Retirement Plans and Third Party and First Party

“Retirement Plans and Third Party and First Party Special Needs Trusts” Presented by: Patricia Nelson-Reade and Bradley J. Frigon

Talk the Talk • Required Minimum Distributions (RMDs) • Required Beginning Date (RBD) • Designated Beneficiary (DB)

Income in Respect to a Decedent (IRD) • Distributions from IRA accounts are all taxable • No step-up in basis at death

Required Beginning Date (RBD) • The RBD is April 1 st of the calendar year AFTER the calendar year in which the beneficiary turns 70 ½. • Bob is born on 6/30/1937. Bob turns 70 on 6/30/2007. Bob turns 70 ½ on 12/30/2007. Bob’s RBD is 4/01/2008. • Jane is born 7/01/1937. Jane turns 70 on 7/01/2007. Jane turns 70 ½ on 01/01/2008. Jane’s RBD is 04/01/2009.

Required Minimum Distribution (RMDs) • A participant’s RMD is calculated under the uniform tables by dividing the factor into the balance of the retirement account as of December 31 of the previous year. • Example: Bob will be 75 years old. The balance of his retirement account as of 12/31/2006 is $287, 500. Bob’s RMD for 2007 is $12, 555 ($287, 500 / 22. 9).

Distributions at Death • Did the participant die before or after RBD? • Are there multiple beneficiaries? • Does the retirement account pass to a DB, and who is the DB?

Death Before RBD • Spouse – Rollover – Inherited • Non Spouse -DB If DB RMDs based upon DB’s life expectancy usingle life tables.

Death after RBD • Spouse – Rollover – Inherited • Non Spouse –DB – RMD is calculated based upon the greater of the beneficiary’s life expectancy or the participant’s life expectancy.

Calculating RMDs for a Beneficiary • If the beneficiary is 58 when the participant dies, the factor to determine the beneficiary’s RMD is 27. The following year, the beneficiary factor to calculate RMD is 26 (27 -1). If the participant was 50 when he died, the beneficiary could use a factor of 34. 2 (the participant’s factor) for calculating RMDs.

No Designated Beneficiary • • Estate Charity Non Qualified Trust Other entity, corporation, partnership

No DB • Five year rule applies: – Under the five year rule, the entire balance of the retirement plan must be distributed to the beneficiary no later than December 31 of the calendar year five years from the participant’s death. Not required to make distributions equally over the five year period.

Multiple Beneficiaries and the Separate Account Rule • Separate Accounts. If you can divide each beneficiary’s share into a separate account then each beneficiary can use own life expectancy. You must contact the custodian and physically divide the accounts. • Note the separate account rule does NOT apply to multiple beneficiaries who take their interest through a trust. • Must be completed by December 31 of the year following the participant’s death

Naming a Trust as the Beneficiary of a Qualified Retirement Account • The Trust must be valid under state law, or would be but for the fact that there is no corpus; • The trust is irrevocable or will, by its terms, become irrevocable upon the death of the participant; • The beneficiaries of the trust must be “identifiable from the trust instrument”; and • Certain documentation must be provided to the plan administrator.

Conduit Trust • With a conduit trust the trustee is required, by the terms of the trust, to pass all plan distributions out to the individual trust beneficiary. • The IRS considers the conduit beneficiary as the sole beneficiary of the trust. Remainder beneficiaries are disregarded for purposes of calculating RMDs even if reminder beneficiaries are not DBs.

Accumulation Trust • A SNT is an accumulation trust because the trustee has the discretion to distribute income and principal to the beneficiary. • With an accumulation trust, do we use the life expectancy of the special needs beneficiary to calculate RMDs or do we look at life expectancy of remainder beneficiaries?

THIS IS ALL ABOUT CALCULATING RMDs

Accumulation Trust Power to Appoint to Charity • A trust that provides discretionary income and principal to A. Upon A’s death, the remaining principal and income is paid to a class of beneficiaries consisting of A’s issue and any charity as appointed by A in his will. Since A’s power to appoint includes a power to appoint to a non-individual, the trust would not have a DB for RMD purposes.

Calculating RMDs for an Accumulation Trust Father establishes a SNT for his special needs son A and designates the SNT as the primary beneficiary of his IRA. The father’s IRA has a $1, 000 balance at the time of his death. Upon A’s death, the balance of the assets of the SNT go to A’s siblings, B and C. A is 20, B is 40, and C is 45 at their father’s death. In this case, the RMD rules require A, B, and C to be considered as beneficiaries. C’s life expectancy is used to determine RMDs because C is the oldest. The factor for C at age 45 is 38. 8. Using a factor of 38. 8 creates a RMD for the initial year of the trust of $25, 773. 20 ($1, 000÷ 38. 8). If RMDs are based on A’s life expectancy, a factor of 63 is used. A factor of 63 decreases RMDs to $15, 873. 02 ($1, 000 ÷ 63). By naming C as a remainder beneficiary, the RMD increased by $9, 900. 18.

