Notes

Outline

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Need For Planning Beneficiary selection must be coordinated with the Will and Trust Subject to double taxation, income tax and estate tax Dispositive provisions in the Will and Trust do not control Often, client’s IRA is largest asset of the estate

The Client’s Objectives Income tax deferral:  investments inside IRA grow income tax deferred Provide retirement security: “grow” the IRA as much as possible to provide most growth for retirement “Stretch-Out IRA”: provide income tax minimization for children or other beneficiaries

Advantages of the New Regulations New uniform table for distributions: usually smaller “Designated Beneficiaries” are not determined until after participant’s death IRA owner has “second chance” to correct errors, even if more than 70 1/2 Make more  post-mortem IRA planning possible Charitable planning is easier

Some Basics Income Tax Deferral – Generally, assets inside an IRA are not taxed until withdrawn To mitigate benefit, IRS mandates distributions by the “required beginning date” (Minimum Required Distributions) Generally, all distributions are taxed as ordinary income

Required Beginning Date (RBD) Applies to employer plans and IRAs Generally April 1 after the year the participant turns 70 1/2 Later of 70 1/2 or retirement for less-than-5%-owner participants in qualified plans Distributions must begin by the RBD Under the new rules, the determination the “designated beneficiary” is not made at the RBD.

Minimum Required Distributions (MRDs) Once the participant turns 70 1/2, minimum distributions must be received at least annually Roth IRA exception First years distribution can be deferred until the RBD – disadvantage of two distributions in the same year A 50% excise tax is levied for failure to satisfy the MRD requirements

Lifetime MRDs – New Simplified Rule Uniform distribution Divisors for all participants of the same age Everyone uses the same Table (old MDIB Table) Age and identity of the beneficiary are irrelevant (assumes the beneficiary is 10 years younger) Exception: participant’s beneficiary is the spouse and the spouse is more than 10 years younger; can use regular actuary table

New Uniform Table

Spouse as Beneficiary – New Rule Eliminates need to choose between the recalculated and fixed methods Use the new uniform  table if spouse is not more than 10 years younger Can use the longer joint life expectancy table if spouse is more than 10 years younger

Heirs as Beneficiary – New Rule Age of beneficiary does not matter: use new uniform table No multiple beneficiary rule No need for separate accounts until after death Can name spouse as beneficiary and receive same benefit under the old rule of naming children as beneficiary

Designated Beneficiary (DBs): Old Rule & New Rule A term of art that differs from “beneficiary” Only individuals can be DBs Estates and charities do not qualify Generally, trusts do not qualify – exception, “pass through” trusts At the RBD, the identity of the DB determines the MRD schedule

Designated Beneficiary: New Rule No longer needed to determine distributions during the participant’s life However, still necessary to determine distributions after the participant’s death

Postmortem MRDs - New Rule Year of Death: use uniform table If owner has a “Designated Beneficiary”    Distribution period is generally the remaining life expectancy of the designated beneficiary (no recalculation)    Distribution consistent - does not matter whether death is before or after RBD

Postmortem MRDs - New Rule If owner has no “Designated Beneficiary” If death before 70 1/2: Must be distributed within 5 years If death after 70 1/2: Use remaining life expectancy of the owner (no recalculation)

Postmortem Distributions: Timing  Non-Spouse as Beneficiary: Distributions must commence by December 31st of the year after the date of death Spouse as Beneficiary: must commence by the year in which the deceased IRA owner would have attained age 70 1/2

“Separate Account Rule” New Rule Applies when participant has multiple beneficiaries Under old rule, had to use the life expectancy of the oldest beneficiary Under new rule, after participant’s death, can use sub-accounts; each beneficiary can use their own life expectancy to determine distributions

Planning Considerations

Spouse as Beneficiary: Relinquishing Control Income tax deferral: Spouse can do a  tax free rollover – distributions are determined by using spouse’s life expectancy Risk of naming undesirable beneficiary If no rollover, distributions can be deferred until owner would have reached RBD Estate tax deferral: Qualifies for “marital deduction” – estate tax deferred until spouse’s death

QTIP Trust: Retaining Control Many times client is unwilling to assume the risk that spouse might disinherit intended remainder beneficiaries Use of QTIP Trust gives spouse “use & enjoyment” during lifetime Protects the remainder for the desired beneficiaries

IRS Requirements: QTIP Trust  Surviving spouse must be the sole lifetime beneficiary Must satisfy the marital deduction rules, ie Trust must pay all income for spouses life Must satisfy the “minimum distribution” rules IRA proceeds paid to owner’s heirs upon death of the spouse Rev. Ruling 2000-2

QTIP as Designated Beneficiary: Income Tax Consequences    Can the QTIP Trust qualify as a “Designated Beneficiary” to use the spouse’s measuring life for post mortem distributions? Yes     As long as Trust meets certain requirements

Trusts as Designated Beneficiary Trust beneficiaries can qualify as DBs if certain requirements are met: Trust is valid under state law (but w/o corpus) Beneficiaries are identifiable Certain information is furnished to the plan administrator, trustee or custodian Trust becomes irrevocable at death

QTIP Trust Beneficiary Advantages Participant maintains testamentary control Estate tax deferral Disadvantages Potential sacrifice of income tax deferral as compared to spousal IRA rollover Greater of income earned or MRD Rev Rul 2000-2: Must distribute all IRA income even if minimum required distribution is less Complexity

Credit Shelter Trust: Beneficiary Generally, Spouse is best choice as DB But, if assets inside the revocable trust are insufficient, the credit shelter trust will be underfunded An underfunded credit shelter trust will cause more estate taxes at the death of the surviving spouse

Example: Under funded Credit Shelter Trust

Solution:Under funded Credit Shelter Trust

Credit Shelter Trust: Issues IRA is a “wasting” asset – poor asset to fund a credit shelter trust Avoid accelerating income tax consequences of a pecuniary formula clause If name trust as beneficiary, it must meet the “designated beneficiary” rules Consider naming spouse as beneficiary, use a “disclaimer” after participant’s death

Children as Beneficiary-New Rule No advantage of stretching distributions during lifetime of the participant Lifetime distributions are the same regardless of the age of the beneficiary Client will be less likely to name children as a primary beneficiary, except in a second marriage situation

Naming a Charity: New Rule Use retirement plans to satisfy charitable bequests rather than appreciated property Distributions based on uniform table (even though charity is not a “designated beneficiary” Charity avoids the deferred income tax consequences Will no longer shorten the IRA’s distribution period

Acceleration vs. Deferral Minimizing distributions is generally best due to the tax-deferred compounding Accelerating distributions can be advantageous in limited cases Gifts are made with the after-tax distributions Funds are otherwise unavailable for this purpose Significant short-term appreciation is expected prior to death with limited deferral potential after death Purchase life insurance

The Role of Life Insurance Provides estate liquidity Estate tax funding so retirement plans can be preserved Lifetime gifts with after-tax distributions Reduces taxable estate Assets in gift trust can fund insurance premiums for liquidity & wealth transfer Wealth replacement Coupling with IRA-to-CRT

The Final Word Coordinate with total estate plan Make sure you have a “designated beneficiary” Provide for contingencies Don’t overlook the estate planning benefits of using trust beneficiaries & disclaimers Ensure adequate estate liquidity to preserve the tax-favored status of retirement plans