Estate Planning for
Retirement Benefits
April Caudill, J.D., CLU, ChFC, AEP
Senior Advanced Planning Attorney
Advanced Financial Security Planning
Northwestern Mutual
The Northwestern Mutual Life Insurance Company – Milwaukee, WI
Overview
Estate Planning
• Making certain property is distributed after
death according to the owner’s wishes
• Minimizing estate and income taxes
• Taking into account
– Specific needs of beneficiaries
– Need for flexibility to adjust to changing
circumstances
• Return of estate tax in 2011
Overview
• Special issues specific to “qualified assets”:
Income in respect of a decedent (IRD):
– Impact of both income and estate tax
– Minimum distribution requirements and
potential conflicts with planning objectives
– Retirement assets pass by beneficiary
designation; many other assets pass by will
– Retirement assets can offer long-term income
tax deferred growth (or tax-free growth for Roth
assets)
Stretch Concept
• “Stretch IRA”
• Qualified assets subject to income tax, but not
until distributed!
• What happens until they are distributed?
– Continued tax-deferred growth
– Or, tax-free in a Roth account
• Logical conclusion: let the assets grow!
• IRS says “not so fast”– you have to at least
take a little bit out each year.
Stretch Concept
• “Stretch” = make the IRA last as long as
possible, take out only the minimum
• Youngest beneficiaries receive the most
dramatic benefit –amount received over their
lifetime can be several times the initial
account value inherited, depending on growth
rate (assuming life expectancy fraction payout
method is used)
• Use of trust can help assure the IRA remains
intact, continues tax-deferred growth
Stretch Concept
• “Stretch” requirements
Designated beneficiary status
– Named as beneficiary
– Taking under ERISA plan terms, such as spouse
Trust – special requirements
Individual beneficiary: not estate or charity
• Big picture: long-term tax deferred growth can be a powerful
wealth transfer tool
• Liquidity provided by an income tax free death benefit can help
families optimize the tax advantages of qualified assets
Required Minimum Distributions
• Individual beneficiaries
– Nonspouse
• Single life payout
• Deadline for election
• 5-year rule or “ghost” life expectancy
– Spouse
• Rollover option
• Uniform lifetime table
• Maximum permitted delay
– Multiple individuals and separate accounts
Required Minimum Distributions
• Charitable beneficiaries
– Tax efficient planning
– Impact of charitable beneficiary on “designated
beneficiary” status of other beneficiaries
– September 30 beneficiary determination date
• Estate beneficiaries
– No “look-through”
– No life expectancy
– Some PLRs allow spousal rollover
Required Minimum Distributions
• Planning objectives
– Make beneficiary designations that optimize
achievement of client’s goals
– Use the longest permitted measuring life so
that income tax deferral or income tax-free
growth is maximized
– Avoid potential exposure to 50% penalty
– Recognize the interaction (conflicts) between
RMDs and other trust requirements or
objectives
Marital Planning
• Number one IRA or QP beneficiary: spouse
• Objective: qualify for the unlimited marital
deduction
• Four ways (if U.S. citizen)
– Leave assets to spouse outright by naming
spouse as beneficiary
– Name a general power marital trust as
beneficiary
– Name a QTIP trust as beneficiary
– Joint and survivor annuity
Marital planning
• Easiest: assets to surviving spouse outright by
naming spouse as beneficiary
– Income tax advantages (versus trust)
– Simplicity
• Rollover dilemma for younger spouse
– Decision of whether to maximize stretch by rolling
over to spouse’s own IRA
• Alternative 1: leave funds in inherited IRA, start taking
RMDs until age 59½
• Alternative 2: roll over; hope funds are not needed
• Alternative 3: prevent dilemma with life insurance
– If it’s already too late …
Marital planning
• General power marital trust as beneficiary
– General power marital trust requirements:
• Surviving spouse must be entitled to all the income
from the trust
• The spouse must be entitled to appoint the property
to the himself or herself, or his or her estate, and
• No other person can have the power to appoint the
property to someone other than the spouse
• Note – these are broad powers, tantamount to outright
ownership. Leaving benefits to spouse outright is simpler
and avoids disadvantages of using a trust
Marital Planning
• General Power Marital Trust as beneficiary
– Note that certain plans require spousal consent to name
beneficiary other than spouse
– Disadvantages of naming marital trust as beneficiary
• No ability to delay distributions until decedent would have reached
age 70½
• Unless benefit is rolled over to surviving spouse’s own IRA (outside
of trust), payouts use single life table (less deferral)
– Surviving spouse might not lose ability to make rollover of
withdrawals in excess of RMDs;
• Depends on extent to which withdrawals are subject to a trustee’s
discretion, or otherwise restricted.
