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Who Should be the Beneficiary of Your IRA? Retirement Planning Lewis W. Dymond, Jr. WealthCounsel, LLC.

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Presentation on theme: "Who Should be the Beneficiary of Your IRA? Retirement Planning Lewis W. Dymond, Jr. WealthCounsel, LLC."— Presentation transcript:

1 Who Should be the Beneficiary of Your IRA? Retirement Planning Lewis W. Dymond, Jr. WealthCounsel, LLC

2 Retirement Planning Recommended Reading: Life and Death Planning for Retirement Benefits The Essential Handbook for Estate Planners Natalie Choate Ataxplan Publications www.ataxplan.com 2

3 Retirement Planning Also Recommend: The Big IRA Book The Ultimate Manual to help you manage your IRA practice and answer the question: Who Should be the Beneficiary of your IRA? Robert S. Keebler with Cecil D. Smith & Carol H. Gonnella Teton Publishers, LLC 800.955.0554 3

4 Course Objectives Help you help your clients: –Pass more wealth to loved ones. –Integrate client’s IRA with their overall estate plan. –Evaluate whether a standalone retirement trust (“SRT”) is right for them and their families. –Use SRTs to protect and grow savings for their families. –Take advantage of the rules applying to separate accounts governing IRAs so that each beneficiary can control his or her own inheritance. 4

5 What Are We Talking About? Defined Contribution Plans: –Under these plans, an employer establishes a retirement account for each employee (“Participant”), and the account receives a “defined contribution” from the employer each year. –The Participant’s retirement income is based on withdrawals from this account, and the investment return. –These plans include profit-sharing plans, money sharing plans, 401(k) plans, thrift plans, ESOPs, SEPs, SIMPLE plans, and employer- funded 403(b) plans. 5

6 What Are We Talking About? And... Individual Retirement Arrangements (IRAs): –These plans are established by the taxpayer – not his or her employer. The taxpayer funds the plan either through personal contributions, as a rollover, or direct transfer from his or her employer’s defined contribution plan. –As a general rule, the same tax law applies to IRAs and to defined contribution plans. Reg §1.408-8 Q&A 1. –There are exceptions! 6

7 What Are We Talking About? Not... Defined Benefit Plans These are plans in which the employer expresses each eligible employee’s benefit as a defined amount paid in installments beginning at retirement. We sometimes call this arrangement a pension. Government Benefits Such as social security, railroad retirement, civil service benefits, etc. 7

8 Why You Need to Understand “As of March 31, 2010, clients hold nearly $16.5 trillion in IRAs and Qualified Plans, and these assets now account for 36% of all household financial assets.”* For a large number of clients, retirement plans may be largest asset held at death. Retirement Plans were designed to accumulate wealth for retirement, not to accumulate for future generations – tax laws designed accordingly. *According to the Investment Company Institute 8

9 Fundamental Concepts Retirement Plans were designed to accumulate wealth for retirement, not to accumulate for future generations – tax laws designed accordingly. 9

10 Fundamental Concepts Principle #1: Encourage people to contribute to IRAs and Qualified Plans. How: Contributions are made with pre-tax dollars. Contributions compound in a tax-free environment. Contributions and earnings are not taxed until withdrawn. 10

11 Fundamental Concepts Principle #2: Discourage people from using money too soon. How: As a general rule, the Code imposes a 10% additional income tax on the taxable portion of a distribution made before the taxpayer reaches age 59½. There are exceptions. 11

12 Fundamental Concepts Principle #3: Penalize taxpayers who don’t use the money during retirement. How: Require that distributions begin at the earlier of age 70½ or upon death of the taxpayer. As a general rule, the Code imposes a 50% additional income tax on the excess of the amount required for distribution over the amount actually distributed. Make things really complicated if a taxpayer dies with money remaining in the IRA or Qualified Plan. 12

13 Fundamental Concepts Principle #1: Encourage people to contribute through the “Power of Tax Deferral” Tax Deferred Investment $1 doubled every year for 20 years tax free $1,048,567 Taxable Investment $1 doubled every year for 20 years taxable 29% tax rate ? 13

14 Assumes 12% annual return 14

15 Fundamental Concepts A “distribution calendar year” is the year for which the plan must make a distribution. Reg §1.401(a)(9)-5 Q&A 1(b) The first distribution calendar year is the year in which the individual either reaches 70½ or retires. Although the RBD is not until April 1 of the following year, the distribution required on that date is for the prior calendar year. A distribution for the second distribution calendar year must be made before December 31 of the year in which the RBD falls. Reg §1.401(a)(9)-5 Q&A 1(c) 15

16 Fundamental Concepts The amount that the Participant must take out each year by and after the RBD is called the “required minimum distribution” (MRD*). * Yes, the correct acronym is MRD because we don’t want to confuse it with the RMD distribution method for SOSEPPs. And MRDs should not be confused with RBDs and the later discussed DBs... got it? 16

17 Fundamental Concepts Lifetime MRDs are determined annually by dividing the prior year-end account balance by a life expectancy factor supplied by the IRS. Uniform Lifetime Table; or Joint and Last Survivor Table, if the Participant’s sole beneficiary is his or her more-than-10 years –younger spouse. Uses the recalculation method, will never divide by “1”; so Participant won’t outlive his or her retirement benefits if only taking MRD each year. 17

18 Fundamental Concepts Uniform Life Table (Reg. 1.401(a)(9)-9 Q&A 2) 18

19 Fundamental Concepts MRD for year of death: If Participant had not yet taken the entire MRD for year of death, any remaining MRD must be taken by the beneficiary before the end of the year. After death, the beneficiary owns the account and must take any of the Participant’s remaining RMDs. If there are multiple beneficiaries, the MRD rules are satisfied as long as ANY beneficiary takes the balance of the year-of-death distribution. It does not need to be distributed pro rata among beneficiaries. 19

