Estate Planning for Retirement Benefits Monday, April 29, 2013

Estate Planning for Retirement Benefits Monday, April 29, 2013 John C. Martin, Esq. Law Offices of John C. Martin I. Introduction How will I benefit from this course? Retirement plans hold an increasing share of individuals net worth Significant balances often remain in these accounts at death, because of tax deferral and the uniform lifetime table Choosing the wrong beneficiary or not choosing any beneficiary can have significant tax or personal consequences 1

Introduction The purpose of Estate Planning for Retirement Benefits What happens to retirement plans at death What planning options exists for beneficiary designations, including retirement plan trusts, gifts to charity, spousal rollovers, individual beneficiaries, and other options What are the pro s and con s of these options? What this course is NOT: An overview of lifetime planning with IRAs or other qualified plans A primer on calculating Required Minimum Distributions (RMDs) State specific each state has different tax, family law, and estate planning law that will affect the client s particular circumstances An overview of Roth IRA planning or the benefits of Roth conversions Detailed analysis on trust drafting or beneficiary designation forms Why Plan for IRAs and other Qualified Plans? FACTS: IRA Value $1,000,000 Decedent s Age 60 Surviving Spouse s Age 54 Oldest Child s Age 28 Youngest Child s Age 25 IRA Payable to IRA Payable to Surviving Spouse (No Surviving Spouse IRA Payable to IRA Payable to Year Immediate Distribution Five-Year Distribution Spousal Rollover) (Spousal Rollover) Oldest Beneficiary Youngest Beneficiary 2 $ 1,414,934 $ 1,429,399 $ 1,429,399 $ 1,429,399 $ 1,429,399 $ 1,429,399 6 $ 1,909,649 $ 2,011,358 $ 2,011,358 $ 2,011,358 $ 2,007,536 $ 2,007,729 11 $ 2,777,954 $ 2,925,909 $ 3,089,713 $ 3,089,713 $ 3,062,913 $ 3,064,272 16 $ 4,041,071 $ 4,256,301 $ 4,722,081 $ 4,758,393 $ 4,660,910 $ 4,665,852 21 $ 5,878,519 $ 6,191,614 $ 7,143,331 $ 7,315,348 $ 7,071,727 $ 7,085,676 26 $ 8,551,444 $ 9,006,900 $ 10,696,628 $ 11,152,316 $ 10,693,703 $ 10,728,077 31 $ 12,439,729 $ 13,102,278 $ 15,862,910 $ 16,854,849 $ 16,109,273 $ 16,187,099 36 $ 18,095,993 $ 19,059,798 $ 23,328,075 $ 25,247,468 $ 24,161,587 $ 24,327,893 41 $ 26,324,122 $ 27,726,164 $ 34,097,600 $ 37,487,640 $ 36,056,209 $ 36,396,985 46 $ 32,962,245 $ 34,717,838 $ 42,743,352 $ 47,335,010 $ 45,718,311 $ 46,234,204 Source: Planning with IRAs and other Qualified Plans, Robert S. Keebler (2004) 2

Why Plan for IRAs and other Qualified Plans? Source: Planning with IRAs and other Qualified Plans, Robert S. Keebler (2004) Why Plan for IRAs and other Qualified Plans? Retirement Planning Assets Account for 34% of all household financial assets - up from 14% in 1978! IRAs alone account for more than 10% - and 47 million US households have IRAs * According to 2009 (2nd qtr.) Investment Company Institute study 3

Why Plan for IRAs and other Qualified Plans? It has been estimated that qualified retirement benefits, IRAs, and life insurance proceeds may constitute as much as 75 to 80 percent of the intangible wealth of most middle-class Americans. * * L. Mezzulo, An Estate Planner s Guide to Qualified Retirement Plan Benefits (ABA Publications, 4 th ed. 2007) at 1. Assets will likely be left over in a retirement plan at death based upon nationwide trends, mortality, and the uniform lifetime table If the participant takes only the MRD starting at age 70 ½, and the account has a steady six percent annual investment return, the account will have more dollars in it at his death than it did when he started taking MRDs, if he dies prior to age 89. 4

General Concepts Generally, Participant must commence Required Minimum Distributions (RMDs) by Required Beginning Date (RBD) RBD = April 1 in the year following the calendar year in which the participant reaches age 70½ Or the calendar year in which the employee retires from employment Exception for Less than 5% Owners General Concepts RMDs are calculated based upon prior year ending account balance divided by life expectancy factor RMD = Prior Year 12/31 Balance Life Expectancy Factor 5

