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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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Why Plan for IRAs and other Qualified Plans?
Source: “Planning with IRAs and other Qualified Plans”, Robert S. Keebler (2004)
Why Plan for IRAs and other Qualified Plans?
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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Why Plan for IRAs and other Qualified Plans?
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
Accumulation Trust – Example 2
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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Accumulation Trust – Example 3
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?
Retirement plans in the context of estate planning
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%.
Non-tax estate planning issues
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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Non-tax estate planning issues
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
Retirement plans in the context of estate planning
• 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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