20 Fundamental Concepts MRDs after death: After the Participant’s death, MRDs apply to the beneficiary. MRDs for the beneficiary normally begin the year after the year of the Participant’s death. Natalie Choate refers to this as the “Required Commencement Date.” Participant’s MRD may be required for Participant in year of death. Rules are different if spouse is the sole beneficiary. 20

21 Fundamental Concepts MRDs after death: The after death MRD rules are more complicated than the lifetime MRD rules. Based on three factors, one of which requires good planning and one of which trumps all else. Death before or after the RBD of the Participant? Who (or what) is the beneficiary? What does the plan allow? 21

22 Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? DB is Code-defined and does not simply mean any beneficiary who is designated by the Participant! Understanding the meaning of DB is crucial to planning for and compliance with post-death MRDs. 22

23 Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? The identity of the beneficiary is not finally fixed, for purposes of these rules, until September 30 of the year following the year of the Participant’s death, the “designation date.” Reg §1.401(a)(9)-4, A-4(a) Natalie Choate refers to this as “Beneficiary Finalization Date.” Important for separate account rules. Important for clean-up strategies (removing non-qualified DBs before designation date). 23

24 Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? Beneficiary means the person or persons (or entity or entities) who are entitled to the plan benefits upon the Participants death. Retirement benefits generally pass as non-probate property, by contract, to the beneficiary named in the beneficiary designation form. The provisions in the Participant’s will or RLT are irrelevant as to who receives the benefits, unless plan or beneficiary designation form provides otherwise. 24

25 Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? Most IRAs and QRPs have printed forms they expect Participant to use. Most (but not all) will accept attachments. Some will accept a separate instrument. When drafting beneficiary designations, make sure what you are trying to do is permitted under the terms of the plan. 25

26 Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? Not every beneficiary is a Designated Beneficiary (DB). A beneficiary might not be a DB, even if designated on a beneficiary designation form. A beneficiary might be a DB, even if not designated by the Participant. Reg §1.401(a)(9)-4 Q&As – Determination of designated beneficiary. Included in materials 26

27 Fundamental Concepts Keys to achieving Designated Beneficiary status: Only individuals can be Designated Beneficiaries. Estates, partnerships, corporations, LLCs, and charities do not qualify. While a trust is not an individual, some trusts qualify for “look- through” status and the trust’s beneficiary(ies) qualify as DBs Reg §1.401(a)(9)-4 Q&A 5(a) and (b) (included in materials). If there are multiple beneficiaries, all must be individuals and must be able to identify the oldest. Need to determine if separate account rule applies. The beneficiary must be designated either “by the terms of the plan” or (if plan allows) by the Participant. 27

28 Fundamental Concepts MRDs after death: 28 Death Before Required Beginning Date Death On or After Required Beginning Date Designated Beneficiary Fixed Term Method (aka “Life Expectancy Rule.”)* Fixed Term Method (aka “Life Expectancy Rule.”)** Non- Designated Beneficiary Five Year Rule Participant’s Life Expectancy (aka “Ghost Life Expectancy”)

29 Fundamental Concepts Fixed-Term aka “Life Expectancy Rule”: Use the DB’s age to determine the DB’s life expectancy from the Treasury Department’s Single Life Table. Calculate the MRD for the first year by dividing the account balance by the DB’s life expectancy. Each subsequent year, calculate the MRD by dividing the remaining account balance by the prior year’s divisor minus “1”. This is said to be a “Stretch-Out” and is, in most cases, a big tax advantage. Under this method, a beneficiary may have to withdraw all of the retirement benefits before he dies. 29

30 Fundamental Concepts Single Life Table – Reg. 1.401(a)(9)-9 Q&A1 30

31 Fundamental Concepts Post Death MRDs - “Five-Year Rule”: The entire plan balance must be distributed to the beneficiary(ies) by December 31 of the year of the 5 th anniversary of the Participant’s death. Annual distributions are not required. Ceases to have any application once the Participant reaches his RBD. Since a Roth IRA has no RBD, the five-year rule is still applicable to Roth IRAs with no DB even if the Participant has reached his RBD for other IRAs or QRPs. Distributions from a Roth IRA cannot satisfy MRDs from non-Roth IRAs. 31

32 Fundamental Concepts Post Death MRDs - “Five-Year Rule”: Under IRC §401(a)(9)(B): The life expectancy method automatically applies if there is a DB; and The 5-year rule only applies when there is no DB. 32

33 Fundamental Concepts Post-Death MRDs - “Five-Year Rule”: However under the Treasury Regulations, the plan can permit the DB to choose between the 5-year rule and the life expectancy method where the Participant died before the RBD. Reg §1.40(a)(9)-3, Q&A-1 This is the ONLY minimum distribution rule that bases post death MRDs on an election by distributee. Election becomes irrevocable by the deadline for making the election, and is applicable for all later years. Plan can provide a default rule if no election made by beneficiary. If plan does not specify a default rule; the default rule is life expectancy method. 33

34 Fundamental Concepts Post-Death MRDs – Participant’s life expectancy method (“Ghost life expectancy”): Only payout option available if the Participants dies after RBD with no DB. Reg §1.401(a)(9)-5, Q&A-5(a)(2) If the benefits are left to a DB, then the longer of the life expectancy method or Participant’s life expectancy method is used. Reg §1.401(a)(9)-5, Q&A-5(a)(3) Calculate the Participant’s remaining life expectancy using the IRS’s Single Life Table based on the age the Participant attained (or would have attained) on the Participant’s birthday in the year of death. Reg §1.401(a)(9)-5, Q&A-5(c)(3) 34

