Dividing Retirement Assets on Death or Divorce

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1 ABA RPTE Spring Symposia Dividing Retirement Assets on Death or Divorce Thursday, May 12,

2 Introduction Moderator: Karen Suhre Speakers:» Henry Talavera» David Valente» Courtney Vomund 2

3 Taking Stock of the Individual s Retirement Related Assets Types of tax-favored retirement plans/accounts Individual Retirement Accounts Traditional Roth Rollover SIMPLE/SEP Inherited 3

4 Taking Stock of the Individual s Retirement Related Assets 401(a) qualified plans Defined contribution 401(k), Profit Sharing, Money Purchase, ESOP Is account vested? Any outstanding participant loans? Is distribution available immediately? Defined benefit Are there any death benefits if no surviving spouse? Are benefits vested? When do benefits begin? Is a lump sum option available? Plan terms and plan funding? 4

5 Taking Stock of the Individual s Retirement Related Assets Other types of tax-favored retirement accounts IRC 403(a), 403(b) IRC 457(b) Nonqualified deferred compensation Top hat plans for executives Defined benefit or defined contribution types Unfunded (may have rabbi trust) Generally subject to IRC 409A 5

6 Taking Stock of the Individual s Retirement Related Assets Title I of ERISA Retirement Plan Coverage Generally governs retirement plans of employers in interstate commerce with common law employees Exceptions for owner-and-spouse only plans, church and government plans Preemption of state law Plan documents control Spousal death benefit rights for most plans Fiduciary responsibility Access to federal courts Reporting and disclosure 6

7 Taking Stock of the Individual s Retirement Related Assets Who are you dealing with for each benefit? Financial institution? Benefits manager at larger employer? Owner of a small business? What procedures, forms, and sources of information exist? PRACTICE POINTER: don t overlook online sources of information such as Form 5500 annual reports--dol.gov/ebsa 7

8 Division of Assets on Divorce--QDROs Qualified Domestic Relations Orders Qualified plan requirement--irc 414(p) Parallel provisions in Title I of ERISA Basic QDRO requirements: Judgment, order or decree made pursuant to state domestic relations law Relates to child support, alimony payments or marital property rights for an alternate payee--spouse, former spouse, child or other dependent of plan participant. Identify plan, participant & alternate payee Amount, percentage or method of determining amount payable to alternate payee 8

9 Division of Assets on Divorce--QDROs Basic QDRO requirements cont d: Time period/number of payments Must not provide for increased benefits or options not allowed by plan May allow benefits to start early in some cases Can t assign benefits already assigned to another alternate payee by prior QDRO Practice Tips: U.S. Department of Labor QDRO publication: The employer or plan administrator may have sample QDRO forms, or may agree to review a draft QDRO before it is filed. 9

10 Division of Assets on Divorce--QDROs Transferring or waiving qualified plan benefits without a valid QDRO can result in the disqualification of a retirement plan. See Family Chiropractic Sports Injury & Rehab Clinic, Inc. v. Commissioner, T.C. Memo (2016) (upholding disqualification upon voluntary transfer of benefits related to a divorce but not specifically addressed in a divorce decree). 10

11 Division of Assets on Divorce--QDROs Sham divorce and QDROs Brown v. Continental Airlines, 647 F.3d 221 (5 th Cir. 2011) Allegedly sham divorces to obtain QDROs for families to have early access to pension plan benefits because plan was perceived to be financially unstable The determination of whether the divorce is a sham must be made by a state judge, not a federal judge or the plan administrator 11

12 Division of Assets on Divorce--QDROs Federal tax treatment of amounts received from a qualified plan pursuant to a QDRO: Spouse or ex-spouse is treated like an employee/plan participant (spouse is generally taxed on QDRO distribution but can rollover) Child support QDROs: employee/plan participant is generally taxed on distribution, can t rollover QDRO payments are exempt from IRC 72(t) early distribution tax General rules pertaining to distribution from a qualified plan or an annuity are applicable 20% federal income withholding may be required in many cases 12

13 Division of Assets on Divorce--QDROs Other considerations when dividing assets upon divorce: Type of alternate payee Survivor benefits Shared payments vs. Separate interests Duration and benefit commencement Valuation methodology Cost of living adjustments Early retirement subsidies Passive gains and losses Treatment of plan loans 13

14 Division of Assets on Divorce--QDROs The Department of Labor ("DOL") clarifies timing and payments under a QDRO, as follows: QDRO can be issued after or to revise a prior QDRO Multiple QDROs for multiple prior spouses are permitted and can require ex-spouse to be treated as surviving spouse May be issued or revised after the death of the participant--post mortem Can be issued after annuity starting date 14

