Trust as Bene / RMD / Income?
H names RLT as bene of his $1,200,000 QP. H was already taking out RMD. RLT (funding trust) splits into Marital (QTIP) and B Trust (Credit Shelter) w/typical provisions for income/principal. W is living and there are 3 adult remainder bene’s who have met age requirements and will receive shares immediately upon W’s death.
I assume the following are still correct (I’ve been out of “private practice” for a few months, teaching instead), assuming first that RLT passes “see through” test:
1) We can’t somehow have W “roll over” to own separate IRA. Is there any way to do this?
2) For RMD purposes, we have to use W’s LE as she is the oldest bene of the trust. Correct?
3) The RLT is silent on how to define income. I assume the 10% rule (according to Michigan UPIA act) will have to be applied to any RMD distribution regarding income?
3) H had not taken out RMD for 2008. How do I get this out ($60,000 +) and who is it payable to, i.e. the RLT or can it just be paid to wife as it is IRD that will be reported on H’s 1040 for 2008?
4)What’s best way to re-title QP with plan administrator assuming we can’t get out of paying it to the trust? (i.e. how do I name it, “Jimmy Smith, deceased, for the benefit of Wife).
Any other ideas on how to get W as only bene so as to roll over into her own IRA?
Thanks!
Rob Gilbreath
Attorney and Counselor at Law
Lansing, Michigan
Permalink Submitted by mk foss on Mon, 2008-10-27 17:25
Taking your third question first – the IRD from the 2008 distribution is not to be reported on the husband’s final 1040. The RMD must be paid to the trust and be taxed there. I’m not sure if it would be the Bpass or the Marital Trust. Do you use Administrative trusts in MI?
If the marital trust is a QTIP trust, the 10% of RMD income distribution could be a problem. Check Rev. Rul 2006-26 to see if a marital deduction is available – the ruling applies because the H was alive on May 30, 2006.
The IRS has issued rulings that allow a spouse who is the trustee and trust beneficiary to roll over an IRA. A ruling will cost $9,000 for the IRS, the professional time to put it together could cost twice that.
In some cases, the trust agreement has been reformed in such a way that the spouse could rollover benefits payable to a trust. See PLRs 200704033 or 2007034047 for some situations ruled on favorably.
As long as the trust is the beneficiary RMDs will be based on the survivor’s life expectancy as the oldest trust beneficiary.
Permalink Submitted by Rob Gilbreath on Mon, 2008-10-27 19:08
Thanks for the information/reply. A few follow up points:
1) How do we know which trust to apply the 2008 distribution when we haven’t valued all assets for federal estate tax purposes?
2) I’m not sure what the term “Administrative Trust” exactly is referring to. Could you expand?
3)I’ll check the Rev Rul’s you’ve cited.
4)The spouse is NOT the trustee. Does this hurt chances to have a rollover to spouse?
Thanks again to those that respond.
Regards,
Rob Gilbreath
Attorney and Counselor at Law
Permalink Submitted by mk foss on Mon, 2008-10-27 21:09
Here in CA trusts are very popular and we often see an “administrative trust” – the trust isn’t a separate document; it’s the decedent’s share of the family trust. Until the assets are valued and it can be determined which assets go in which trust, the administrative trust collects the income and pays the expenses. The trust also ordinarily distributes income to the surviving spouse, if the spouse is the beneficiary of all of the trusts it may be split into.
If the family trust is filing returns before the split, the pre-split trust would receive the distribution. Based on Rev Rul 2005-36, the entity receiving the year of death distribution need not necessarily be the entity receiving post death RMDs.
There are some rulings granted where the surviving spouse is not the trustee, but most of them that we see have the fact pattern where she is. Again, the private letter rulings are expensive and those that draft them may have a better idea of your chances. Robert Keebler CPA practices in Green Bay, WI and works with the IRS on private rulings. There are many other good people (inlcuding Ed Slott and Bruce Steiner) but Bob is probably closest to you geographically.
Permalink Submitted by Rob Gilbreath on Tue, 2008-10-28 13:12
One quick follow up:
No matter which trust receives the distribution from the QP, will this distribution of over $1,000,000 be considered gross income for the trust? I would hate for it to get whacked by the crazy trust tax rates.
Thanks again for all of your help.
