One of the most complicated sections of the final required minimum distribution regulations issued recently is Section 1.401(a)(9)-4(f)(4), “Multiple Trust Agreements,” a holdover from the proposed regulations. That section provides:
If a beneficiary of a transparent trust is another trust, the beneficiaries of the second trust will be treated as beneficiaries of the first trust, … In that case, the beneficiaries of the second trust are treated as designated as the employee's beneficiaries under the plan. (Emphasis supplied.)
The drafters of the proposed and final regulations may have considered only actual beneficiaries when they referred to “second trust beneficiaries.” If so, the bolded language makes sense. But the language above does not say it is limited to current beneficiaries, which also opens the door to include residual beneficiaries. Under this broad construction, this provision of the final rules will have widespread effect.
For example, suppose a client with two children creates trusts for each of them and their families under the client's estate plan. Each child's trust provides that if the child dies without issue, the balance of the trust flows into the trust for the next child and the child's family. If both children eventually die without issue, the remaining assets of the trust pass to the charity. Would the charity be considered a designated beneficiary of the client under a literal reading of the above provision of multiple trust agreements? If so, the trusts will not qualify for a 10-year deferral. If not, the trusts will qualify.
Accidental or intentional release
The language of the multiple trust agreements referenced above, and in particular the language “treated as designated as benefiting the employee under the plan,” precisely parallels the more general language of section 1.401(a)(9)-4(f). (3) of the final rules:
(3) The beneficiaries of the trust are treated as beneficiaries of the employee-
(i) In general. Subject to the rules of paragraph (f)(3)(ii) and (iii) of this section, the following beneficiaries of a transparent trust are treated as designated as the employee's beneficiary under the plan–
(A) Any beneficiary who may receive trust amounts representing the employee's interest in the plan, which are neither vested nor deferred until the death of another beneficiary of the trust who has not previously left him (and who not treated as deceased) employee; AND
(B) Any beneficiary of an accumulating trust that may receive amounts in the trust representing the employee's interest in the plan that are not distributed to the beneficiaries described in paragraph (f)(3)(i)(A) of this section .”
(ii) Certain disregarded trust beneficiaries—
(A) Entitlement Conditional on Beneficiary's Death.
Any beneficiary of an accumulating trust who could receive amounts from the trust representing the employee's interest in the plan solely because of the death of another beneficiary described in paragraph (f)(3)(i)(B) of this section, is not treated as being designated as the employee's beneficiary under the plan.” (Emphasis supplied.)
While subsection 4(f)(3) provides that certain beneficiaries of the trust shall not be “treated as designated as beneficiaries of the employee under the plan,” the language of multiple trust agreements 4(f)(4) contains no similar exception “if a beneficiary of an express trust is another trust.” The question is, was this omission unintentional or intentional?
Example (2) in section 1.401(a)(9)-4(f)(6) of the final regulations may provide some guidance in answering this question. “Under the terms of the P Trust, all the trust income is paid annually to B, and no one has the power to appoint or distribute the directorship of the P Trust to any person other than B's brother or sister. A, C, who is less than 10 years younger than A (and thus a qualified designated beneficiary) and is younger than B, is the sole remaining beneficiary of the P Trust. Also, under the terms of the P Trust, if C predeceases B, then, IN Upon B's death, the entire principal of Trust P is distributed to Charity Z (a section 501(c)(3) tax-exempt organization).“
The Internal Revenue Service's analysis concludes: “Under paragraph (f)(2)(iii)(A) (the correct reference appears to be to paragraph (f)(3)(ii)(A) ) of this section because Charity Z's right to the trust amounts is based on the death of a beneficiary described in paragraph (f)(3)(i)(B) of this section who is not also described in paragraph (f (3)(i)(A) of this section, Charity Z is not taken into account as a beneficiary of A.”
Assume that, instead of a full remainder beneficiary, the second beneficiary of the trust in the multiple trust arrangement mentioned above receives assets from the first trust only if all current beneficiaries of the first trust pass. Also assume that if all beneficiaries of the second trust pass, the remaining trust assets of the second trust pass to Charity Y. Based on the analysis in Example 2, why should Charity Y's interest in the second trust be disregarded? Read literally, however, the multiple trust agreement section of the final rules would treat Charity Y as a designated beneficiary of the employee under the plan.
Although reasonable minds may differ, logic would dictate that Charity Y be disregarded as a designated beneficiary in the second trust in the same way that Charity Z is disregarded as a designated beneficiary in Example 2 of the IRS final rules. Although the multiple trust agreement section labels all beneficiaries of the second trust as “designated beneficiaries,” it never specifically addresses whether some of them should nevertheless be treated as designated disregarded beneficiaries. The disregarded beneficiary section of the final rules, which is not limited in its application, should undoubtedly fill this gap.
Drafting option
Until the IRS clarifies this situation, one drafting option is to avoid designating a charity as the ultimate beneficiary under a trust instrument if the trust holds the IRA assets. Similarly, if individuals are designated as potential beneficiaries, the drafting attorney may choose to limit the ages of the individuals who receive the IRA assets in the trust.