Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

beneficiary(ies) in the same year it is received, as part of DNI, in which case the deduction also passes to the beneficiaries. Reg. § 1.691(c)-2 . A different rule applies to charitable remainder trusts; see ¶ 7.5.05 (C). If the IRD is not passed out to the trust beneficiaries in DNI, then the IRD and the IRD deduction stay in the trust. The deduction for federal estate taxes paid on IRD ( ¶ 4.6.04 – ¶ 4.6.08 ) is an itemized deduction, subject to reduction (in certain years) under § 68 ; see ¶ 4.6.08 . § 68 does not apply to trusts or estates, however, only individuals. This creates an incentive for a participant whose estate will be subject to federal estate taxes to name a trust or estate as beneficiary of income-taxable benefits. So far we have spoken of the trustee’s receiving a retirement plan distribution, including it in the trust’s gross income, then paying it out to the trust beneficiary and taking a DNI deduction. This simple pattern becomes more complex if the “separate share rule” of § 663(c) applies. Under this rule, “in the case of a single trust having more than one beneficiary, substantially separate and independent shares of different beneficiaries in the trust shall be treated as separate trusts.” When the separate share rule applies, if a fiduciary distributes money to a beneficiary, that distribution will carry out DNI only to the extent there is DNI that is properly allocable to that particular beneficiary’s “separate share.” IRD and the separate share rule The separate share regulations have the following special rule regarding the allocation of IRD that is “corpus” (principal) for trust accounting purposes: “(3) Income in respect of a decedent. This paragraph (b)(3) governs the allocation of the portion of gross income includible in distributable net income that is income in respect of a decedent within the meaning of section 691(a) and is not ...[trust accounting income]. Such gross income is allocated among the separate shares that could potentially be funded with these amounts.... based on the relative value of each share that could potentially be funded with such amounts.” Reg. § 1.663(c)-2(b)(3) . Emphasis added. Here’s how the separate share rule would apply to a retirement plan distribution that is corpus for trust accounting purposes: Jody Example: Jody dies in Year 1, leaving his $1 million 401(k) plan, $1 million of real estate, and $1 million of marketable securities to a trust. At Jody’s death, the trust is to be divided into two equal shares, one for each of Jody’s children Brad and Angelina, so each child is to receive a total of $1.5 million. Each child’s share is to be distributed outright to the child upon attaining age 35. Angelina is already age 36; Brad is 33. In Year 1, the 401(k) plan sends the trustee a check for the entire plan balance of $1 million, creating $1 million of gross income to the trust. The trustee The separate share rule of § 663(c) governs the allocation of DNI among multiple beneficiaries of a trust or estate. Do not confuse this rule with the separate accounts rule that dictates when multiple beneficiaries of a retirement plan are treated separately for purposes of the minimum distribution rules. See ¶ 6.3.02 , ¶ 1.8.01 . These are completely different and unrelated rules! Separate Accounts vs. Separate Shares