Separate Accounts and RMD

[Guest P A Weick]

Decedent died in 2001. Trust with separate accounts for each beneficiary was the designated beneficiary. The IRA was divided into these separate accounts in 2002. I had always thought that as long as separate accounts were established before 12/31 of the year after the year of the decedent's death each beneficiary could use their own life expectancy but am advised that this only applies in the years after the separate accounts are established, in this case 2003. That result appears odd but is consistent with the language of Treas. Regs. 1.401(a)(9)-8(A)(2). I have thought of claiming that the accounts were established when the owner died, not when they were physically separated. Any other ideas?

[Appleby]

The seperate accounting rule, for purposes of determing the factor used to calculate post death distributions does not apply to trust beneficiaries. The life expectancy of the oldest beneficiary under the trust must be used

[mbozek]

A separate share for each IRA beneficiary with separate life expectancies can only be established if the IRA owner designated a separate account for each beneficiary in the IRA beneficiary designation. Designation of separate accounts in the trust is not sufficient.

[Guest reg_h2b]

Interesting Issue.

Bottom line:

Under the new Final Regs effective 1/1/2003 I don't know. I need further IRS guidance. Maybe someone out there can update me if the IRS has released any further interpretations since the final MRD regs were released.

Here's why I differ- somewhat-- from the previous posts, but first a question:

Appleby and Mbozek what are you specifically basing your conclusion on: Final Reg. § 1.401(a)(9)-4, A-5©? (i.e. "...the separate account rules under A-2 of § 1.401(a)(9)-8 are not available to beneficiaries of a trust with respect to the trust's interest in the employee's benefit.")

Background: Natalie Choate's Opinion

Natalie Choate gave her response to this issue here

http://www.ataxplan.com/faq/faq_frame.htm

(under "Separate Accounts vs. Separate Trusts"). Here's her bottom line paragraph:

"However, Reg. § 1.401(a)(9)-4, A-5© should not be interpreted as prohibiting separate trusts from using the separate accounts rule. If benefits are left to one "funding" trust (such as Participant's living trust), and upon Participant's death the trustee is required to create and fund separate trusts (such as marital and credit shelter trusts, or a separate trust for each child), the trustee of the trust that is named as beneficiary of the retirement plan has until December 31 of the year after the year of the Participant's death to cause the retirement benefit to be allocated into separate accounts, one payable to each of the separated trusts. This is no different from a plan benefit that is left to multiple children being divided into separate accounts payable to the children individually."

As I say that's Natalie's opinion based on her reading of the final regs. Reasonable people can disagree with this conclusion. Indeed, I last corresponded with the IRS about this issue (early fall 2002) there seems to be an internal "discussion" about what Reg. § 1.401(a)(9)-4, A-5© actually means. It is interesting to note that Reg. § 1.401(a)(9)-4, A-5©'s language was NOT in the proposed MRD regs released for comment in 2001. I have the distinct impression that this issue was not sufficently discussed with all the relevant parties within the IRS before the final MRD regs. were released.

Here's what I know and what I don't know:

1. I know that under the old prop. regs. (can be used until 1/1/2003) the key standard was whether the trustee had discretion as to the allocation of the plan assets. If the trustee had NO discretion then separate accounts CAN be used provided that separate accounting is used and the trust is permissible (trust's bene's are the designated bene's). Note, contrary to what a lot of advisors say, under the old prop. regs. you could have even had separate accounts WITHIN a trust or subtrust. Multiple subtrusts created at DOD were not strictly necessary for separate accounts under the old prop regs. Background, this "no discretion" standard under the old prop regs was communicated to me multiple times (in 2001 and 2002) and in detail by the IRS Technical Plans Staff while dealing with a case that relates exactly to this issue at hand i.e. it's *not* my opinion. I consider the sources on the IRS Technical Plans Staff I dealt with to be definitive on this issue under the old prop. regs.

2. However, under the new final regs released in 2002, Reg. § 1.401(a)(9)-4, A-5© certainly does call into question whether the final regs really mean that the "no discretion" standard is now totally irrelevant. Ms. Choate's analysis makes more "sense" to me than a strict interpretation of Reg. § 1.401(a)(9)-4, A-5© does but since she does not state any IRS interpretation to back up her case it remains only her opinion. Bottom line: we need further guidance from IRS on Reg. § 1.401(a)(9)-4, A-5©.

3. Mbozek, your statement that, "separate life expectancies can only be established if the IRA owner designated a separate account for each beneficiary in the IRA beneficiary designation" is what I used to think after reading PLR 199903050 (old prop. regs):

"... Because the separation of plan benefits among Trusts A, B, and C occurred under the terms of Trust M rather than under the beneficiary designation form, the determination of Individual A's designated beneficiary can not be done on a separate account basis. Therefore, there were no separate accounts as of Individual A's death. Thus, all beneficiaries of the trusts created under Trust M must be considered in determining the applicable distribution period, because the general rule under Q&A H-2(a) applies." (PLR 199903050).

