2013 Advanced Elder Law Review: November 5-6 | Washington, DC
2013 Advanced Elder Law Review: November 5-6 | Washington, DC
Complex Planning with IRAs
Materials Prepared by:
Stephen C. Hartnett, J.D., LL.M. (in Taxation);
Dennis Sandoval, CELA
Updated and Presented by:
Bradley J. Frigon, JD, LLM, CELA, CAP
Overview of Retirement Assets
• What are Retirement Assets?
– Individual Retirement Accounts (IRAs)
– SEP-IRAs / Simple Plans / Keoghs
– 403(b) Plan
– 457 Plan
– Qualified Plans
• Money Purchase
• Profit Sharing
• 401(k) Plan
Overview of Retirement Assets
• Income in Respect of a Decedent (IRD)
– No step-up in basis under IRC § 1014.
– Taxed to beneficiary as ordinary income
when distributed from a retirement plan.
• Most heavily taxed assets, with double or
triple taxation possible: Income, Estate,
GST.
Income Tax Objective: Defer Income
Tax as Long as Possible
• The typical income tax objective
with respect to retirement accounts
is to defer and to reduce the amount
of distributions as much as possible
in order to generate investment
income on the deferred income
taxes.
Income Tax Objective: Defer Income Tax as
Long as Possible (cont.)
• For example, if there is $100,000 in a
traditional IRA, then if the entire account is
liquidated in a single year there could be a
combined federal and state income tax
liability of $40,000 from the taxable
distribution, leaving the individual with just
$60,000 to invest after taxes. Had the
distribution not been made, the $40,000
would remain in the IRA and would
generate investment income for
Income Tax Objective: Defer Income
Taxes as Long as Possible (cont.)
• If, instead, the IRA Owner had a
$100,000
Roth
IRA,
then
a
complete distribution would not
trigger any income tax liability
because distributions from Roth
accounts are generally tax-exempt.
Still, there is a significant cost of
Income Tax Objective: Defer Income
Taxes as Long as Possible (cont.)
• Once the $100,000 leaves the Roth
account,
the
investment
income
earned on the $100,000 is generally
taxable whereas it would have been
tax-exempt had it been earned in the
Roth account. Thus, with either a
traditional IRA or a Roth IRA, the
income tax objective is to keep the
balance at $100,000 inside the IRA
and to avoid an early distribution.
Required Beginning Date For
Account Owner
• A
participant
must
begin
taking
Required
Minimum
Distributions
(RMDs) from his retirement assets by
his Required Beginning Date or “RBD.”
The RBD is April 1
st
of the calendar year
AFTER the calendar year in which the
participant reaches age 70½.
Required Beginning Date For
Account Owner (cont.)
• There is an exception for QUALIFIED PLANS
only – if the participant is not retired at age 70½
and the participant is not a five percent or
greater owner in the business in which he or she
works, RBD can be postponed until April 1
st
of
the year after the participant actually retires.
RMDs from an IRA cannot be postponed beyond
age 70½, even if the participant is continuing to
defer distributions from the qualified plan.
Roth IRAs
• Roth
IRAs
are
exempt
from
mandatory
lifetime
distributions.
Individuals who have a Roth 401(k)
or Roth 403(b) account do not have
this advantage, but they can easily
obtain it by making a tax-free rollover
of the account to a Roth IRA.
Required Beginning Date
Bob is born on 6/30/1942. Bob turns 70 on
6/30/2012. Bob turns 70 ½ on 12/30/2012.
Bob’s RBD is 4/01/2013.
Jane is born 7/1/1942. Jane turns 70 on
7/1/2012. Jane turns age 70 ½ on 1/1/2013.
RBD is 4/1/2014.
Required Lifetime Distributions After
Age 70 ½
• General Rules – Unless you are married
to someone who is more than ten years
younger than you, there is one – and
only one- table of numbers that tells you
the portion of your IRA, 403(b) plan or
qualified retirement plan that must be
distributed to you each year after you
attain the age of 70 ½.
Required Lifetime Distributions After
Age 70 ½ (cont.)
• The only exception to this table is if (1) you
are married to a person who is more than
ten years younger than you and (2) she or
he is the only beneficiary on the account.
In that case the required amounts are even
less than the amounts shown in the table.
To be exact, the required amounts are
based on the actual joint life expectancy of
you and your younger spouse.
Required Lifetime Distributions After
Age 70 ½ (cont.)
• Two Simple Steps:
– Step 1: Find out the value of your investments in
your retirement plan account on the last day of
the preceding year. For example, on New Years
Day – look at the closing stock prices for
December 31.
– Step 2: Multiply the value of your investments by
the percentage in the table that is next to the age
that you will be at the end of this year. This is the
minimum amount that you must receive this year
to avoid a 50% penalty.
Required Lifetime Distributions After
Age 70 ½ (cont.)
• Example:
– Ann had $100,000 in her sole IRA at
the beginning of the year. By the
end of this year, she will be age 80.
She must receive at least $5,350
during the year to avoid a 50%
penalty (5.35% times $100,000).
