Estate Planning for Retirement Benefits Monday, April 29, 2013 · Source: “Planning with IRAs and...

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Estate Planning for Retirement Benefits Monday, April 29, 2013

John C. Martin, Esq.

Law Offices of John C. Martin

I. Introduction

• How will I benefit from this course?

• Retirement plans hold an increasing share of individuals’ net

worth

• Significant balances often remain in these accounts at death,

because of tax deferral and the uniform lifetime table

• Choosing the wrong beneficiary or not choosing any beneficiary

can have significant tax or personal consequences

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Introduction

• The purpose of Estate Planning for Retirement Benefits

• What happens to retirement plans at death

• What planning options exists for beneficiary designations,

including retirement plan trusts, gifts to charity, spousal rollovers,

individual beneficiaries, and other options

• What are the pro’s and con’s of these options?

• What this course is NOT:

• An overview of lifetime planning with IRAs or other qualified plans

• A primer on calculating Required Minimum Distributions (RMDs)

• State specific– each state has different tax, family law, and estate

planning law that will affect the client’s particular circumstances

• An overview of Roth IRA planning or the benefits of Roth

conversions

• Detailed analysis on trust drafting or beneficiary designation forms

Why Plan for IRAs and other Qualified Plans?

Year

Immediate

Distribution

Five-Year

Distribution

IRA Payable to

Surviving

Spouse (No

Spousal

Rollover)

IRA Payable to

Surviving

Spouse

(Spousal

Rollover)

IRA Payable to

Oldest

Beneficiary

IRA Payable to

Youngest

Beneficiary

2 1,414,934$ 1,429,399$ 1,429,399$ 1,429,399$ 1,429,399$ 1,429,399$

6 1,909,649$ 2,011,358$ 2,011,358$ 2,011,358$ 2,007,536$ 2,007,729$

11 2,777,954$ 2,925,909$ 3,089,713$ 3,089,713$ 3,062,913$ 3,064,272$

16 4,041,071$ 4,256,301$ 4,722,081$ 4,758,393$ 4,660,910$ 4,665,852$

21 5,878,519$ 6,191,614$ 7,143,331$ 7,315,348$ 7,071,727$ 7,085,676$

26 8,551,444$ 9,006,900$ 10,696,628$ 11,152,316$ 10,693,703$ 10,728,077$

31 12,439,729$ 13,102,278$ 15,862,910$ 16,854,849$ 16,109,273$ 16,187,099$

36 18,095,993$ 19,059,798$ 23,328,075$ 25,247,468$ 24,161,587$ 24,327,893$

41 26,324,122$ 27,726,164$ 34,097,600$ 37,487,640$ 36,056,209$ 36,396,985$

46 32,962,245$ 34,717,838$ 42,743,352$ 47,335,010$ 45,718,311$ 46,234,204$

Source: “Planning with IRAs and other Qualified Plans”, Robert S. Keebler (2004)

FACTS:

IRA Value $1,000,000

Decedent’s Age 60

Surviving Spouse’s Age 54

Oldest Child’s Age 28

Youngest Child’s Age 25

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Source: “Planning with IRAs and other Qualified Plans”, Robert S. Keebler (2004)


Retirement Planning Assets

• Account for 34% of all household financial assets - up

from 14% in 1978!

• IRAs alone account for more than 10% - and 47 million

US households have IRAs

* According to 2009 (2nd qtr.) Investment Company

Institute study

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It has been estimated that “qualified retirement benefits,

IRAs, and life insurance proceeds may constitute as much as

75 to 80 percent of the intangible wealth of most middle-class

Americans.”*

* L. Mezzulo, An Estate Planner’s Guide to Qualified Retirement Plan Benefits (ABA Publications, 4th ed. 2007) at 1.

• Assets will likely be left over in a retirement plan at death

based upon nationwide trends, mortality, and the uniform

lifetime table

• If the participant takes only the MRD starting at age 70 ½ , and

the account has a steady six percent annual investment return,

the account will have more dollars in it at his death than it did

when he started taking MRDs, if he dies prior to age 89.

