IRAs Payable to Non-QTIP IRA Trusts

• Author: Seymour Goldberg
• Profession: Senior partner in the law firm of Goldberg & Goldberg, P.C., in Woodbury, New York
• Pages: 59-75

59

IRAS PAYABLE TO

NON-QTIP IRA TRUSTS

(Good, bad, and the ugly.)

Many taxpayers often have retirement assets such as IRAs payable

to trusts. These trust s can be revocable trusts, irrevocable trusts, or

trusts u nder a will.

If done correctly, these trust s can in essence result in a windfall for

the trust b eneficiary and provide the beneficiar y with a long-term bene-

fit. However, if done incorrectly or if the trust f lunks the IRS r ules, then

it can be a time bomb with deva stating problems for the trustee and pos-

sibly the professional advisor who is involved in the creation of t he trust

and/or the compliance aspects of the t rust after the death of IRA owner

or employee plan participant whose retirement account or IR A account

is payable to a trust.

An IR A trust can generally provide for the protect ion against the

creditors of the trust beneficiary a nd prevent the trust f rom being

included in the trust benef iciary’s estate for estate tax purposes if the

trust beneficiary dies du ring the payout period. In addition, the IR A

trust can be used as a generation-skipping vehicle and also as a credit

shelter trust if done correctly.

In the event that the IR A trust is nonqualifying (a trust t hat does

not satisfy the IR S stretch payment rules), then significant tax problems

and other liability issues may be triggered. This can become a problem

for the trustee and possibly the trustee’s advisors as well.

There are a number of problems that exist from a legal point of view

when drafting an IRA trust. If a practitioner is not versed in the state

trust law that def ines income and principal, then the tru st document may

be wr itten in a m anner th at is incons istent wit h the intent of the gra ntor.

For example, if the IRA tr ust provides that income shall be paid to

the trust benef iciary each year, then one must exa mine the definition of

income when a required minimum distribution is paid to the trust under

state law. Many of the states have adopted a version of the 1997 Uniform

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60 | IRA G   IRS C I 

Principal and Income Act. In a non-QTIP (Qualified Terminable Inter-

est Property) IR A trust, the defin ition of income in most (but not all)

adopting jurisdict ions of the 1997 version of the Uniform Principal and

Income Act is that 10 percent of the required minimum distribution

amount received by the trust is considered income. In that case, if the

required mini mum distribution payable to the IRA tr ust is $30,000, t hen

the trust benef iciary will only receive 10 percent of $30,000, or $3,000,

not $30,000. However, if the trust provision provides that Joey, the non-

spouse trust benef iciary, shall receive the greater of income or the required

minimum distribution that the t rust receives each year, then Joey will

receive $30,000, not $3,000. If the trust states only that Joey receives

income (not the greater of income or the required mini mum distribution

amount), and if Joey was erroneously paid $30,000 instead of $3,000, then

the trustee has a significant legal problem. The trustee would have to

advise the trust beneficiary, Joey, that he was overpaid by $27,000. This

overpayment can lead to headaches for the tru stee if Joey paid income

taxes on the $30,000 amount and spent the remaining money.

Many other draft ing issues must be covered in t he trust docu ment

as well. For example, if the IRA t rust provides for the payment of trust

expenses (which it should and generally does), then trust expenses are

generally charged against trust income under state trust law. However,

if the trus t income is only 10 percent of the required mi nimum distribu-

tion amount, then the t rust income may not be sufficient to support the

payment of trust expenses. For that reason, I suggest that a non-QTIP

trust provide that any trust ex penses be charged against principal, not

income. In that connection when a non-QTIP IRA trust is used, I sug-

gest that the trust provide that all distributions received by the tr ust

from the decedent’s IRA be considered principal and that the trustee

shall accelerate distributions from the IRA to t he trust in order to pay

the trustee ex penses, which are also charged against principal. I do

not net the trust expenses against t he required minimum distribution

amount payable to Joey even though an IRS letter ru ling permits the

netting approach. An I RS letter ruling granted to a particular ta xpayer

is not binding on the IRS on a ny other taxpayer.

Once an IRA t rust is established, then the beneficiar y form with

the IRA institution should provide, for example, that the Harvey t rust

f/b/o Marty, dated July 1, 2012, is the primary beneficiary of Harvey’s

IRA provided t hat Marty survives Harvey. It should also provide that if

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