Overview of Retirement Assets
• Uniform Table
Age RM
D
Age RM
D
Age RM
D
Age RM
D
Age RM
D
70
27.4
79
19.5
88
12.7
97
7.6
106
4.2
71
26.5
80
18.7
89
12.0
98
7.1
107
3.9
72
25.6
81
17.9
90
11.4
99
6.7
108
3.7
73
24.7
82
17.1
91
10.8 100
6.3
109
3.4
74
23.8
83
16.3
92
10.2 101
5.9
110
3.1
75
22.9
84
15.5
93
9.6
102
5.5
111
2.9
76
22.0
85
14.8
94
9.1
103
5.2
112
2.6
77
21.2
86
14.1
95
8.6
104
4.9
113
2.4
Overview of Retirement Assets
• Selected Excerpt from Joint Table
Age
s
50
51
52
53
54
55
56
57
58
70
35.1 34.3 33.4 32.6 31.8 31.1 30.3 29.5 28.8
71
35.0 34.2 33.3 32.5 31.7 30.9 30.1 29.4 28.6
72
34.9 34.1 33.2 32.4 31.6 30.8 30.0 29.2 28.4
73
34.8 34.0 33.1 32.3 31.5 30.6 29.8 29.1 28.3
74
34.8 33.9 33.0 32.2 31.4 30.5 29.7 28.9 28.1
75
34.7 33.8 33.0 32.1 31.3 30.4 29.6 28.8 28.0
76
34.6 33.8 32.9 32.0 31.2 30.3 29.5 28.7 27.9
77
34.6 33.7 32.8 32.0 31.1 30.3 29.4 28.6 27.8
78
34.5 33.6 32.8 31.9 31.0 30.2 29.3 28.5 27.7
Penalties
• Penalties
– 50% penalty for failure to take RMD.
• IRC § 4974
– 10% penalty for taking a distribution
before age 59½.
Exceptions to 10% Penalty
• Distributions due to death or disability;
• Distributions for payment of unreimbursed medical expenses
that exceed 7.5% of AGI;
• Distributions for the payment of health insurance premiums
for certain unemployed individuals;
• Distributions for the payment of qualified higher education
expenses;
• Distributions consisting of substantially equal periodic
payments;
• Distributions to a qualified first-time homebuyer; and
• Distributions due to an IRS levy on the IRA.
If you do not meet one of the above exceptions, you can avoid
paying the 10% penalty tax if you redeposit the early
distribution amount within 60 days of the distribution.
Required Distributions After Death –
Terminology (cont.)
• “Beneficiaries” versus “Designated Beneficiary”
(“DB”) – A beneficiary is any person or entity that is
entitled to receive benefits from a QRP or IRA account
after the account owner’s death. By comparison, a
designated beneficiary is an individual who is entitled
to the benefits of the IRA or QRP account upon the
death
of
the
employee/participant/IRA
owner
(hereafter “account owner”). Neither a charity nor the
decedent’s estate will qualify as a DB since neither
has a life expectancy. If certain criteria are met, a trust
may be the beneficiary of an IRA or QRP and
distributions will be based on the beneficiaries of that
trust (an “eligible trust”).
Required Distributions After Death –
Terminology (cont.)
• Determination Date – The date when the beneficiaries
must be determined is September 30 of the calendar year
that follows the calendar year of the account owner’s
death. Example: Sarah died on April 29, 2012. The
determination date for her IRA and QRP accounts will be
September 30, 2013. The minimum distributions will be
computed based only on the beneficiaries who still have
an interest on the determination date. If a beneficiary’s
interest is eliminated between the time that the account
owner died and the determination date – for example by a
cash out or a disclaimer – then that beneficiary will not
have any impact on the required minimum distributions.
Distributions at Death For Spouse
• Spouse as Beneficiary – Rollover Option
– Spouse must be sole beneficiary of IRA.
– No RMDs until age 70 ½.
– Use Uniform Table.
– Spouse can name new beneficiaries to
take IRA at death.
Spousal Rollover
• In order for the spouse to rollover the
inherited retirement assets, he or she must
be the sole beneficiary of the retirement
asset. So, if an IRA named a spouse and
child as beneficiaries, spouse would only
be the sole beneficiary of half of the IRA.
Therefore, the spouse could rollover half
of the IRA into an IRA in her name and
child could take the other half as an
inherited IRA.
Spousal Rollover (cont.)
• If the beneficiary of the retirement asset was
a trust whose sole beneficiary was the
spouse and where spouse is the trustee or
has withdrawal power over the trust assets,
then spouse could roll over the retirement
assets to an IRA in her name. If however, the
trust named spouse as income beneficiary
and
spouse
and
descendants
as
discretionary beneficiaries of principal for
health, education, maintenance and support
– then spousal rollover would not be
available.
Distributions at Death
• Spousal Inherited IRA
• Death Before RBD
– Surviving spouse can take distributions
based on his or her life expectancy, but
can delay taking distributions until the
deceased spouse would have reached
age 70 ½.
– Use Single Life Expectancy Table.
– Recalculate each year.
Distributions at Death (cont.)
• Spousal Inherited IRA
• Death After RBD
– Distributions based on the longer of
spouse’s or participant’s life expectancy.
– Can delay taking distributions until the
deceased spouse would have reached age
70 ½.
– Use Single Life Expectancy Table.
– If using spouse’s life expectancy,
recalculate each year. If using participant’s
life expectancy, then find age at date of
When Rollover is Not Recommended
• When spouse is younger than
age 59 ½.
• Second Marriage.
• Estate Tax Planning.
• Creditor and Management
Concerns.
Distributions at Death
• Inherited IRA (Beneficiary Other Than Spouse)
• Death Before RBD
– Option 1:
• Distributions
based
on
beneficiary’s
life
expectancy;
• Must take first distribution by December 31st of
year after participant’s death;
• Use Single Life Expectancy Table;
• Find age of beneficiary at date of death of the
account owner, then subtract one each year, or
• Option 2
Distributions at Death (cont.)
• Inherited IRA (Beneficiary Other Than
Spouse)
• Death After RBD
– Option 1:
• Distributions based on longer of beneficiary’s
life expectancy or the life expectancy of the
participant as of the year of death;
• Must take first distribution by December 31st of
year after participant’s death;
• Use Single Life Expectancy Table, or
– Option 2
Calculating RMDs for a Beneficiary
• If the beneficiary is 58 when the participant
dies,
the
factor
to
determine
the
beneficiary’s RMD is 27. The following
year, the beneficiary factor to calculate
RMD is 26 (27-1). If the participant was
50 when he died, the beneficiary could use
a factor of 34.2 (the participant’s factor) for
calculating RMDs.