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General Concepts

• Generally, Participant must commence Required

Minimum Distributions (RMDs) by Required Beginning

Date (RBD)

• RBD = April 1 in the year following the calendar year in

which the participant reaches age 70½

• Or the calendar year in which the employee retires from

employment

• Exception for Less than 5% Owners

General Concepts

• RMDs are calculated based upon prior year ending

account balance divided by life expectancy factor

Prior Year 12/31 Balance

Life Expectancy Factor RMD =

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Life Expectancy Factor

• Uniform Table for participant’s lifetime distributions

• Exception if spouse is actually more than 10 years

younger than participant - then use Joint & Last Survivor

Table

• Single Life Table for use by “qualified beneficiary” after

participant’s death

• Determines “Stretch Out” for “Inherited IRAs”

Uniform Table

Age Divisor Age Divisor Age Divisor

70 27.4 86 14.1 102 5.5

71 26.5 87 13.4 103 5.2

72 25.6 88 12.7 104 4.9

73 24.7 89 12.0 105 4.5

74 23.8 90 11.4 106 4.2

75 22.9 91 10.8 107 3.9

76 22.0 92 10.2 108 3.7

77 21.2 93 9.6 109 3.4

78 20.3 94 9.1 110 3.1

79 19.5 95 8.6 111 2.9

80 18.7 96 8.1 112 2.6

81 17.9 97 7.6 113 2.4

82 17.1 98 7.1 114 2.1

83 16.3 99 6.7 115 and older 1.9

84 15.5 100 6.3

85 14.8 101 5.9

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Single Life Table

Age Divisor Age Divisor Age Divisor Age Divisor Age Divisor Age Divisor Age Divisor

0 82.4 16 66.9 32 51.4 48 36.0 64 21.8 80 10.2 96 3.8

1 81.6 17 66.0 33 50.4 49 35.1 65 21.0 81 9.7 97 3.6

2 80.6 18 65.0 34 49.4 50 34.2 66 20.2 82 9.1 98 3.4

3 79.7 19 64.0 35 48.5 51 33.3 67 19.4 83 8.6 99 3.1

4 78.7 20 63.0 36 47.5 52 32.3 68 18.6 84 8.1 100 2.9

5 77.7 21 62.1 37 46.5 53 31.4 69 17.8 85 7.6 101 2.7

6 76.7 22 61.1 38 45.6 54 30.5 70 17.0 86 7.1 102 2.5

7 75.8 23 60.1 39 44.6 55 29.6 71 16.3 87 6.7 103 2.3

8 74.8 24 59.1 40 43.6 56 28.7 72 15.5 88 6.3 104 2.1

9 73.8 25 58.2 41 42.7 57 27.9 73 14.8 89 5.9 105 1.9

10 72.8 26 57.2 42 41.7 58 27.0 74 14.1 90 5.5 106 1.7

11 71.8 27 56.2 43 40.7 59 26.1 75 13.4 91 5.2 107 1.5

12 70.8 28 55.3 44 39.8 60 25.2 76 12.7 92 4.9 108 1.4

13 69.9 29 54.3 45 38.8 61 24.4 77 12.1 93 4.6 109 1.2

14 68.9 30 53.3 46 37.9 62 23.5 78 11.4 94 4.3 110 1.1

15 67.9 31 52.4 47 37.0 63 22.7 79 10.8 95 4.1 111 1.0

Example 1

• Figuring the MRD for an individual during their lifetime

after the RBD.

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At Death:

• Two Critical Questions:

• Did the participant reach his or her Required Beginning

Date (RBD)?

• Is there a “Designated Beneficiary” (DB)?

Required Minimum Distributions (RMDs)

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Life Expectancy

Rule

Life Expectancy

Rule

Five-Year Rule

Death Before Required

Beginning Date

Death On or After Required

Beginning Date

Designated

Beneficiary

Non-

Designated

Beneficiary

“Ghost” Life

Expectancy

Rule

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What is a Designated Beneficiary?

