Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

The separate share regulations have the following special rule regarding the allocation of IRD that is “corpus” (principal) for trust accounting purposes: “(3) Income in respect of a decedent. This paragraph (b)(3) governs the allocation of the portion of gross income includible in distributable net income that is income in respect of a decedent within the meaning of section 691(a) and is not ...[trust accounting income]. Such gross income is allocated among the separate shares that could potentially be funded with these amounts.... based on the relative value of each share that could potentially be funded with such amounts.” Reg. § 1.663(c)-2(b)(3) . Emphasis added. Here’s how the separate share rule would apply to a retirement plan distribution that is corpus for trust accounting purposes: Jody Example: Jody dies in Year 1, leaving his $1 million 401(k) plan, $1 million of real estate, and $1 million of marketable securities to a trust. At Jody’s death, the trust is to be divided into two equal shares, one for each of Jody’s children Brad and Angelina, so each child is to receive a total of $1.5 million. Each child’s share is to be distributed outright to the child upon attaining age 35. Angelina is already age 36; Brad is 33. In Year 1, the 401(k) plan sends the trustee a check for the entire plan balance of $1 million, creating $1 million of gross income to the trust. The trustee immediately distributes the $1 million it received from the 401(k) plan to Angelina in partial fulfillment of her 50 percent share. The trust has no other income, and makes no other distributions, in Year 1. What is the trust’s DNI deduction for the distribution to Angelina? Step 1: Does the separate share rule apply? The separate share rule applies here because distributions to Jody’s children are made “in substantially the same manner as if separate trusts had been created” for them. Reg. § 1.663(c)-3(a) . If this had been a “spray” trust, with the trustee having discretion to pay income and/or principal of the entire fund to either child at any time (instead of having to give each child an equal amount) the separate share rule would not apply. Step 2: Is the plan distribution corpus? The regulation next requires that we determine whether the 401(k) plan is “corpus” for trust accounting purposes. Assume that it is; see ¶ 6.1.02 . Step 3: Does the trust instrument or state law dictate to which share(s) this plan distribution shall be allocated? If either the trust instrument or state law mandates that the plan distribution be allocated to a particular share, that allocation will be followed for purposes of allocating the resulting DNI among the separate shares. To carry out Step 3, therefore, we must look at the terms of Jody’s particular trust and/or state law: Scenario 1: If Jody’s trust required the trustee to allocate the 401(k) plan proceeds to Angelina’s share, then all the income arising from that plan distribution is allocated to Angelina’s “separate share” and the $1 million cash distribution from the trust carries out $1 million of DNI to Angelina. Reg. § 1.663(c)-5 , Example 9.