15 Death After Divorce Post-Mortem QDROs Pension Protection Act of 2006, see Pub.L. No , 1001, 120 Stat. 780 (2006);29 C.F.R ("a domestic relations order shall not fail to be treated as a qualified domestic relations order solely because of the time at which it is issued."); See Files v. ExxonMobil Pension Plan, 428 F.3d 478 (3dCir.2005)(finding a posthumous order constituted a QDRO), cert.denied,547 U.S (2006); Yale-New Haven Hospital v. Nicholls, 788 F.3d 79 (2d.Cir.2015). 15

16 Death After Divorce Post-Mortem QDROs The DOL regulations provide the following example of the rule's application, entitled "Orders issued after death": Participant and Spouse divorce, and the administrator of Participant's plan receives a domestic relations order, but the administrator finds the order deficient and determines that it is not a QDRO. 16

17 Death After Divorce Post-Mortem QDROs Shortly thereafter, Participant dies while actively employed and a second domestic relations order correcting the defects in the first order is subsequently submitted to the plan. The second order does not fail to be treated as a QDRO solely because it is issued after the death of the participant. The result would be the same even if no order had been issued before the participant s death, in other words, if the order issued after death were the only order. 17

18 Death After Divorce Post-Mortem QDROs The Court in Yale-New Haven Hospital v. Nicholls, 788 F.3d 79 (2d Cir. 2015), found that posthumous domestic relations orders may retroactively divest the deceased participant s surviving spouse of survivor benefits otherwise payable under the plan. See also Cingrani v. Sheet Metal Workers Local No. 73 Pension Fund, No. 15 C 6430 (N.D. Ill. December 15, 2015) finding that a QDRO issued after death of ex-spouse may in some cases restore to the participant benefits awarded to the ex-spouse but never paid due to her death. PRACTICE POINTER: QDRO should specify who gets benefits if the alternate payee dies before receiving full payment. 18

19 Death After Divorce & Other Issues Effect Of Divorce On Beneficiary Designations Made Before Divorce Egelhoff v. Egelhoff, 532 U.S.141 (2001) ERISA preempts state law providing for automatic revocation on divorce of prior beneficiary designation naming ex-spouse Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, 129 S.Ct.865 (2009) Waiver of ex-spouse s interest via divorce decree was ineffective where decree was not a QDRO and employee/participant did not execute a new beneficiary designation. Plan document provisions control. No federal common law recognition of waiver. 19

20 Death After Divorce & Other Issues PRACTICE POINTERS: Remarriage will generally result in revocation of a prior beneficiary designation under ERISA and tax qualified plan surviving spouse benefit rules & plan terms. Some plan documents provide for automatic revocation of beneficiary designations on divorce but many do not. To be safe, a divorced plan participant should always file new beneficiary designations. 20

21 Division of Non-Qualified Plan Assets on Divorce Nonqualified deferred compensation plans Excess plans vs Top Hat plans Plan documents may specify whether and when domestic relations orders will be honored 409A exception to the anti-acceleration provisions designed to accommodate domestic relations orders Treas.Reg. 409A- 3(j)(4)(ii) Revenue Ruling Nonqualified benefits can be transferred to a participant s ex-spouse Participant does not recognize income on transfer IRC 1041 Ex-spouse (not participant) recognizes income when plan benefits are paid or made available. 21

22 Division of IRAs on Divorce QDRO rules do not generally apply to IRAs State law would typically apply Possible preemption argument for some SEP/SIMPLE IRAs If IRA is transferred to owner s spouse or exspouse under a divorce or separation agreement, there is no tax on the original owner, and spouse or ex-spouse is treated as the IRA owner. IRC 408(d)(6). 22

23 Death and Probate Retirement plan assets as non-probate assets Typically pass via beneficiary designations or plan terms May avoid probate, estate creditors Still part of taxable estate Plan document typically lists default beneficiaries if there is no surviving designated beneficiary Surviving spouse typically must be the default beneficiary in qualified plans 23

24 Death and Income Taxes RMD = Required Minimum Distribution Involves distributions during participant s life and subsequent to participant s death To what plans to the minimum distribution rules apply? Qualified Retirement Plans ( QRPs ) IRAs (including SEP, SARSEP, and SIMPLE IRAs) 403(b) plans, 457(b) plans Inherited plans Roth 401(k) plans Roth IRAs (after participant s death) DB plans subject to different set of rules than DC plans 24