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Treas. Reg §1.401(a)(9)-4

• Must be named a DB under the terms of the plan or by an

affirmative election by the employee

• DB need not be specified by name but must be

identifiable on the date of death

• May be a class of beneficiaries capable of expansion or

contraction (e.g., my children or grandchildren)

• DB must be an individual alive on the date of death

• DB may also be individuals named as beneficiaries of a

qualifying trust

Example No. 3

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Individual & See Through Trust Beneficiaries

Examples 3-4

Rule: Annual MRDs over the life expectancy of a Designated

Beneficiary are computed by dividing the prior year-end

account balance by a life expectancy factor. A Use the

single life table and the fixed-term method (see glossary

and previous slides)

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What is a Designated Beneficiary?

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These are NOT a “designated beneficiary”

• Estate

• Charity

• Non-qualifying trust

• Any non-individual other than a qualifying trust

• Individual born after the date of the participant’s death

• What happens if we or the plan documents name a non-

designated beneficiary as the beneficiary?

• Example No. 5 (See handout) Estate with non-spouse estate

beneficiary

• Example No. 6 (See handout) Charitable beneficiary

Non-designated beneficiaries

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• General rule:

(1) The participant has NO designated beneficiary unless all

of the beneficiaries are individuals;

(2) If all of the beneficiaries are individuals, the ADP is the

based on the oldest beneficiary’s life expectancy;

There are two “escape hatches” from these rules:

(1)The Separate Accounts Rule

(2)The ability to “remove” a beneficiary prior to the

“Beneficiary Finalization Date”

Multiple beneficiaries

• Example No. 7 (Percy Example– Separate Accounts

Rule)

Note: all beneficiaries must be individuals, but a beneficiary

may be “removed” prior to the beneficiary finalization

date.

• Example No. 8 (Removal of Beneficiaries prior to

Beneficiary Finalization Date)

Multiple beneficiaries -- Examples

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Special Rules for Spousal Beneficiaries

• Spousal Rollovers vs. Spouse Beneficiary

• Spousal Beneficiary is rarely chosen– why?

• Life expectancy factor of spouse is used by reference to the

Single Life Table beginning in the year the IRA owner would

have turned age 70½. Each year thereafter the life expectancy

divisor is recalculated by referencing the Single Life Table

Spousal Rollover

• Spouse Treats the IRA as her own plan

• Advantages

• Rollover delays RMD until spouse’s own RBD until she is 70 ½

• Inherited IRA provisions allow beneficiary’s life expectancy to

be used for distributions after death of IRA owner

• Can use the “recalculate method” obtaining the divisor from the

Uniform Lifetime Table.

• The spouse can name his or her own DBs for the rollover IRA.

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Spousal Rollover

• There is no “deadline” in which the spouse must make

the roll over (but see below)

• Drawback: if the spouse is under 59 ½ , and he or she

does a roll over, the spouse cannot take benefits until

he or she turns 59 ½, or the 10% penalty will apply. By

contrast, if the spouse continues as a beneficiary under

the participant’s IRA, he or she can withdraw benefits

under the fixed term MRD method.

Trusts as Beneficiaries

• Not a designated beneficiary– 5 year rule or ghost life

expectancy

• Exception for certain see through trusts

• “Conduit” and “Accumulation” trusts

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Advantages of Using Trusts Generally

• Spendthrift protection

• Creditor protection

• Divorce (“Predator”) protection

• Special needs

• Consistent investment management

• Estate planning

• “Dead-hand” control

Disadvantages of Using Trusts Generally

• Trust tax rates

• Legal and trustee fees

• Income tax returns

• Greater complexity

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IRAs Payable to Trusts

• Four Requirements of All IRA Trusts

• Trust is valid under state law

• Trust is irrevocable upon death of owner

• Beneficiaries of the trust are identifiable from the trust

instrument

• Documentation requirement is satisfied

Problem with multiple beneficiaries of trusts

• While the separate accounts rule is applicable for

individual beneficiaries named at the beneficiary

designation form level, it is generally not applicable for

multiple beneficiaries of a single trust named in the

beneficiary designation form.