Overview of Retirement Assets
• Single Life Expectancy Table for Inherited IRAs
Age RMD Age RMD Age RMD Age RMD Age RMD
20
63.0
29
54.3
38
45.6
47
37.0
56
28.7
21
62.1
30
53.3
39
44.6
48
36.0
57
27.9
22
61.1
31
52.4
40
43.6
49
35.1
58
27.0
23
60.1
32
51.4
41
42.7
50
34.2
59
26.1
24
59.1
33
50.4
42
41.7
51
33.3
60
25.2
25
58.2
34
49.4
43
40.7
52
32.3
61
24.4
26
57.2
35
48.5
44
39.8
53
31.4
62
23.5
27
56.2
36
47.5
45
38.8
54
30.5
63
22.7
Overview of Retirement Assets
• Single Life Expectancy Table for Inherited
IRAs
Age
RMD Age RMD Age RMD Age RMD Age RMD
65
21.0
74
14.1
83
8.6
92
4.9
101
2.7
66
20.2
75
13.4
84
8.1
93
4.6
102
2.5
67
19.4
76
12.7
85
7.6
94
4.3
103
2.3
68
18.6
77
12.1
86
7.1
95
4.1
104
2.1
69
17.8
78
11.4
87
6.7
96
3.8
105
1.9
70
17.0
79
10.8
88
6.3
97
3.6
106
1.7
71
16.3
80
10.2
89
5.9
98
3.4
107
1.5
Distributions at Death
• Proper Titling for Inherited IRA
– John Doe (Deceased) IRA fbo Mary Doe.
– John Doe (Deceased) IRA fbo Mary Doe,
Trustee under the John Doe Trust dated
January 1, 1995.
– John Doe (Deceased) IRA fbo Mary Doe,
Trustee of the Jane Doe Trust created
under the John Doe Trust dated January
1, 1995.
Distributions at Death
• No Designated Beneficiary
Named?
–No beneficiary designated by
participant
–Estate
–Charity Distributions at Death
–Non-Qualified Trust
No Designated Beneficiary
• Five year rule applies:
– Under the five year rule, the entire balance of
the retirement plan must be distributed to the
beneficiary no later than December 31 of the
calendar year five years from the participant’s
death. Not required to make distributions
equally over the five year period.
Reasons to Name a Trust as Beneficiary
of Retirement Assets
• Protect Retirement Assets
– Minor beneficiaries
– Special needs beneficiaries
– Spendthrift beneficiaries
– Asset Protection
• Children from a Previous Marriage
• Under-funded Credit Shelter or Bypass
Trust
Multiple Beneficiaries
and the Separate Account Rule
• If you can divide each beneficiary’s share
into a separate account then each
beneficiary can use own life expectancy.
You must contact the custodian and
physically divide the accounts.
• Must be completed by December 31 of the
year following the participant’s death.
Separate Account Rule and Trusts
• Note the separate account rule does NOT
apply to multiple beneficiaries who take
their interest through a trust.
• Several PLRs ruled that if a trust was to be
divided into sub-trusts for each beneficiary
after the settlor’s death, every sub-trust
must calculate RMDs based upon oldest
beneficiary of the original trust.
IRA accounts and Trust Rules
– If you are an elder law attorney – This entire
discussion is about Required Minimum
Distributions (RMDs).
– If you are a trust and estate lawyer, do not
confuse taxable income to a trust or a
beneficiary with income for SSI purposes.
They are not the same.
DB and RMD Rules for Trusts
• First Step: If a participant names a qualified
trust as the beneficiary of an eligible retirement
plan, then the trust beneficiary will be treated as
the beneficiary of the account for purposes of
determining whether there is a designated
beneficiary and who it is.
• Second Step: Once the trust qualifies as a
qualified trust and a beneficiary is identified as a
designated beneficiary, then you must determine
the applicable measuring life.
Qualified Designated Beneficiary Trust
• To be a Qualified Trust -
– Trust must be is valid under state law.
– Trust must be irrevocable or becomes
irrevocable by participant’s date of death.
– All beneficiaries are identifiable under the
terms of the trust.
– A copy of the trust document is provided to
the plan administrator or IRA custodian by
no later than October 31 of the calendar
year after the death of the participant.
Deadlines
• Deadline for meeting requirement is October 31
st
of the year following the plan participant’s death.
• Deadline for providing plan documentation is
September 30
th
of the year following the plan
participant’s death.
– Documents required to be furnished:
– Either a copy of trust documents and all
amendments, or
– A list of all trust beneficiaries, including
contingent and remainder beneficiaries and a
statement as to the circumstances under which
they will take.
Conduit Trust
• With a conduit trust the trustee is required,
by the terms of the trust, to pass all plan
distributions
to
the
individual
trust
beneficiary.
• The IRS considers the conduit beneficiary
as the sole beneficiary of the trust.
Remainder beneficiaries are disregarded
for purposes of calculating RMDs even if
Conduit Trust (cont.)
• Example: A creates a trust for the benefit of his
wife. The terms of the trust provide that wife
must receive all income. Trustee has discretion
to distribute principal for wife’s health, education
and support. Upon wife’s death all property
passes to A’s siblings. If a sibling predeceases
then passes to charity.
• Since Conduit trust only look at wife’s life
expectancy to determine RMD’s. Do not need to
look at A’s siblings or charity.
Accumulation Trust
• With an accumulation trust, the trustee has
the discretion to distribute income and
principal to the beneficiary.
• With an accumulation trust, must look at
life
expectancy
of
all
remainder
beneficiaries to determine measuring life
for RMD purposes.
– A special needs, or a discretionary
support trust would be examples of an
accumulation trust.
Accumulation Trust
Power to Appoint to Charity
• A creates a trust that provides discretionary income and
principal to son B. Upon B’s death, the remaining principal
and income is paid to a class of beneficiaries consisting of B’s
issue and any charity as appointed by B in his will. Since B’s
power to appoint includes a power to appoint to a
non-individual, the trust would not have a DB for RMD purposes.
