Estate Planning for Retirement Benefits

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The Northwestern Mutual Life Insurance Company – Milwaukee, WI

Estate Planning for

Retirement Benefits



Estate Planning

Making certain property is distributed after

death according to the owner’s wishes

Minimizing estate and income taxes

Taking into account

– Specific needs of beneficiaries

– Need for flexibility to adjust to changing




Special issues specific to “qualified assets”:

Income in respect of a decedent (IRD):

– Impact of both income and estate tax – Minimum distribution requirements and

potential conflicts with planning objectives

– Retirement assets pass by beneficiary

designation; many other assets pass by will

– Retirement assets can offer long-term income


Stretch Concept

“Stretch IRA”

Qualified assets subject to income tax, but not

until distributed!

What happens until they are distributed?

– Continued tax-deferred growth – Or, tax-free in a Roth account

Logical conclusion: let the assets grow!

IRS says “not so fast”– you have to at least


Stretch Concept

“Stretch” = make the IRA last as long as

possible, take out only the minimum

Youngest beneficiaries receive the most

dramatic benefit –amount received over their

lifetime can be several times the initial

account value inherited, depending on growth

rate (assuming life expectancy fraction payout

method is used)

Use of trust can help assure the IRA remains


Stretch Concept

“Stretch” requirements

Designated beneficiary status

– Named as beneficiary

– Taking under ERISA plan terms, such as spouse

Trust – special requirements

Individual beneficiary: not estate or charity

• Big picture: long-term tax deferred growth can be a powerful

wealth transfer tool

• Liquidity provided by an income tax free death benefit can help


Required Minimum Distributions

Individual beneficiaries

– Nonspouse

• Single life payout

• Deadline for election

• 5-year rule or “ghost” life expectancy

– Spouse

• Rollover option

• Uniform lifetime table

• Maximum permitted delay


Required Minimum Distributions

Charitable beneficiaries

– Tax efficient planning

– Impact of charitable beneficiary on “designated

beneficiary” status of other beneficiaries

– September 30 beneficiary determination date

Estate beneficiaries

– No “look-through” – No life expectancy


Required Minimum Distributions

Planning objectives

– Make beneficiary designations that optimize

achievement of client’s goals

– Use the longest permitted measuring life so

that income tax deferral or income tax-free growth is maximized

– Avoid potential exposure to 50% penalty

– Recognize the interaction (conflicts) between


Marital Planning

Number one IRA or QP beneficiary: spouse

Objective: qualify for the unlimited marital


Four ways (if U.S. citizen)

– Leave assets to spouse outright by naming

spouse as beneficiary

– Name a general power marital trust as



Marital planning

Easiest: assets to surviving spouse outright by

naming spouse as beneficiary

– Income tax advantages (versus trust) – Simplicity

Rollover dilemma for younger spouse

– Decision of whether to maximize stretch by rolling

over to spouse’s own IRA

• Alternative 1: leave funds in inherited IRA, start taking

RMDs until age 59½

• Alternative 2: roll over; hope funds are not needed • Alternative 3: prevent dilemma with life insurance


Marital planning

General power marital trust as beneficiary

– General power marital trust requirements:

• Surviving spouse must be entitled to all the income from the trust

• The spouse must be entitled to appoint the property to the himself or herself, or his or her estate, and • No other person can have the power to appoint the

property to someone other than the spouse


Marital Planning

• General Power Marital Trust as beneficiary

– Note that certain plans require spousal consent to name

beneficiary other than spouse

– Disadvantages of naming marital trust as beneficiary

• No ability to delay distributions until decedent would have reached age 70½

• Unless benefit is rolled over to surviving spouse’s own IRA (outside of trust), payouts use single life table (less deferral)

– Surviving spouse might not lose ability to make rollover of

withdrawals in excess of RMDs;


Marital Planning

Qualified terminable interest property (QTIP)

trust as beneficiary

– Allows account owner/participant to limit

surviving spouse’s access to principal, direct it to children or other heirs

• Spouse can be given any degree of access to principal or no access

• Spouse can be given limited power to appoint principal at death, or not

• Typically used to assure that children from a


Marital Planning

Requirements for QTIP treatment:

