Retirement Beneficiary Planning

Transcription

1 Retirement Beneficiary Planning Sara K. Yen, J.D., LL.M. Part I Minimum Distribution Rules 1.01 Lifetime (a) Required Minimum Distributions Everyone determines RMDs by referring to the Uniform Lifetime Table. Reg (a)(9)-9. The exception is when the owner names a spouse as sole beneficiary and the spouse is more than 10 years younger than the owner. That spouse then uses the Joint and Last Survivor Table (joint life expectancy of participant and spouse). Reg (a)(9)-9. (b) Required Beginning Date Generally, this is April 1 of the year following the year in which the IRA owner reaches age 70 ½. IRC 401(a)(9)(C). (c) Roth IRAs There are no distributions required from a Roth during lifetime Post-Death (a) Designated Beneficiary IRC 401(a)(9)(E), Reg (a)(9)-4, A-1 (1) Individual Designated beneficiary must be an individual. An estate does not qualify. Page 1 of 10

2 (2) See-Through Trusts A trust may qualify if certain rules are met. See 4.01(a), below. (b) Required Minimum Distributions (1) Non-Designated Beneficiary Rules Generally, these are non-individual beneficiaries, such as an estate, a charity, or a non-qualifying trust. (a) Participant Died Before Required Beginning Date 5-year rule: Must be distributed by the end of the year that contains the 5th anniversary of the date of death. May postpone distribution until the end of the full period, meaning no withdrawal is required each year. (b) Participant Died After Required Beginning Date No 5-year rule. Ghost Life Expectancy: Distributed in annual installments over the life expectancy of the deceased plan owner (as if s/he hadn t died). (2) Designated Beneficiary Rules (a) Individual Life expectancy of the individual. (b) Class or Group Life expectancy of oldest member of group if no separate shares created. See 3.01 below. Page 2 of 10

3 Part II Choosing a Beneficiary: Income Tax-Favored vs. Less Tax-Favored 2.01 Young Individuals Are Income Tax-Favored A young individual naturally gets the benefit of long-term tax deferral because they can use their life expectancy for the payout. Also applies to a properly drafted see-through trust with a young person as beneficiary of the trust Older Individuals Are Less Tax-Favored Can also use their life expectancy for the payout, but because the life expectancy is shorter, they will naturally have less of a tax benefit Surviving Spouse Is Tax-Favored Surviving Spouses are the only individuals who can elect to treat an inherited IRA as his ) or her own IRA. This means the surviving spouse can postpone distributions from the rollover until s/he reaches age 70 ½. (Other beneficiaries must start distributions by the end of the year following the owner s death.) Surviving spouse can also take the minimum required distributions from a rollover IRA using the Uniform Lifetime Table which is more favorable than the single life expectancy that must be used otherwise. Surviving spouse can name his or her own designated beneficiary for the rollover IRA, and after Surviving spouse s death, the beneficiary will get to use their own life expectancy for the minimum required distributions Trust For Surviving Spouse Is Less Tax-Favored Naming a trust for the surviving spouse as beneficiary of an IRA takes away all the advantages that a surviving spouse has by virtue of being the surviving spouse Charity Is Tax-Favored A charity or Charitable Remainder Trust is income tax-exempt, and will pay no income tax on any retirement benefits. Page 3 of 10

4 2.06 Estate Is Less Tax-Favored An estate (or a non-see-through trust) does not qualify for the life expectancy of the beneficiary payout. It is not income tax-exempt, and is typically in a higher income tax bracket than individual family members. Part III Fixing Beneficiary Problems 3.01 Multiple Individual Beneficiaries Example: My children, in equal shares. Basic Rule: All beneficiaries will use the life expectancy of the oldest individual in the group as the measuring period. Fix: Separate Share Exception. If the account is divided into separate inherited IRAs by December 31 of the year after the year of death, each individual can use their own life expectancy Non-Individual Beneficiary As Part of Multiple Named Beneficiaries This most often occurs when a charity is included in a group designation. Ò Basic Rule: The non-individual does not qualify for designated beneficiary treatment, and poisons the whole designation. The beneficiaries must use either the 5-year rule or the ghost life expectancy of the decedent. Fix: Payoff Exception. If the non-individual can be paid by September 30th of the year after the year of death, then they will not be treated as a non-individual/non-designated beneficiary. The remaining beneficiaries, if all individuals, can then create separate shares and use their individual life expectancies Getting To Spousal Rollover Where There Are Errors In The Designation (a) General Rule (But Not Legal Precedent!) Generally, if a decedent s IRA proceeds pass through a third party, such as an estate or trust, and then are distributed to the decedent s surviving spouse, the Page 4 of 10

