Life and Death Planning for Retirement Benefits

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168 Life and Death Planning for Retirement Benefits
unitrust alternative. In the IRS’s view, the 10 percent rule dictates how the trustee is to allocate
plan distributions in determining the income of the trust, but has nothing whatsoever to do with
the income of the plan! Therefore if the instrument specifically requires the trustee to pay the
spouse the income of the trust’s share of the plan, the trustee is required to pay her the internal
income of the trust’s share of the plan (or unitrust amount, if applicable), regardless of whether
the UPIA 1997 10 percent rule applies to the trust.
While this IRS interpretation probably makes a hash of the UPIA drafters’ intent (it seems
clear they thought the “income of the plan” was 10 percent of the RMD), it is a blessing for estate
planners, because it means that most marital trusts drafted since 1989 with retirement benefits in
mind will not have to be amended due to Rev. Rul. 2006-26, despite the widespread adoption of
UPIA 1997 by state legislatures. The IRS view that the benefits and the trust itself constitute
separate items of QTIP has been known since Rev. Rul. 1989-89, 1989-2 C.B. 231, and
accordingly many estate planners have long included the extra language specifying that the spouse
must receive income “of the plan” as well as “of the trust.” For example, the requirement that the
trustee pay the spouse the income of the plan, not merely of the trust, has been part of the sample
forms in this book since its first edition (1996). See Form 4.5,
A marital trust that is named as beneficiary of a retirement plan, and which states that the
surviving spouse is entitled to all income “of the trust,” but does not specifically state that the
spouse is entitled to all income of the trust’s interest in the retirement plan, should be amended if
applicable state law would not require income of the plan to be paid to the surviving spouse.
Trustees of existing marital trusts that hold inherited retirement benefits, where the
participant has already died, do not have the option of amending the trust. If the trust does not
contain its own IRS-acceptable definition of income with respect to retirement benefits, and does
not contain the magic words that the spouse is entitled to the income of the plan, and is governed
by the UPIA 1997 10 percent rule, the trustee faces a dilemma. Rev. Rul. 2006-26 indicates that
such a trust may not qualify for the marital deduction. However, if the federal estate tax return has
been filed and accepted, with the marital deduction allowed, it’s not clear what the IRS can do
about it at this stage. Fixing this problem is beyond the scope of this book.
3.3.05 Ways to meet the “entitled” requirement; Income vs. RMD
In determining whether the spouse is “entitled for life to all of the income” of a marital
trust, the same rules apply to both QTIP and General Power marital trusts.
Reg. The simplest, most-used, and generally recommended method of
meeting the “entitled” requirement is for the trust instrument to require the trustee to withdraw
from the plan, each year, and distribute to the surviving spouse, all income of the retirement plan.
This method is explained in
The primary reason one might wish to investigate other methods would be to achieve
greater deferral of the retirement plan distributions; if the trustee does not have to withdraw the
“income,” the theory is, that income can be allowed to accumulate tax-deferred or tax-free inside
the retirement plan. Looking into these other alternatives is worthwhile only if there is likely to be
any income in excess of the RMD amount; see “A.” For more on these other alternatives, see “B.”
A. Does the “income” actually exceed the RMD? Regardless of whether the trustee is
required to withdraw “income” from the retirement plan, the trustee must withdraw the