– Spouse must be entitled to all the income from

the trust, payable at least annually,

– No other person can have the power to appoint

the property to anyone other than the spouse during the spouse’s lifetime, and

– Executor must irrevocably elect QTIP treatment


Marital Planning

QTIP trust requirement: “Entitled to All


– Trust terms should entitle the spouse to both

the trust's and the plan's income annually

– Easiest way to satisfy is for trustee to calculate

the "income" of the both trust and the IRA

– Trustee then withdraws from the IRA the greater

of its “income” or the RMD amount


Marital Planning

QTIP trust requirement: “Entitled to All Income”

– Determination of “income” under state law varies – IRS has approved use of unitrust amount (generally

3% to 5%)

– IRS approves of “traditional” method

– IRS disapproves of “10% rule” where 90% of RMD

amount is allocated to principal/10% to income.

Note that some trusts/state statutes define income in this manner. Might not qualify for marital


Marital Planning

QTIP Trust as beneficiary: Disadvantages

– Complexity: defining income, reconciling

“income” with RMDs

– Might not accomplish goals if surviving spouse

is near age of children.

– Perhaps acquire life insurance instead for


Marital planning

Pecuniary Formula Marital Bequests

– What is this?

– Participant’s will designates a specific dollar

amount to go to the marital and credit shelter trust

– Executor allocates IRA to the trust in satisfaction of

the bequest

– Potential taxation at the estate level on the IRA or

plan proceeds

• Some PLRs have allowed spousal rollover in these circumstances


Marital planning

Noncitizen Spouse

Deferred estate tax treatment available only

for assets passing to qualified domestic

trust (QDOT), unless modified by estate tax


Designed to prevent noncitizen surviving

spouse from taking assets outside the U.S.,

escaping transfer taxes

QDOT must meet other requirements for


Marital Planning

Additional requirements for QDOT trusts:

• Trustee should be a U.S. domestic corporation; • No distributions of principal permitted without

withholding of estate tax

• Trust must be maintained and administered under

the laws of a state or the District of Columbia.

• Bonding requirements and limitations on the


Marital Planning

QDOT practical issues:

– QDOT can be named as beneficiary, or

nonspouse beneficiary can have one created and roll over assets to it

– QDOT can also be structured as an IRA if

maintained at a financial institution

– Requirement that no principal be distributed;

deferred estate tax owed if RMD amount exceeds trust “income”

– Determination of “income” subject to same


Marital Planning

Dealing With the QDOT requirements:

Participant could leave the retirement

assets to other beneficiaries and purchase

life insurance in an ILIT to benefit the

noncitizen spouse;

Participant could forego the marital

deduction and have executor pay the estate

tax at the first death;

Roth conversion could allow surviving


Marital Planning

Rollovers by Noncitizen

Rollover to a plan in another country is a

taxable distribution (10% penalty might also

apply) unless authorized by a tax treaty

Tax treaty might allow noncitizen to leave

funds in existing plan but have them taxed

upon withdrawal only in the other country

Money from other countries typically cannot


Planning Issues for Trusts

Other trust planning issues:

“Look-through” trust requirements

Credit shelter trust as beneficiary

Special needs trust


Planning Issues for Trusts

Trust beneficiaries

– Requirements for “look-through” treatment

• All beneficiaries are individuals • Valid under state law

• Documentation requirement • Trust must be irrevocable

• Beneficiaries must be identifiable

– Which beneficiaries “count” for purposes of


Planning Issues for Trusts

Conduit trust: Income/RMDs paid out to

beneficiaries each year:

– Only “Primary beneficiaries” counted

– Example: to my children with remainder to my

grandchildren – children are only ones counted.

