Life and Death Planning for Retirement Benefits

Chapter 6: Leaving Retirement Benefits in Trust

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issue upon his wife’s death. The trustee receives a required minimum distribution RMD) from the IRA. Under the state law applicable to Paul’s trust, 10 percent of the RMD is allocated to trust income and the balance to principal; see ¶ 6.1.02 (C). The trustee has no authority to distribute more than 10 percent of the RMD to Paul’s wife; the other 90 percent must be retained in the trust, and will be taxed at trust income tax rates. Even if the trust says the trustee can distribute principal to Paul’s wife “if her income is not sufficient for her support,” the trustee cannot give her more than the 10-percent “income” amount unless she actually needs more for her support. Accordingly, when drafting a trust that may receive retirement benefits, if you want the trust to take advantage of the DNI deduction to reduce income taxes on distributions from the retirement plan, the trust instrument must give the trustee discretion to distribute principal (or at least the part of principal that consists of distributions from retirement plans) to the individual beneficiaries. If you want the trust to be forced to take advantage of this deduction, see “conduit trusts” at ¶ 6.3.05 . 6.5.04 Trusts and the IRD deduction If a retirement plan distribution to the trust is IRD when received, the trust is entitled to the applicable § 691(c) deduction, if any (see ¶ 4.6.04 ), unless the IRD is passed out to the trust beneficiary(ies) in the same year it is received, as part of DNI, in which case the deduction also passes to the beneficiaries. Reg. § 1.691(c)-2 . A different rule applies to charitable remainder trusts; see ¶ 7.5.05 (C). If the IRD is not passed out to the trust beneficiaries in DNI, then the IRD and the IRD deduction stay in the trust. The deduction for federal estate taxes paid on IRD ( ¶ 4.6.04 – ¶ 4.6.08 ) is an itemized deduction, subject to reduction (in certain years) under § 68 ; see ¶ 4.6.08 . § 68 does not apply to trusts or estates, however, only individuals. This creates an incentive for a participant whose estate will be subject to federal estate taxes to name a trust or estate as beneficiary of income-taxable benefits. 6.5.05 IRD and the separate share rule So far we have spoken of the trustee’s receiving a retirement plan distribution, including it in the trust’s gross income, then paying it out to the trust beneficiary and taking a DNI deduction. This simple pattern becomes more complex if the “separate share rule” of § 663(c) applies. Under this rule, “in the case of a single trust having more than one beneficiary, substantially separate and independent shares of different beneficiaries in the trust shall be treated as separate trusts.” When the separate share rule applies, if a fiduciary distributes money to a beneficiary, that distribution will carry out DNI only to the extent there is DNI that is properly allocable to that particular beneficiary’s “separate share.” Separate Accounts vs. Separate Shares The separate share rule of § 663(c) governs the allocation of DNI among multiple beneficiaries of a trust or estate. Do not confuse this rule with the separate accounts rule that dictates when multiple beneficiaries of a retirement plan are treated separately for purposes of the minimum distribution rules. See ¶ 6.3.02 , ¶ 1.8.01 . These are completely different and unrelated rules!