| April 12 2010
Often a trust is an appropriate retirement plan beneficiary to avoid having the account payable to a beneficiary who is a minor or not yet financially mature enough to handle a large inheritance. However, naming a trust as beneficiary has pitfalls and drawbacks.
The first concern is to assure that the trust will qualify as a “look-through trust” so that minimum required distributions (MRDs) can be paid over the life expectancy of a trust beneficiary. If the trust fails to qualify, the account must be paid out fully by the end of the fifth year after the year of death if the owner dies before the required beginning date, or over the owner’s remaining life expectancy if the owner dies after the required beginning date. To qualify, the trust must meet four requirements. Three of these are relatively easy: (i) the trust must be valid under state law (ii) the trust must be irrevocable, or become irrevocable upon the grantor’s death (the latter is nearly always the case), and (iii) the trustee, by October 31 of the year following the year of the owner’s death, must provide certain documentation to the plan trustee or custodian.
The fourth requirement for a look-through trust, that all its beneficiaries be identifiable individuals, is fraught with perils. A charitable remainderman or a distant, elderly relative, no matter how unlikely to receive the benefits, may cause the trust to fail or to have a very short measuring life for MRDs. One possible solution is to structure the trust as a “conduit trust” (i.e., a trust in which all retirement plan distributions must be immediately distributed to a trust beneficiary), in which case all potential remaindermen may be disregarded for purposes of the “identifiable individuals” test.
Even if the trust qualifies, naming a trust as beneficiary has a least two drawbacks: (i) even if the trust divides into separate shares, all beneficiaries must use the oldest trust beneficiary’s life expectancy (the “separate account” rule is unavailable), and (ii) when the trust must make distributions, it can be difficult to distribute a retirement plan to a beneficiary without making a taxable distribution (the IRS, in several letter rulings, has permitted this, but many plan custodians refuse to cooperate). Therefore, when a trust is named as beneficiary, it is advisable to name individuals as contingent beneficiaries so that if, at the time of the owner’s death, the trust will immediately be fully distributed, the trustee can disclaim the benefits and permit them to become payable directly to the individual beneficiaries, who can then divide the account into separate accounts and use their separate life expectancies to calculate MRDs.