Accumulation trust: income/RMDs can be held

in trust instead of distributed

– All beneficiaries counted

– Example: to my children with remainder to my


Planning Issues for Trusts

• Special Needs Trust

– Normally an accumulation trust: trustee has complete

discretion to retain assets or make distributions

• Result is that all beneficiaries counted: individual with

special needs, as well as any remainder beneficiaries

– Negative results if remainder beneficiary is an estate or

charity: no designated beneficiary status; faster payout, taxed at trust’s income tax rates

– Planning strategy: if funding special needs trust with

qualified assets, remainder beneficiaries need to be individuals near same age for optimal tax results

• Alternative: fund special needs trust with life insurance,


Planning Issues for Trusts

Credit Shelter Trust as beneficiary

– Most basic planning strategy for individuals

potentially subject to estate tax

– All other trust requirements discussed previously


– If no other assets available, credit shelter trust

useful to protect retirement assets from estate tax

• Retirement and other IRD assets are a “wasting asset” • Some of credit shelter is used up by income tax liabilities

and RMDs


Planning Issues for Trusts

Credit shelter trust as beneficiary:

If spouse is beneficiary of credit shelter trust,

consider trade-offs

– Credit shelter trust saves estate tax but at the cost

of short-term flexibility for the surviving spouse

– Trust as beneficiary triggers other disadvantages --

requirements for designated beneficiary status, potentially higher income taxes

• Alternative strategy: name surviving spouse as


Planning Issues for Trusts

Multiple beneficiaries

General rule: use shortest life expectancy –

i.e., life expectancy of oldest beneficiary

– Bad deal if one much older beneficiary and

others are younger – payout to younger

beneficiaries is much faster, much less long-term growth.

– Multiple beneficiaries taking through one trust


Planning Issues for Trusts

Example: Tom is widowed, has a $3 million IRA. His will names his sister Joan, age 59 as guardian for his two

children, Dan (8) and Ann (21). Tom names Joan, Dan and Ann as outright beneficiaries of his IRA.

First year payout if they can establish separate accounts and receive payouts over their life expectancies (i.e., they are not taking through a trust):


Planning Issues for Trusts

Example (cont’d): If Tom named a trust instead

of naming Joan, Dan and Ann individually.

– Result: now all three must take distributions based

on Joan’s life expectancy

Potential solutions:

– Separate trusts, where each is a named beneficiary – One master trusts with multiple “little” trusts that

are each an IRA/plan beneficiary

– Separate IRAs

– Disclaimer or payout to Joan before September 30


Income Tax Issues

Income in respect of a decedent (IRD)

– Definition: income to which decedent was

entitled but had not yet been taxed

– No stepped up basis

– Subject to income tax as all ordinary income – Taxed only when distributed – thus, “stretch”


Income Tax Issues

• Income tax deduction for beneficiary; available for

estate tax paid on IRD (IRC Sec. 691(c))

• Designed to mitigate impact of double taxation • Calculates how much of estate tax was

attributable to IRD assets, then each person


Income Tax Issues

IRD Deduction

• Example: Julie dies in 2011 leaving $1 million IRA and $5 million of other assets. Assume that the amount of federal estate tax attributable to the IRA is $350,000.

• If Julie’s two children are equal beneficiaries of the IRA, each receives a 691(c) deduction in the amount of



Income Tax Issues

Charitable beneficiary:

– Advantage: Very efficient tax planning tool, since

charity does not pay income tax; full amount of plan balance benefits the charity.

– Advantage: IRA going to charity escapes estate tax

due to estate tax charitable deduction.

– Disadvantage: Existence of a charity as a

beneficiary at the beneficiary determination date (September 30 of year after death) means that no beneficiaries have “designated beneficiary” status.

– Result: if charity is one of multiple beneficiaries,


Income Tax Issues

Charitable beneficiary of retirement assets


– Name charity as one of several beneficiaries

• Beneficiary of a specified fraction

• Beneficiary of a specified dollar amount

– Name a trust as beneficiary and provide for a

charity as beneficiary of some portion of the trust

– Name a trust as beneficiary and a charity as a

remainder beneficiary


Income Tax Issues

Method: Name charity as one of multiple

beneficiaries of IRA

• Beneficiary of a specified fraction: OK idea -- allows for separate account treatment and possible payoff of charity before beneficiary determination date

– Example: 20% to the Boy Scouts of America

• Beneficiary of a specified dollar amount: bad idea -- more difficult to create a separate account for the charitable gift under the separate account rules.


Income Tax Issues

Method: Name a trust as beneficiary and

provide for a charity as beneficiary of some

portion of the trust

– Bad idea: use of qualified assets to satisfy


Income Tax Issues

Method: Name a trust as beneficiary and a

charity as a remainder beneficiary

– OK so long as trust is a conduit trust and does

not accumulate distributions.

