Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

included in DNI (and accordingly cannot be passed through to the trust beneficiary) unless various tests are met. Reg. § 1.643(a)-3(a) , (b) . Now the bad news: The mere fact that a trustee receives a retirement plan distribution and later makes a distribution to a trust beneficiary does not automatically mean that the distribution to the beneficiary carries with it the gross income arising from the retirement plan distribution. The trust might still be liable for the income tax on the retirement plan distribution it received. The question is (in trust administration lingo) whether such distribution “carries out DNI.” Here are the six hurdles the trustee must clear in order for the trust’s distribution of IRD to carry out the income tax burden to the trust beneficiary as part of DNI: A. Trust must authorize the distribution. The DNI deduction will not be available unless the beneficiary is entitled to receive the money; thus, obtaining this deduction requires attention at the trust drafting stage. See ¶ 6.5.03 . B. Income must be required to be, or must actually be, distributed, in year received. The DNI deduction is available only for gross income that either is required to be distributed, or is actually distributed, to the individual beneficiary in the same taxable year it is received by the trust (or within 65 days after the end of such taxable year, if the trustee elects under § 663(b) to have such distribution treated as made during such taxable year). § 651(a) , § 661(a) . Thus, in the case of discretionary distributions, the trustee must take action prior to the deadline; if no one considers the problem until it is time to prepare the trust’s tax return, it will be too late. C. Allocation of DNI when separate share rule applies. If there are two or more beneficiaries, and they have “substantially separate and independent shares,” a distribution to one beneficiary will not carry out DNI that is allocated under the “separate share” rule to a different beneficiary. See ¶ 6.5.05 – ¶ 6.5.06 for how this rule applies to retirement benefits. D. Transfer of the plan does not carry out DNI. Though a distribution from a retirement plan to a trust is IRD, and becomes part of DNI, the retirement plan itself, which is a “right to receive IRD,” is outside the normal DNI rules. Accordingly, transferring the plan itself to the beneficiary generally does not “carry out DNI.” See ¶ 6.5.07 – ¶ 6.5.08 . E. No DNI deduction for distribution to charity. The trust generally does not get a DNI deduction for distributions to charity. See ¶ 7.4.02 . F. No DNI deduction for certain pecuniary bequests. Finally, the DNI deduction is not available for distributions in fulfillment of a bequest of a specific sum of money (“straight” pecuniary bequest) unless the governing instrument requires that such distribution is to be paid in more than three instalments (which would be unusual). § 663(a)(1) , Reg. § 1.663(a)- 1 . Thus a trustee’s distribution in fulfilment of a typical pecuniary bequest such as “pay $10,000 to my grandchild” will not “carry out DNI” to the grandchild. A “formula” pecuniary bequest is not considered a bequest of a specific sum of money for this purpose, so a formula pecuniary bequest can “carry out DNI.” Reg. § 1.663(a)-1(b)(1) . A “formula pecuniary bequest” does not mean any pecuniary amount determined by a formula; it means a bequest of a sum of money determined by a formula where the amount of the bequest cannot be determined as of the date of death. Many marital deduction bequests are of this type. See PLR 2002-10002 for an example of a formula pecuniary bequest to a credit shelter trust.