35 Fundamental Concepts Special situations and rules: Multiple beneficiaries Surviving spouse as beneficiary Separate account rule Lifetime Rollovers Roth IRAs Trust as beneficiary 35

36 Fundamental Concepts Multiple Beneficiaries: No Designated Beneficiary unless all of the beneficiaries are individuals (Reg §1.401(a)(9)-4 Q&A-3); and If all of the beneficiaries are individuals, life expectancy divisor is that of the oldest beneficiary. Two escape hatches: Separate Accounts Rule. Ability to “remove” a beneficiary through disclaimer or distribution of that beneficiary’s share by the Designation Date (September 30 of the year following the year of death). 36

37 Fundamental Concepts Separate Accounts Rule: If Participant’s benefits under a plan are divided into separate accounts with different beneficiaries, the post death MRD rules apply separately to each account. Reg §1.401(a)(9)-8 Q&A – 2(a)(2) This regulation does NOT apply to multiple beneficiaries who take their interests through a trust that is named as beneficiary of the plan. Powerful tool when planning for retirement benefits. Allows multiple beneficiaries to each use their own life expectancy in determining post-death MRDs. 37

38 Fundamental Concepts Separate Accounts Rule - compliance: Pro rata sharing in gains and loses. Normally fractional or percentage division. Pecuniary gift would not meet the definition unless (under local law or beneficiary designation) the gift shares in post-death gains and losses pro rata with the other beneficiaries’ shares. Pecuniary gifts can be eliminated by distributing the pecuniary gift before the Designation Date. Accounts must be “established” by December 31 of the year following the year of death to use separate life expectancies. If established later, the separate accounts are still effective for all other purposes. 38

39 Fundamental Concepts Review of Critical Dates: September 30 of the year following the year of death. Designation date – the date at which the beneficiaries are identified. Eliminate non-DBs by disclaimer or satisfaction of bequest. October 31 of the year following the year of death. Date by which trust documentation must be filed in the case where a trust is named as DB. December 31 of the year following the year of death. Required Commencement Date – the date by which the first distribution must be made. Date by which separate accounts must be created. 39

40 Fundamental Concepts Surviving Spouse as Sole Beneficiary: Lifetime distributions – more-than-10-year-younger spouse, use of Joint and Survivor Table. 40

41 Fundamental Concepts Surviving Spouse as Sole Beneficiary: Spouse can rollover inherited benefits to spouse’s own retirement plan or elect to treat an inherited IRA as spouse’s own IRA. Reg §1.408-8 Q&A 5(a) A spouse who is under 70½ can postpone distribution from his or her IRA until he or she reaches own RBD. Spouse can take MRDs using the “recalculate method” from the Uniform Lifetime Table. Spouse can name his or her own DBs. There is no “deadline” in which the spouse must make the rollover except as to benefits already distributed. 41

42 Fundamental Concepts Surviving Spouse as Sole Beneficiary: Postponed Required Commencement Date when Participant dies before his or her RBD, if spouse remains the beneficiary. Annual distributions do not have to begin until the end of the latter of the year following the year in which the Participant died, or the year in which the Participant would have reached 70½. Reg §1.401(a)(9)-3 Q&A 3(b) If the spouse dies before the date he or she is required to take distributions, then MRDs will not be based on the Spouse’s remaining life expectancy – instead, a new period starts using either the 5-year rule or, if the spouse has a DB, the fixed- term method. Reg §1.401(a)(9)-3 Q&A 5 and 6 42

43 Fundamental Concepts Surviving Spouse as Sole Beneficiary: If spouse remains the beneficiary, spouse’s MRDs are calculated using recalculation method. Life expectancy is determined using the Single Life Table. Upon the spouse’s death, benefits are paid over the spouse’s remaining life expectancy under the fixed-term method. 43

44 Trust as Beneficiary Two biggest myths about estate planning for QRPs and IRAs You can’t name a trust and get a stretch-out. Naming an individual will result in a stretch-out. 44

45 Trust as Beneficiary 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% 45

46 Trust as Beneficiary Can a trust be named as a beneficiary? Normally a trust is a non-individual and therefore can not qualify for Designated Beneficiary status. 5 Year if Participant dies before RBD Ghost life expectancy, if after RBD HOWEVER, under the regulations, it is possible to name a trust as beneficiary and still have a Designated Beneficiary for purposes of determining MRDs. But special rules apply. 46

47 Trust as Beneficiary Reg §1.401(a)(9)-4, Q&A-5(b) A “see-through trust” – look through the trust and treat the trust beneficiaries as the Participant’s Designated Beneficiaries, just as if they had been named directly as beneficiaries by the Participant. Two exceptions: Spousal rollover not available. “Separate Accounts” treatment not available. Reg §1.401(a)(9)-4, Q&A 5(c) 47

48 Trust as Beneficiary Qualifying as a see-through trust: The trust must be valid under state law. Trust is irrevocable or will, by its terms, become irrevocable upon the death of the Participant. Certain documentation must be provided to the plan administrator by October 31 of the year after the year of the Participant’s death. Beneficiaries must be identifiable from the trust instrument and all must be individuals. 48

49 Trust as Beneficiary The trust must be irrevocable: Reg §1.401(a)(9)-4 Q&A 5(b)(2) “The trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.” Including the statement, “This trust becomes irrevocable upon my death” probably not be necessary in a revocable living trust or testamentary trust under a will. WealthDocx™ includes out of caution and for benefit of plan provider. Choate: “A Trustee’s power, after the Participant’s death, to amend administrative provisions of the trust should not be considered a power to revoke.” See PLRs 200537004 and 200522012. 49