5 spouse will be treated as acquiring them from the third party and not from the decedent, and the surviving spouse will not be eligible to rollover the IRA proceeds into his or her own IRA. However, if the estate fiduciary or the trustee(s) of a trust which distributes IRA proceeds to a surviving spouse has no discretion with respect to either the allocation of the IRA proceeds to a trust or a subtrust within the trust, or to the payment of the IRA proceeds to the surviving spouse, then for purposes of 408(d)(3) of the IRC, the IRS will (likely) treat the surviving spouse as having acquired the IRA proceeds from the decedent and not from the trust (b) Estate Named As Beneficiary OR No Named Beneficiary and Default Is Estate PLR Decedent died testate after starting his required minimum distributions. His IRA named Estate of Decedent as the beneficiary. Surviving spouse was named the executrix of the estate, and she was also the sole residuary beneficiary. Generally, an estate is not a designated beneficiary, and so the distributions to the estate would be made over decedent s ghost life expectancy. However, here, because surviving spouse was the sole residuary beneficiary, and also the executrix with no third party holding the power to intervene and direct Ò distribution, the surviving spouse was allowed to make a spousal rollover of the IRA. She could then use her single life expectancy for the distributions, and could also name her own ultimate beneficiaries. (c) Trust Named As Beneficiary PLR Decedent died aged 77. Surviving spouse was not yet 70 ½. IRA with balance of $3,262,000 designated Revocable Living Trust as beneficiary. Revocable Trust divides into Family Trust and Marital Trust upon Decedent s death. Family trust holds decedent s applicable exclusion (then $625,000) and Marital Trust holds decedent s remaining estate (approx. $8.0 million, including the IRA). Surviving spouse is the sole beneficiary of the Marital Trust, and also the sole Trustee with the power to allocate the assets among the trusts. Because surviving spouse was the sole beneficiary of the Marital Trust and also the Trustee, and there was no third party holding the power to intervene and direct distribution, surviving spouse was allowed to make a spousal rollover of the IRA. This has also been achieved with an extra step in the process. IRA was payable to the estate of the IRA owner with surviving spouse as sole executor. A Pour-over Will then paid the estate to a Revocable Living Trust with the spouse as sole Page 5 of 10

6 trustee. Trust terms were all to the surviving spouse unless there was a disclaimer. Spousal rollover was allowed. (d) Spousal Rollover Through Trust PLR IRA allowed surviving spouse to execute spousal rollover where IRA was payable to a trust with the surviving spouse and sons as co-trustees. This appears to be a departure from the previous trend of not allowing rollover where third parties are involved in a fiduciary role. However, the surviving spouse was the only trustee with the right to allocate assets, and the IRA approved the spousal rollover. (e) IRA Payable to Trust PLR , PLR IRA was payable to a Trust which contained formula funding of two sub-trusts, a General Power of Appointment Marital Trust and a Credit Shelter Trust. There were, however, non-spouse trustees of the trust, and the IRA did not approve the spousal rollover. The IRS wants the surviving spouse to have sole discretion as to what asset goes where. (f) IRA Payable to Trust PLR ' IRA was payable to a trust which contained formula funding for three sub trusts (A, B, and C). There were non-spouse trustees. There was no discretion on the part of the trustees as to how the trust assets would be allocated among the three sub-trusts, and the IRA had to be allocated to trust A. Surviving spouse was the sole beneficiary of trust A. IRS allowed spousal rollover despite the third party trustees, because they had no discretion to allocate the IRA. Part IV Paying IRAs To Trusts 4.01 Naming a Trust as a Designated Beneficiary An IRA can be payable to a trust. The IRA distributions will be payable over the life expectancy of the oldest trust beneficiary. Page 6 of 10