IRA Account Owner Trust Is trust designated beneficiary? No Conduit Trust ? Yes Life expectancy of beneficiary* *Unless account owner is younger No May be required to use life expectancy of oldest beneficiary unless no DB* Next Slide

IRA Account Owner Charity Estate Did owner die before RBD? Yes Five year rule No Remaining life expectancy of decedent as of death

IRA Account Owner Child and/or Grandchild Can accounts be separated by December 31 of the year following death? Yes Life expectancy of each child or grandchild No Life expectancy of oldest beneficiary

What to Remember • What is OK Remainder beneficiaries close in age; Power to appoint to younger beneficiaries. • What NOT to do No Charities; No Estate; No power of appointment including right to appoint to a charity or older individuals.

What to Do 1. Beneficiary Finalization Date. September 30 of the year following the participant’s death. 2. Charitable Remainder Trust. 3. IRA Charitable Rollover Extended.

Income Taxation of First Party Special Needs Trust • Tax Treatment Depends on whether Trust is a “Grantor Trust” for Income Tax Purposes. • If “Grantor Trust” then income, deductions and credits taxed to trust beneficiary. Distributions from trust are irrelevant for income tax purposes for a grantor trust. • If SNT is not “Grantor Trust” then Complex Trust. If a complex trust, the amount and timing of distributions are critical.

Grantor Trust Rules IRC Sections 671 -678 • If the trust violates one provision of grantor trust rules, then trust is taxed as a grantor trust. • IRC Sec. 677, “the grantor shall be treated as the owner of any portion of a trust. . . Whose income without the approval or consent of an adverse party, is or in the discretion of the grantor or a nonadverse party, or both, may be distributed to the grantor or grantor’s spouse; or held or accumulated for future distributions to the grantor or the grantor’s spouse.

Adverse Party • A person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he or she possesses respecting the trust. (IRC Sec. 672(a)). • In most cases, a family member serving as trustee is an adverse party (residual trust beneficiary).

Other Methods to Make Trust Grantor Trust • Giving the beneficiary a “special power of appointment (IRC Sec. 674). • Allowing the beneficiary to substitute property of equal value (IRC Sec. 675). • Permitting the beneficiary to borrow from the trust without giving adequate security (IRC Sec. 675(2)).

Should your (d)(4)(A) Trust be a Grantor Trust?

Example One Grantor Trust • • Income to trust $25, 000; All paid out to beneficiary; $5, 000 for trustee fee and expenses; Assume beneficiary has no other deductions or income.

Tax Due • Trustee fees and expenses are itemized deduction to beneficiary subject to 2% floor. • In 2007, the standard deduction for a single individual is $5, 350 • As a result, beneficiary cannot deduct trustee fees • Beneficiary pays tax on $16, 250 ($25, 000 less standard deduction of $5, 350 and $3, 400 for personal exemption. • Total Federal tax is $2, 046. 00

NONGRANTOR TRUST • Increased Personal Exemption for “Qualified Disability Trust” • “Qualified Disability Trust” is a trust established under 42 U. S. C 1396 p. • For 2007, Personal Exemption for QDT is the same as for an unmarried individual who is not a surviving spouse or head of household ($3, 400).

Non. Grantor QDT • Trust deducts Trustee fees and expenses of $5, 000 and $3, 400 for a QDT against income of $25, 000. • If Trust had paid out $25, 000 for beneficiary during the year, beneficiary would receive a K-1 reporting $16, 600 of taxable income ($25, 000 less $3, 400). The beneficiary applies standard deduction of $5, 350 and personal exemption of $3, 400 against $16, 600 of income which generates zero income tax to the beneficiary. • Compare this example to grantor trust where beneficiary paid $2, 045 of tax.

Factors to Consider • • • Look at Trust distributions Administration Costs Tax Rates No incentive to accumulate income Tax Returns and Reporting Requirements.