25 RMDs During Participant s Life Must make RMD by December 31 of each year, beginning with year in which participant reaches 70 ½ years of age First RMD may be delayed until April 1 st of the following year, and that date is known as the Required Beginning Date ( RBD ) For QRPs (where participant is not a 5% owner) and 403(b) plans, the RBD is the later of the above date, or April 1 of the year following the participant s retirement Calculation: divide plan balance as of end of prior year by life expectancy factor ( Applicable Distribution Period ) Penalty for missed RMD = 50% of missed RMD Participant (or beneficiary after participant s death) may request waiver of penalty through Form

26 Multiple Retirement Plans If > 1 QRP, the RMD must be calculated separately for each plan, and each plan must distribute the RMD relevant to that plan If > 1 (non-roth) IRA, though the RMD must be separately calculated for each plan, the participant may take the aggregate of the RMDs from one IRA or a combination of the IRAs. Same flexibility where participant has multiple 403(b)s 26

27 Special Rights of Spouses at Death Spousal survivor annuities (defined benefit plans) Survivor rights in defined contribution plans Lifetime consent requirements Spouse s Choice/Special Rollover Rules Keep inherited IRA as such or rollover qualified plan funds to inherited IRA Rollover decedent s IRA or qualified plan funds into spouse s own IRA Rollover to a qualified plan covering the surviving spouse (if permitted) 27

28 Special Rights of Spouses at Death Spouse s Choice/Special Rollover Rules (cont.) Tax treatment varies depending on age of spouse (under 59-1/2, 10% early distribution penalty tax may apply if surviving spouse withdraws funds from his/her own IRA or QP) RMD calculations differ depending on vehicle chosen Qualified Plans vs. IRA different investment options, availability of loans, etc. Windsor issues for same-sex spouses 28

29 Spouse s Community Property Rights ERISA preemption of state community property law Boggs v. Boggs--on death of non-employee spouse, her state law marital interest in qualified retirement plan did not pass to her heirs Community Property Rights may be enforceable via QDRO Exception to preemption 29

30 RMDs After Participant s Death Will be based on: life expectancy of the beneficiary, the life expectancy of the participant, or the 5 year rule Inquiry: did participant die before, on/after his RBD? If he died on/after RBD, beneficiary must take year of death RMD (if not taken by participant) take annual distributions based on ADP (either beneficiary s life expectancy, or the deceased participant s life expectancy, whichever is greater) If he died before his RBD, then non-spouse beneficiary will use her own life expectancy as the ADP, unless the 5 year rule applies 30

31 RMDs After Participant s Death What is 5 year rule? If it applies, there is no RMD in any of the years except the final year of the payout period. In that final year, the RMD is 100% of the account When does it apply? Applies if participant died before his RBD and without a Designated Beneficiary Plan itself could provide that the 5 year rule applies nonetheless Plan itself could also permit the Designated Beneficiary to choose between life expectancy payout and the 5 year rule 31

32 Estate Planning Tools Gauge desired level of asset protection How significant are retirement assets relative to other assets? Assess unique situations (e.g. disabled/addicted beneficiary) Consider funding disabled child s share with nonretirement assets Consider mechanism for equalization 32

33 Estate Planning Tools To achieve (asset protection for beneficiaries and) income tax deferral, trust needs to qualify for seethrough treatment If trust does qualify, RMDs will be based on age of oldest trust beneficiary If trust does not qualify, then if account owner died Before RBD: payout in as little as five years On/after RBD: withdrawals based on owner s remaining life expectancy 33

34 Estate Planning Tools 1. Valid trust under state law 2. Trust must be irrevocable, or by its terms irrevocable on death of account owner 3. Underlying beneficiaries must all be identifiable as designated beneficiaries (humans) 4. Trust documentation must be provided to retirement plan custodian by Oct. 31 of year following year of account owner s death 34

35 Estate Planning Tools If trust qualifies and has multiple beneficiaries, RMDs based on life expectancy of oldest beneficiary Consider naming sub-trusts as opposed to master funding trust If client is survived by spouse and trust held FBO spouse for life, then children, distributions will be based on life expectancy of spouse (assuming she s oldest beneficiary); does not change at her death Conduit vs. Accumulation trust (consider fiduciary income tax brackets & NIIT) 35

36 Define terms Estate Planning Tools Retirement Benefit: NQ/Qualified annuity, DC plan, prof. sharing, pension, stock bonus, other QRP, IRA, benefits/arrangements under IRC 408, 408A, 457, 403, and 401 Minimum Distribution Rules RMD: year of death vs. any other year 36