Marital Planning
• Qualified terminable interest property (QTIP)
trust as beneficiary
– Allows account owner/participant to limit
surviving spouse’s access to principal, direct it
to children or other heirs
• Spouse can be given any degree of access to
principal or no access
• Spouse can be given limited power to appoint
principal at death, or not
• Typically used to assure that children from a
previous marriage receive principal after death of
surviving spouse
Marital Planning
• Requirements for QTIP treatment:
– Spouse must be entitled to all the income from
the trust, payable at least annually,
– No other person can have the power to appoint
the property to anyone other than the spouse
during the spouse’s lifetime, and
– Executor must irrevocably elect QTIP treatment
on the decedent's estate return for both the
trust and the IRA
Marital Planning
• QTIP trust requirement: “Entitled to All
Income”
– Trust terms should entitle the spouse to both
the trust's and the plan's income annually
– Easiest way to satisfy is for trustee to calculate
the "income" of the both trust and the IRA
– Trustee then withdraws from the IRA the greater
of its “income” or the RMD amount
• Disadvantageous if RMD would have been much
lower than income (e.g., young spouse)
Marital Planning
• QTIP trust requirement: “Entitled to All Income”
– Determination of “income” under state law varies
– IRS has approved use of unitrust amount (generally
3% to 5%)
– IRS approves of “traditional” method
– IRS disapproves of “10% rule” where 90% of RMD
amount is allocated to principal/10% to income.
Note that some trusts/state statutes define income
in this manner. Might not qualify for marital
deduction. (See Revenue Ruling 2006-26, 2006-22
IRB 939 )
Marital Planning
• QTIP Trust as beneficiary: Disadvantages
– Complexity: defining income, reconciling
“income” with RMDs
– Might not accomplish goals if surviving spouse
is near age of children.
– Perhaps acquire life insurance instead for
surviving spouse and leave qualified assets to
kids (or vice versa).
Marital planning
• Pecuniary Formula Marital Bequests
– What is this?
– Participant’s will designates a specific dollar
amount to go to the marital and credit shelter trust
– Executor allocates IRA to the trust in satisfaction of
the bequest
– Potential taxation at the estate level on the IRA or
plan proceeds
• Some PLRs have allowed spousal rollover in these
circumstances
• Alternative is use of a fractional formula:
e.g., ½ of my estate to each trust
Marital planning
Noncitizen Spouse
• Deferred estate tax treatment available only
for assets passing to qualified domestic
trust (QDOT), unless modified by estate tax
treaty
• Designed to prevent noncitizen surviving
spouse from taking assets outside the U.S.,
escaping transfer taxes
• QDOT must meet other requirements for
marital or QTIP trust plus additional ones …
Marital Planning
Additional requirements for QDOT trusts:
• Trustee should be a U.S. domestic corporation;
• No distributions of principal permitted without
withholding of estate tax
• Trust must be maintained and administered under
the laws of a state or the District of Columbia.
• Bonding requirements and limitations on the
amount of foreign real property the trust can hold.