50 Trust as Beneficiary Beneficiaries must be identifiable and all must be individuals: Reg §1.401(a)(9)-4 Q&A 5(b)(3) “The beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the employee's benefit are identifiable within the meaning of A-1 of this section from the trust instrument.” “A designated beneficiary need not be specified by name in the plan or by the employee to the plan in order to be a designated beneficiary so long as the individual who is to be the beneficiary is identifiable under the plan. “The members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible, to identify the class member with the shortest life expectancy.” 50

51 Trust as Beneficiary Beneficiaries must be identifiable and all must be individuals: Must be able to identify the beneficiary with the shortest life expectancy (oldest beneficiary). “...the designated beneficiary with the shortest life expectancy will be the designated beneficiary for purposes of determining the applicable distribution period.” Reg §1.401(a)(9)-5 Q&A 7(a)(1) 51

52 Trust as Beneficiary Beneficiaries must be identifiable and all must be individuals: Which beneficiaries count? General rule is that contingent and successor beneficiaries count, UNLESS... The beneficiary is “a mere potential successor to the interest of one of the employee's beneficiaries upon that beneficiary's death.” When determining who is “a mere potential successor”, there are two types of trusts: –Conduit Trusts –Accumulation Trusts 52

53 Trust as Beneficiary Conduit Trust: Reg §1.401(a)(9)-5 Q&A 7(c)(3), example 2 Trustee must withdraw all RMDs over life expectancy of the current beneficiary (oldest current beneficiary). Trustee must distribute those distributions (plus any non- required distributions) immediately to the current beneficiary(ies). Trustee may not retain (“accumulate”) in the trust any plan distributions made during the lifetime of the conduit beneficiary. 53

54 Trust as Beneficiary Conduit Trust: Need only look at current beneficiaries; all [contingent or successor] beneficiaries are mere potential successors in interest. Current beneficiaries must all be individuals and identifiable from terms of the trust. RMDs based on the life expectancy of the oldest current beneficiary. Do not need to consider or count the remainder or remote contingent beneficiaries. 54

55 Trust as Beneficiary Accumulation Trust: Any trust that is not a Conduit Trust is an “Accumulation Trust.” Trustee not required to immediately distribute withdrawals from the retirement plan; the withdrawals can be held in trust (accumulated). Much more difficult to determine which beneficiaries count. Must consider all contingent and successor beneficiaries unless the beneficiary is a mere potential successor to the interest of another beneficiary. All must be identifiable and individuals. Life expectancy of oldest of all current and remainder beneficiaries used to calculate RMD. 55

56 Trust as Beneficiary Accumulation Trust – mere potential successor: “Mere potential successor” not defined in regs or code. PLRs 200438044 and 200708084 clarifies that if, upon the death of a beneficiary, the IRA is distributed outright to a named living person, then those that receive if that beneficiary is deceased are “mere potential successors.” Natalie Choate refers to this as the “Snapshot Approach” – Outright to a Now Living Person (O/R-2-NLP) –In trust for my wife and upon her death outright to my then living children in equal shares. –Snapshot taken at time of death and any successor beneficiaries to then living children would be mere potential successors. 56

57 Trust as Beneficiary Accumulation Trust – O/R-2-NLP: Not consistent with good estate planning. Outright distributions rarely desirable, especially for potentially young beneficiaries. 57

58 Trust as Beneficiary Accumulation Trust – Problems: We must consider all potential remainder and contingent beneficiaries. All must be identifiable and individuals. Must be able to identify all potential remainder and contingent beneficiaries; no matter how remote and they must all be individuals. 58

59 Trust as Beneficiary Accumulation Trust – Problems identifying beneficiaries: Classes of beneficiaries; e.g. “descendants,” “descendants and spouses.” Remote contingent beneficiaries. Heirs-at-law Potential escheat to state Powers of appointment. Permissible appointees Creditors of the estate 59

60 Trust as Beneficiary Accumulation Trust – classes of beneficiaries: When defining classes, include a provision presuming those older than the measuring life deceased. “Upon the death of..., my Trustee shall distribute the remaining trust property per capita at each generation to my descendants. But any persons born before Mary C. Client will be deemed deceased.” 60

61 Trust as Beneficiary Accumulation Trust – Remote Contingent Beneficiaries; Heirs-at-law; escheat to the state: First presume any heirs-at-law older than the measuring life are deceased. –“Notwithstanding the foregoing, for each separate trust created under this agreement any persons born before the oldest trust beneficiary of that separate trust who is entitled to distributions under the terms of that trust, determined as of September 30th of the year following the year of my death, shall be deemed deceased and any provision of the laws of Colorado potentially requiring escheat or distribution to the state or a non-individual shall be disregarded.” 61

62 Trust as Beneficiary Accumulation Trust – Remote Contingent Beneficiaries; Heirs-at-law; escheat to the state: Second, use the “Circle Trust” concept to prevent an escheat to the state if there are no younger members of the class. –If no younger member of the class exists, the trust terminates and vests in current beneficiary. –WealthDocx™ adds this to the RAP provision. –“...each trust created under this agreement will terminate at the earlier of the death of the last to die of the Remote Contingent Beneficiaries as defined in Article Five or.... –“At that time, the remaining trust property will vest in and be distributed to the persons entitled to receive mandatory distributions of net income of the trust and in the same proportions....” 62

63 Trust as Beneficiary Accumulation Trust – Powers of appointment: First, limit classes of permissible appointees by presuming those older than the measuring life are deceased. Second, no general powers of appointment. Can’t allow appointment to estate or creditors of estate who might be non-individuals. 63