37 Estate Planning Tools Distributions standards: HEMS standard vs. fully discretionary Martial trust: be careful of preserving marital deduction! Instruct trustee to withdraw greater of net income (of marital trust s share of retirement benefit) or RMD Decanting: include limitation relating to oldest beneficiary of Receiving Trust Segregation: consider segregating retirement plan proceeds from other trust property Withholding power: ensure not applicable to obligation to distribute allocable share of RMD General savings clause: avoid ineligible beneficiaries 37

38 Estate Planning Tools Protector: give protector (or disinterested trustee) power to amend trust accordingly Powers of appointment: restrict exercise (permissible appointees) Adoption: include limitation Debts, Expenses and Taxes: consider prohibiting contribution from a Retirement Benefit) to settlor s estate for debts, taxes, expenses of administration, or other claims Spendthrift clauses: ensure it restrains voluntary and involuntary transfers 38

39 Estate as Beneficiary Generally not recommended if funds are to benefit individuals. IRS PLRs sometimes allow spouse to rollover retirement accounts where estate is named beneficiary--expensive, slow process Some banks may allow IRA rollover by spouse without ruling; qualified plans probably would not. Non-spouse beneficiaries apparently cannot defer taxes via transfer/rollover if estate is designated beneficiary Estate has no life expectancy, can t stretch out taxable RMDs Estate creditors may claim funds 39

40 Charity or Charitable Remainder Trust as Beneficiary Naming charity directly as 100% beneficiary Benefits included in income of charitable recipient distribution income-tax free Estate tax charitable deduction Naming charity directly as partial beneficiary Caution: risks loss of stretch period; requires separate accounts Consider separate IRAs or pecuniary gift to charity Naming CRT as beneficiary 40

41 Death and Creditors: Protection of Inherited Retirement Assets Clark v. Rameker, 134 S.Ct.2242 (2014) Clark (the bankruptcy debtor) inherited the IRA from her mother Clark argued the IRA contained retirement funds covered by Section 522(b)(3)(C) of the Bankruptcy Code, which exempts retirement funds in certain tax exempt accounts such as IRAs from the bankruptcy estate 41

42 Death and Creditors: Protection of Inherited Retirement Assets The Court listed the following three reasons why inherited IRAs are not exempt retirement funds : (1) The Debtor/Inheritor cannot invest additional money in the IRA (2) The Debtor/Inheritor must take distributions even if (s)he is not eligible for retirement (3) The Debtor/Inheritor may withdraw all or part of the IRA at any time and for any purpose without penalty 42

43 Death and Creditors: Protection of Inherited Retirement Assets A surviving spouse beneficiary who rolls over funds to her own IRA or to her own tax qualified plan should be able to claim the retirement funds exemption under the Bankruptcy Code. An alternate creditor firewall for beneficiaries in certain qualified plans that are covered by Title I of ERISA: Bankruptcy Code Section 541(c)(2) and ERISA Section 206(d) Patterson v. Shumate. Consider whether there is an option to leave funds in a qualified plan after death rather than taking a distribution or rolling over to a qualified plan Qualified plan may be less flexible on RMDs than an IRA plan terms can vary greatly and should be reviewed carefully. 43

44 Death and Creditors: Protection of Inherited Retirement Assets State asset protection laws Exemption statute of the state of residence of the debtor controls. States vary widely on exemptions for retirement funds several specifically protect inherited IRAs IRAs--No ERISA preemption of state law (except possibly SEPs or SIMPLEs) Non-ERISA qualified plans (e.g. owner/spouse only plans, church and government plans) may also be eligible for state law protection 44

45 Disclaimers of Retirement Assets General Rule (Code Section 2518) ERISA Issue Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, et al. Effect on RMDs, rollover eligibility Contingent beneficiary/default beneficiary per plan or beneficiary designation Varying employer and ERISA attorney approaches to disclaimers in qualified plans 45

46 For more information: Research papers are on the Spring Symposia meeting app and website Additional articles are linked on RPTE Qualified Plans Committee webpage: com=rp Article published in Spring 2015 RPTE Law Journal: Bankruptcy Protection of Retirement Plan Beneficiaries After Clark v. Rameker 46

47 Conclusions and Questions Thank you for participating today. Please contact us if you have any questions. Karen K. Suhre Henry Talavera David Valente Courtney Vomund 47

Individual Retirement Accounts as Estate Planning Tools: Opportunities and Pitfalls

Individual Retirement Accounts as Estate Planning Tools: Opportunities and Pitfalls December 2010 This material is provided for educational purposes only. This material is not intended to constitute legal,