IRA Beneficiary Designations, Division, and Trustee Discretion: Clarity or Confusion?

Analyzing PLR 202506004

Table of Contents

1. Intro

2. Background

3. PLR 202506004 – Facts

4. IRS Rulings and (Limited) Analysis

5. Key Takeaways, and Application of New Rules

6. Bonus Materials

Intro

One of the most impactful recent determinations in retirement asset planning – PLR 202506004 – was released last month. Unfortunately its utility is limited, especially due to the application of old pre-SECURE Act rules. Nonetheless, it serves as a great illustration of some principles that often pop up in the planning and administration of trusts and estates.

In July 2024, long-awaited Treasury Regulations revising the rules on see-through trusts and other issues based on the changes of the SECURE Act 1.0 and 2.0 were finalized. In many cases, these final rules provided clarity while, in other cases, they left certain questions open. As has long been the case for trusts that are the beneficiaries of qualified plans and individual retirement accounts, IRS written determinations often imperfectly color between the lines (while having limited utility as authority).

We will discuss some of the new principles and outcomes below, as contrasted with PLR 202506004. The foundational material is free for all readers, but the analysis of the Ruling itself and bonus materials are reserved for paid subscribers.

(As a subscriber bonus, I have provided some slides on the new regulations at the bottom of this article – click here to access the slides.)

Background

Many of the updated rules concern the determination of required minimum distributions after the death of a plan participant. These distributions, in many cases, use the life expectancy of an individual beneficiary. Since entities (like non-see-through trusts, estates, and charities) don’t have a finite life expectancy, they get shoehorned into a 5-year lump sum payout if a participant dies before their required beginning date, or annual distributions as if the participant was still alive (based on the participant’s “ghost” life expectancy) if the participant dies after their required beginning date. In situations where individuals are beneficiaries of ongoing trusts, so long as certain requirements are met, the life expectancy of (typically the oldest) identifiable individual beneficiary can be used to create a 10-year lump sum distribution or life expectancy distributions in lieu of the 5-year/ghost life expectancy rules that would otherwise apply to an entity like a trust.

One area not expressly resolved by the new or old rules, however, is the treatment for retirement assets where the estate or trust acts as more of a collection mechanism for retirement assets – whether there are to be outright distributions of the residuary, or specific (preferably non-pecuniary) distributions, to individuals at the end of the administration period. In such a situation, if an estate or trust is the beneficiary of retirement assets, it is routine to request that the individual residuary beneficiaries, instead of the estate or trust itself, be treated as the beneficiary, in order to preserve a payout period for required minimum distributions based on the rules that apply to individuals instead of entities. Many private letter rulings have approved this treatment, but it is not expressly called out in the new or old rules (outside of some new separate account rules, to be discussed below, supporting this outcome based on stringent requirements).

This outcome, often known as a “bypass” or “drop-down” request, often requires coordination with a custodian or plan administrator who may or may not request a court order or IRS written determination. While this outcome has become routine enough by repetition so as to not always require a safety ruling from the IRS in theory, it may not function as well in situations where both charitable organizations and individuals hold a share of the residuary or receive specific distributions.

Rewinding a bit, we must ask why we might name the estate or trust as a beneficiary instead of naming individuals themselves. The typical answer is administrative flexibility. It tends to be a lot easier to amend a revocable trust or a will, for example, than to create complex beneficiary designations and/or change such beneficiary designations if and when an update to the estate plan occurs. Of course, this runs headlong into the desire to maximize income tax deferral. While the SECURE Act 1.0 itself reduced some of this potential deferral, it still on balance prevented the worst-case scenario – application of the 5-year rule or ghost life expectancy. If, however, an estate or trust is named as beneficiary and provides outright distributions to residuary beneficiaries, the burden of keeping administration open for 5+ years can be too steep a trade-off for this tax deferral depending on the scope of retirement assets involved.

This also raises an issue where, for example, there are specific pecuniary bequests instead of residuary shares – the former of which is expressed as a dollar amount, while the latter is usually expressed as a percent or fraction. Retirement assets are typically treated as income in respect of a decedent, governed by IRC Section 691, if and when received by a beneficiary. But, could the drop-down or bypass request create an issue when made in satisfaction of a pecuniary bequest?

Such was the case in CCA 200644020, in which the creation of a separate IRA share in the name of charitable beneficiaries in satisfaction of a pecuniary amount in a revocable trust was treated as acceleration of IRC under the principles of IRC Section 691(a)(2) and Kenan v. Commissioner, 114 F.2d 217 (2d Cir. 1940). Since the revocable trust was named as beneficiary to begin with, this resulted in taxation of the revocable trust in full on the IRA balance on accelerated IRD. While some thought leaders have questioned the viability of this position by the IRS Office of Chief Counsel (especially because this Memorandum does not address the effect of Treas. Reg. 1.691(a)-4(b)(2), to be discussed below), the safe play suggests avoiding this outcome. One way to avoid this issue in general (acceleration of income or gain when satisfying pecuniary bequests with non-cash assets) is by using percent or fractional shares, instead of pecuniary (dollar) amounts.

Of course, one must question whether the revocable trust itself might have been able to receive an income tax deduction for a charitable contribution in this case. In most cases, an estate or trust has different rules for an income tax charitable deduction than for individuals under IRC Section 642(c). This Code Section allows for a deduction to the trust or estate for income allocated to charity, so long as the governing instrument permits trust income to be applied for charitable purposes. Generally, if this requirement is met, the trust can take a deduction for up to 100% of its gross income – unlike an individual. But, there are some exceptions where IRC Section 170 (which applies to individuals) might instead apply to a trust – such as contributions to taxable private foundations under IRC Section 642(c)(6) or where the income so contributed is treated as “unrelated business income” under IRC Section 681.

In the Chief Counsel Memorandum above, the revocable trust was denied a deduction for the accelerated IRD under IRC Section 642(c) because the terms of the trust did not direct or require the trustee to satisfy the pecuniary charitable legacies from gross income (thus failing the authorization by governing instrument requirement). Notably, the trustee did have the authority to satisfy any division or distribution of principal in cash or in kind, but this power did not extend to income. The trust did not take the cash out of the IRA and then distribute it to the charitable organizations, but it was taxed as if it had – and it’s not likely that this would have made a difference due to the lack of express authority to satisfy the charitable legacies from gross income in general.

Some, but not all, of these issues were on display in a recent Private Letter Ruling – 202506004 – which refined some of these questions while also examining a “drop-down” or “bypass” for non-charitable beneficiaries of a trust as weighed against a trust’s withdrawal from retirement accounts to pay charitable beneficiaries in cash.

PLR 202506004 – Facts