First Party Trusts and Inherited Retirement Accounts PLR 200620025 Taxpayer A died at age 68 while owning an Individual Retirement Account (IRA). This IRA named his four sons as beneficiaries through a beneficiary designation. One of his sons was a minor and receiving Medicaid benefits. The mother obtained an order from the State Court authorizing the creation of a special needs trust for her son’s benefit. The trust authorized by the court was a first party special needs trust with a payback provision. The mother was designated as trustee, and the son as the sole lifetime beneficiary of the trust. During the son’s life, the trustee may distribute to or apply for his benefit as much of the net income of the trust as advisable in the trustee’s sole discretion. Income not distributed must be added to principal.

Continuation of Facts Upon the son’s death, the State Department of Children and Families will receive reimbursement from the trust assets up to the amount of medical assistance that they paid on the son’s behalf during his lifetime. Any remaining trust assets will then be distributed to the son’s heirs at law. The minor son’s heirs at law consists of his mother and siblings. The son’s mother executed a timely disclaimer as to her contingent remainder interest in the trust.

Ruling Requests • Whether the transfer of the father’s IRA to the son’s SNT causes an immediate recognition of income under IRD Code Sec. 691(a) (2). • Whether annual RMDs from the SNT may be calculated using the son’s life expectancy.

Holding of PLR 200620025 • Under Rev. Rul. 85 -13, a grantor trust and the grantor of the trust are treated as the same taxpayer for federal income tax purposes; • A transfer of a grantor’s assets to a grantor trust is disregarded for federal income tax purposes; • Use son’s life expectancy for purposes of calculating RMDs.

Key Facts of PLR 200620025 • Must be a grantor trust; Don’t assume. • Disclaimer of remainder interest by mother. Do you need to disclaim or reform your trust? • Creating separate accounts under the separate share rule by Dec. 31 of the year following death. • Trust was a Special Needs Trust

Process to transfer Title of Inherited Trust Account According to PLR 200620025 • Trustee to trustee transfer – also called plan to plan, custodian to custodian • not considered distribution, rollover or contribution

Process to transfer Title of Inherited Trust Account According to PLR 200620025 • Disabled son’s share of Father’s IRA is transferred by trustee to trustee transfer in following name: • IRA in deceased father’s name to benefit disabled son’s name through Special Needs Trust’s name • No mention of EIN number v. SS# for disabled son’s trust

Private Letter Ruling: 200826008 Facts: • Deceased parent named children, including minor child, as IRA beneficiaries • Minor child’s share in a separate IRA as sole beneficiary

Private Letter Ruling: 200826008 Conservator proposes court petition to authorize creation of trust on following terms: minor sole benefit her life; discretionary health, support, maintenance, and education standard for income and principal ; accumulated net income added to principal each year; staggered increasing powers of withdrawal given to minor child and eventually receiving power to withdraw all of trust; testamentary power of appointment given to minor child

Private Letter Ruling: 200826008 Conclusion: Trust is a grantor trust, all of which is owned by the minor child. Therefore, assuming transfer of minor child’s share of IRA to trust is not a gift by minor child, such transfer is not a sale or disposition of the IRA for federal income tax purposes or for purposes under IRA statute (§ 691(a)(2)). Letter Ruling expressly states no opinion under § 401(a)(9), re. calculating minimum distribution requirements In re. to calculating distribution requirements, problem with this trust may be testamentary power of appointment -- may fail requirement that all beneficiaries be reasonably identifiable to be considered a designated beneficiary.

Other Key Points to Remember • Both of these are Inherited IRAs • PLRs cannot be cited as precedent • Disclose on tax return • Uncooperative IRA custodians • Early action necessary so have time to separate accounts for different beneficiaries, disclaim, file court petition, create or reform trust

Possible extension of PLR 200620025 for transfer of disabled person’s own IRA to d 4(a) trust? Supportive of extension: • Emphasis on special needs of beneficiary – not matter of convenience • Grantor trust provisions are applicable to self-settled trust for IRA’s Major distinctions: • IRD analysis of IRC Section 691 n/a to disabled person’s own IRA • Black letter – IRA and retirement plans must be titled in individual’s name – revocable trusts and other grantor trusts not acceptable

Developing Area Request a private letter ruling? Reasonable basis w/o private letter ruling? Model account title after PLR 200620025 – ex. John Smith Individual Retirement Trust Account f/b/o John Smith Special Needs Trust Use beneficiary’s SS# rather than obtain new EIN# Tax return IRS Form 8275. Disclose item not adequately disclosed on tax return IRA custodian’s report

Payback Claims and Taxes • The withdrawal of money from a retirement account will generate income tax; • Paying a state Medicaid claim after the beneficiary dies is probably not a deductible expense to the trust for income tax purposes; • Make sure trustee holds back enough money to pay income tax or elects sufficient withholding • Personal liability for trustee?