The decedent established a trust under her last will and testament. The trust was the beneficiary of an individual retirement account that the decedent established in February 2004, by entering into an IRA Trust Agreement and IRA Adoption Agreement (the IRA bank agreements) with a bank. The bank‘s trust operations merged with a second bank and, as a result, the second bank was the trustee of both the IRA and the trust.
Will Codicils and Beneficiaries Under the Will
At the time of the decedent’s death, she was survived by one child, her mother and her brother. Her husband had predeceased her.
Prior to her death, the decedent modified her will by four codicils. The second codicil, which revoked the first codicil, appointed new guardians for the decedent’s minor child in the event the decedent predeceased her husband. The third codicil amended the definition of the term “education” as it was used in the will.
The fourth codicil appointed new co-executors of the decedent’s will and provided that if the decedent’s husband failed to survived her by 30 days, all of the decedent’s property would be bequeathed to the bank as trustee, to be held for the benefit of her child, pursuant to certain terms and conditions.
The will also provided for the entire trust to be administered as one trust, under the terms of which the child would receive one-quarter of the principal and any accumulated income at age 21; one-third of the remaining principal and any accumulated income at age 25; one-half of the remaining principal and any accumulated income at age 30; and the remaining balance of the principal and accumulated income at age 35. The will further provided that if the decedent’s child was under age 18 when the decedent died, the trustee would have discretion to distribute the trust’s net income to the decedent’s child for "support, welfare, maintenance and education." In addition, the trust could invade the principal in the event the trust’s net income was insufficient to provide adequate maintenance, support, welfare or education. Finally, the will provided that in the event the child predeceased the decedent or died before the termination of the trust, the child’s interest would pass to the child's surviving issue. If the deceased child died without issue, then the child’s interest in the trust would cease.
Under the will, the trust would end when the decedent’s child reached age 35. At that time, the balance of trust would be distributed to the decedent’s then-living child or, if the child was deceased, to the deceased child’s issue, per stirpes. There were no other additional contingent beneficiaries of the trust.
Under the bank IRA agreements, as of the date she established the IRA, the decedent named her child as the IRA’s primary beneficiary. On a subsequent date, the decedent filed a written beneficiary designation form revoking the designation of her child as the IRA beneficiary and named the trust as the primary IRA beneficiary. The IRA agreements also appointed the bank as the IRA trustee.
In Private Letter Ruling 201320021, (Feb. 19, 2013), the Internal Revenue Service answered two questions:
1. Is the trust, the named beneficiary of the IRA, a "see-through trust" within the meaning of Treasury Regulations Section 1.401(a)(9)-4, Q&A-5? If so, are the beneficiary(ies) “designated beneficiaries” of the IRA for purposes of Internal Revenue Code Section 401(a)(9)?
2. Is the decedent’s child, as the beneficiary of the trust, the only designated beneficiary of the IRA? If so, should the child’s life expectancy be used to determine the applicable distribution period under Section 401(a)(9)?
Under IRC Section 401(a)(9)(B)(ii), if an IRA holder dies before her interest has been distributed, the entire interest must be distributed within five years of the IRA holder’s death. However, there’s an exception: If any portion of the interest of a deceasedIRA holder is payable to a designated beneficiary, such portion will be distributed, beginning no later than one year after the deceased's death, in accordance with the regulations over the life of the designated beneficiary. IRC Section 401(a)(9)(B)(iii).
IRC Section 401(a)(9)(E) defines "designated beneficiary" as any individual designated a beneficiary by the employee (that is, the IRA holder).
Treas. Regs. Section 1.401(a)(9)-4, Q&A-1 states that a designated beneficiary is an individual who’s designated as a beneficiary under a plan, either by the terms of the plan or by an affirmative election by an employee. A beneficiary designated under a plan is an individual who’s entitled to a portion of an employee's benefit contingent on an employee's death or another specified event. An individual who takes under a will won’t be a designated beneficiary, unless that individual is also designated as a beneficiary under the plan.