Life Expectancy Factor Uniform Table for participant s lifetime distributions Exception if spouse is actually more than 10 years younger than participant - then use Joint & Last Survivor Table Single Life Table for use by qualified beneficiary after participant s death Determines Stretch Out for Inherited IRAs Uniform Table Age Divisor Age Divisor Age Divisor 70 27.4 86 14.1 102 5.5 71 26.5 87 13.4 103 5.2 72 25.6 88 12.7 104 4.9 73 24.7 89 12.0 105 4.5 74 23.8 90 11.4 106 4.2 75 22.9 91 10.8 107 3.9 76 22.0 92 10.2 108 3.7 77 21.2 93 9.6 109 3.4 78 20.3 94 9.1 110 3.1 79 19.5 95 8.6 111 2.9 80 18.7 96 8.1 112 2.6 81 17.9 97 7.6 113 2.4 82 17.1 98 7.1 114 2.1 83 16.3 99 6.7 115 and older 1.9 84 15.5 100 6.3 85 14.8 101 5.9 6

Single Life Table Age Divisor Age Divisor Age Divisor Age Divisor Age Divisor Age Divisor Age Divisor 0 82.4 16 66.9 32 51.4 48 36.0 64 21.8 80 10.2 96 3.8 1 81.6 17 66.0 33 50.4 49 35.1 65 21.0 81 9.7 97 3.6 2 80.6 18 65.0 34 49.4 50 34.2 66 20.2 82 9.1 98 3.4 3 79.7 19 64.0 35 48.5 51 33.3 67 19.4 83 8.6 99 3.1 4 78.7 20 63.0 36 47.5 52 32.3 68 18.6 84 8.1 100 2.9 5 77.7 21 62.1 37 46.5 53 31.4 69 17.8 85 7.6 101 2.7 6 76.7 22 61.1 38 45.6 54 30.5 70 17.0 86 7.1 102 2.5 7 75.8 23 60.1 39 44.6 55 29.6 71 16.3 87 6.7 103 2.3 8 74.8 24 59.1 40 43.6 56 28.7 72 15.5 88 6.3 104 2.1 9 73.8 25 58.2 41 42.7 57 27.9 73 14.8 89 5.9 105 1.9 10 72.8 26 57.2 42 41.7 58 27.0 74 14.1 90 5.5 106 1.7 11 71.8 27 56.2 43 40.7 59 26.1 75 13.4 91 5.2 107 1.5 12 70.8 28 55.3 44 39.8 60 25.2 76 12.7 92 4.9 108 1.4 13 69.9 29 54.3 45 38.8 61 24.4 77 12.1 93 4.6 109 1.2 14 68.9 30 53.3 46 37.9 62 23.5 78 11.4 94 4.3 110 1.1 15 67.9 31 52.4 47 37.0 63 22.7 79 10.8 95 4.1 111 1.0 Example 1 Figuring the MRD for an individual during their lifetime after the RBD. 7

At Death: Two Critical Questions: Did the participant reach his or her Required Beginning Date (RBD)? Is there a Designated Beneficiary (DB)? Required Minimum Distributions (RMDs) Death Before Required Beginning Date Death On or After Required Beginning Date Designated Beneficiary Life Expectancy Rule Life Expectancy Rule Non- Designated Beneficiary Five-Year Rule Ghost Life Expectancy Rule 16 8

What is a Designated Beneficiary? Treas. Reg 1.401(a)(9)-4 Must be named a DB under the terms of the plan or by an affirmative election by the employee DB need not be specified by name but must be identifiable on the date of death May be a class of beneficiaries capable of expansion or contraction (e.g., my children or grandchildren) DB must be an individual alive on the date of death DB may also be individuals named as beneficiaries of a qualifying trust 17 Example No. 3 Individual & See Through Trust Beneficiaries Examples 3-4 Rule: Annual MRDs over the life expectancy of a Designated Beneficiary are computed by dividing the prior year-end account balance by a life expectancy factor. A Use the single life table and the fixed-term method (see glossary and previous slides) 18 9

What is a Designated Beneficiary? These are NOT a designated beneficiary Estate Charity Non-qualifying trust Any non-individual other than a qualifying trust Individual born after the date of the participant s death 19 Non-designated beneficiaries What happens if we or the plan documents name a nondesignated beneficiary as the beneficiary? Example No. 5 (See handout) Estate with non-spouse estate beneficiary Example No. 6 (See handout) Charitable beneficiary 10

Multiple beneficiaries General rule: (1) The participant has NO designated beneficiary unless all of the beneficiaries are individuals; (2) If all of the beneficiaries are individuals, the ADP is the based on the oldest beneficiary s life expectancy; There are two escape hatches from these rules: (1)The Separate Accounts Rule (2)The ability to remove a beneficiary prior to the Beneficiary Finalization Date Multiple beneficiaries -- Examples Example No. 7 (Percy Example Separate Accounts Rule) Note: all beneficiaries must be individuals, but a beneficiary may be removed prior to the beneficiary finalization date. Example No. 8 (Removal of Beneficiaries prior to Beneficiary Finalization Date) 11

