Estate Planning With Qualified Plans

Transcription

1 Estate Planning With Qualified Plans Gayle Evans A. Introduction Gayle Evans a member of Chinnery Evans & Nail PC, in Lee s Summit, Missouri, as well as DosterUllom, LLC, in Chesterfield, Missouri, has been in the private practice of law for over 30 years, with emphasis in estate planning, business law, and employee benefits. She serves as general counsel to business clients, with specific expertise in implementing employee benefit plans, including employee stock ownership plans (ESOPs). Gayle provides estate planning for individual clients and business owners. She is a frequent speaker at national tax seminars and writes on estate planning and employee benefits topics. In addition, she has been a faculty member, speaker, and writer for ALI-ABA for more than 10 years. She can be reached at gevans@chinnery.com. 1. Qualified Plans (stock bonus, pension, or profit sharing plans qualified under the Internal Revenue Code of 1986 as amended (IRC) 401(a)) and IRAs (Individual Retirement Accounts qualified under IRC 408(a)) are a source of significant wealth in this country. (Unless otherwise indicated, all section references are to the IRC.) Congressional tax incentives, the miracle of taxfree compounding, and stock market successes (oh, for the good old days) have combined to enable individuals to build sizeable retirement account balances. 2. Estate planning with retirement benefits poses a challenge due to the complex web of rules and regulations spun by the IRC, the Employee Retirement Income Security Act of 1974 (ERISA), and the Retirement Equity Act of 1984 (REA). 3. This outline frames a series of issues the client and advisor may face in estate planning with Qualified Plans and IRAs: a. How are Retirement Benefits taxed? b. When to begin taking distributions? c. What form of distribution to take? d. Who should be named as beneficiary? e. What to do with an inherited IRA? ALI-ABA Estate Planning Course Materials Journal 29

2 30 ALI-ABA Estate Planning Course Materials Journal December 2011 f. IRA planning: regular IRA or Roth? g. How the spousal consent rules work? h. How to deal with retirement benefits in the event of divorce? B. Estate Taxation Of Annuities, Qualified Plans, And IRAs 1. Section 2039 Generally a. The primary estate tax provision governing Qualified Plan benefits, IRAs, and annuities is section Section 2039(a) generally provides that a decedent s gross estate includes the value of any annuity or other payment receivable by a beneficiary by reason of having survived the decedent if: i. The survivor s annuity arises under a contract (other than an insurance policy on the decedent s life); and ii. The contract also made provision for an annuity or other payment to the decedent geared to his or her life or life expectancy. b. Section 2039(b) provides that the amount included in the decedent s gross estate is proportionate to the amount of the purchase price contributed by the decedent (or by the decedent s employer on the decedent s behalf). 2. Includible Interests a. Section 2039 uses the phrase annuity or other payment. The statute covers not only the typical commercial annuity, but also Qualified Plans, IRAs, and a number of employer-sponsored survivor benefit plans. For example: i. The self and survivor annuity a contract providing for payments for the decedent s life, and thereafter to a designated beneficiary; ii. The joint and survivor annuity, providing for payments for the joint lives of the decedent and another person, with payments to continue to the survivor after the death of either; iii. Deferred compensation agreements entered into by the decedent and the decedent s employer for payments made to decedent for life and thereafter to a designated beneficiary. 3. Amount Includible

3 Qualified Plans 31 a. Generally. Section 2039(b) provides that the amount of an annuity payment includible in the decedent s gross estate is the value proportionate to the amount of the purchase price contributed by the decedent. b. For this purpose, contributions made by the decedent s employer are treated as having been made by the decedent. c. For example, assume that the decedent and spouse each contributed $15,000 to the purchase price of an annuity contract under the terms of which the issuing company agreed to pay an annuity to the decedent and spouse for their joint lives, and to continue the annuity for the survivor s life. Assume the value of the survivor s annuity at the decedent s death is $20,000 (computed under Treas. Reg ). Since the decedent contributed one-half of the cost of the contract, the amount included in the decedent s gross estate is $10,000. d. Computation Of Value. For most purposes, the computation of a time-related interest (annuity, estate for life or term of years, remainder, or reversion) is made under the prescribed tables of section e. Commercial annuities, however, are valued based on the commuted value of the future payments. Treas. Reg (a). 4. Other Relevant Estate Tax Provisions. If the death benefits are payable to the annuitant s estate rather than to a named beneficiary, the value is included in the decedent s gross estate under section If the decedent reserved or retained an interest in the contract described under sections 2036, 2037, or 2038 for example, a power to cash in the contract or to designate a different annuitant inclusion would be under the applicable section. 5. Gift Tax. Unlike other assets, retirement benefits cannot be gifted away during lifetime. Qualified Retirement Plans are not assignable, and IRAs cannot be assigned without losing their status as IRAs. Annuity rights can be gifted, such as by an irrevocable designation of a survivor annuitant, which is a transfer under section GST Tax. A discussion of the generation-skipping transfer (GST) tax is beyond the scope of this outline, except to state that the GST tax is applicable to distributions from Qualified Plans and IRAs. The estate planner should attempt to avoid the GST tax and make use of the GST exemption if possible. C. Income Taxation Of Qualified Plans, Annuities, And IRAs 1. Generally. Distributions from annuities, Qualified Plans, and traditional IRAs are taxed as ordinary income under section 72 at the time they are actually received. The participant s basis in the retirement

