Life and Death Planning for Retirement Benefits

350

Life and Death Planning for Retirement Benefits

Scenario 3: Continuing the Jody Example from ¶ 6.5.05 , suppose Jody’s trust provides that “The Trustee shall not be obligated to allocate each asset equally to the two shares, but rather may allocate different assets to each child’s share, provided that the total amount allocated to each child’s share is equal.” The trust thus authorizes discretionary pick-and-choose (non-pro rata) funding. The trustee has exercised its authority to choose which assets to use to fund each beneficiary’s share: The trustee, in proper exercise of its discretion, allocated the entire $1 million 401(k) plan distribution to Angelina’s share. Does this enable the trustee to deduct the entire distribution as DNI? Probably not. Though other interpretations are possible, the usual interpretation of the regulation is that, since the trustee could have elected to fund either beneficiary’s share of the trust with the IRD, the trustee must (in computing its taxable income and DNI) allocate the IRD equally to the two shares. Under this interpretation, discretionary pick-and-choose funding generally produces the same result as mandatory pro rata funding (see exceptions below). If the trustee of a trust that (1) is subject to the separate share rule and (2) permits discretionary pick-and-choose funding wants the gross income arising from a retirement plan to be allocated disproportionately, there are two ways to avoid the separate share rule and its apparently-mandatory pro rata allocation of IRD-corpus, assuming these techniques can be used consistent with the fiduciary’s obligations to all trust beneficiaries:  Transfer the plan itself, rather than a distribution. In the Jody Example, the trustee could transfer the 401(k) plan itself to Angelina, rather than withdrawing money from the plan and distributing the money to Angelina. See ¶ 6.1.05 . Such a transfer generates no gross income at the trust level and accordingly the separate share rule for allocation of DNI never comes into play. The problem of Reg. § 1.663(c)-2(b)(3) is avoided. See ¶ 6.5.07 .  Fund other shares first. If the trustee wants to allocate a particular IRD-corpus item to one beneficiary’s share, the trustee can distribute all the other assets first, fully funding all the other beneficiaries’ shares before the year in which he withdraws funds from the plan. Then he is left with only one asset, the retirement plan, which he cashes out in the later year. This cash can only be used to fund one beneficiary’s share (because all other beneficiaries have received their shares in full in previous years), so the distribution carries out all the DNI. See ¶ 6.1.05 regarding the ability of a trust or estate to transfer an inherited IRA or plan to the beneficiaries of the trust or estate. This ¶ 6.5.07 discusses the income tax effects of such a transfer to a specific or residuary legatee. For transfer in fulfilment of a pecuniary bequest, see ¶ 6.5.08 . The general rule is that the transfer of an inherited retirement plan “by the estate of the decedent or a person who received such right by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent” triggers immediate realization of the income represented by the retirement plan, because it is the transfer of a right to receive IRD. § 691(a)(2) , first sentence; see ¶ 4.6.03 . Income tax effect of transferring plan