But after talking to the IRA technical staff in 2002 (indeed the person who I'm pretty sure wrote PLR 199903050) I was assured that this is basically a "safe harbor" type of standard under the old prop. regs. If the design. bene's are instead in the trust then the key standard becomes trustee discretion on the allocation of plan benefits. Which of course makes perfect sense. In that case the trust is merely acting as an "administrative conduit" (i.e. no economic difference if the bene's are on the plan bene form or in the trust identified on the plan bene. form.)

So that's a brief history of what the old prop. regs really mean. I would not be at all surprised that some people at the IRS would not be aware of this "trustee discretion standard". In fact, I suspect that whomever wrote Reg. § 1.401(a)(9)-4, A-5© may very well have not been aware that this changes an established IRS interpretation under the old prop. regs. That's what happens when an IRS interpretation of the regs by one IRS department is not actually codified in the old prop. regs by another IRS department. Disappointing perhaps, but not surprising.

Strict Interpretation Leads to Perverse Results:

1. Re-determination of Designated Bene's.

Indeed, if the IRS held to the "strict standard" under Reg. § 1.401(a)(9)-4, A-5© previous bene's who HAD separate accounts under the OLD prop. regs. may no longer have separate accounts after the 1/1/2003 date because of the "re-determination" of design. bene's clause in the Final MRD regs. Did the IRS think that through before Reg. § 1.401(a)(9)-4, A-5©? Probably not. So on 12/31/2002 you may have had separate accounts but on 1/1/2003 those same "separate accounts" may not be so separate!

2. There are other perverse effects from a strict interpretation. If there are three bene's but the trust only mandates that two bene's receive plan benefits w/o trustee discretion is it really logical to have all three considered for the life expectancy. What is the difference if you had a plan bene form with a bene with a 0% allocation along with the other two X% bene's? Would you count that 0% bene also for LE purposes? If not, then why would we make a distinction when it involves a trust?

3. Spousal Rollover Logic; Follow the Money:

Furthermore, the strict interpretation contradicts existing standards. IRS has said a "no discretion standard" still holds for spousal rollover purposes.

For example, assume funding trust on bene form, separates into maritial and family trusts at DOD, IRA benefit split without trustee discretion into marital and family trusts, spouse unlimited right to withdraw benefits from marital trust.

Spousal Rollover Purposes:

IRS would rule that the bene of the marital would have right to rollover marital trusts share to her IRA. Spouse allowed because the IRS deems the benefit to have come directly from the IRA *not* from the trust. That was the IRS's interpretation under 402© w/ the old prop. regs and- I've been assured by the IRS- the new final MRD regs change nothing in this regard.

MRD Purposes:

However, under the same senario under a strict Reg. § 1.401(a)(9)-4, A-5© interpretation the IRS would rule the bene's of the family trust (and the Maritial Trust for that matter) would receive the IRA's benefits from the family trust as opposed to deeming the benefit coming from the IRA itself. Contradiction!. Two subtrusts, same facts, different IRS conclusions. Yes, I know the IRS can come back and say the spousal rollover is not a MRD ruling but a ruling under 402© (?). But come on! Were talking about a basic issue here: where does the IRS deem the IRA benefit as coming from the decedent's IRA or the Trust/subtrust.

I think it's a pretty clear contradiction for the IRS to say on the one hand for spousal rollover purposes the assets come from the IRA/plan but for MRD purposes were going to rule that it came from the trust. That just makes no sense. If the spouse withdraws $1 from sps's maritial trust did it come from the trust or the decedent's IRA? In effect, a strict interpretation of A-5© is saying "where the $1 comes from depends on where you put that $1 in the future". If sps. puts it into the sps. IRA (rollover) it came from the decedent's IRA but if sps doesn't rollover then sps. is a bene and treating the $1 as a distribution and the IRS deems the $1 to have come from the subtrust. Again, this makes no sense.

Conclusion: A Way Out?

The IRS OLD PROP REG interpretation of separate accounts w/ a trust had *no* such internal contradictions, no perverse conclusions. That interpretation did not try to to make disctinctions where there were no effective differences (ie between a bene's on the plan and bene's in the trusts w/o trustee discretion).

A strict interpretation of Reg. § 1.401(a)(9)-4, A-5© seems to create more problems than it solves. A simple solution would be to treat this issue like spousal rollovers when a trust is on the bene form. Generally, the Reg's says no rollover or in our case no separate accounts when a trust is involved. But the IRS (via PLR's) has consistently made an exception to the general rule regarding sps. rollovers when the trust acts like an adminstrative conduit (ie when no trustee discretion). I see no reason why the final MRD regs couldn't be interpreted the same way. Again, this is only my opinion on what the IRS could/should do. Nothing more.

If you agree or disagree with this analysis I'd love to hear from you. But, please, if you give your analysis please note what you are basing it on (ie Regs, PLR #?, personal communication w/ IRS staff, personal opinion, etc.).

[mbozek]

I dont know anything more than the final regs. Perhaps you should contact Majorie Hoffman, the IRS attorney responsbile for drafting the MRD regs for her opinion.