• If the terms of the trust did not provide a power of appointment
to charity, then B’s life expectancy would be used because all
of B’s issue must be younger in age.
Qualified Designated Beneficiary Trust
• Look through beneficiaries
– CAUTION: “Atom Bomb” Beneficiaries
• Solution – Limit to younger beneficiaries for
purposes of distributing retirement assets
– CAUTION: Powers of Appointment
• Solution – Limit powers of appoint to
younger beneficiaries for purposes of
appointing retirement assets
Qualified Designated Beneficiary Trust
(cont.)
• Look through beneficiaries.
– CAUTION: Using retirement assets to pay
trustor’s debts, estate taxes or administration
expenses = paying to estate of the trustor, i.e., no
designated beneficiary.
– Solution:
• Prohibit use of retirement assets to pay for
debts,
estate
taxes
or
administration
expenses, unless these payments can be
made prior to September 30 of year after the
trustor dies.
Calculating RMDs for an Accumulation
Trust
• Father establishes a SNT for his special needs son
A and designates the SNT as the primary
beneficiary of his IRA. The father’s IRA has a
$1,000,000 balance at the time of his death. Upon
A’s death, the balance of the assets of the SNT go
to A’s siblings, B and C. A is 20, B is 40, and C is
45 at their father’s death. In this case, the RMD
rules require A, B, and C to be considered as
beneficiaries. C’s life expectancy is used to
determine RMDs because C is the oldest.
Calculating RMDs for an
Accumulation Trust (cont.)
• The factor for C at age 45 is 38.8. Using a
factor of 38.8 creates a RMD for the initial
year of the trust of $25,773.20
($1,000,000÷ 38.8). If RMDs are based on
A’s life expectancy, a factor of 63 is used.
A factor of 63 decreases RMDs to
$15,873.02 ($1,000,000 ÷ 63). By naming
C as a remainder beneficiary, the RMD
increased by $9,900.18.
Evaluating the Impact of RMDs
•
If the beneficiary has considerable expenses and the trustee will
use all RMDs to pay for the beneficiary’s care or other needs,
then an increase of RMDS is probably not significant.
•
If beneficiary does not have significant expenses and RMDs will
accumulate in trust, then trust will pay income tax on
accumulated income. ). Although similar tax rates (15%, 25%,
28%, 33%, and 35%) apply to both individuals and trusts, the tax
brackets for a trust are more compact than for an individual. In
2013, a trust with taxable income over $11,950 is taxed at a
39.6%-rate bracket. In contrast, an unmarried individual must
have taxable income over $400,000 to reach the 39.6% rate
bracket for 2013 (or taxable income of $450,000 for married
individuals filing joint returns.
•
Falling under the 5 year rule would be a costly mistake for most
beneficiaries.
Options to Consider
• Drafting
• Charitable Remainder Trust
• Disclaimers
Drafting
• When all of the beneficiaries of an accumulation trust are
relatively close in age, RMDs will not be significantly
impacted. Nonetheless, the attorney should understand
that payments from the inherited IRA to a trust after the
death of the account owner will be taxable income to the
trust. If it is likely the trust will distribute all current income
to or for the benefit of the trust beneficiary, then there will
be minimal income tax consequence to the trust. If RMDs
are significantly higher due to the ages of the remainder
beneficiaries or a non-designated beneficiary is involved,
the drafting attorney should consider dividing the trust into
two separate subtrusts.
Charitable Remainder Trust
Planning
• Another option that should be considered is a
lump-sum distribution of all or a portion of a
taxable retirement account to a charitable
remainder trust (CRT) that may first benefit the
surviving spouse, then other beneficiaries (such
as children), and then a charity. The principal
income tax advantage is that a CRT is a
tax-exempt trust, so there will be no income tax
liability when it receives the income from the
retirement plan account.
Charitable Remainder Trust
Planning (cont.)
• The IRS addressed the issue on whether the terms of the
CRT making distribution to another trust must be limited to a
term of 20 years or the life of the beneficiary in Revenue
Ruling 2002-20. Revenue Ruling 2002-20 provides that CRT
distributions can be made to a second trust, for the life of an
individual who is “financially disabled” under three situations.
The ruling states that an individual shall be determined to be
“financially disabled” if the individual is unable to manage his
financial affairs by reason of a medically determinable
physical or mental impairment which can be expected to
result in death, or which has lasted or can be expected to last
for a continuance period of not less than 12 months.
Disclaimers of Retirement
Benefits
• A disclaimer is the refusal to accept a gift or
inheritance. Federal tax law recognizes that a
person cannot be forced to accept a gift or
inheritance. Therefore
a
disclaimer
itself
(provided it meets the requirements of § 2518) is
not treated as a taxable transfer. For tax purposes,
the person making the disclaimer never accepted
the property in the first place, he never owned it
and therefore could not have given it away. For
SSI/Medicaid purposes, a disclaimer will be treated
as a transfer of assets.
Disclaimers of Retirement
Benefits (cont.)
• Disclaimers of inherited retirement benefits can be
very useful in post mortem planning even when
dealing with special needs planning. However, the
order of who disclaims and when will be critical. For
example, you will create a period of ineligibility or be
forced to create a first party pay-back trust if you
named the beneficiary with a disability as your primary
beneficiary and then disclaimed. Even if your
contingent beneficiary was a special needs trust, a
disclaimer by the disabled beneficiary to his or her
special needs trust would create a period of
ineligibility.
Disclaimers of Retirement
Benefits (cont.)
• Conversely, a disclaimer is an effective means to
eliminate an older beneficiary, power of appointment
or charitable beneficiary that impacts RMDs for the
special needs beneficiary. Acceptance of required
minimum distributions (“RMDs”) by the primary
beneficiary of retirement accounts following the
participant’s death prevents the beneficiary from
disclaiming both the RMDs and the income
attributable to the RMDs. However, the beneficiary
may validly disclaim the balance of the retirement
accounts.