Marital Planning
QDOT practical issues:
– QDOT can be named as beneficiary, or
nonspouse beneficiary can have one created
and roll over assets to it
– QDOT can also be structured as an IRA if
maintained at a financial institution
– Requirement that no principal be distributed;
deferred estate tax owed if RMD amount
exceeds trust “income”
– Determination of “income” subject to same
state law variations as with QTIP trust
Marital Planning
Dealing With the QDOT requirements:
• Participant could leave the retirement
assets to other beneficiaries and purchase
life insurance in an ILIT to benefit the
noncitizen spouse;
• Participant could forego the marital
deduction and have executor pay the estate
tax at the first death;
• Roth conversion could allow surviving
spouse to avoid RMDs
Marital Planning
Rollovers by Noncitizen
• Rollover to a plan in another country is a
taxable distribution (10% penalty might also
apply) unless authorized by a tax treaty
• Tax treaty might allow noncitizen to leave
funds in existing plan but have them taxed
upon withdrawal only in the other country
• Money from other countries typically cannot
be rolled into U.S. accounts; not considered
a tax-free rollover.
Planning Issues for Trusts
Other trust planning issues:
• “Look-through” trust requirements
• Credit shelter trust as beneficiary
• Special needs trust
• Trusts for multiple beneficiaries
Planning Issues for Trusts
• Trust beneficiaries
– Requirements for “look-through” treatment
•
•
•
•
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All beneficiaries are individuals
Valid under state law
Documentation requirement
Trust must be irrevocable
Beneficiaries must be identifiable
– Which beneficiaries “count” for purposes of
requirement that all must be individuals?
Planning Issues for Trusts
• Conduit trust: Income/RMDs paid out to
beneficiaries each year:
– Only “Primary beneficiaries” counted
– Example: to my children with remainder to my
grandchildren – children are only ones counted.
• Accumulation trust: income/RMDs can be held
in trust instead of distributed
– All beneficiaries counted
– Example: to my children with remainder to my
grandchildren –all are counted.
Planning Issues for Trusts
• Special Needs Trust
– Normally an accumulation trust: trustee has complete
discretion to retain assets or make distributions
• Result is that all beneficiaries counted: individual with
special needs, as well as any remainder beneficiaries
– Negative results if remainder beneficiary is an estate or
charity: no designated beneficiary status; faster payout,
taxed at trust’s income tax rates
– Planning strategy: if funding special needs trust with
qualified assets, remainder beneficiaries need to be
individuals near same age for optimal tax results
• Alternative: fund special needs trust with life insurance,
leave retirement assets to spouse and/or other children
Planning Issues for Trusts
• Credit Shelter Trust as beneficiary
– Most basic planning strategy for individuals
potentially subject to estate tax
– All other trust requirements discussed previously
apply
– If no other assets available, credit shelter trust
useful to protect retirement assets from estate tax
• Retirement and other IRD assets are a “wasting asset”
• Some of credit shelter is used up by income tax liabilities
and RMDs
• An asset that receives stepped-up basis is preferable
Planning Issues for Trusts
Credit shelter trust as beneficiary:
• If spouse is beneficiary of credit shelter trust,
consider trade-offs
– Credit shelter trust saves estate tax but at the cost
of short-term flexibility for the surviving spouse
– Trust as beneficiary triggers other disadvantages -requirements for designated beneficiary status,
potentially higher income taxes
• Alternative strategy: name surviving spouse as
beneficiary and credit shelter trust as contingent
beneficiary. Spouse can disclaim if so desired.
Planning Issues for Trusts
Multiple beneficiaries
• General rule: use shortest life expectancy –
i.e., life expectancy of oldest beneficiary
– Bad deal if one much older beneficiary and
others are younger – payout to younger
beneficiaries is much faster, much less longterm growth.
– Multiple beneficiaries taking through one trust
do not get to use their own life expectancies,
even if “separate” accounts are established
Planning Issues for Trusts
Example: Tom is widowed, has a $3 million IRA. His will
names his sister Joan, age 59 as guardian for his two
children, Dan (8) and Ann (21). Tom names Joan, Dan and
Ann as outright beneficiaries of his IRA.
First year payout if they can establish separate accounts and
receive payouts over their life expectancies (i.e., they are
not taking through a trust):
Joan $1M/26.1=$38,314
Ann $1M/62.1= $16,103
Dan $1M/74.8 = $13,369
Planning Issues for Trusts
• Example (cont’d): If Tom named a trust instead
of naming Joan, Dan and Ann individually.