– Bad idea if trust is an accumulation trust: trust


Income Tax Issues

Method: Name a trust as beneficiary of a

fractional share of the account and a charity

as beneficiary of another fractional share

– OK idea: just need make sure separate


Income Tax Issues

Method: Name charity as the sole

beneficiary of IRA or plan

– Best idea for larger charitable bequests

– Avoids issue of charity potentially disqualifying

other beneficiaries from designated beneficiary status

• For smaller bequests, consider use of will (and


After Death

“Clean-up” Strategies: After IRA owner/plan participant has died

• Distributions to “undesirable” beneficiaries prior to

September 30 of year after death

– Can remedy existence of older or charitable beneficiaries,

especially where separate accounts not available

• Qualified disclaimer: refusal to accept an inheritance

– Allows IRA or qualified plan benefit to go to contingent


– Does not constitute a gift by disclaimant

– Useful when one of multiple beneficiaries is much older or


After Death

Requirements for qualified disclaimer

– Must be in writing

– For qualified assets: must be received by

Executor and/or plan trustee or account custodian by 9 months after date of death


After Death

Requirements for qualified disclaimer


– Person disclaiming cannot have accepted the

interest or any of its benefits

• Acceptance of RMD for decedent’s year of death does not constitute acceptance of the entire plan • Partial disclaimer might be possible even if


After Death

Requirements for qualified disclaimer


– Interest must pass without any direction on the

part of the person disclaiming

– Property must pass to someone other than the


After Death

Separate accounts

– Requires pro rata allocation of post-death

gains, losses, contributions and forfeitures among beneficiaries

– Allows each outright beneficiary to use own life

expectancy (if not taking through a trust) if established by 12/31 of year after death

– Deadline of 12/31 applies only for purposes of


After Death

Separate accounts

– If deadline is not met, separate accounts can

still be established but oldest beneficiary’s life expectancy will be the measuring life

– Separate accounts allow beneficiaries to

choose different investments, avoid interacting, etc.

– Might result in each beneficiary being


After Death

Rollover by surviving spouse

– Allows spouse to treat IRA or plan account as

his/her own; delay distributions

– Spouse can also leave account intact and

receive RMDs beginning in year after death or when decedent would have reached 70 ½

– Spouse can convert to a Roth account:

• Compelling long-term “stretch” wealth transfer strategy


After Death

“Rollover” (direct transfer) by nonspouse


– Qualified plan assets can be “rolled over” to

inherited IRA titled in decedent’s name for benefit of beneficiary

– Requires direct transfer, no 60-day rollover – IRA assets can be retitled in same manner – Nonspouse beneficiary has option to convert

qualified plan account to an inherited Roth account

Nonspouse cannot convert an inherited IRA to a


After Death

Qualified Plan 5-year “trap”

– Nonspouse beneficiary of qualified plan might

have 5 years under plan to decide how to receive funds

– However, choice of a life expectancy payout

must be made by December 31 of the year after death

– Nonspouse beneficiary who waits longer than

the December 31 deadline can still make a


After Death

Qualified Plan 5-year “trap”

– Spouse beneficiary who does not roll over to

his/her own IRA could normally wait until decedent would have been 70 ½

– If funds left in plan, default could make the

entire account become an RMD in 5th year after


– Surviving spouse would no longer have ability to


After Death

Net Unrealized Appreciation

– Special treatment available if decedent’s qualified

plan account held appreciated employer stock

– During decedent’s lifetime: could take distribution

of stock as part of lump sum distribution, be taxed only on basis, defer income tax on gain until sold.

– Executor can make NUA election

– Beneficiary receives the same treatment, provided

he takes a lump sum distribution of the benefit.

– Note that NUA opportunity lost if benefit is


After Death

4 Critical after-death deadlines:

– Qualified disclaimer deadline: 9 months after

date of death

– Beneficiary determination date: September 30

of year after death

– Trust documentation deadline: October 31 of

year after death

– Deadline for creating separate accounts and for


Circular 230 Statement: These teaching materials:

do not constitute legal or tax advice; are not

intended to (and cannot) be used to avoid tax




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