Decanting
• Decanting may be an option to remove an older
beneficiary or a nondesignated beneficiary
provided
the
impermissible
or
problem
beneficiaries are removed by the September 30
th
deadline. Currently, there are no rulings by the IRS
on whether decanting is an effective means to
correct
an
existing
trust
with
older
or
nondesignated beneficiaries. Additionally, it is
unclear whether a state Medicaid office would take
the position that a decanting of an existing third
party
SNT
constitutes
a
transfer
without
consideration by the SNT beneficiary.
Reformation
• Private Letter Rulings have discussed a court’s
modification of a trust or beneficiary designation
made by the settlor of a trust or the IRA owner with
varying results, depending on the specific facts of
the case. In PLR 200742026, the IRS refused to
recognize a retroactive beneficiary designation
made by the court when the decedent failed to
name a contingent beneficiary (although there was
no disagreement that the decedent intended to
name one) after a new IRA custodian began
administering the IRA.
Reformation (cont.)
• The same year as the surviving spouse
died, the Trustees sought and obtained an
order from the State Court modifying the
trust to provide, among other things, that
descendents of the decedent couple born
before 1955, contingent beneficiaries, and
charities could not be named as potential
appointees of a beneficiary’s lifetime
power of appointment.
Reformation (cont.)
• The Trustees realized that there was a
problem - the trust document clearly
reflected the grantors’ intent that the trust
qualify as a “see-through” trust, thus
avoiding the requirement that distribution
of an IRA must be made within five years
and instead uses the life expectancy of
the oldest beneficiary to calculate the
required minimum distributions from the
IRA.
Reformation (cont.)
• Despite the court order, the IRS refused to
give effect to the retroactive reformation
because charities were potential contingent
beneficiaries
of
the
trust
and
only
individuals can be “designated beneficiaries”
for the purpose of satisfying 401(a)(9). The
IRS reasoned that generally, the reformation
of a trust instrument is not effective to
change the tax consequences of a
completed transaction.
Some Benefits Cannot be
Transferred
• Some
benefits
available
through
certain
retirement systems cannot be assigned to a trust.
These prohibitions are sometimes found in the
public service sector for professionals including,
but not limited to, firefighters, police officers, and
EMTs. Consider, for example, the unpublished
case of Saccone v. Board of Trustees of the
Police and Firemen’s Retirement System. Mr.
Saccone was a retired firefighter; there were
certain death benefits available to Mr. Saccone’s
wife and son, who was disabled.
NAELA 2013 Advanced Elder Law Review – November 2013
Overview of IRA’s and Retirement Plans
Materials Prepared by: Stephen C. Hartnett, J.D., LL.M. (in Taxation) & Dennis Sandoval, CELA
Updated and Presented by: Bradley Frigon, JD, LLM, CELA, CAP
1. Overview of Retirement Assets
What are Retirement Assets?
• Individual Retirement Accounts • SEP-IRAs • Simple Plans • Keoghs • 403(b) Plan • 457 Plan • Qualified Plans o Money Purchase o Profit Sharing o 401(k) Plan
Retirement Assets Are Income in Respect of a Decedent.
Retirement Assets are income in respect of a decedent.1 Income in respect of a decedent, or “IRD,” are all items of taxable income of a decedent that are not properly taxable to the decedent on his or her last or prior income tax returns. In addition to retirement assets, income in respect of a decedent can include compensation, bonuses, benefit plan distributions, partnership income, interest, dividends, annuities and installment obligations. IRD items are not entitled to a step-up in basis under IRC § 1014. Therefore, IRD items are often the most heavily taxed assets in a decedent’s estate, always subject to income tax and sometimes also subject to estate and generation-skipping transfer taxes as well. The income tax on IRD assets is paid by the beneficiary of the IRD asset.
Where an estate is taxable, the recipient of IRD assets may be eligible for an offsetting IRD deduction for the federal estate taxes attributable to the IRD.2 The deduction is taken as a Schedule A itemization in an amount equal to the percentage of the IRD being brought into taxable income in any given year (i.e., if 50% of IRD assets are distributed in the current year and subject to income taxation, then 50% of the allowable IRD deduction can be taken in the current year, with the balance carried forward to future years when additional IRD assets are distributed). The amount of the IRD deduction is calculated by determining the federal estate tax of the
1
IRC § 691(a).
2
decedent with IRD assets included and with IRD assets excluded. The IRD deduction is the difference between the two.3 For example, an unmarried participant dies in 2013 with an IRA of $350,000, plus $5,600,000 in other assets. The participant’s total federal and state estate tax is approximately $122,500. The entire estate tax is attributable to the IRA account because, if that account were not included in the participant’s gross estate, there would be no estate tax. (The entire estate tax would have been absorbed by the available applicable credit amount.) When the IRA account is distributed to the participant’s beneficiaries, all amounts distributed are included in the gross income of the beneficiaries. Taking into account the special deduction allowed under IRC § 691(c), and assuming the participant’s beneficiaries have an average rate of income tax of 25%, the total income tax on the date of death IRA plan balance will be $48,125. This is calculated as follows:
IRC § 691 income: $350,000
Less IRC § 691(c) deduction: $122,500
Taxable amount: $227,500
25% tax: $56,875
The total effective rate of tax (both income and estate) on the IRA account after the IRC § 691(c) deduction is 60%.
In the real world, the $691(c) deduction can be very complicated to calculate. A decedent’s estate will have many different items of IRD, including accrued interest and dividends paid after the date of death. Additionally, IRD is often received over a period of years and not all at once. The deduction is often overlooked by the accountant unless the attorney administering the estate alerts the beneficiaries to the deduction. Remember, the IRC § 691(c) deduction is not available if the IRD is not subject to estate tax.
