The following article was written by Charles (Chuck) Rubin for JDsupra.com. It details a new estate planning technique approved by the IRS that may prove useful to individuals in second marriages.
A common issue in planning for marriages with prior children is how to provide for the surviving spouse, while also making provision for children of a prior marriage or relationship. A regularly used planning arrangement is to designate as successor owner at death of the original owner a marital trust that provides for assets to be expended for the surviving spouse during his or her lifetime, with a remainder to the children and lineal descendants of the first spouse to die. This avoids the problem of leaving the assets outright to the surviving spouse, who then can leave the assets to other beneficiaries at his or her death.
If the asset at issue is an IRA or qualified plan interest, the owning spouse may have similar concerns. However, income tax issues complicate the planning. For income tax planning purposes, it is usually desirable that the owning spouse have the option to “stretch” the payouts over the life expectancy of the surviving spouse (or of the decedent spouse) and thus defer income taxes by having the beneficiary be a “qualified beneficiary” of the IRA/qualified plan assets. This can be done via an outright beneficiary designation to the surviving spouse, but presents the same issues with prior children of the decedent spouse as discussed above. Unfortunately, in regard to an IRA or qualified plan asset, the use of trusts to receive the interests faces planning obstacles per the provisions of the Regulations that limit the ability to have the trust beneficiary(ies) be treated as “qualified beneficiaries.”
A recent private letter ruling confirms a fairly straightforward planning mechanism to obtain stretch status for an IRA via a trust under these circumstances. The blessed methodology is for the IRA owner’s revocable trust to be named as beneficiary of the IRA at the owner’s death. The revocable trust provides that a separate trust will be created to hold all IRA and qualified plan assets received. The spouse is named as the sole lifetime beneficiary of the trust, and the owner’s children are named as remaindermen. The IRS ruled that this arrangement passes muster under the Regulations, and the surviving spouse is treated as a qualified beneficiary of the IRA,and the sole one at that.
To reach this result, the general provisions for qualifying trust beneficiaries as qualified beneficiaries must be met. These include the requirements under section 1.401(a)(9)-4, Q&A-5: (1) the trust is valid under state law, or would be but for the fact there is no corpus; (2) the trust is irrevocable or will, by its terms, become irrevocable upon 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 are identifiable within the meaning of section 1.401(a)(9)-4, Q&A-1, from the trust instrument; and (4) the documentation described in section 1.401(a)(9)-4, Q&A-6, has been provided to the plan administrator. Further, for the spouse to be sole designated beneficiary, the trust must be a conduit trust – it must contain provisions requiring the immediate distribution of all retirement plan or RIA distributions by the trustee to the beneficiary.
The payment to two trusts (first the revocable trust, and then onto the separate trust for IRA/retirement plan assets), is permitted under section 1.401(a)(9)-4, Q&A-5(d). That provision states that if the beneficiary of the trust named as beneficiary of an employee’s interest is another trust, the beneficiaries of the other trust will be treated as having been designated as beneficiaries of the first trust, and thus, as having been designated by the employee under the plan for purposes of determining the distribution period under section 401(a)(9)(A)(ii), provided that the requirements of section 1.401(a)(9)-4, Q&A-5(b), are satisfied with respect to such other trust in addition to the trust named as beneficiary.