Chapter 16. Accommodation of Special Assets: Interests in Qualified Plans and IRAs

• Author: Jerold I. Horn
• Pages: 483-535

16

Accommodation of Special Assets

Interests in Qualified Plans and IRAs

Interests in individual retirement accounts (IRAs) and qualified plans, and

the interface between the interests and private trusts, affect millions of

people and perhaps trillions of dollars. Nevertheless, many years after the

enactment of the governing statute, the rate at which an interest is

distributable to a private trust remains unclear.

The last change in the Code that materially affected the rate at which an

interest is distributable to a beneficiary was effective as of the beginning of

1984. See Code § 401(a)(9). The IRS issued proposed regulations in 1987,

modified them slightly at the end of 1997, issued a new set of proposed

regulations in January of 2001, and issued final regulations in April of

2002. The law, such as it is, remains opaque as it applies in essential

respects to trusts as beneficiaries.

Unless an interest in a qualified plan or IRA is payable to a “designated

beneficiary,” distribution of the interest cannot extend beyond (i) if the

participant or owner dies upon or after his or her required beginning date

(that is, usually April 1 of the calendar year after the calendar year in which

the participant or owner attains age 70½), the life or life expectancy of the

participant or owner or (ii) if the participant or owner dies before his or her

required beginning date, the five-year period that begins with the December

31 that immediately follows the death. Any longer (that is, extended) period

of distribution is a function of (i) the existence of a designated beneficiary

and (ii) if a designated beneficiary exists, the life expectancy of the

designated beneficiary who has the shortest life expectancy. Reduced to its

essentials, the uncertainty relates to whether, and to what extent, features

that are common to private trusts preclude the existence of a designated

beneficiary.

Virtually all of the features to which the uncertainty relates are central,

not peripheral, to why property owners create trusts. Without limitation, the

features include

i. the ability of a trustee to use trust property to pay death costs,

i. the discretion of a trustee to allocate trust property to a

disposition,

ii. the ability of a trustee to use trust property to benefit a

nonindividual,

iii. the ability of a trustee to distribute trust property to the estate of

a beneficiary,

iv. the discretion of a trustee to distribute or accumulate income and

to distribute principal,

v. the ability of a donee to appoint trust property, and

vi. the ability of a trustee to retain trust property beyond the life

expectancies of those who are living at the creation of the trust.

These, in truth, represent many uncertainties, each significant.

The uncertainty emanates from the confluence of interests in IRAs and

qualified plans, on the one hand, and private trusts, on the other. Obviously,

a lawyer can eliminate the uncertainty by avoiding the use of trusts as

beneficiaries. However, for the reasons that are discussed in Part I, below,

the writer rejects that solution. One who agrees with the reasoning that is

expressed in Part I, below, cannot avoid the uncertainty and must address

the issues that the uncertainty presents.

PART ONE

INTEGRATION OF QUALIFIED PLANS AND IRAS INTO THE

ESTATE PLAN

The writer posits two objectives. The first objective is to integrate interests

in qualified plans and IRAs with other assets in the estate plan. The second

objective is to defer income. The first objective is a short-hand reference to

the objectives that the client seeks to apply to his or her other assets.

A conflict exists between (i) the first objective of integrating qualified-

plan and IRA interests with most other assets in an estate plan and (ii) the

second objective of maximizing deferral of income from qualified-plan and

IRA interests for income tax purposes. The set of principles that applies

only to qualified-plan and IRA interests for income tax purposes conflicts

with the sets of principles that apply to qualified-plan and IRA interests and

other assets for estate tax, gift tax, generation-skipping tax, and nontax

purposes.

As applied to beneficiaries other than first spouses, the first objective

usually seems more important than the second. The reasoning is that if

trusts are the vehicles of choice for the other assets, trusts also

presumptively are the vehicles of choice for the interests in qualified plans

and IRAs. Payment outright to a first spouse might work little or no

violence to the values that are implicit in integration. However, payment

outright to anyone other than a first spouse is more likely to undermine

these values.

If qualified-plan and IRA interests pass to a trust that can serve as a

receptacle for the interests and for other assets, the planning will

accomplish the first objective but might not accomplish the second. If, in

order to attempt to solve the problem, the qualified-plan and IRA interests

were payable to one or more individuals outright rather than to a trust, the

arrangement would accomplish the second objective but tend to prevent

accomplishment of the first.

The clients of the writer tend to agree that, as applied to beneficiaries

other than first spouses, integration is more important than deferral. Perhaps

this phenomenon is a function of the writer’s counseling, or of how the

writer poses the issues and asks the questions. Indeed, all can ponder why

clients of one attorney use a particular technique, whereas clients of another

attorney use a competing technique.

The anecdotal experience of the writer is that nonlawyers (such as

accountants, financial planners, trust officers, life insurance underwriters,

and stockbrokers) who counsel with respect to interests in qualified plans

and IRAs tend to focus solely upon deferral and to ignore integration

entirely. Perhaps this phenomenon is attributable to a lack of appreciation of

nonlawyers for the role of trusts in estate plans and to a lack of ability of

nonlawyers to harmonize deferral and integration.

Different degrees of disintegration include (i) interference with transfer-

tax objectives (such as full use of applicable credits and GST exemptions

and avoidance of inclusion in gross estates of beneficiaries), (ii)

interference with nontax objectives (such as management of assets and

protection of assets from creditors and spouses), and (iii) inability to

marshal assets in order to facilitate allocation of assets among various

dispositions and payment of death costs. The different degrees of