4 32 ALI-ABA Estate Planning Course Materials Journal December 2011 benefit or investment in the contract is recovered ratably over the expected period of the distribution. Qualified distributions from Roth IRAs are not taxed. 2. Withholding. Distributions from Qualified Plans and IRAs are subject to withholding unless the recipient elects not to have tax withheld. An eligible rollover distribution is subject to a mandatory 20 percent withholding unless transferred directly to an IRA or another Qualified Plan. 3. Basis. A participant s basis in a Qualified Plan is made up of nondeductible contributions, amounts includible in income attributable to life insurance coverage, and repayment of any loan that was treated as a taxable distribution. The IRS has provided a method for calculating the amount of an annuity payment treated as a tax-free return of basis. 4. Income In Respect Of A Decedent. Taxable distributions from Qualified Plans and IRAs, and the taxable gain in a deferred annuity contract, are treated as income in respect of a decedent (IRD) under section 691. There is no step-up in basis under section 1014 with respect to such amounts. The beneficiary of the benefits is entitled to an income tax deduction under section 691(c) for the amount of any federal estate taxes paid on the benefit. If disclaimed, the actual recipient of the benefit, not the disclaiming person, will have IRD. 5. Tax Treatment Of Rollover To Traditional IRA Or Qualified Plan. A participant may elect to roll over part or all of a qualifying distribution from a Qualified Plan to a traditional IRA, or another Qualified Plan, and defer the payment of income tax on the distribution until withdrawn from the IRA by the owner or beneficiary. a. To qualify for rollover treatment, the distribution must be transferred to a traditional IRA or another Qualified Plan within 60 days of the distribution. Although the entire distribution need not be rolled over, the portion not rolled over will be subject to ordinary income tax. b. If the distribution includes property, the property or the proceeds from the sale of the property may be rolled over. Any gain or loss realized on the sale of property will not be recognized provided that the post-distribution gain is rolled over. However, a participant cannot keep noncash property received in a distribution and roll over an equivalent amount of cash. c. The 60-day rule commences with physical receipt of the distribution. The IRS has the discretion to waive the 60-day rule if enforcement would be against equity or good conscience. d. Withholding is imposed at the rate of 20 percent on any distribution that is eligible to be rolled over but is not transferred directly to a Qualified Plan or traditional IRA, regardless of whether the recipient intends to roll over the distribution.

5 Qualified Plans 33 D. Minimum Distribution Rules And Penalty Taxes Overview 1. Introduction a. Congress enacted section 401(a)(9), known as the Minimum Distribution Rules, to discourage the transfer of monies in Qualified Plans and IRAs to the next generation tax-free. The rules prescribe when distributions must begin and the minimum amount that must be distributed. If the required minimum is not distributed, a 50 percent excise tax is levied on the under-distribution. b. In addition, the Minimum Distribution Rules deal with designating a beneficiary of plan benefits at the death of the participant. The Minimum Distribution Rules apply to Qualified Plans and IRAs. The Minimum Distribution Rules do not apply to Roth IRAs during the account owner s lifetime, but do apply after the account owner s death. c. Note: These rules are problematic only when the participant wants to leave the funds in the plan to grow tax-free for the longest possible period. After age 59½, the participant can always take distributions faster and in larger amounts than the Minimum Distribution Rules prescribe. d. Another Note: The terms of a particular Qualified Plan or IRA may be more restrictive than the Minimum Distribution Rules, and the plan will control. e. In addition to the Minimum Distribution Rules, there are other penalty taxes that may attach to distributions from Qualified Plans and IRAs, which can be described by this silly jingle: Not too early, Not too late, Not too little, Not too great. 2. Not Too Early 10 Percent Early Withdrawal Penalty a. A 10 percent penalty tax is imposed on distributions made from a Qualified Plan or IRA before the participant reaches age 59½. 72(t). The penalty is increased to 25 percent if the early withdrawal is from a Simple Retirement Account within the first two years. The 10 percent early withdrawal penalty will not apply if the payments are: i. On account of death; ii. On account of disability;