64 Trust as Beneficiary Conduit Trust or Accumulation Trust? 64

65 Trust as Beneficiary Conduit Trust - Advantages: Certainty – Supported by Treasury Regulations. Easiest to draft. Greatest flexibility for remainder and contingent beneficiaries. Greatest flexibility for granting beneficiaries testamentary powers of appointments. –General or Limited –No restrictions on permissible appointees Easiest to achieve desired distribution pattern. 65

66 Trust as Beneficiary Conduit Trust - Disadvantages: Loss of Trustee discretion as to amounts withdrawn from IRAs and QRPs. –RMDs. –Lose flexibility in case of major anticipated tax increase. –Lack of creditor protection. –Lack of predator protection. –Lack of beneficiary protection. Uncertainty regarding the future of the minimum distribution rules. 66

67 Trust as Beneficiary Accumulation Trust - Advantages: Trustee discretion maintained as to amounts withdrawn from IRAs and QRPs. –Asset protection from creditors –Failed marriages –Substance of spendthrift issues –Incentive trust provisions –Flexibility for tax planning 67

68 Trust as Beneficiary Accumulation Trust - Disadvantages: Much trickier to draft. Limits remainder and contingent beneficiary distribution patterns: –No older remainder or contingent beneficiaries. –No charitable remainder or contingent beneficiaries. Powers of appointment. –No general power of appointment. –Limits on permissible appointees. 68

69 Trust as Beneficiary GSTT Issues: Normally allocating GST exemption to trusts designed to be funded with IRAs is not an efficient use of GST exemption because it is an item of IRD. When drafting a stand-alone retirement trust, would normally allocate GST Exemption first to the RLT and then to the SRT. Roth IRAs are an exception. 69

70 Trust as Beneficiary GSTT Issues: GST Exempt Trust: –Accumulation Trust is preferred. –Conduit Trust works. GST Nonexempt Trust or Partially Exempt: –Conduit Trust is preferred with a general power of appointment. Property included in beneficiary’s estate. Avoids GSTT taxable termination or distribution in favor of estate tax inclusion. –Accumulation trust is not recommended because can’t use a general power of appointment. 70

71 Trust as Beneficiary The Keebler/Kavesh Switch – Best of both worlds? PLR 200537044: –Included in your materials. –Obtained by WealthCounsel member, Phil Kavesh and Robert Keebler, CPA. Stand-alone retirement trust with trusts initially drafted with conduit trust provisions. –Trust protector has the power at the death of the Grantor to void the conduit trust provisions; and –Amend the remainder beneficiary and power of appointment provisions. –“... also note that said actions were taken within nine (9) months of the date of Decedent's death, and are treated as a disclaimer under the laws of State.” 71

72 Trust as Beneficiary The Keebler/Kavesh Switch – Best of both worlds? Advantages: –Begin with the certainty of a conduit trust. –Flexibility of a 2 nd look. Disadvantages: –Reliance on a PLR that has been subject to criticism by certain practitioners. –Possible attacks on Trust Protector’s discretion by beneficiaries. 72

73 Trust as Beneficiary WealthDocx™ Conduit Provisions within the Client’s RLT: 73

74 Trust as Beneficiary Thus creating the following conduit language: Distributions from Qualified Retirement Plans to Trusts other than the Marital Trust Each year, beginning with the year of my death, if any trust created under this agreement other than the Marital Trust becomes the beneficiary of death benefits under any qualified retirement plan, my Trustee shall withdraw from the trust’s share of the plan, in each year, the required minimum distribution required under Section 401(a)(9) of the Internal Revenue Code. My Trustee may withdraw additional amounts from the trust’s share of the plan as my Trustee deems advisable; but, only if the dispositive terms of the trust authorize my Trustee to immediately distribute the withdrawn amount as provided in this subsection. My Trustee shall immediately distribute all amounts withdrawn to: My wife, if a beneficiary of the trust; and If my wife is not a beneficiary of the trust, to my descendants, per stirpes, who are beneficiaries of the trust; and If my wife is not a beneficiary of the trust and no descendant of mine is a beneficiary of the trust, then to the income beneficiaries of the trust in equal shares. Amounts required to be withdrawn and distributed under this subsection shall, to the extent they are withdrawn and distributed, reduce mandatory distribution amounts under other provisions of this agreement that otherwise require distribution of all of the income of the trust. The purpose of this Section is to insure that the life expectancy of the beneficiaries of the trust may be used to calculate the minimum distributions required by the Internal Revenue Code. This subsection shall be interpreted consistent with my intent despite any direction to the contrary in this agreement. 74

75 Trust as Beneficiary Thus Creating (Cont.): Minimum Required Distribution In administering my trust, the minimum required distribution for any year shall be, for each qualified retirement plan, the greater of (1) the value of the qualified retirement plan determined as of the preceding year-end, divided by the applicable distribution period; and (2) the amount that my Trustee shall be required to withdraw under the laws then applicable to the trust to avoid penalty. If I die before my required beginning date with respect to a qualified retirement plan, the applicable distribution period means the life expectancy of the beneficiary. If I die on or after my required beginning date with respect to a qualified retirement plan, the applicable distribution period means the life expectancy of the beneficiary, or (if longer) my remaining life expectancy. Notwithstanding the foregoing, if I die on or after my required beginning date with respect to a qualified retirement plan, the minimum required distribution for the year of my death shall mean (a) the amount that was required to be distributed to me with respect to the qualified retirement plan during the year, minus (b) amounts actually distributed to me with respect to the qualified retirement plan during the year. “Life expectancy,” “required beginning date” and other similar terms used in this subsection, shall be determined in accordance with Section 401(a)(9) of the Internal Revenue Code. 75