Only individuals may be designated beneficiaries for purposes of Section 401(a)(9). A trust may not be a designated beneficiary. However, under Treas. Regs. Section 1.401(a)(9)-4, Q&A-5, a beneficiary of a trust with respect to the trust's interest in an employee's benefit plan may be treated as a designated beneficiary if:
(1) the trust is valid under state law or would be, but for the fact there’s no corpus;
(2) the trust is irrevocable or will, by its terms, become irrevocable on the death of the employee;
(3) the beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the employee's benefit plan are identifiable from the trust instrument; and
(4) relevant documentation has been timely provided to the plan administrator.
If all four requirements are met, the trust is a “see-through trust,” and the beneficiary of the trust is a designated beneficiary under the plan or IRA.
Measuring the Applicable Distribution Period
Under Treas. Regs. Section 1.401(a)(9)-5, Q&A-5(c)(1), with respect to a non-spouse beneficiary, the applicable distribution period measured by the beneficiary's remaining life expectancy is determined using the beneficiary's age as of the beneficiary's birthday in the calendar year immediately following that of the employees death.
In subsequent calendar years, the applicable distribution period is reduced by one for each calendar year that’s elapsed after the calendar year immediately following that of the employee's death.
The IRS noted that, as of the decedent’s date of death, she was not 70 ½, and as such, no distributions were made. Because the decedent died before the distribution of the benefits began, either the 5-year rule or the life expectancy rule would apply to determine the distribution period. The IRA didn’t specify whether the 5-year rule or the life expectancy rule would apply. And, under Treas. Regs. Section 1.401(a)(9)-4, if a governing instrument doesn’t specify whether to apply the 5-year rule or the life expectancy rule, then distributions should be made in accordance with the life expectancy rule when a designated beneficiary exists. If, however, there’s no designated beneficiary, then the 5-year rule would apply.
In this case, the decedent designated the trust as the beneficiary of her IRA. However, a trust can’t be a designated beneficiary, unless it’s a see-through trust. The decedent’s estate represented to the IRS that all four requirements of a see-through trust were met: the trust was valid under the laws of the state where it was created; it was irrevocable on the decedent death; the beneficiary of the trust, who’s a beneficiary of the trust’s interest in the IRA, is identifiable under Treas. Regs. Section 1.401(a)(9)-4, Q&A-5(a); and the required documentation under Treas. Regs. Section 1.401(a)(9)-4, Q&A-6 was provided to the IRA custodian.
Because the trust was a see-through trust, the trust beneficiary was a designated beneficiary for purposes of Section 401(a)(9).
The IRS then determined who was the designated beneficiary of decedent’s IRA under Sections 401(a)(9) and 408(a)(6). Under Treas. Regs. Section 1.401(a)(9)-5, Q&A-7(a), a trust beneficiary with the shortest life expectancy will be the designated beneficiary with respect to an IRA. Treas. Regs. Section 1.401(a)(9)-4, Q&A-5 provides that when a trust is named as the beneficiary of an employee under a plan, the beneficiary of the trust with respect to the trust's interest in an employee's benefit will be treated as having been designated as the beneficiary of the employee under the plan if certain requirements are met.
In this case, the IRS already determined that the four requirements of a see-through trust under Treas. Regs. Section 1.401(a)(9), Q&A-5 were met. In addition, the identity of each person entitled to receive any portion of the IRA within the trust was determinable by reading the trust’s provisions: The decedent’s will named her child as the beneficiary of the trust. Although the decedent was survived by her child, her mother and her brother, the will didn’t provide for contingent beneficiaries of the trust. The decedent had only one child, who was the beneficiary of the trust’s interest in the IRA. The IRS thus concluded that the decedent’s child was the designated beneficiary with respect to the IRA, and the child’s life expectancy should be used to determine the applicable distribution period.