When naming designated beneficiaries of individual retirement accounts, it’s usually best to avoid naming a trust, as this could disqualify not only the trust but also any individuals named as beneficiaries. A recent Private Letter Ruling, PLR 201923016 (released June 7, 2019) addressed a case in which a Roth IRA account was held in a living trust and, at the grantor’s death, was subsequently transferred to a marital trust for the benefit of the surviving spouse. To determine whether the spouse was the legitimate beneficiary of the Roth IRA account, the Internal Revenue Service had to determine whether the marital trust was a “see-through” trust under applicable law. The IRS ruled that the spouse was the designated beneficiary of the grantor’s Roth IRA for purposes of determining the distribution period under Internal Revenue Code section 401(a)(9) and that required minimum distributions (RMDs) are to be calculated based on her life expectancy.
Marital Trust Is Beneficiary of Roth IRA
The grantor established a revocable living trust that became irrevocable at his death and was divided into a “marital trust” for the benefit of his surviving spouse, a trust for the benefit his daughter (daughter’s trust) and a third “family trust.” At the time of his death, the grantor was the beneficiary of the Roth IRA account, and according to the beneficiary designation form, the marital trust was the named beneficiary of the Roth IRA account. The original trust also instructed that, at the death of the surviving spouse, assets in the martial trust would flow to the daughter’s trust, and at the death of the daughter, the remaining assets would flow into the family trust to be distributed to the daughter’s living descendants.
The taxpayer requested that:
1) The surviving spouse be treated as the designated beneficiary of the Roth IRA for purposes of IRC Section 401(a)(9); and
2) RMDs from the Roth IRA account be calculated based on the life expectancy of the surviving spouse. Under this method, the first-year RMD is determined based on the spouse’s corresponding life expectancy factor in the year of the first distribution under the Single Life Table. For succeeding years, this initial factor is reduced by one each year.
If Trust Named as Beneficiary
In general, naming a trust as the beneficiary of an IRA account can be problematic because the IRA beneficiary must be determined to be an individual(s) whose life expectancy may be used to calculate RMDs. Treasury Regulations Section 1.401(a)(9)-4 provides that only individuals may be designated beneficiaries; a person who isn’t an individual, such as the decedent’s estate or a charitable organization, may not be a designated beneficiary. Note that if a person other than an individual is designated as a beneficiary of a decedent’s benefit, the decedent will be treated as having no designated beneficiary, even if there are also individuals designated as beneficiaries.
However, if a trust named as a designated beneficiary satisfies certain requirements, individuals who would benefit from the named trust may be determined to be the actual designated beneficiaries. Treas. Regs. Section 1.401(a)(9)-4 addresses “see-through trust” provisions and provides that when a trust is named as a beneficiary, beneficiaries of the trust with respect to the trust’s interest in the grantor’s benefit will be treated as designated beneficiaries if the following requirements are met:
(1) the trust is valid under state law;
(2) the trust is irrevocable or will, by its terms, become irrevocable on the death of the individual/grantor;
(3) the beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the grantor’s benefit are identifiable within the meaning of Treas. Regs. Section 1.401(a)(9)-4 from the trust instrument; and
(4) relevant documentation has been timely provided to the plan administrator.
See-Through Trust Requirements Met
The IRS found that the requirements of a see-through trust under Treas. Regs. Section 1.401(a)(9)-4 were met such that the beneficiaries of the marital trust should be treated as designated beneficiaries. The IRS found that the taxpayer produced a valid and irrevocable trust and that the beneficiaries with respect to the trust’s interest in the grantor’s benefit were identifiable from the trust instrument.
Although the court in State A previously issued an order ratifying a settlement agreement to allow the daughter to act as an independent trustee of marital trust and retroactively elect to treat the marital trust as an accumulation trust as if the election under the original trust were timely made, the order doesn’t retroactively change the provisions that applied at the time of the grantor’s death for purposes of IRC Section 401(a)(9). As the election to treat the marital trust as an accumulation trust wasn’t timely made, the spouse is treated as the sole designated beneficiary of Roth IRA for purposes of the RMD rules of Section 401(a)(9).
Because the IRS concluded that the spouse is the sole designated beneficiary of Roth IRA, it follows that Treas. Regs. Section 1.401(a)(9)-5 applies to determine the distribution period for RMDs of the beneficiary’s remaining life expectancy using the beneficiary’s age as of the beneficiary's birthday in the calendar year immediately following the calendar year of the grantor’s death.
The IRS concluded that:
1) The spouse is treated as the designated beneficiary of Roth IRA for purposes of determining the distribution period under Section 401(a)(9); and
2) RMDs from the Roth IRA are calculated based on the life expectancy of the spouse pursuant to Treas. Regs. Section 1.401(a)(9)-5.
Note that distribution rules for nonspousal inherited IRAs and Roth IRAs may change as per the Setting Every Community Up for Retirement Enhancement Act recently passed by Congress. Under this bill, inherited balances may not be stretched over a beneficiary’s lifetime and must be distributed within 10 years. This bill hasn’t yet been voted on in the Senate.