Question About Who Can Be A Trustee

[Guest Grumpy456]

A sole proprietor client of mine wants to set up a plan--the only participant will be himself (he doesn't employ any common law employees). His attorney (non-ERISA) questions whether he can be the grantor of the plan's trust, the sole trustee and the sole beneficiary. Isn't this a common situation for a sole proprietor. I may not get this all exactly right, but the client's attorney says that if the sole proprietor is the sole trustee and the sole beneficiary that there is a merger of legal and equitable title and the trust evaporates. Does anyone know whether he is right and, if he is, how I should set up the plan? Thanks!

[jpod]

Under the facts as you have described them, ERISA is inapplicable, so the ERISA "trust" requirement does not apply, and under the IRC it is sufficient if there is a bank or other IRS-approved institution as the custodian.

If you don't have a qualifying custodian, you need a trust. I think the attorney is correct. I believe that there is an old IRS ruling or other guidance that confirms the "merger" analysis in the context of an IRC section 501(a) trust. The solution I have used is to make the spouse the trustee.

[Guest Grumpy456]

Is the conclusion the same if the plan sponsor is a corporation that is owned 100% by an individual who will be the sole trustee and the sole plan participant?

[rcline46]

"Grantor" is a red herring, not applicable in a qualified plan. To my knowledge, under the qualified plan rules, the IRS has never challenged a sole prop or partners in a partnership acting as trustees of a qualified plan, and being the beneficiaries.

Never use an attorney who does not do ERISA work to render un-written opinions on ERISA/Qualified plan items.

[Guest Grumpy456]

The issue the attorney raised, if I understand it, had only to do with the sole proprietor being the sole trustee (the individual who legally owns the trust assets) and being the sole beneficiary (the individual for whom the trust holds assets). I may get this wrong, but the trustee holds legal title to the trust's assets while the beneficiary holds equitable title to the trusts assets. The purpose of the trust is to separate legal from equitable title. If the same person ends up owning legal and equitable title, title, the attorney says, "merges" and the trust no longer exists by law. My problem is that I think all sorts of sole properietors or 100% corporate owners set up plans for themselves all the time and likely appoint themselves as trustee and are the plan's sole participant. I see the attorney's point, I think, but don't know how to reconcile it with my experience.

[Bird]

You're right, it's done like that all the time and is not a problem. I'm not sure I can explain it but rcline's answer is probably best. The attorney is extrapolating a concept that simply doesn't apply in this case.

[K2retire]

It is legally possible and no problem -- until the sole trustee, sole participant, employer becomes incapacitated or dies. Perhaps that is what the attorney meant.

[Peter Gulia]

There might be many reasons for a lawyer to give the advice or suggestion that he or she talks about; and to those of us who weren’t in a conversation the reasoning might not be discernible.

All of the posters mention a practical observation: that the IRS (and EBSA, if a plan is ERISA-governed) might exercise some discretion not to challenge a way of managing a retirement plan that’s common and sometimes practically necessary. But beyond this, there might be some legal reasoning for why a “one-man show” doesn’t result in an invalid trust.

The doctrine about a merger of legal and equitable interests might undo a trust if the would-be trustee owns ALL of the would-be trust’s beneficial interests. Restatement (Third) of Trusts §§ 2, 6, 25, 69; Uniform Trust Code § 402(a)(5). A comment to the Uniform Law Commission’s Uniform Trust Code makes clear the ULC’s view that “[t]he doctrine of merger is properly applicable only if all beneficial interests, both life interests and remainders, are vested in the same person[.]” The above-cited Restatement, which states the American Law Institute’s view of the common law of trusts, recognizes that a provision for a remainder beneficiary (other than the one person’s estate) makes a trust one in which not all beneficial interests belong to the same person. Further, a comment in another Restatement suggests ALI’s view that a settlor’s power to revoke a trust (and thus undo a remainder beneficiary’s expectancy) does not by itself result in a trust-defeating merger of legal and equitable titles. Restatement (Third) of Property: Wills and Other Donative Transfers § 7.1, comment b (2003).

Of course, these sources are general, and a lawyer should consider the statutes and court decisions of each relevant State. This caution matters because, as the ULC comment observed, “[t]he doctrine of merger has been inappropriately applied by the courts in some jurisdictions to invalidate self-declarations of trust in which the settlor is the sole life beneficiary but other persons are designated as beneficiaries of the remainder.” Although the Uniform Law Commissioners might have found that some courts’ decisions were wrong, such a decision might be a relevant persuasive authority, or even a controlling precedent, for the law of a particular State.

If merely naming a remainder beneficiary is good enough to sustain a revocable trust, it ought to be enough for the kind of irrevocable trust needed to support a § 401(a) retirement plan.

A plan and trust creator who wants to be sure should get a lawyer’s written advice.

[Bird]

good grief

[Guest Sieve]

Rule against perpetuities, anyone?

The rule used to be that the trust had to be valid under state law (except for the necessity to have a corpus). Anyone know if that's still the rule, or does the IRS not care any longer?

[K2retire]

Rule against perpetuities, anyone?

No idea if it's still true, but just the mention of the term is giving me flashbacks!

[Peter Gulia]

Beyond caring about Federal income tax treatment, a business owner establishing his or her retirement plan might have other reasons to be careful about the plan's trust. Defending an exclusion, exemption, or other protection under bankruptcy law or other law about protection from one's creditors might turn on whether the plan and its trust meet all tax-qualification requirements or whether the plan's and trust's anti-alienation or spendthrift provisions are valid. Whether the plan's trust is valid under the non-tax law that governs the trust can matter for those protections.