• In such a case, generally the trust’s oldest beneficiary’s life

expectancy– including contingent beneficiaries--- will be

used for the purposes of figuring MRD– and not that of

each individual beneficiary of the trust.

• Non-individual beneficiaries may also disqualify the trust as

a DB

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Example

• Solutions:

• Create separate trusts (or substrusts) for each beneficiary and

name each trust in the beneficiary designation form

• Eliminate trust beneficiaries before beneficiary finalization date

• Create conduit trust as a safe harbor

• Example: “Elimination” of beneficiaries

Conduit Trust

• A type of see-through trust in which all distributions from the

IRA are immediately distributed to the trust

beneficiary/beneficiaries.

• Effect: the retirement benefits are deemed paid “to” the

individual beneficiary(ies) for purposes of the MRD rules, and

accordingly the “all beneficiaries must be individuals” test is

met. The life expectancy of the oldest trust beneficiary will be

used, but not including “contingent” beneficiaries

• Drawbacks: It lessens the trustee’s control. Also, if the MRD

rules change requiring faster distributions, the trust beneficiary

will leave the money sooner than the participant may have

intended.

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Accumulation Trust

• A trust in which distributions from the IRA are allowed to

accumulate within the trust (any trust that is not a conduit

trust is an accumulation trust)

• Advantages: provide more of the benefits of trusts in

general– in particular, the ability to control IRA

distributions for the benefit of a beneficiary.

Accumulation Trust

The key issue in analyzing an accumulation

trust is to determine which beneficiaries are

“countable.”

All beneficiaries are countable unless such

beneficiary is deemed to be a “mere potential

successor” beneficiary.

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Accumulation Trust – Example 1

Mother – Age 80

Trust

Discretionary Distributions

Entire Trust outright upon

Grandchildren reaching age 30

If Grandchildren die before

reaching age 40

Mother is “countable” for

determining applicable

life expectancy

See PLR 200228025

and Treas. Reg. §

1.401(a)(9)-5 Q&A 7

Child – age 30

Child – age 30

IRA


Trust

To Red Cross

Child #1

Discretionary

Distributions

At Child #1’s death Contingent beneficiary

must be counted.

Non-individual contingent

beneficiary.

No designated beneficiary

status.

Treas. Reg. § 1.401(a)(9)-

5 Q&A 7

IRA

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Child 2– Age 25

Trust

Income

Entire Trust terminates and is distributed

to Child 1 if Child 2 is deceased

Remainder

Child 1– age 30

IRA

This is a “circle” trust where it is

impossible for trust property to

be distributed to a non-individual

beneficiary. Child 1’s life

expectancy is used.

See Treas. Reg. § 1.401(a)(9)-5

A-7(c)3), Example 1

Is a trust the best choice merely because it qualifies as a “see-through trust”?

• Not always.

• For example, a surviving spouse beneficiary most likely would

result in a longer period of deferral because of the ability to roll over

the benefits into the spouse’s own plan. A trust, by contrast, would

require the spouse to use her own life expectancy, or worse, a life

expectancy of an older beneficiary of the trust (note: exceptions

apply).

• Qualifying the trust as a see-through is IRRELEVANT if the

decedent was past his RBD when he died, or the trust beneficiary is

older than or close to the same age as the participant.

• On the other hand, the client’s non-tax objectives may

make a Trust a compelling choice. OR, in the case of

young non spouse beneficiaries, the non-tax and tax

objectives may overlap.

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The Beneficiary Designation Form

• Why is it important?

• Remember, the Will or trust of decedent will not trump the

beneficiary designation form, so the form is just as important as a

will or trust

• Reviewing to ensure that the separate accounts rule will apply, or

if it will be possible to eliminate beneficiaries before the

Beneficiary Finalization Date.

• In the case of a trust beneficiary, reviewing to make sure that

each individual sub trust is named.

• Executor can be given certain powers to make Roth conversions,

which can be specified in the BD form.

