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The Hidden Minimum Required Distribution Rules Dangers in Drafting a See-Through Trust (Part 2)

A see-through trust, if drafted properly, may serve as a useful planning vehicle. It allows an IRA to distribute IRA amounts to the trust ratably over the expected remaining life of the designated beneficiary (and still comply with the 401(a)(9) minimum distribution rules). It also allows a trustee to use his or her discretion as to how much of those IRA assets the trust will actually pass on the beneficiaries. This stands in direct opposition to the “conduit trust” which also, under 401(a)(9), allows IRA amounts to be distributed ratably over the expected remaining life of the designated beneficiary, but requires the amounts to flow directly from the IRA to the beneficiary (i.e., no trustee discretion; all amounts directly from IRA to beneficiary).

But drafting a valid see-through trust is not easy. To qualify as a valid see-through trust, the trust must provide for an “identifiable individual designated beneficiary”. For example, what if the IRA provides that the designated beneficiary is a subtrust for daughter. The subtrust provides that the trustee shall distribute income and principal to daughter for her health, education, maintenance and support until she reaches age 35, when daughter may receive income and principal without restrictions. In this case, daughter may qualify as a identifiable individual designated beneficiary, allowing the IRA to distribute the IRA amounts ratably over daughter’s lifetime (a good tax result). But what if the subtrust gives the daughter a general power of appointment should the daughter fail to reach age 35. Who is the designated beneficiary now? The answer is, we cannot identify one. The daughter could appoint anyone in the world, and so we cannot name a specific identifiable individual designated beneficiary and we do not have a valid see-through trust. Under 401(a)(9), the IRA must now distribute all IRA amounts to the trust not later than the end of the fifth anniversary of mother’s death (a bad tax result). Since we botched the see-through trust, the full amount of the IRA is taxable far earlier than if drafted correctly.

But the IRS has approved of a possible way around this mess. More on this to come in Part 3…