IRA Drop-Down or Bypass Requests: New and Proposed Rules

Possible clarity in one area opens up additional confusion in others

Table of Contents

1. A Hypothetical

2. The Old Framework

3. New Rules for Trusts

4. Is a Revocable Trust a See-Through Trust?

5. Proposed Rules on Subaccounts for Trusts

6. Key Takeaways

A Hypothetical

Jim, a single individual, has three children. His revocable trust is the named beneficiary of Jim’s IRA, worth $1,500,000. Jim’s revocable trust provides that after payment of expenses and taxes, the remaining assets will be divided into separate equal shares for his children. Each child’s share will be distributed outright, directly to the child.

What payout period will apply to Jim’s IRA?

The Old Framework

In this article, we will compare and contrast how this question has traditionally been answered to how it might now be answered. For some technical background on this issue, please see this article on PLR 202506004 where we analyze a mix of charitable and non-charitable beneficiaries receiving various outright bequests in a similar situation – where the revocable trust itself was named as beneficiary of an IRA.

To recap, the outcome for the non-charitable beneficiaries in this PLR was the creation of a separate IRA share for each by trustee-to-trustee transfer (as opposed to complete liquidation of the IRA at the trust level, and distribution of cash). This was advantageous, as it shifted and deferred income taxation of the IRA to the individual non-charitable beneficiaries. The question, however, was when these IRA distributions must be received by each beneficiary under the required minimum distribution rules of IRC Section 401(a)(9).

Technical Sidebar: Where trusts are named as affirmative or default beneficiaries of an IRA or qualified retirement plan – each of which we will call an “IRA” for the sake of simplicity and flow in this article – the default payout period for IRA distributions depends on whether the trust qualifies as a “see-through trust,” now as defined in Treas. Reg. 1.401(a)(9)-4(f)(1). If a trust is not a see-through trust, it is treated like any other entity like an estate or trust that does not die a natural “death” like an individual. For IRAs, deferral of distributions is limited for an entity using one of the following rules of IRC Section 401(a)(9)(B) so as to avoid perpetual income tax deferral:

• If the decedent who contributed to the IRA, who we will call a “participant,” died before their required beginning date, then the IRA must be distributed to the trust within 5 years of the decedent’s death – as a lump sum not later than December 31 of the year containing the 5^th anniversary of the decedent’s death (the “5-year rule”).

• If the participant died on or after their required beginning date, then the beneficiaries step into the participant’s shoes and must continue to receive IRA distributions at least as rapidly as the decedent was receiving then, over the decedent’s remaining “ghost” life expectancy (the “ghost life expectancy rule”).

These graphics illustrate these principles:

Long story short, since the revocable trust in PLR 202506004 had a charity as a beneficiary, the trust was not treated as a see-through trust under the old rules (i.e., the trust was not a “designated beneficiary”). The outcome was that the payout to each individual IRA carved off for non-charitable beneficiaries made payouts based on the ghost life expectancy rule, since the participant had died after their required beginning date.

Which brings us back to our original question. In such a situation where the revocable trust (or perhaps even an estate) has only a temporary existence as a parking lot to collect assets before distributing them outright to remainder beneficiaries, is there any way we can “ignore” the trust and treat the residuary beneficiaries as if they were direct beneficiaries of the IRA? If so, from there we could further determine at the individual beneficiary level whether each is, for example, a designated beneficiary or eligible designated beneficiary. We will not cover the rules relating to these classifications in this article, however, so as to keep focus on the original hypothetical posed above.

New Rules for Trusts