76 Trust as Beneficiary Making sure the QTIP qualifies: The surviving spouse should have a power to compel the trustee to withdraw the income earned in the IRA and to distribute that income, along with any other income earned by the trust, to him/her. A safe haven is created for the martial deduction if the terms of the trust require the trustee to withdraw an amount equal to the income earned in the IRA and to distribute that income, along with any other income earned by the trust, to the surviving spouse no less frequently than annually. Revenue Ruling 2006-26. 76

77 Trust as Beneficiary WealthDocx™ Conduit Provisions within the Client’s RLT: Do not name the RLT as beneficiary. Name the subtrusts directly as beneficiaries in the Participant’s beneficiary designation form. It is clear from the regulations that the separate accounts concept applies at the plan level, not the trust level. The plan benefit is not considered divided into separate accounts merely because it is payable to a trust that divides into separate share trusts. Reg §1.401(a)(9)-4, Q&A 5(c). 77

78 Trust as Beneficiary Separate Account Rule for Sub-Trusts – PLR 200537044: Upon the death of the Settlor, the IRA stand-alone trust creates separate shares for each beneficiary (in this case, separate shares for 9 beneficiaries), each trust share “treated effective ab initio to the date of the Decedent’s death” and each share functioned as a “separate and distinct trust” for the beneficiary. The beneficiary designation form named each separate share as a primary beneficiary of the IRA. Before the December 31 st deadline, the IRA was divided into separate accounts for each share. Held: Separate account treatment permitted; MRD of the IRA for each separate trust share measured by the lifetime of its sole beneficiary for whom the share was created. 78

79 Trust as Beneficiary Separate Account Rule for Sub-Trusts – PLR 200537044: Payable to single trust No separate shares identified in the beneficiary designation form IRA paid over oldest life expectancy ( if oldest beneficiary identifiable and all beneficiaries are individuals) 79

80 Trust as Beneficiary Separate Account Rule for Sub-Trusts – PLR 200537044: IRA Payable to multiple share trusts Separate shares identified in the beneficiary designation form IRA paid over each trust beneficiary’s life expectancy, as long as each share qualifies for “look-through” status 80

81 Stand-Alone Retirement Trust The case for using an SRT to receive retirement plan benefits: QRPs and IRAs are special assets with unique tax rules. Just like other assets, best to transfer property to next generation in trust rather than outright. When facts are such that an accumulation trust or the flexibility of the Keebler/Kavesh switch are best; it is difficult if not impossible to achieve in a will or RLT. 81

82 Stand-Alone Retirement Trust The stand-alone retirement trust is an intervivos trust created by the Participant as Grantor. It is unfunded (or nominally funded) during the Grantor’s life. To receive retirement plan benefits upon the death of the Participant. By means of properly drafted beneficiary designations. May be revocable or irrevocable. 82

83 Stand-Alone Retirement Trust Revocable or Irrevocable: –Commerce Bank vs. Bolander, 154 P.3d 1184, Kan. App., 2007. Participant named his RLT as beneficiary of his IRA. Kansas statute specifically states that the assets of a revocable trust are “subject to the claims of the settlor's creditors.” Inherited IRA is not an exempt asset. Therefore Participant’s creditor’s attach the IRA. Query: Would the result have been different if the beneficiary designation had named the subtrusts rather than the RLT itself? 83

84 Drafting the SRT Materials for this Section: PowerPoint Slides – Cases 1 - 4 Retirement Trusts (1 – 4) Answer Summaries for SRTs Beneficiary designations (1 – 4) Answer Summaries for beneficiary designations 84

85 Case Study #1 Cynthia M. Client Age 62. Widowed. 3 adult children: Peter, Paul and Mary; all responsible. Total estate $900,000. IRA $500,000. Desire to maximize stretch-out for each of the 3 children. 85

86 Case Study #1 Plan design: RLT for non-IRA assets totaling $400,000. –Include conduit trust provisions. Optionally: Draft Stand-alone Retirement Trust for the IRA. –Draft each trust as a conduit trust. –Upon death, the SRT divides into shares for descendants, per stirpes (survivorship options). –Trustee will have discretion to withdraw additional amounts in excess of RMDs. Beneficiary designation. –Divide IRA into shares for descendants, per stirpes. –Allocate each share to that descendant’s separate trust. 86

87 Case Study #1 RLT – Conduit Provisions 87

88 Case Study #1 Beneficiary Designation WealthCounsel, LLC88

89 Case Study #1 Beneficiary Designation WealthCounsel, LLC89

90 Case Study #1 Beneficiary Designation WealthCounsel, LLC90

91 Case Study #2 Cynthia M. Client Age 62. Widowed. 3 adult children: Peter, Paul and Mary; Mary is a special needs child. Total estate $900,000. IRA $500,000. Desire to maximize stretch-out for each of the 3 children. 91

92 Case Study #2 Plan design: RLT for non-IRA assets totaling $400,000. Stand-alone retirement trusts for the IRA. –Draft all as accumulation trusts. –Upon death the SRT divides into shares for descendants, per stirpes (survivorship options). –Peter’s and Paul’s as general needs trust. –Mary’s is a special needs trust. Beneficiary designation. –Divide IRA into shares for descendants, per stirpes. –Allocate each share to that descendants separate trust. 92

93 Case Study #2 93

94 Case Study #2 94

95 Case Study #2 95

96 Case Study #3 Thomas C. Client Age 63. Happily married to Cindy age 58; 1 st marriage. 3 adult children: Peter, Paul and Mary; all responsible. Total estate $2,500,000. IRA $1,500,000. May need to fully fund applicable credit exemption amount with IRA. Desire to maximize stretch-out for each of the 3 children. 96