Rob Gilbreath
Attorney and Counselor at Law
Permalink Submitted by mk foss on Fri, 2008-10-31 22:20
The RMD of a retirement plan or IRA is gross income to the trust; if it is distributed to the beneficiary – it’s taxed tp the beneficiary.
If the trust calls for “income” distributions and the trust agreement doesn’t define income – you may have to rely on your state law. It could be that each RMD is 90% taxable. Of course, the income could be offset by expenses – legal fees, accounting fees, invesment management etc
Permalink Submitted by Bruce Steiner on Sun, 2008-11-02 14:23
Mary Kay: thanks for the kind words.
As to your key question, whether you can get the IRA to the spouse so she can roll it over, see my article on this subject in the October 1997 issue of Estate Planning: http://www.kkwc.com/docs/AR20050125164755.pdf. As you can see from the article, it’s usually possible to get the IRA to the spouse even where the spouse is not named as the beneficiary. But without seeing the trust, we can’t say whether it’s feasible in this case.
As Mary Kay pointed out, you can’t use the 10% rule for the marital trust. See Rev. Rul. 2006-26. But, as noted in my article, even if you can’t do the rollover, the spouse may be able to roll over the excess of the income over the required distributions.
If the credit shelter trust is fully discretionary, it shouldn’t matter what is income and what is principal in the credit shelter trust.
Make sure that funding the marital or credit shelter share with the IRA doesn’t accelerate the income. See TAM 200644020.
While you didn’t raise this issue, you may also want to see if it’s possible to keep the children’s shares in trust for their benefit after the spouse’s death, to keep their inheritances out of their estates, and to better protect against the children’s potential creditors (including their spouses).
As this case illustrates, while revocable trusts are sometimes advisable (particularly in California for reasons specific to California), they often cause more trouble than they are worth, particularly when they are named as the beneficiary of retirement benefits.
Given the amount involved, you may wish to consult with co-counsel, especially given the amount involved.
Bruce Steiner, attorney
NYC
also admitted in NJ and FL
Permalink Submitted by Rob Gilbreath on Wed, 2008-11-12 19:20
Hi Mary Kay –
Quick follow up.
1)My question is will the entire $1,000,000 of the qualified plan money that is to be distributed to the trust be treated as Gross Income and taxed at trust rates? (e.g will over $350,000 have to be paid in income taxes).
I know the RMD for this year can probably be pushed out to the surviving spouse, but is the entire plan amount taxed, i.e. considered income to the trust just by the mere distribution to the trust???
2) I believe the plan’s default beneficiary is the spouse. Do you think we could have the trustees and all bene’s (including “ghosties” as I like to call them, unborns!) disclaim the trust’s interest in the plan thus leaving the default provision of the plan to kick in and the spouse could roll into her own IRA?? Any new PLR’s you’re aware of that allowed this?
What is the real advantage of having the spouse named as primary beneficiary in my case, (i.e. she is over 70 1/2) and can’t we use her life expectancy if the trust was named primary beneficiary (oldest bene) in the first place?
Am I missing an income tax advantage of having her named as the primary beneficiary instead of the trust?
Thanks Mary Kay for all of your help.
– Regards
Rob Gilbreath
Attorney and Counselor at Law
Permalink Submitted by Bruce Steiner on Wed, 2008-11-12 19:32
With enough disclaimers, it should be possible to get the IRA to the spouse. It shouldn’t be necessary to get the unborns to disclaim. Depending on what state’s law applies, you may need court approval for minor grandchildren, but (at least in New York) that’s routine where the minor grandchildren are only giving up what they would get by reason of the children’s disclaiming.
If the benefits are payable to the trust, and the spouse is the oldest beneficiary of the trust, the best you can do (if, among other things, the plan so permits) is stretch distributions out over the spouse’s life expectancy. But if you can get the benefits to the spouse, she can roll them over. She can then wait until she reaches 70 1/2, name new beneficiaries, take smaller distributions after 70 1/2, after her death her beneficiaries can use their life expectancies, and she may be able to convert to a Roth. These benefits can be substantial.
If the benefits are payable to the trust, then to the extent the trust receives distributions each year, then if the trust so permits, the trustees can distribute some or all of the amounts the trust receives each year to the spouse or children or grandchildren, or can accumulate them in the trust. The trustees can consider the income tax brackets of each possible recipient, as well as the trust’s tax rates. But make sure the trust doesn’t assign an interest in the benefits in satisfaction of a pecuniary bequest, or else you may accelerate the income.