– Result: now all three must take distributions based
on Joan’s life expectancy
• Potential solutions:
– Separate trusts, where each is a named beneficiary
– One master trusts with multiple “little” trusts that
are each an IRA/plan beneficiary
– Separate IRAs
– Disclaimer or payout to Joan before September 30
of year after death
Income Tax Issues
• Income in respect of a decedent (IRD)
– Definition: income to which decedent was
entitled but had not yet been taxed
– No stepped up basis
– Subject to income tax as all ordinary income
– Taxed only when distributed – thus, “stretch”
strategies important
Income Tax Issues
• Income tax deduction for beneficiary; available for
estate tax paid on IRD (IRC Sec. 691(c))
• Designed to mitigate impact of double taxation
• Calculates how much of estate tax was
attributable to IRD assets, then each person
receiving IRD receives a proportionate amount of
the deduction
Income Tax Issues
IRD Deduction
• Example: Julie dies in 2011 leaving $1 million IRA and $5
million of other assets. Assume that the amount of federal
estate tax attributable to the IRA is $350,000.
• If Julie’s two children are equal beneficiaries of the IRA,
each receives a 691(c) deduction in the amount of
$175,000.
• Deduction is an itemized deduction, but not subject to the
2% floor.
Income Tax Issues
Charitable beneficiary:
– Advantage: Very efficient tax planning tool, since
charity does not pay income tax; full amount of
plan balance benefits the charity.
– Advantage: IRA going to charity escapes estate tax
due to estate tax charitable deduction.
– Disadvantage: Existence of a charity as a
beneficiary at the beneficiary determination date
(September 30 of year after death) means that no
beneficiaries have “designated beneficiary” status.
– Result: if charity is one of multiple beneficiaries,
special planning is necessary.
Income Tax Issues
Charitable beneficiary of retirement assets
• Methods:
– Name charity as one of several beneficiaries
• Beneficiary of a specified fraction
• Beneficiary of a specified dollar amount
– Name a trust as beneficiary and provide for a
charity as beneficiary of some portion of the trust
– Name a trust as beneficiary and a charity as a
remainder beneficiary
– Name charity as the sole beneficiary of IRA or plan
Income Tax Issues
• Method: Name charity as one of multiple
beneficiaries of IRA
• Beneficiary of a specified fraction: OK idea -- allows
for separate account treatment and possible payoff
of charity before beneficiary determination date
– Example: 20% to the Boy Scouts of America
• Beneficiary of a specified dollar amount: bad idea -more difficult to create a separate account for the
charitable gift under the separate account rules.
– Example: $10,000 to United Way
Income Tax Issues
• Method: Name a trust as beneficiary and
provide for a charity as beneficiary of some
portion of the trust
– Bad idea: use of qualified assets to satisfy
charitable bequest might result in taxation of
the IRA/plan funds at the trust level, especially
if trustee has a choice of assets with which to
satisfy the charitable bequest.
Income Tax Issues
• Method: Name a trust as beneficiary and a
charity as a remainder beneficiary
– OK so long as trust is a conduit trust and does
not accumulate distributions.
– Bad idea if trust is an accumulation trust: trust
will be treated as having no designated
beneficiaries. This means no “stretch”
opportunity for beneficiaries.
Income Tax Issues
• Method: Name a trust as beneficiary of a
fractional share of the account and a charity
as beneficiary of another fractional share
– OK idea: just need make sure separate
accounts are created prior to September 30
deadline.
Income Tax Issues
• Method: Name charity as the sole
beneficiary of IRA or plan
– Best idea for larger charitable bequests
– Avoids issue of charity potentially disqualifying
other beneficiaries from designated beneficiary
status
• For smaller bequests, consider use of will (and
other assets) instead of qualified assets, to avoid
potentially jeopardizing a stretch strategy.
After Death
“Clean-up” Strategies: After IRA owner/plan participant has died
• Distributions to “undesirable” beneficiaries prior to
September 30 of year after death
– Can remedy existence of older or charitable beneficiaries,
especially where separate accounts not available
• Qualified disclaimer: refusal to accept an inheritance
– Allows IRA or qualified plan benefit to go to contingent
beneficiary
– Does not constitute a gift by disclaimant
– Useful when one of multiple beneficiaries is much older or
otherwise defeats stretch objectives.
After Death
• Requirements for qualified disclaimer
– Must be in writing
– For qualified assets: must be received by
Executor and/or plan trustee or account
custodian by 9 months after date of death
• Note that person disclaiming does NOT have until
September 30 of the year after death
After Death
• Requirements for qualified disclaimer
(cont’d)
– Person disclaiming cannot have accepted the
interest or any of its benefits
• Acceptance of RMD for decedent’s year of death
does not constitute acceptance of the entire plan
• Partial disclaimer might be possible even if
beneficiary has received additional amounts
After Death
• Requirements for qualified disclaimer
(cont’d)
– Interest must pass without any direction on the
part of the person disclaiming
– Property must pass to someone other than the
person disclaiming, unless the person
disclaiming is the decedent’s spouse.
After Death
• Separate accounts
– Requires pro rata allocation of post-death
gains, losses, contributions and forfeitures
among beneficiaries
– Allows each outright beneficiary to use own life
expectancy (if not taking through a trust) if
established by 12/31 of year after death
– Deadline of 12/31 applies only for purposes of
determining whether separate account holders
can use their own life expectancies.
After Death
• Separate accounts
– If deadline is not met, separate accounts can
still be established but oldest beneficiary’s life
expectancy will be the measuring life
– Separate accounts allow beneficiaries to
choose different investments, avoid interacting,
etc.
– Might result in each beneficiary being
responsible only for his/her own RMDs
After Death
• Rollover by surviving spouse
– Allows spouse to treat IRA or plan account as
his/her own; delay distributions
– Spouse can also leave account intact and
receive RMDs beginning in year after death or
when decedent would have reached 70 ½
– Spouse can convert to a Roth account:
• Compelling long-term “stretch” wealth transfer
strategy
• No RMDs are required to owner of a Roth IRA
After Death
• “Rollover” (direct transfer) by nonspouse
beneficiary
– Qualified plan assets can be “rolled over” to
inherited IRA titled in decedent’s name for benefit
of beneficiary
– Requires direct transfer, no 60-day rollover
– IRA assets can be retitled in same manner
– Nonspouse beneficiary has option to convert
qualified plan account to an inherited Roth account
– Nonspouse cannot convert an inherited IRA to a
Roth account
After Death
• Qualified Plan 5-year “trap”
– Nonspouse beneficiary of qualified plan might
have 5 years under plan to decide how to
receive funds
– However, choice of a life expectancy payout
must be made by December 31 of the year
after death
– Nonspouse beneficiary who waits longer than
the December 31 deadline can still make a
nonspouse rollover, but distributions will have to
be completed within 5 years.
After Death
• Qualified Plan 5-year “trap”
– Spouse beneficiary who does not roll over to
his/her own IRA could normally wait until
decedent would have been 70 ½
– If funds left in plan, default could make the
entire account become an RMD in 5th year after
death
– Surviving spouse would no longer have ability to
roll over to his/her own IRA
After Death
• Net Unrealized Appreciation
– Special treatment available if decedent’s qualified
plan account held appreciated employer stock
– During decedent’s lifetime: could take distribution
of stock as part of lump sum distribution, be taxed
only on basis, defer income tax on gain until sold.
– Executor can make NUA election
– Beneficiary receives the same treatment, provided
he takes a lump sum distribution of the benefit.
– Note that NUA opportunity lost if benefit is
transferred to an IRA
After Death
• 4 Critical after-death deadlines:
– Qualified disclaimer deadline: 9 months after
date of death
– Beneficiary determination date: September 30
of year after death
– Trust documentation deadline: October 31 of
year after death
– Deadline for creating separate accounts and for
electing a lifetime distribution payout:
December 31 of year after death
Circular 230 Statement: These teaching materials:
do not constitute legal or tax advice; are not
intended to (and cannot) be used to avoid tax
penalties; are not written to promote or market or
recommend a transaction or arrangement.