97 Case Study #3 Plan design: RLT for non-IRA assets totaling $1,000,000. Spouse Primary Beneficiary of IRA. Stand-alone retirement trusts for the IRA. –If spouse alive, all to a bypass trust. –If spouse deceased, divides into shares for descendants, per stirpes (survivorship options). –Each trust will start as a conduit trust. –Trustee will have discretion to withdraw additional amounts in excess of RMD. –Trust Protector has power to convert any trust to an accumulation trust – PLR 200537044 (Keebler-Kavesh Switch). 97

98 Case Study #3 98

99 Case Study #3 99

100 Case Study #3 100

101 Case Study #3 101

102 Case Study #3 102

103 Case Study #3 103

104 Case Study #3 104

105 Case Study #3 105

106 Case Study #3 Beneficiary Designation: Primary Designation: –All to spouse. Contingent, if Spouse Disclaims: –To the bypass trust created in the stand-alone retirement trust. Contingent, if Spouse deceased: –Divide into shares for descendants, per stirpes. –Allocate each share to that descendant’s separate trust created in the stand-alone retirement trust. 106

107 Case Study #3 107

108 Case Study #3 108

109 Case Study #3 109

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112 Case Study #3 112

113 Case Study #4 Thomas C. Client Age 63. Married to Cindy age 38; 2 nd marriage. 3 adult children by prior marriage: Peter, Paul and Mary; all responsible. Total estate $2,500,000. IRA $1,500,000. May need to fully fund applicable credit exemption amount with IRA. Desire to maximize stretch-out for each of the 3 children. 113

114 Case Study #4 Plan design: RLT for non-IRA assets totaling $1,000,000. Stand-alone retirement trusts for the IRA. –Clayton Election – All to QTIP; non-QTIPed to Bypass Trust. –If spouse deceased, divides into shares for descendants, per stirpes (survivorship options). –Each trust will start as a conduit trust. –Trustee will have discretion to withdraw additional amounts in excess of RMD. –Trust Protector has power to convert any trust to an accumulation trust – PLR 200537044 (Keebler-Kavesh Switch). 114

115 Case Study #4 115

116 Case Study #4 116

117 Case Study #4 117

118 Case Study #4 Beneficiary Designation: Primary Designation, if spouse alive: –All to QTIP created under the stand-alone retirement trust; –But to the extent any portion of the QTIP is not elected for QTIP treatment,allocate the portion not elected for QTIP treatment to the bypass trust established under the stand-alone retirement trust. Contingent, if Spouse deceased - –Divide into shares for descendants, per stirpes. –Allocate each share to that descendants separate trust created in the stand-alone retirement trust. 118

119 Case Study #4 119

120 Case Study #4 120

121 Case Study #4 121

122 Case Study #4 122

123 Case Study #4 123

124 Postmortem Saves Consider Spousal Rollover: PLR 2002236052: Facts: Estate named as beneficiary of husband’s IRA. Wife was the sole beneficiary of the estate and was the executor. Wife proposed distributing husband’s IRA to her and then rolling over the distributions to her own IRA. 124

125 Postmortem Saves Consider Spousal Rollover: PLR 2002236052: Holding: “As a general rule, if amounts are distributed from an IRA to the estate of a deceased IRA holder and subsequently paid to the spouse as the beneficiary of said estate, the spouse shall be treated as having received the IRA proceeds from the estate and not directly from the IRA. In such a case, the surviving spouse will not be eligible to either rollover the IRA proceeds into an IRA set up and maintained in her name or treat said IRA as her own IRA.” 125

126 Postmortem Saves Consider Spousal Rollover: PLR 2002236052: Holding (cont): “However, in this case, the surviving spouse of Taxpayer A, is the sole executrix of Taxpayer A's estate with authority to allocate assets in Taxpayer A's estate to the beneficiaries and is also the sole residuary beneficiary of said estate, to whom she, as executrix, paid the proceeds of IRA T, the Service will not apply the general rule. In effect, the surviving spouse will be treated as though she received the IRA proceeds directly from IRA T rather than from the estate. Thus, surviving spouse will be treated as the distributee of said amounts.” The rollover was allowed “as long as the rollover of such distribution occurs no later than the 60th day from the date said distribution is received by the surviving spouse.” 126

127 Postmortem Saves Consider Spousal Rollover: PLR 1999420452: Facts: Husband named his RLT as beneficiary of his IRA. RLT used a marital fractional to divide into a Marital – General Power of Appointment Trust and a Non-Marital – Family Trust. Surviving spouse was sole Trustee. All of husband’s IRA was allocated to the Marital Trust. Wife proposed withdrawing the IRA and rolling into her own IRA. 127

128 Postmortem Saves Consider Spousal Rollover: PLR 199942052: Holding: “Generally, if a decedent's IRA proceeds pass through a third party, e.g. a trust, and then are distributed to the decedent's surviving spouse, said spouse will be treated as acquiring them from the third party and not from the decedent. Thus, generally, said surviving spouse will not be eligible to transfer the IRA proceeds into his/her own IRA. 128

129 Postmortem Saves Consider Spousal Rollover: PLR 199942052: Holding (continued): “However, if a trust is the beneficiary of an IRA, and the surviving spouse is sole trustee of the trust with power to allocate, and, as beneficiary has the right to demand payment of trust principal at any time and for any reason, then for purposes of section 408(d)(3) of the Code, if the trustee of the trust pays to the surviving spouse, as beneficiary of the trust, proceeds of an IRA which constitute trust principal, the Service will treat the surviving spouse as having acquired the IRA proceeds from the decedent and not from the trust.” 129