Options for Distributions from Retirement Plans
There are a variety of distribution options available for qualified plans (although the participant’s spouse will generally need to consent to the option chosen, as described more thoroughly below). The most common options are:
• Joint and Survivor Annuity
This option provides for a monthly annuity to the participant for life. Upon the participant’s death, a percentage of the initial annuity amount (up to the whole thereof, but usually 50%) is paid to the participant’s spouse for his or her life, assuming the spouse survives the participant.
• Single Life Annuity
This option provides for an annuity payment to be made only for the life of the participant. Because the payments are made for only one life expectancy, they are greater than the amount paid under a joint and survivor annuity option. Oftentimes, financial planners will recommend choosing the option and using a portion of the greater cash flow to pay the premiums on a life insurance policy, annuity or long term care policy on the participant. Of course, the effectiveness of this strategy depends on the age and health of the participant, and well as the performance of the annuity or life insurance policy selected.
• Period Certain or Term Certain Annuity
When this option is selected, an annuity payment is made for a specified number of years – regardless of whether the participant is alive or not. If the participant dies before the period expires, then the annuity payments continue to be made to the remainder beneficiary. If the participant outlives the period certain, then he or she will be without a retirement income for the balance of her life.
• Lump Sum
Under this option, the distribution is made in a single sum.
The Retirement Equity Act, or “REA”, requires that distributions from a qualified plan in which the participant is married must be paid in the form of a joint and survivor annuity. The annuity must provide payments to the spouse of the participant for such spouse’s life that are equal to at least fifty percent of the amounts payable to the participant during his or her life.4 After the participant has attained age 35, he or she may waive the requirement for a joint and survivor retirement annuity under REA if the participant’s spouse consents to such waiver.
Rollover Options
Most types of distributions from a qualified plan or individual retirement account can be “rolled over” into the same or a different qualified plan or individual retirement account without being subject to income taxation or penalty, if done within sixty days. Examples of distributions from qualified plans and individual retirement accounts that are NOT eligible for rollover treatment include:
• One of a series of payments taken over a single or joint life expectancy;
• One of a series of payments received for a specified period often years or more; • A Required Minimum Distribution, or “RMD”5
(explained infra).
A rollover distribution from a retirement plan or IRA is subject to a 20% federal income tax withholding requirement. The withholding requirement can cause forced income taxation of a
4
IRC § 417(a)(7)(B).
5
portion of the distribution where the participant does not have an alternative source to replace the 20% of the distribution withheld for taxes. For example, a participant requests a distribution of $100,000 from her IRA, intending to roll it over before the expiration of sixty days to another IRA custodian. The original IRA custodian withholds $20,000, as required under federal law, and distributes $80,000 to participant. Participant does not have $20,000 from alternative sources and so is only able to deposit $80,000 with the new IRA custodian. Participant will have $20,000 of taxable income to report.
Under certain circumstances the IRS can waive the sixty-day requirement and allow a valid rollover even if beyond sixty days. See Rev. Rul. 2003-16; IRC § 40(d)(3)(I).
A method to avoid tax withholding is to use a “trustee to trustee” transfer rather than an IRA rollover. Because the money is never distributed directly to the participant, a “trustee to trustee” transfer is not subject to the otherwise mandatory withholding requirements.
Required Beginning Date
A participant must begin taking RMDs from his or her retirement assets by his or her Required Beginning Date or “RBD.” The RBD is April 1st of the calendar year AFTER the calendar year in which the participant reaches age 70½. There is an exception for QUALIFIED PLANS only – if the participant is not retired at age 70½ and the participant is not a five percent or greater owner in the business in which he or she works, RBD can be postponed until April 1st of the year after the participant actually retires. RMDs from an IRA cannot be postponed beyond age 70½, even if the participant is continuing to defer distributions from the qualified plan.
Example:
Bob is born on 6/30/1942. Bob turns 70 on 6/30/2012. Bob turns 70 ½ on 12/30/2012. Bob’s RBD is 4/01/2013. Jane is born 7/1/1942. Jane turns 70 on 7/1/2012.
Jane turns age 70 ½ on 1/1/2013. RBD is 4/1/2014.
Required Minimum Distributions
Once a participant has reached his RBD, then he must begin taking annual RMDs based on the Uniform Table. The only exception to use of the Uniform Table by the participant is when the participant’s spouse is more than ten years younger than the participant, in which case the participant has the option to use the Joint Life Expectancy Table. The Uniform Table is reproduced as Appendix “A.” A portion of the Joint Table is reproduced at Appendix “B.”
To use the Uniform Table, find the age of the participant for the calendar and determine the factor to be used. For instance, the factor at age 73 is 24.7. The factor is then divided into the balance of the participant’s retirement plan(s) as of December 31 of the previous calendar year. This result is the RMD for that year.
IRAs can be left to accumulate tax-deferred. Where the participant has different types of retirement plans, however, such as an IRA, 401(k) and profit sharing plan, the RMD may not be aggregated – it must be taken on a pro rata basis from each type of retirement plan. Take, for instance, the example of a participant who has two IRAs totaling $50,000 and a 401(k) with a value of $50,000. If the participant is age 73, the RMD would be $4,049 ($100,000 / 24.7). The distribution must come one-half from the 401(k) plan and one-half from either one or both of the IRAs.
CAUTION: If the first RMD is postponed until April 1 of the calendar year after the participant turns age 70½, then two RMDs must be made in the first year – one by April 1 to cover the RMD for the previous calendar year in which the participant turned 70½ and a second by no later than December 31, to cover the RMD for the current calendar year. Only one RMD would be required for each year thereafter. To avoid this result, the participant must take her first RMD in the year she turns age 70½, and not in the following calendar year.
Penalties
The penalty for failing to take a RMD is 50% of the amount of the RMD.6 The IRS, in limited cases, may waive the penalty where “reasonable cause” is shown.
