On Friday, April 29, 2011, the IRS issued Private Letter Ruling (“PLR”) 201117042. An ancillary issue in this PLR was whether an IRA could be titled in the name of a revocable trust during a Grantor’s lifetime. The IRS said that an IRA could not be held in the name of a Trust.
Here is a quick summary of the facts of the case as they relate to this issue:
The account owner was declared to be disabled by the Social Security Administration. The agent of the IRA account owner signed paperwork to transfer the disabled owners IRA to a Trust which would qualify as a Special Needs Trust under state law (the Trust was not here in TX.) The IRA was transferred to the Trust and the taxpayer was issued a 1099 showing a distribution from the IRA to the trust. The IRS stated the 1099 was validly issued because there was a taxable distribution when the IRA was transferred to the Grantor trust. Thus, there was an immediate tax bill due on the entire amount of the IRA.
Please keep in mind that a PLR does not create binding precedent and is only valid for the client who requested the letter ruling. However, they do give us a glimpse as to how the IRS will likely rule in similar situations.
If you are interested, here is a short 10 minute pod cast on Friday’s ruling. It is offered by Bob Keebler, a CPA and an expert on retirement distribution planning.
So, this gives us confirmation that it is a bad idea to transfer an IRA from the owner to a Trust. However, it is still a good idea, and in my opinion wise planning, to name a trust as a beneficiary of an IRA. I personally believe it is best to set up a stand alone trust for larger IRAs to ensure the IRA will be able to take advantage of the stretch provisions. The second best option, although it does have its pitfalls, is to name a sub-trust created inside the client’s Will or Revocable Living Trust as a beneficiary of their IRA. Of course, if the client is married, his or her spouse should likely be the primary beneficiary and the trust should be the secondary beneficiary.
Following are some of the reasons why I believe a stand alone trust is the better option:
1. There are a number of regular provisions in a living trust that will disqualify it as a designated beneficiary trust. For instance, the beneficiaries will not be able to use their own life expectancy for calculating RMDs and may be forced to use a life expectancy as short as 5 years. These provisions include but are not limited to: payment of debts; expenses and taxes; accounting for principal and income; and charitable beneficiaries.
2. Although it is possible to firewall some or all of these provisions when a beneficiary is given a conduit trust, the process of firewalling becomes much more complicated if an accumulation trust will be used.
3. Since a standalone IRA Trust with the toggle switch feature can allow the protective benefits of an accumulation trust if needed in the future and the separate IRA trust has already received a PLR stating it qualifies as a designated beneficiary trust (PLR 200537044). Plus, if the IRAs (husband and wife) exceed a $150,000, it makes more sense to use a standalone trust than take the risk that a 5-year RMD rule could apply and that future protection may be lost.
Here are some practical reasons:
1. A Standalone trust clearly states on the very first page that it is established to meet the requirements of a designated beneficiary trust. In addition, it is much easier for a custodian to read, understand and implement. When these designated beneficiary trust provisions are buried inside a larger living trust, the custodian often delegates their decision to their legal department which can hold up the process of implementing the trust in a timely manner.
2. By having a standalone trust, it alerts the beneficiaries to the fact that the IRA has special treatment and makes it less likely that the beneficiaries (including a beneficiary that may be serving as Trustee) will immediately go to the custodian and cash out the IRA or take other actions that may have adverse tax consequences.
There are several PLRs that state a trust can be a beneficiary of an IRA. One of the first was PLR 200537044. For a more detailed discussion on naming a trust as the beneficiary of an IRA, here are two good articles: