DRAFTING TO INTEGRATE RETIREMENT PLANS AND IRAs INTO THE ESTATE PLAN KAREN S. GERSTNER Karen S. Gerstner & Associates, P.C. 5615 Kirby Drive, Suite 306 Houston, Texas 77005-2445 Telephone: (713) 520-5205 Fax: (713) 520-5235 e-mail: karen@gerstnerlaw.com State Bar of Texas 25 TH ANNUAL ESTATE PLANNING & PROBATE DRAFTING October 9-10, 2014 Dallas CHAPTER 3.2
TABLE OF CONTENTS I. OVERVIEW OF FINAL REGULATIONS... 1 A. Disclaimer And Scope Of Outline... 1 B. Minimum Distribution Rules... 1 1. Purpose Of Minimum Distribution Rules... 1 a. To Provide Retirement Benefits Primarily To The Employee (And His Spouse)............... 1 b. To Prevent Indefinite Postponement Of Income Taxes................................... 1 2. When Are Minimum Distributions Required To Commence?................................. 1 a. Required Beginning Date.... 1 b. Lifetime Distributions To Participant Must Commence By Required Beginning Date........... 1 3. Distribution Periods During Participant's Life Under The New Rules........................... 2 a. Participant's "Young Spouse" Is Not Sole Beneficiary... 2 b. Participant's Young Spouse Is Sole Beneficiary... 2 c. IRS Tables... 2 4. Key To Distribution Periods After Participant's Death: Designated Beneficiary................... 2 a. Who Is A Designated Beneficiary?... 2 b. New Applicable Date For Determining Designated Beneficiary........................... 3 c. Which Designated Beneficiary "Problems" Can Be Fixed After The Participant's Death?....... 3 5. Required Distributions On Or After Death Of Participant.................................... 4 a. Participant's Death Before RBD... 4 b. Participant's Death After RBD... 7 6. Creation Of Separate Accounts After Participant's Death.................................... 8 a. Separate Accounts: Issues Relating To Beneficiary Designation Wording................... 9 b. Method For Division Into Separate Accounts After Participant's Death..................... 1 0 c. Ambiguities In Final Regulations Regarding Separate Accounts.......................... 1 0 7. Effective Dates.... 1 1 a. Transitional Rules... 1 1 b. Relief From 5 Year Rule... 1 1 c. Relief For Failure To Provide Trust Documentation................................... 1 1 8. Reporting Requirements... 1 1 C. Taxation Overview... 1 1 1. Income Taxation... 1 1 a. Special Income Tax Rules... 1 1 b. Rollovers... 1 2 c. Inherited Retirement Plans.... 1 2 d. $5,000 Death Benefit Exclusion... 1 3 2. Estate Taxation... 1 3 a. General Rule... 1 3 b. Two Transitional Rules May Still Provide Exclusion From Participant's Estate For Qualified Plans Benefits... 1 3 c. Estate Tax Transitional Rules Not Applicable To IRAs................................. 1 4 d. Caution Advised.... 1 4 D. Penalty Taxes... 1 4 1. Premature Distributions.... 1 4 2. Late Or Insufficient Distributions... 1 4 3. Elimination Of Penalty Taxes On Excess Accumulations And Distributions.................... 1 4 E. Spousal Rights.... 1 4 1. Two Required Spousal Benefits For Certain Plans......................................... 1 4 a. QJSA... 1 4 b. QPSA... 1 4 2. Spousal Benefit Requirements For Other Plans... 1 4 a. Spouse Must Be Beneficiary... 1 4 b. No Annuity Rule... 1 4 c. Not A Transferee Plan... 1 4 3. Additional Technical Rules... 1 4 -i-
4. Waivers And Consents... 1 4 a. Participant's Waiver... 1 4 b. Spousal Consent To Waiver... 1 5 c. Sample Language... 1 5 d. Consideration To Spousal Rights... 1 5 F. Community Property Laws... 1 5 1. Devisability Issue.... 1 5 a. Qualified Plans - No Right Of Disposition... 1 5 b. IRAs - Boggs Not Applicable... 1 6 c. Status Of IRA Rollovers From Qualified Plans....................................... 1 6 2. Drafting Issues... 1 6 a. How Does The Interest Pass?.... 1 6 b. To Whom Should The Interest Pass?.... 1 6 c. Documentation Of Disclaimer By Participant......................................... 1 7 3. Planning Ideas To Assist NPS In Her Estate Planning...................................... 1 8 II. OPTIMAL BENEFICIARY DESIGNATIONS.... 1 8 A. Married Participant: Designate Spouse As Primary Beneficiary................................. 1 8 1. Qualifies for Estate Tax Marital Deduction... 1 8 a. Automatic QTIP Treatment For Survivor Annuities.................................... 1 8 b. Periodic Payment Issues... 1 8 2. No Gift Tax Issue.... 1 8 3. Spouse Qualifies As Sole Designated Beneficiary......................................... 1 8 4. Spouse's Options Upon Death Of Participant... 1 9 a. Spouse's IRA Rollover Option... 1 9 b. Spouse's Assumption Of Participant's IRA... 1 9 c. Disadvantages Of Spousal IRA Rollover.... 1 9 d. Taking Distributions As Participant's Beneficiary..................................... 1 9 e. Disclaimer Option... 1 9 B. Single Participant With Children: Designate Adult Children As Outright Beneficiaries............... 2 0 1. Multiple Beneficiary Rule... 2 0 a. Separate Accounts/Segregated Shares... 2 0 2. Caveat: Restrictive Qualified Plan Provisions............................................ 2 0 C. Single Participant, No Children, Charitable Intent: Designate Charity As Direct Beneficiary.......... 2 0 1. Charity Is Not A Designated Beneficiary But No Longer Adversely Affects Participant........... 2 1 2. Charity As One Of Multiple Beneficiaries: Use Separate Accounts........................... 2 1 3. Estate Tax Result: Charitable Deduction... 2 1 4. Income Tax Result For Charity... 2 1 III. REASONS FOR DESIGNATING A TRUST AS THE BENEFICIARY OF RETIREMENT PLANS... 2 1 A. Non-Tax Reasons... 2 1 B. Tax Reasons... 2 1 IV. OBTAINING DESIGNATED BENEFICIARY TREATMENT IF A TRUST IS NAMED AS BENEFICIARY OF RETIREMENT PLANS.... 2 1 A. History Of The Trust Regulatory Requirements... 2 1 B. Trust Itself Is Not A Designated Beneficiary... 2 1 C. Trust Regulatory Requirements Under The Final Regulations................................... 2 2 1. Overview Of The Four Trust Requirements... 2 2 a. First Requirement.... 2 2 b. Second Requirement... 2 2 c. Third Requirement... 2 2 d. Fourth Requirement... 2 2 2. Trust Documentation No Longer Required At RBD........................................ 2 2 a. Exception: Trust For Young Spouse... 2 2 b. Post-Death Trust Documentation.... 2 3 -ii-
3. What Types Of Trusts Created For The Spouse Will Qualify For Sole DB Treatment?............ 2 3 a. Conduit Trust... 2 3 b. Grantor Trust... 2 3 4. Identification Of All Trust Beneficiaries Having An Interest In Participant's Plan................. 2 3 a. Contingent Beneficiaries... 2 3 b. Successor Beneficiary... 2 4 c. Specific Examples In The Regulations... 2 4 D. Unanswered Questions Regarding Trusts Named As Beneficiaries............................... 2 5 1. Beneficiaries Of Powers Of Appointment... 2 5 a. General Powers And Broad Special Powers... 2 5 b. Limited Powers... 2 5 2. Remainder Beneficiaries... 2 5 a. Is The Life Expectancy Theory Still Viable?......................................... 2 6 V. SPECIAL CONCERNS IN NAMING A QTIP TRUST AS BENEFICIARY... 2 6 A. Complete Distribution To QTIP Trust... 2 6 1. Estate Tax Marital Deduction... 2 6 2. Income Tax Issues... 2 6 3. IRD.... 2 6 a. No IRD Deduction... 2 6 4. Allocation Between Principal And Income... 2 6 a. Texas Uniform Principal And Income Act Allocation Rules............................. 2 6 b. Comparison to "National" UPIA... 2 7 5. Observation Regarding Reduction In Value Of Retirement Plan Due To IRD................... 2 7 B. Periodic Payments To QTIP Trust... 2 7 1. Estate Tax Marital Deduction Issues.... 2 7 a. Satisfying The "Qualifying Income Interest For Life" Requirement....................... 2 7 b. Two Alternatives For Meeting The Qualifying Income Interest Requirement................ 2 8 c. Conflict Between Minimum Distribution Rules And "All Income" Requirement Under The Estate Tax Marital Deduction Rules... 2 8 d. Solution: Two Choices Now For Meeting "All Income" Requirement..................... 2 9 e. Principal And Income Allocation Issues... 2 9 f. Post-death Administrative Requirement: Two QTIP Elections............................ 3 0 g. Plan Distribution Options Must Be Satisfactory....................................... 3 0 2. Designated Beneficiary Issues.... 3 0 a. The Trust Regulatory Requirements... 3 0 3. IRD Issues... 3 1 a. Specific Bequest Approach... 3 1 b. Fractional Share Approach... 3 1 c. Residuary Trust... 3 1 4. Tax Payment Issues... 3 1 a. Estate Taxes... 3 1 b. Income Taxes And Expenses... 3 1 5. Instructive Rulings.... 3 2 6. Will Contests And Other Litigation.... 3 2 VI. SPECIAL CONCERNS IN NAMING A QDOT TRUST AS BENEFICIARY.... 3 2 A. Spouse Not U.S. Citizen.... 3 2 B. Creation of QDOT... 3 2 C. Rollover to QDOT by Non-Citizen Spouse... 3 2 1. Three Illustrative Rulings... 3 2 a. PLR 9623063... 3 2 b. PLR 9109021... 3 2 c. PLR 9321032.... 3 2 D. Annuity As QDOT... 3 3 E. Final QDOT Regulations... 3 3 -iii-
VII. SPECIAL CONCERNS IN NAMING A BYPASS TRUST AS BENEFICIARY... 3 3 A. Complete Distribution To Bypass Trust.... 3 3 1. IRD Deduction.... 3 3 2. Principal And Income Allocation Issues... 3 3 B. Minimum Distribution Payments To Bypass Trust... 3 3 1. Principal And Income Allocation Issues... 3 3 2. IRD Reduces Estate Tax Effectiveness... 3 3 3. Strategies For The Participant During Life... 3 3 a. Not Waiting Until Age 70 ½ To Take Distributions From His Retirement Plans............. 3 4 b. Not Taking Merely The Minimum Required Distributions Upon Reaching RBD............. 3 4 c. Rolling Over Qualified Plan Benefits To An IRA..................................... 3 4 d. Converting To A Roth IRA..... 3 4 4. Complicating Factors.... 3 4 a. Multiple Beneficiaries... 3 4 5. Drafting Strategies.... 3 5 a. Beneficiary Designations... 3 5 b. Bypass Trust Provisions.... 3 6 C. New Approaches... 3 7 1. Elect Portability... 3 7 a. Better Income Tax Situation For Surviving Spouse.................................... 3 7 b. Better Income Tax Situation For Children After Death Of Surviving Spouse................ 3 7 c. Disadvantages Of Portability Election.... 3 7 2. Non Pro Rata Distributions... 3 8 a. What Is The Plan?... 3 8 b. What Are the Risks Of This Plan?.... 3 8 c. Federal Income Tax Support... 3 8 d. Texas Statutory Provisions... 4 0 VIII. SPECIAL CONCERNS IN NAMING A CHARITABLE REMAINDER TRUST AS BENEFICIARY OF RETIREMENT PLANS.... 4 0 A. Distinguish From Naming A Charity As The Beneficiary....................................... 4 0 B. Distinguish Naming A Charitable Remainder Trust And Naming a QTIP Trust With Remainder To Charity As The Beneficiary... 4 1 1. Marital Deduction Issue.... 4 1 2. Income Tax Issues... 4 1 3. Benefits To Spouse... 4 1 4. Benefits To Charity... 4 1 C. Disadvantage Of Naming A Charitable Trust As Beneficiary.................................... 4 1 1. No Designated Beneficiary-But No Longer Hurts Participant................................ 4 1 2. Other Beneficiaries May Suffer Because Of The Multiple Beneficiary Rule.................... 4 1 a. Percentage Or Fractional Share Designation.......................................... 4 2 b. Post-death Creation Of Separate Accounts/Cashing Out Charity.......................... 4 2 3. Loss Of IRD Deduction... 4 2 4. Avoid Naming A Charitable Beneficiary Of Roth IRA..................................... 4 2 D. Direct Rollover Of IRA To Charity... 4 2 IX. SPECIAL CONCERNS IN NAMING A GST TRUST AS BENEFICIARY.... 4 2 A. No GST Exemption Allocation Until Participant's Death....................................... 4 2 B. GST Exemption Allocation At Death.... 4 3 1. IRD Issue... 4 3 2. Various Problems.... 4 3 3. Advantages.... 4 3 4. Potential Problems.... 4 3 -iv-
X. TRUST (OR ESTATE) WAS NAMED AS BENEFICIARY BUT THERE IS A SURVIVING SPOUSE AND SPOUSE DESIRES IRA ROLLOVER.... 4 3 A. Not A Planning Technique: Trying To Salvage Spousal IRA Rollover............................ 4 3 B. Illustrative Rulings... 4 3 1. Some Favorable Rulings: Spousal IRA Rollover Permitted.................................. 4 3 a. Factors Leading To Favorable Ruling... 4 4 2. Unfavorable Rulings: No Spousal IRA Rollover Permitted................................. 4 4 a. Reasons For Unfavorable Ruling.... 4 4 XI. CONCLUSION... 4 4 A. Rules For Allocating Plans/IRAs to Trusts Are Complex....................................... 4 4 B. Consider Obtaining A Private Letter Ruling... 4 4 C. Consider Other Alternatives To Trust as Beneficiary.......................................... 4 5 LIST OF EXHIBITS Exhibit 1 Exhibit 2 Exhibit 3 Exhibits 4-16 Exhibit 17 Uniform Lifetime Table Joint and Last Survivor Table Single Life Table Sample Beneficiary Designation Wording and Sample "Schedule A" Beneficiary Designation Attachments ( for a split of benefits between charity and individuals, see Exhibits 15 and 16) Beneficiary Designation Considerations -v-