7 (a) Four Requirements For All Trusts to Qualify As A Designated Beneficiary Reg (a)(9)-4 (1) Trust must be valid under state law. (2) Trust must be irrevocable upon the death of the owner. This is difficult to satisfy with a joint Revocable Living Trust. Even though the trust may divide for tax purposes into an irrevocable Family Trust and a revocable Survivor s Trust, the IRS view the trusts as one revocable trust. See PLRs , , and (3) The beneficiaries of the trust must be identifiable from the trust instrument By September 30 of the year following the year of death. (4) Documentation requirement is satisfied (b) Two Types of Trusts Used as IRA Beneficiary (1) Accumulation Trust ) Distributions from the IRA are allowed to accumulate inside the trust. To determine what payout is allowed, it first must be determined which beneficiaries are countable. All beneficiaries are countable unless a beneficiary is deemed to be a mere potential successor beneficiary. Use the life expectancy of the oldest countable beneficiary, if all are individuals. If a countable beneficiary is a non-individual, the whole trust is poisoned and the IRA must pay out based on either the 5-year rule or the ghost life expectancy of the decedent. Problem may be fixable by paying off non-individual beneficiary. (2) Conduit Trust Trustee is required to withdraw the minimum distributions from the IRA over the life expectancy of the individual trust beneficiary, or the oldest member of a group of individual trust beneficiaries, and distribute the withdrawals out to the beneficiary or group members. The trustee may not hold the distributions inside the trust. Page 7 of 10

8 The benefit of a conduit trust is that it has the same effect as naming the trust beneficiary directly, except rather than the beneficiary being able to decide how to manage the account and when to make extra withdrawals, the IRA owner gets to specify a minimum payout plan Because the designated beneficiary will receive 100% of the IRA benefits if s/he lives to his or her life expectancy, no other contingent or remainder beneficiaries need be considered in determining the payout method. (c) Standalone Retirement Trust These trusts are drafted specifically to qualify for designated beneficiary status. Because they are only intended for one purpose and to deal with one asset, they are much easier to get qualified. Because the trustee of a standalone retirement trust puts a block between the beneficiary and the IRA assets, which greatly increases the chances that the beneficiary will get the tax benefit of the full stretch, it is often a much better vehicle to handle the transfer of IRA assets than outright distribution, particularly where wealth accumulation is a client goal. It is critical that the beneficiary designation is properly drafted in conjunction with naming any kind of trust as an IRA beneficiary. Part ) V Common Mistakes 5.01 Concerns With Revocable Living Trusts (a) Irrevocable Requirement To qualify as a designated beneficiary, the entire trust must be irrevocable upon the death of the IRA owner. With a Revocable Living Trust, the whole trust may not be irrevocable upon the first death. The IRS will view the portion of the trust that remains irrevocable as tainting the whole trust, and this requirement will be failed. (b) No Separate Share Treatment It is very difficult to obtain separate share treatment in a Revocable Living Trust which may bar each individual (trust) beneficiary to use their own life expectancy for withdrawals. Page 8 of 10

9 (c) Powers of Appointment A Power of Appointment which grants the power to appoint to a non-individual or an individual older than the oldest beneficiary would disqualify the trust because not all beneficiaries of the trust would be identifiable by September 30 of the year following the year of the owner s death. In a recent Private Letter Ruling ( , January 20, 2012), the IRS approved the release of a power of appointment by one of the trust beneficiaries, which then effectively closed the class of beneficiaries by the September 30 date. Accordingly, the trust qualified as a designated beneficiary under IRC 401(a)(9) and the accompanying regulations. (d) Incorrectly Drafted Beneficiary Designations Payable To Trust If the beneficiary designation form pays the benefits to a single trust, and no separate shares are identified in the form, the IRA will be paid over the oldest life expectancy of the trust beneficiaries. Example: To the Trustee of the Dad Client IRA Trust for the Benefit of Children, dated January 6, 2009, as amended and/or restated. If the form pays the benefits to multiple trusts, with each trust named in the beneficiary designation form, the IRA will be paid over each separate trust beneficiary s life expectancy. ) Example: One half (1/2) of the Death Benefit shall be payable to the Trustee of the Daughter Client Trust as created under the Dad Client IRA Trust for the Benefit of the Children, dated January 6, 2009, as amended and/or restated. to the Trustee of the Son Client Trust as created 5.02 Spousal Rollover Before Age 59 ½ Rolling over an inherited IRA to a spousal IRA prior to the beneficiary reaching age 59 ½ will cause any additional pre-59 ½ distributions to be subject to the 10% early distribution penalty. If no rollover occurs and the IRA is held as an inherited IRA, pre-59 ½ distributions can be taken penalty free Title Mistakes For non-spousal beneficiaries, the inherited IRA must be kept in the name of the deceased IRA owner. Re-titling into the name of the beneficiary will result in a taxable event. Page 9 of 10

10 Individual: Dad Client, deceased, IRA for the benefit of Daughter Client. Trust: Dad Client, deceased, IRA for the benefit of Daughter Client as Trustee of the Client Family Trust dated January 6, Page 10 of 10