Life and Death Planning for Retirement Benefits

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Chapter 6: Leaving Retirement Benefits in Trust 327
issue upon his wife’s death. The trustee receives a required minimum distribution RMD) from the
IRA. Under the state law applicable to Paul’s trust, 10 percent of the RMD is allocated to trust
income and the balance to principal; see C). The trustee has no authority to distribute
more than 10 percent of the RMD to Paul’s wife; the other 90 percent must be retained in the trust,
and will be taxed at trust income tax rates. Even if the trust says the trustee can distribute principal
to Paul’s wife “if her income is not sufficient for her support,” the trustee cannot give her more
than the 10-percent “income” amount unless she actually needs more for her support.
Accordingly, when drafting a trust that may receive retirement benefits, if you want the
trust to take advantage of the DNI deduction to reduce income taxes on distributions from the
retirement plan, the trust instrument must give the trustee discretion to distribute principal (or at
least the part of principal that consists of distributions from retirement plans) to the individual
beneficiaries. If you want the trust to be forced to take advantage of this deduction, see “conduit
trusts” at
6.5.04 Trusts and the IRD deduction
If a retirement plan distribution to the trust is IRD when received, the trust is entitled to the
applicable deduction, if any (see , unless the IRD is passed out to the trust
beneficiary(ies) in the same year it is received, as part of DNI, in which case the deduction also
passes to the beneficiaries. Reg. 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 is an itemized
deduction, subject to reduction (in certain years) under see 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.
6.5.05 IRD and the separate share rule
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” o 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.”
Separate Accounts vs. Separate Shares
The separate share rule of 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 ¶ These are completely
different and unrelated rules!