. This replaced the requirement in the 1987 proposed regulations that a copy of the trust be provided to the plan administrator. 2. These requirements must be satisfied during any period during which required minimum distributions are being determined by treating the beneficiaries of the trust as designated beneficiaries of the employee. In most cases, this will not be until after the participant s death. 3. The first requirement is straightforward. The only question -2-

Preserving the Designated Beneficiary If a Trust Is Named as Beneficiary of a Qualified Plan or IRA

Preserving the Designated Beneficiary If a Trust Is Named as Beneficiary of a Qualified Plan or IRA Virginia F. Coleman All section references are to the Internal Revenue Code ( IRC ) unless otherwise