Permalink Submitted by mk foss on Thu, 2008-11-13 01:10
As Bruce said, disclaimers that allow the benefits to be rolled over by the surviving spouse are the best alternative.
The current year RMD must be withdrawn by 12/31/08; many people are waiting until the last possible minute to claim the 2008 RMD because there are hints of possible legislative changes. This could be a year where custodians have difficult processing all of the RMD requests that come in after December 1.
Bruce alluded to the fact that it’s not straight forward when a trust is the IRA beneficiary in determining who is taxable. Many trust agreements provide that income be distributed. When the RMD is paid to the trust, you’d look to the trust agreement to see whether RMDs are treated as income or principal for that trust. If the trust agreement does not specify, then you look to the state law to determine how much is income.
If the surviving spouse is entitled to income, it could be that only 10% of the RMD is treated as income. The law varies from state to state. When the agreement is silent, you look to the state’s version of the principal and income act. Distributing all of the taxable income could cause a problem if the trust agreement just specifies income and not taxable income.
Any income not distriubted is taxable to the trust at the compressed rates.
Distributions to the beneficiary start in the year after the death and your disclaimer period (9 months) is already running.
Good luck,
Mary Kay
Permalink Submitted by Rob Gilbreath on Thu, 2008-11-13 16:50
Final Follow Up – Promise!
I think I’ve got it:
1) The entire balance of the QP, ($1,200,000) is not distributed to the Trust, only the RMD for each year is distributed to the Trust, correct?
Thus, the 1,200,000 won’t be exposed to income taxation (on a 1041), only the RMD will be exposed to income taxation each year.
2) The amount of income tax on the RMD distributed to the trust depends on the trust’s definition of income. There is no definition of income for the subject trust, therefore, I use Mich’s UPIA, or the 10% rule. So, only 10% of the RMD can be kicked out to the spouse and 90% of the RMD will be taxed at the trust rate for 2008, correct?
3) Spouse is over 70 1/2 already, (77), assuming we keep the trust as bene, upon Spouse’s death, can the children, as remainder trust benes, roll any remaining proceeds to their own IRA, or are we stuck again now using the oldests child’s life expectancy until all funds are paid?
4) According to Bruce, a big advantage of using disclaimers would be that the Spouse could roll into her own IRA, name her kids as her beneficiaries, and each of them could wait until they were 70 1/2 to begin taking RMD, name their kids, etc. Thus, allowing a greater stretch out than the trust scenario. This applies even though the spouse is already 70 1/2 and so was the decedent at the time of his death, correct?
5) Finally, if I use the disclaimer method, should I obtain a PLR first,or because daughter is trustee/administrator of plan do you think this might be an unnecessary expense as she would be certain to approve the disclaimer approach?
Again, I appreciate all the help.
Rob Gilbreath
Permalink Submitted by mk foss on Fri, 2008-11-14 00:06
Your are mostly correct.
On the first point, just the RMD is subject to tax each year unless the trustee withdraws more than the RMD.
Point two – the 10% rule would apply so that the spouse pays tax on 10% of the distribution and the trust on the rest.
Point three – this is where the answers diverge. The spouse’s life expectancy is used as the starting point for all RMDs to the trust. You use the factor for her age in the year after the death and reduce it each year. When the spouse passes away, the last factor based on the spouse’s life is used for the first post-death distribution but reduced by one each year. If the trust is supposed to terminate at the spouse’s death, the remaining IRA can be assigned to the beneficiaries but they would not get to use a life expectancy greater than the trust would have if it was ongoing. There’s no rollover for nonspouse beneficiaries.
Point four – as Bruce indicated the disclaimer and rollover would be great. It would allow the spouse to name the children as beneficiaries so they could use their own life expectancies when she passes away. They could not however get an additional stretch out based on their children’s life expectancies.
Point five – I think most plan administrators would be nervous about transferring funds to the spouse without a disclaimer. That’s a legal question however. The daughter might want to check with the legal counsel for the plan before making a determination. A disclaimer is supposed to be filed with the plan administrator within 9 months of the date of death and PLRs take time.
Mary Kay