Special Rules for Spousal Beneficiaries Spousal Rollovers vs. Spouse Beneficiary Spousal Beneficiary is rarely chosen why? Life expectancy factor of spouse is used by reference to the Single Life Table beginning in the year the IRA owner would have turned age 70½. Each year thereafter the life expectancy divisor is recalculated by referencing the Single Life Table Spousal Rollover Spouse Treats the IRA as her own plan Advantages Rollover delays RMD until spouse s own RBD until she is 70 ½ Inherited IRA provisions allow beneficiary s life expectancy to be used for distributions after death of IRA owner Can use the recalculate method obtaining the divisor from the Uniform Lifetime Table. The spouse can name his or her own DBs for the rollover IRA. 12

Spousal Rollover There is no deadline in which the spouse must make the roll over (but see below) Drawback: if the spouse is under 59 ½, and he or she does a roll over, the spouse cannot take benefits until he or she turns 59 ½, or the 10% penalty will apply. By contrast, if the spouse continues as a beneficiary under the participant s IRA, he or she can withdraw benefits under the fixed term MRD method. Trusts as Beneficiaries Not a designated beneficiary 5 year rule or ghost life expectancy Exception for certain see through trusts Conduit and Accumulation trusts 13

Advantages of Using Trusts Generally Spendthrift protection Creditor protection Divorce ( Predator ) protection Special needs Consistent investment management Estate planning Dead-hand control Disadvantages of Using Trusts Generally Trust tax rates Legal and trustee fees Income tax returns Greater complexity 14

IRAs Payable to Trusts Four Requirements of All IRA Trusts Trust is valid under state law Trust is irrevocable upon death of owner Beneficiaries of the trust are identifiable from the trust instrument Documentation requirement is satisfied Problem with multiple beneficiaries of trusts While the separate accounts rule is applicable for individual beneficiaries named at the beneficiary designation form level, it is generally not applicable for multiple beneficiaries of a single trust named in the beneficiary designation form. In such a case, generally the trust s oldest beneficiary s life expectancy including contingent beneficiaries--- will be used for the purposes of figuring MRD and not that of each individual beneficiary of the trust. Non-individual beneficiaries may also disqualify the trust as a DB 15

Example Solutions: Create separate trusts (or substrusts) for each beneficiary and name each trust in the beneficiary designation form Eliminate trust beneficiaries before beneficiary finalization date Create conduit trust as a safe harbor Example: Elimination of beneficiaries Conduit Trust A type of see-through trust in which all distributions from the IRA are immediately distributed to the trust beneficiary/beneficiaries. Effect: the retirement benefits are deemed paid to the individual beneficiary(ies) for purposes of the MRD rules, and accordingly the all beneficiaries must be individuals test is met. The life expectancy of the oldest trust beneficiary will be used, but not including contingent beneficiaries Drawbacks: It lessens the trustee s control. Also, if the MRD rules change requiring faster distributions, the trust beneficiary will leave the money sooner than the participant may have intended. 16

Accumulation Trust A trust in which distributions from the IRA are allowed to accumulate within the trust (any trust that is not a conduit trust is an accumulation trust) Advantages: provide more of the benefits of trusts in general in particular, the ability to control IRA distributions for the benefit of a beneficiary. Accumulation Trust The key issue in analyzing an accumulation trust is to determine which beneficiaries are countable. All beneficiaries are countable unless such beneficiary is deemed to be a mere potential successor beneficiary. 17

Accumulation Trust Example 1 IRA Trust Discretionary Distributions Mother is countable for determining applicable life expectancy See PLR 200228025 and Treas. Reg. 1.401(a)(9)-5 Q&A 7 Entire Trust outright upon Grandchildren reaching age 30 Child age 30 Child age 30 If Grandchildren die before reaching age 40 Mother Age 80 Accumulation Trust Example 2 IRA Trust Discretionary Distributions Child #1 At Child #1 s death Contingent beneficiary must be counted. To Red Cross Non-individual contingent beneficiary. No designated beneficiary status. Treas. Reg. 1.401(a)(9)- 5 Q&A 7 18