There is also a 10% penalty for taking distributions from an IRA or qualified plan prior to age 59½ (premature withdrawal penalty).7 There are several exceptions to the application of this penalty, including:
• Distributions due to your death or disability;
• Distributions for payment of unreimbursed medical expenses that exceed 7.5% of your AGI;
• Distributions for the payment of health insurance premiums for certain unemployed individuals;
• Distributions for the payment of qualified higher education expenses; • Distributions consisting of substantially equal periodic payments; • Distributions to a qualified first-time homebuyer; and
• Distributions due to an IRS levy on the IRA.
If you do not meet one of the above exceptions, you can avoid paying the 10% penalty tax if you redeposit the early distribution amount within 60 days of the distribution.
6
IRC § 4974.
7
2. Distributions at Death
Determination of Beneficiary
The determination of the identity of the beneficiary of a retirement plan is often critical as to what distribution options are available, as will be discussed further below. The beneficiary of an IRA or retirement plan must be determined by no later than September 30 of the calendar year after the participant’s death. This means that the participant can change beneficiaries during his lifetime and his RMD will not change, because it will be calculated using the Uniform Table in almost all events. The only exception would be if the participant changes the beneficiary designation to a spouse who is more than ten years younger than the participant and the participant chooses to use the Joint Table.
The period between date of death of the participant and September 30 of the following calendar year is sometimes referred to as the “shake-out period.” The nickname arose because during that period the beneficiary can be changed (such as by disclaimer) or an undesirable beneficiary can be removed in order to maximize “stretch” distributions. For example, the devise to an undesirable beneficiary can be removed from consideration by satisfying the devise prior to September 30. This time period can also be used to create separate accounts where there are multiple beneficiaries designated under the IRA or retirement plan. In some circumstance, the creation of separate accounts allows for the age of each beneficiary to be used in determining RMDs from his or her share. The concepts of stretch distributions and separate shares are discussed further below.
Spouse as Beneficiary
When a spouse is named as the beneficiary of an IRA or retirement plan, the spouse has many options.
• Rollover
A spouse may rollover an inherited retirement asset into an IRA in his or her own name. In order for the spouse to rollover the inherited retirement assets, he or she must be the sole beneficiary of the retirement asset. So, if an IRA named a spouse and child as beneficiaries, spouse would only be the sole beneficiary as to half of the IRA. Therefore, the spouse could rollover half of the IRA into an IRA in her name and child could take the other half as an inherited IRA. If the beneficiary of the retirement asset was a trust whose sole beneficiary was the spouse and where spouse is the trustee or has withdrawal power over the trust assets, then spouse could roll over the retirement assets to an IRA in her name. If however, the trust named spouse as income beneficiary and spouse and descendants as discretionary beneficiaries of principal for health, education, maintenance and support – then spousal rollover would not be available.
If a spouse elects to rollover an inherited IRA, she can defer taking distributions until she reaches her RBD. If the surviving spouse is under age 59 1/2, rolling over the IRA may not be an appropriate option if the surviving spouse needs any of the IRA funds for the surviving spouse’s
beneficiary after the rollover. When RMDs begin, they will be based on the Uniform Table. She can name new death beneficiaries to her IRA.
Also if the surviving were to die before reaching age 70 ½, the surviving spouse would be treated as the IRA owner, rather than as a beneficiary. Thus, if he or she has not designated a succeeding beneficiary of the IRA, the IRA will be distributed after the surviving spouse’s death as if there were no beneficiary (i.e. to his or her estate). The MRDs will be higher in this situation and the assets will be subject to the surviving spouse’s creditors.
In addition to when the surviving spouse is under 59 ½ , another situation in which allowing a surviving spousal rollover might not be desirable is where the participant is in a second plus marriage and would like assurance that the retirement assets will benefit children from a prior marriage after the death of the surviving spouse. A QTIP trust is usually the recommended method to make sure the retirement account will eventually pass to the deceased spouse’s children. Although a QTIP trust will ensure that property is left to the children of the deceased spouse, the income tax benefits from designating a QTIP trust as a beneficiary will usually be less than what can be achieved from a rollover to a surviving spouse.
Additionally, a rollover might not be desirable if the combined estates of the husband and wife might be subject to estate tax at the death of the surviving spouse. This situation may require using all or part of a spouse’s retirement account to fund a credit shelter trust.
• Inherited IRA –Death Before Required Beginning Date
Another option is for the spouse to treat the IRA as an inherited IRA. If this option is chosen and the participant died before his or her RBD, then the surviving spouse will take distributions from the IRA based on her life expectancy using the IRS Single Life Expectancy Table (see Appendix “C”). To use the table, the spouse will find the factor associated with her age at the date of the participant’s death and use that factor. She is the only death beneficiary that is allowed to recalculate when using the Single Life Expectancy Tables, so she will return to the tables each year to determine her RMD. For instance, if the spouse is age 65 when the participant dies, the factor for determining the first RMD (payable by December 31 of the first calendar year after the calendar year of the participant’s death) would be 21. The following year the spouse would look at the table again and determine the factor is 20.2. In the third year the factor is 19.4.
In an exception to the rule that all inherited retirement assets must begin distributing to beneficiaries no later than December 31st of the calendar year after the year of the participant’s death, where the participant dies before his or her RBD (i.e. deceased spouse was 65 at date of death), a surviving spouse who elects to treat the participant spouse’s retirement asset as an inherited retirement may defer taking his or her first RMD until the deceased spouse would have been required to take his or her first RBD.
• Inherited IRA –Death After Required Beginning Date
If the participant died after his or her RBD, and the spouse wants to treat the IRA as an
greater of her life expectancy using the IRS Single Life Expectancy Table (recalculated), or the life expectancy of the participant (but in this case the life expectancy would not be recalculated – instead the life expectancy for the participant would be determined as of his year of death and one would be subtracted from the number each year thereafter). For instance, if the participant died at age 75, then the first RMD would be 13.4. The following year’s distribution would be calculated using a factor of 13.4 – 1, or 12.4. Accordingly, the IRA would be fully distributed at the end of 14 years.
