Life and Death Planning for Retirement Benefits

Chapter 3: Marital Matters

187

Any trust that contains the specific direction that the trustee must pay the surviving spouse the income of any retirement plan payable to the trust does not have to be amended to reflect Rev. Rul. 2006-26, for the following reason. Under the IRS’s logic, the “income of the retirement plan” means, as noted in ¶ 6.1.02 , either the internal investment income of the account or an acceptable unitrust alternative. In the IRS’s view, the 10 percent rule dictates how the trustee is to allocate plan distributions in determining the income of the trust , but has nothing whatsoever to do with the income of the plan ! Therefore if the instrument specifically requires the trustee to pay the spouse the income of the trust’s share of the plan, the trustee is required to pay her the internal income of the trust’s share of the plan (or unitrust amount, if applicable), regardless of whether the UPIA 1997 10 percent rule applies to the trust. While this IRS interpretation probably makes a hash of the UPIA drafters’ intent (it seems clear they thought the “income of the plan” was 10 percent of the RMD), it is a blessing for estate planners, because it means that most marital trusts drafted since 1989 with retirement benefits in mind will not have to be amended due to Rev. Rul. 2006-26, despite the widespread adoption of UPIA 1997 by state legislatures. The IRS view that the benefits and the trust itself constitute separate items of QTIP has been known since Rev. Rul. 1989-89, 1989-2 CB 231, and accordingly many estate planners have long included the extra language specifying that the spouse must receive income “of the plan” as well as “of the trust.” For example, the requirement that the trustee pay the spouse the income of the plan, not merely of the trust, has been part of the sample forms in this book since its first edition (1996). See Form 4.5, Appendix B . A marital trust that is named as beneficiary of a retirement plan, and which states that the surviving spouse is entitled to all income “of the trust,” but does not specifically state that the spouse is entitled to all income of the trust’s interest in the retirement plan , should be amended if applicable state law would not require income of the plan to be paid to the surviving spouse. Trustees of existing marital trusts that hold inherited retirement benefits, where the participant has already died, do not have the option of amending the trust. If the trust does not contain its own IRS-acceptable definition of income with respect to retirement benefits, and does not contain the magic words that the spouse is entitled to the income of the plan, and is governed by the UPIA 1997 10 percent rule, the trustee faces a dilemma. Rev. Rul. 2006-26 indicates that such a trust may not qualify for the marital deduction. However, if the federal estate tax return has been filed and accepted, with the marital deduction allowed, it’s not clear what the IRS can do about it at this stage. Fixing this problem is beyond the scope of this book. In determining whether the spouse is “entitled for life to all of the income” of a marital trust, the same rules apply to both QTIP ( ¶ 3.3.02 ) and General Power ( ¶ 3.3.09 ) marital trusts. Reg. § 20.2056(b)-7(d)(2) . The simplest, most-used, and generally recommended method of meeting the “entitled” requirement is for the trust instrument to require the trustee to withdraw from the plan, each year, and distribute to the surviving spouse, all income of the retirement plan. This method is explained in ¶ 3.3.06 . The primary reason one might wish to investigate other methods would be to achieve greater deferral of the retirement plan distributions; if the trustee does not have to withdraw the “income,” the theory is, that income can be allowed to accumulate tax-deferred or tax-free inside Ways to meet the “entitled” requirement; Income vs. RMD