Accumulation Trust Example 3 IRA Trust Income This is a circle trust where it is impossible for trust property to be distributed to a non-individual beneficiary. Child 1 s life expectancy is used. See Treas. Reg. 1.401(a)(9)-5 A-7(c)3), Example 1 Child 1 age 30 Entire Trust terminates and is distributed to Child 1 if Child 2 is deceased Remainder Child 2 Age 25 Not always. Is a trust the best choice merely because it qualifies as a see-through trust? For example, a surviving spouse beneficiary most likely would result in a longer period of deferral because of the ability to roll over the benefits into the spouse s own plan. A trust, by contrast, would require the spouse to use her own life expectancy, or worse, a life expectancy of an older beneficiary of the trust (note: exceptions apply). Qualifying the trust as a see-through is IRRELEVANT if the decedent was past his RBD when he died, or the trust beneficiary is older than or close to the same age as the participant. On the other hand, the client s non-tax objectives may make a Trust a compelling choice. OR, in the case of young non spouse beneficiaries, the non-tax and tax objectives may overlap. 19

The Beneficiary Designation Form Why is it important? Remember, the Will or trust of decedent will not trump the beneficiary designation form, so the form is just as important as a will or trust Reviewing to ensure that the separate accounts rule will apply, or if it will be possible to eliminate beneficiaries before the Beneficiary Finalization Date. In the case of a trust beneficiary, reviewing to make sure that each individual sub trust is named. Executor can be given certain powers to make Roth conversions, which can be specified in the BD form. See handout (checklist) Special Rules for Non-IRA QRPs It is necessary to review the plan documents of any non- IRA QRP, to determine the permissible beneficiaries, and whether the payout options are different than under the default rules. Many plan administrators will not permit stretch out after the participant s death. It may make sense for the participant to roll over to an IRA from a QRP as soon as possible. 20

Retirement plans in the context of estate planning Is Probate Required? Maybe, if the estate is named as a beneficiary. Are Retirement plans subject to estate taxes? Yes they are in the decedent s taxable estate 2013 Rules $5.2 Million exemption amount & 40% rate Are Retirement plans subject to income taxes? Most retirement plans (except for Roths) are subject to income tax and / or penalties upon withdrawal of plan assets. How does this work after the death of the participant? Are Retirement Plans Asset Protected? Yes, but the distributions are not unless they are accumulated in a trust. Is a stretch automatic as long as you have named an individual beneficiary? Retirement plans in the context of estate planning Gross Estate Non-probate transfers Revocable Trust Survivorship property Life Insurance IRA s 401(k) s POD accounts Probate transfers Property in your separate name Distributions under your Will Probate Process 21

Non-tax estate planning issues 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%. Non-tax estate planning issues Assume only $100,000 at age 40 earning 6% Child withdraws and spends MRD after tax Child s Cum. Withdrawals+Balance Age IRA Legacy Cash Out Trust 50 $ 170,352 $ 65,000 60 $ 264,583 $ 65,000 84 $ 474,953 $ 65,000 A difference of over $ 400,000 on a $100,000 IRA! 22

Non-tax estate planning issues Assume only $100,000 at age 40 earning 6% Child withdraws and spends MRD after tax IRA is Cashed-out Early and Invested still a big loss Child s Cum. Withdrawals+Balance Age IRA Legacy Cash Out Trust 50 $ 170,352 $ 98,361 60 $ 264,583 $ 137,062 84 $ 474,953 $ 158,983 Retirement plans in the context of estate planning Five goals when performing estate planning for retirement accounts 1. Achieve the client s non-tax testamentary intent (While a gift to charity may be tax advantageous, the client may not have charitable intent) 2. Achieve maximum stretch out for the longest period possible 3. Minimize estate tax, if possible, and while doing so make sure to fund the retirement plan to the right trust or individual upon the first spouse s death. 4. Achieve maximum asset protection, if possible and desired by the client 5. Do not mess up the beneficiary designation, or ignore it 23

Questions / Answers Questions? Presented by John C. Martin, Attorney The Law Offices of John C. Martin 1145 Merrill Street Menlo Park, California 94025 Tel: 650-329-9500 Email: jcm@johncmartinlaw.com The contents of this presentation are not intended to be, nor should they be construed as, legal advice or the formation of an attorney-client relationship. Thank you. IRS CIRCULAR 230 NOTICE: To the extent that this presentation concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. 24

Bibliography: Choate, Natalie B. Life and Death Planning for Retirement Benefits: The Essential Handbook for Estate Planners 7 th Ed. / Natalie B. Choate Choate, Natalie B., various online articles, available at www.ataxplan.com. Mezzulo, Louis. An Estate Planner s Guide to Qualified Retirement Plan Benefits (ABA Publications, 4th ed. 2007). Ray, Thomas and Dymond, Lewis (Presenters). Sophisticated Planning for IRA & Qualified Plan Distributions with WealthDocsTM (Presented on May 6-7, 2008) Keebler, Robert (Presenter). Sophisticated Planning for IRA & Qualified Plan Distributions (Presented on July 25, 2005). 25