All Other Qualified Beneficiaries
Before the Pension Protection Act of 20068 (PPA), non-spouse beneficiaries were only allowed to authorize a plan-to-plan transfer from one IRA inherited from a participant to another inherited IRA in the name of the same participant and payable to that same beneficiary.9 After the PPA, non-spouse beneficiaries may also rollover a distribution from an eligible retirement plan to an IRA, thereby allowing a non-spouse to defer distributions. This new non-spousal rollover must be completed by a direct trustee-to-trustee transfer. The same minimum distribution rules that apply to an inherited IRAs will apply to rollover IRAs for a non-spouse. The recipient IRA is treated as an inherited IRA that must be titled in the name of the participant, and the non-spouse beneficiary must qualify as a designated beneficiary. Transfers may also be made to inherited IRAs that are held by trusts for the benefit of a non-spouse beneficiary.10
• Inherited IRA –Death Before Required Beginning Date • Option 1 – Distributions Over Beneficiary’s Life Expectancy
When the participant dies before the RBD and the beneficiary is other than the surviving spouse, RMDs are based on the beneficiary’s life expectancy using the Single Life Table (see Appendix “C”). To use the table, the beneficiary will find the factor associated with his or her age at the date of the participant’s death, and then simply subtract one from the factor every year thereafter. For instance, if the beneficiary is age 55 when the participant dies, the factor for determine the first RMD would be 29.6. The following year the beneficiary would subtract one and the beneficiary’s new factor for determining RMD for that year would be 28.6 (29.6 – 1). The Inherited IRA would be fully distributed in year 30.
Distributions must begin no later than December 31 of the calendar year after the year in which the participant died. Failure to take distributions by that would, in effect, be an election by the beneficiary to use option 2 – the five year rule.
• Option 2 – Five-Year Rule
Under the five-year rule there is no set schedule of distributions, but the retirement assets must be fully distributed to the beneficiary no later than December 31 of the calendar year five years from the death of the beneficiary. For instance, under the five-year rule the beneficiary could withdraw 20% of the retirement assets in year one, 25% in year two, 33.3% in year three,
half the remaining balance in year four and the remainder in year five. Alternatively, the beneficiary could decide to take no distributions for the first four years and instead withdraw the entire balance on at the end of year five.
• Inherited IRA –Death After Required Beginning Date
• Option 1 – Distributions Over Greater of Beneficiary’s or Participant’s Life Expectancy
When the participant dies after the RBD and the beneficiary is other than the surviving spouse, RMDs are based on the greater of the beneficiary’s or the participant’s life expectancy using the Single Life Table. (See Appendix “C”). To use the table, the beneficiary will find the factor associated with his or her age at the date of the participant’s death (or the age of the participant, if younger), and then simply subtract one from the factor every year thereafter. For instance, if the beneficiary is age 55 when the participant dies, the factor for determine the first RMD would be 29.6. The following year the beneficiary would subtract one and the beneficiary’s new factor for determining RMD for that year would be 28.6 (29.6 – 1). The Inherited IRA would be fully distributed in year 30.
Distributions must begin no later than December 31 of the calendar year after the year in which the participant died. Failure to take distributions by that would, in effect, be an election by the beneficiary to use option 2 – the five-year rule.
• Option 2 – Five-Year Rule
No Designated Beneficiary
In some circumstances, the IRS considers that there is no designated beneficiary named for purposes of being able to determine RMDs. The first circumstance when this occurs is when the participant in fact fails to name a beneficiary for his or her retirement asset. Four less obvious events where the IRS considers there to be no designated beneficiary are when the participant names a beneficiary, but the beneficiary is one of the following:
• Estate • Charity
• Non-Qualified Trust
• Other Entity (such as corporation or partnership)
The IRS considers there to be no designated beneficiary in these events because it is not possible to determine the life expectancy of an estate, charity, non-qualified trust or other entity.
What are the distribution requirements when no designated beneficiary is named? Here again, there are two scenarios.
• Participant Dies Before RBD
If the participant dies before his required beginning date without having designated a beneficiary, then the retirement asset must be withdrawn under the five-year rule.
• Participant Dies After RBD
If the participant dies after having reached his RBD without having designated a beneficiary, then the recipient of the retirement assets has two withdrawal options:
o Take RMDs over Participant’s Life Expectancy
The recipient of the retirement assets could take RMDs based on the remaining life expectancy of the participant using the IRS’s single life expectancy table. For example, if the participant dies at age 73, his factor for that age under the Single Life Expectancy Table is 14.8. The recipient of the retirement assets would need to take an initial RMD by December 31 of the calendar year after the participant’s death equal to the value of the retirement asset divided by 14.8. The following year, the recipient would take a second RMD using a factor of 13.8 (14.8 -1), so that the retirement asset would be fully distributed over fifteen years, or
o Five-Year Rule
The recipient of the retirement assets could take distributions from the retirement asset under the five-year rule.
Proper Titling of an Inherited Retirement Asset
Many practitioners and financial professionals erroneously believe that title to an inherited retirement asset should be taken in the name of the beneficiary. This is not correct. Distributing the assets from a retirement plan (or liquidating the assets and then distributing them) to the beneficiary or an IRA in the name of the beneficiary would be considered a taxable distribution by the IRS, requiring that income taxes be paid on the full amount in the year of distribution. Instead, an inherited IRA should be titled in the name of the deceased participant, but for the benefit of the beneficiary. Following are some examples:
• John Doe (Deceased) IRA fbo Mary Doe
• John Doe (Deceased) IRA fbo Mary Doe, Trustee under the John Doe Bypass Trust dated January 1, 1995
• John Doe (Deceased) IRA fbo Mary Doe, Trustee of the Jane Doe Trust created under the John Doe Living Trust dated January 1, 1995.
