In Private Letter Ruling 201203003 (Oct. 11, 2011), the decedent left his retirement plan benefits to a trust for the benefit of his wife. Upon his wife’s death, the balance of the trust was payable to his children, in separate trusts for their benefit. Each child’s trust was divided into an exemption trust that was generation-skipping transfer (GST) tax-exempt and a primary trust that wasn’t GST tax-exempt.
Each child had the right to withdraw one-half of the primary trust at age 30 and the balance at age 35. They also both had a testamentary general power of appointment (POA). The daughter was over age 35 when the decedent died, but the son wasn’t.
Further, each child had a special testamentary POA over the exemption trust, exercisable in favor of the decedent’s issue. In default of exercise, the balance of each trust was payable to the child’s issue, or if none, then to the decedent’s other issue, or if none, then to a charity. The trustee set up an inherited individual retirement account and transferred the retirement benefits to the inherited IRA, as permitted by Internal Revenue Code Section 402(c)(11). The goal was to stretch the inherited IRA over the spouse’s life expectancy.
From an income tax standpoint, transferring the retirement benefits to the inherited IRA wasn’t as favorable as if the decedent had left his retirement benefits to his wife outright. She then could have rolled them over into her own IRA, named new beneficiaries, converted to a Roth IRA and obtained a much longer stretchout. However, in some cases, the desire to control the principal outweighs the income tax benefit of the rollover, especially if the retirement benefits are a large portion of the total assets, and the spouse will need substantial distributions.
Obstacles to Stretchout
There were two obstacles to the stretchout. First, the son had a general POA over his primary trust, which he could exercise in favor of someone older than the surviving spouse. Second, if the son was the last survivor of his father’s issue and died before age 35, with respect to his primary trust, without exercising his POA, the remainder would go to charity. Similarly, if either child was the last survivor of the father’s issue, the remainder of his exemption trust would go to charity.
The son solved the first problem by partially releasing his POA, so that he could only exercise it in favor of individuals who weren’t older than the surviving spouse. This still allowed for a broad class of permissible appointees. The Internal Revenue Service approved a similar class of permissible appointees in PLR 200235038 (June 4, 2002). In this regard, while the regulations require that the beneficiaries be identifiable, the members of a class capable of expansion are treated as identifiable if it’s possible to identify the class member with the shortest life expectancy, that is, the oldest one.1
What about the charity? If the son survived the decedent’s spouse, but died before age 35 without exercising his POA, and if he were the last survivor of his father’s issue, the balance of his primary trust would go to charity. If either child were the last survivor of his father’s issue, the balance of his exemption trust would go to charity.
However, the Treasury regulations provide that a “mere successor beneficiary” can be disregarded in determining the trust’s beneficiaries. The test is based on the facts as of the decedent’s death.2 In this case, if a child survived the decedent’s spouse and then died without exercising the POA, the balance of that child’s trusts would go to the other child outright. The charity would only take if the other child didn’t survive the sibling. That made the charity a mere potential successor beneficiary to the daughter, so it could
This ruling is significant because it illustrates how post-mortem action can limit the class of beneficiaries (the PLR approved a broad class of permissible appointees) and how an outright remainder beneficiary can act as a blocker, allowing successor beneficiaries to be disregarded.4
1. Treasury Regulations Section 1.401(a)-9-4, A-1.
2. Michelle L. Ward, “Michelle Ward & PLR 201203003: Trust Qualified as Designated Beneficiary After Beneficiary Released Certain Powers,” LISI Employee Benefits and Retirement Planning Newsletter #594 (Feb. 1, 2012); Natalie Choate, “Natalie Choate on PLR 201203003: How to Analyze & Clean Up a See-Through Trust,” LISI Employee Benefits and Retirement Planning Newsletter #593 (Jan. 31, 2012).
3. Treas. Regs. Section 1.401(a)(9)-5 A-7(c).
4. See Bruce D. Steiner, “Bruce Steiner & PLR 201203003: Stretchout of IRA Payable to Trust with Broad Powers of Appointment & Charitable Beneficiary,” LISI Employee Benefits and Retirement Planning Newsletter #596 (Feb. 14, 2012).