130 Postmortem Saves Other Recent PLRs addressing spousal rollover: PLR 200611037: The Service allowed a surviving spouse, who was the executrix of her husband’s estate and the sole residuary beneficiary of the estate, to rollover her husband’s IRA, which the estate was the beneficiary, into an IRA set up and maintained in her name. PLR 200603036: Trust named beneficiary of IRA. Spouse was trustee and sole beneficiary of trust. Rollover was allowed by surviving spouse. PLR 200618030: Spouse not allowed to perform rollover as she was not sole beneficiary of trust. 130

131 Postmortem Saves What to do if the trust is named? As stated earlier, it is always best to make division and allocation at the plan level through the beneficiary designation form, NOT at the trust level. 131

132 Postmortem Saves What to do if the trust is named? A bit of history: PLR 200234074: Issued May, 2002, after the final regulations were issued but decided under the proposed regulations. The benefits were payable to a trust that divided into two trusts (X and Y) for benefit of the spouse. The plan benefits were allocated to Y pursuant to language in the trust. Spouse disclaimed. Upon death of spouse, Trust Y distributed in equal shares to the Participant’s children. In what Natalie Choate describes as “one of its best-reasoned PLRs ever,” the IRS stated that the children’s interests qualified as separate accounts for MRD purposes even though the named beneficiary was a trust. 132

133 Postmortem Saves What to do if the trust is named? A bit of history: Reg §1.401(a)(9)-4, Q&A 5(c): Again per Natalie Choate “(p)erhaps because this result was so clear and logical the IRS promptly abandoned it.” A new sentenced appeared at the end of the Answer in the regulation cited above. “However, the separate account rules under A-2 of §1.401(a)(9)- 8 are not available to beneficiaries of a trust with respect to the trust's interest in the employee's benefit.” 133

134 Postmortem Saves What to do if the trust is named? A bit of history: Reg 1.401(a)(9)-4, Q&A 5(c): It was not contained in either set of proposed regulations. No opportunity for public comment. A complete flip-flop on the IRS’s position as stated in PLR 200234074. Unfortunately, it is now clear that the IRS regards the added sentence as precluding separate accounts treatment for any benefits that are payable to a single trust. PLRs 200317041; 200317043; and 200317044, issued under the final regulations, are almost identical in relevant facts to PLR 200234074, but the IRS reached the exact opposite result requiring that the oldest child’s life expectancy be used for each child’s share. 134

135 Postmortem Saves What to do if the trust is named? Remove “undesirable” beneficiaries by Designation Date: As explained earlier, the Participant’s Designated Beneficiary “will be determined based on the beneficiaries designated as of the date of death who remain beneficiaries as of September 30 of the calendar year following the calendar year of the Participant’s death.” Reg §1.401(a)(9)-4 Q&A 4(a) gives two examples of how a date-of-death beneficiary can be removed: Distribution on or before September 30. Qualified Disclaimer before September 30. 135

136 Postmortem Saves What to do if the trust is named? Remove “undesirable” beneficiaries by Designation Date: Distribution on or before September 30. PLRs 200432027 : IRA payable to a trust that divides into shares for 3 children. Trust provided that upon the death of the grantor, the trustee shall pay from the principal of the trust estate the expenses of the last illness and the funeral and burial expenses of the grantor, as well as the probate administration expenses and estate taxes to the extent that the probate estate is insufficient to cover these items. Prior to September 30 (Designation Date), Trustee had withdrawn sufficient funds to cover the administration expenses and taxes. All estate taxes had been paid before September 30. 136

137 Postmortem Saves What to do if the trust is named? Remove “undesirable” beneficiaries by Designation Date: Distribution on or before September 30. PLRs 200432027 (cont’d): After receipt of IRS closing letter, account to be divided into three separate shares for the children in name of decedent for benefit of each of the children. Trust did qualify for look-through status. Age of oldest child determined MRD. Query: what if the separate accounts had been set up by September 30 of the calendar year following death? 137

138 Postmortem Saves What to do if the trust is named? Remove “undesirable” beneficiaries by Designation Date: Distribution on or before September 30. PLRs 200449041-42: Participant left his IRA to a trust that divided into percentage shares for wife and two daughters. Wife’s share distributed to her followed by rollover before September 30 of the calendar year following death. Two daughters could use oldest daughter’s life expectancy. Did not need to count wife since not a beneficiary as of designation date. 138

139 Postmortem Saves What to do if the trust is named? Remove “undesirable” beneficiaries by Designation Date: Distribution on or before September 30. PLRs 200608032: IRA payable to a trust with pecuniary charitable bequests balance distributed to children. One of the children’s shares held in an accumulation trust. Accumulation trust had an OR2-NLP beneficiary that was younger than the child. Trust prohibited payment of IRAs to charity and administrative expenses, debts and taxes. Charitable contributions were paid before September 30. Oldest child’s life expectancy was used to determine MRDs for all children. 139

140 Postmortem Saves What to do if the trust is named? Remove “undesirable” beneficiaries by Designation Date: Disclaimer before September 30. PLRs 200444033 and 200444034: Trust named as beneficiary that provided a lifetime trust for grantor’s sister, and upon death of sister, divided into separate shares for grantor’s two nieces. Sister disclaimed her interest by valid disclaimer. Trustee proposed to divide IRA into separate IRAs in name of decedent for nieces by trustee-to-trustee transfers. IRS approved. Both IRAs MRDs would be calculated based upon life expectancy of oldest niece. 140


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