• See handout (checklist)

Special Rules for Non-IRA QRPs

• It is necessary to review the plan documents of any non-

IRA QRP, to determine the permissible beneficiaries, and

whether the payout options are different than under the

default rules. Many plan administrators will not permit

stretch out after the participant’s death.

• It may make sense for the participant to roll over to an

IRA from a QRP as soon as possible.

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Retirement plans in the context of estate planning

• Is Probate Required?

• Maybe, if the estate is named as a beneficiary.

• Are Retirement plans subject to estate taxes?

• Yes– they are in the decedent’s taxable estate

• 2013 Rules– $5.2 Million exemption amount & 40% rate

• Are Retirement plans subject to income taxes?

• Most retirement plans (except for Roths) are subject to income tax

and / or penalties upon withdrawal of plan assets. How does this

work after the death of the participant?

• Are Retirement Plans Asset Protected?

• Yes, but the distributions are not unless they are accumulated in a

trust.

• Is a stretch automatic as long as you have named an

individual beneficiary?


Gross Estate

Distributions

under your Will

Non-probate transfers

Revocable Trust

Survivorship property

Life Insurance

IRA’s

401(k)’s

POD accounts

Probate transfers Property in your

separate name

Probate

Process

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Non-tax estate planning issues

Twenty-five year old inherits a $100,000 IRA has two

choices:

• $60,000 automobile.

• $400,000 after tax income over life expectancy.

• Based on anticipated growth rate of 5%.

• Combined state and federal income tax rate of 35%.


Child’s Cum. Withdrawals+Balance

Age IRA Legacy Trust

Cash Out

50 $ 170,352 $ 65,000

60 $ 264,583 $ 65,000

84 $ 474,953 $ 65,000

Assume only $100,000 at age 40 earning 6%

Child withdraws and spends MRD after tax

A difference of over $ 400,000 on a $100,000 IRA!

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Assume only $100,000 at age 40 earning 6%

Child withdraws and spends MRD after tax

Child’s Cum. Withdrawals+Balance

Age IRA Legacy Trust

Cash Out

50 $ 170,352 $ 98,361

60 $ 264,583 $ 137,062

84 $ 474,953 $ 158,983

IRA is Cashed-out Early and Invested– still a big loss


• Five goals when performing estate planning for

retirement accounts

1. Achieve the client’s non-tax testamentary intent (While a gift to

charity may be tax advantageous, the client may not have

charitable intent)

2. Achieve maximum stretch out for the longest period possible

3. Minimize estate tax, if possible, and while doing so make sure

to fund the retirement plan to the right trust or individual upon

the first spouse’s death.

4. Achieve maximum asset protection, if possible and desired by

the client

5. Do not mess up the beneficiary designation, or ignore it

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Questions / Answers

Questions?

Presented by

John C. Martin, Attorney

The Law Offices of John C. Martin

1145 Merrill Street

Menlo Park, California 94025

Tel: 650-329-9500

Email: [email protected]

The contents of this presentation are not intended to be, nor should they be construed as, legal advice or the formation of an

attorney-client relationship. Thank you.

IRS CIRCULAR 230 NOTICE: To the extent that this presentation concerns tax matters, it is not intended to be used and cannot be used by

a taxpayer for the purpose of avoiding penalties that may be imposed by law.

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Bibliography:

Choate, Natalie B. Life and Death Planning for Retirement Benefits: The

Essential Handbook for Estate Planners– 7th Ed. / Natalie B. Choate

Choate, Natalie B., various online articles, available at www.ataxplan.com.

Mezzulo, Louis. An Estate Planner’s Guide to Qualified Retirement Plan

Benefits (ABA Publications, 4th ed. 2007).

Ray, Thomas and Dymond, Lewis (Presenters). “Sophisticated Planning for

IRA & Qualified Plan Distributions with WealthDocsTM” (Presented on May 6-

7, 2008)

Keebler, Robert (Presenter). “Sophisticated Planning for IRA & Qualified Plan

Distributions” (Presented on July 25, 2005).

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