Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
What is it?
Retirement plans help an individual defer tax, but not
avoid tax
Large qualified plan or IRA balances can mean
potentially large
– income tax payments
– estate taxes
Complex, technical rules govern distribution of assets
from qualified plans and IRAs
Copyright 2009, The National Underwriter Company
1
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
What is it? (cont)
Careful planning is necessary to
–
minimize tax payments
–
insure compliance with laws governing asset distribution
The courts have generally not given planners the
benefit of the doubt
Copyright 2009, The National Underwriter Company
2
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
When is it indicated?
– Substantial retirement assets at
retirement or at death
– Desire to stretch out distributions and
defer income taxation
– There is a surviving spouse
Copyright 2009, The National Underwriter Company
3
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Advantages
– Various advantages to either a rollover or
keeping assets where they are
– Planning can reduce estate tax
– Planning can stretch out distributions and
defer income taxation
Copyright 2009, The National Underwriter Company
4
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Disadvantages
– Various disadvantages to either a rollover
or keeping assets where they are
– Failure to name a beneficiary or to plan
can lead to increased taxation
Copyright 2009, The National Underwriter Company
5
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Tax Implications
– Subject to estate tax
– Marital deduction
– Distributions required at age 70½ (or
retirement, for qualified plans)
•
Roth IRAs (distributions not required until
death)
Copyright 2009, The National Underwriter Company
6
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Tax Implications (cont)
– Distributions generally fully subject to
income tax (except to extent of
nondeductible contributions)
•
Qualified distributions from Roth IRA not
subject to income tax
– Offsetting income tax deduction for estate
tax attributable to IRA or qualified plan
Copyright 2009, The National Underwriter Company
7
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Rollover vs. Keeping It
In the Plan
Advantages of a rollover
– if plan participant is a controlling owner, a rollover may allow
termination of the qualified plan; plan contributions and
administration can cease
– IRA may offer more investment flexibility
– QJSA requires spouse consent for initial rollover, but not for
subsequent changes in IRA beneficiary
Copyright 2009, The National Underwriter Company
8
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Rollover vs. Keeping It
In the Plan (cont)
Advantages of keeping it in a qualified plan
– plan loans may be available up to $50,000 limit
– plan can invest in life insurance
– some participants may be able to use 10 year averaging on lump
sum distributions
Copyright 2009, The National Underwriter Company
9
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Rollover vs. Keeping It
In the Plan (cont)
Advantages of keeping it in a qualified plan (cont)
– ERISA’s anti-alienation rule gives qualified plans better protection
against creditors
– PBGC insurance may offer plan protection to defined benefit
participants
– qualified plan offers greater security for nonparticipant spouse
Copyright 2009, The National Underwriter Company
10
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Converting to a Roth IRA
Consider basic aspects of Roth IRA
– conversion not permitted if modified AGI exceeds $100,000 (this
limit does not apply after 2009)
– no conversion if account holder married filing separately (this limit
does not apply after 2009)
– no limit on conversion amount; can be part or all of existing IRA
– amount converted is included in gross income of IRA account
holder for federal income tax purposes
– distributions of principal and income from Roth IRA income tax free
if certain conditions are met
– no minimum distribution rules apply to Roth IRAs except after death
Copyright 2009, The National Underwriter Company
11
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Economics of the
Conversion
• Roth IRA conversion is a wash IF
– taxes had to be paid out of the IRA
– only the net amount would be invested in the Roth
– income tax rates not expected to change
Copyright 2009, The National Underwriter Company
12
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Economics of the
Conversion (cont)
• Minimum distribution requirements makes traditional
IRAs less attractive to older clients. Distributions and
tax on Roth IRA growth can be deferred until after
death
• Roth earnings not subject to income tax; may be
beneficial IF owner can pay tax with other funds and
roll full IRA amount to Roth
Copyright 2009, The National Underwriter Company
13
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Why Consider Roth IRA
Conversion?
• basic economics of conversion can be attractive
• conversion reduces taxes at death
• conversion provides a better source for unified credit
applicable exclusion amount than a traditional IRA or
qualified plan; Roth IRA is not IRD
Copyright 2009, The National Underwriter Company
14
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Negatives of a Roth IRA
Conversion
• to get full benefit of conversion to a Roth IRA, client
must pay taxes from non-IRA funds in the year of
conversion
• future tax law changes cannot be predicted; these
changes may or may not favor investment in a Roth
IRA instead of a traditional IRA
Copyright 2009, The National Underwriter Company
15
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Nonparticipant Spouse’s
Rights
• rights on state level may vary
– community property states vs. common law states
• nonparticipant spouse rights at federal level given
under Retirement Equity Act of 1984 (REA)
Copyright 2009, The National Underwriter Company
16
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Nonparticipant Spouse’s
Rights (cont)
Major considerations under REA
• plans subject to “qualified joint and survivor annuity”
(QJSA) must have consent of nonparticipant spouse
– for any change in beneficiary that reduces spousal benefits
– for rollover to IRA
Copyright 2009, The National Underwriter Company
17
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Nonparticipant Spouse’s
Rights (cont)
Major considerations under REA (cont’d)
• Stock bonus, profit sharing plan, or ESOP need not
meet QJSA requirement if participant’s non-forfeitable
account balance payable as death benefit to spouse;
spousal consent:
– needed to change death benefit beneficiary
– NOT needed for lump sum distribution
Copyright 2009, The National Underwriter Company
18
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
An Issue at Retirement: Using a “Frozen Plan”
A frozen plan is one that has been amended to
terminate future employer contributions and new plan
entrants, but continues to exist for the benefit of existing
participants
– may not be feasible for business-owner retiree
– administrative costs for maintenance can be high
Copyright 2009, The National Underwriter Company
19
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Planning Retirement Distributions
Lump sum or periodic payments
– lump sum of entire amount with immediate taxation almost
never recommended
– periodic payments reduce tax burden
Copyright 2009, The National Underwriter Company
20
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Planning Retirement Distributions (cont)
Tax deferral as the basic goal
– potential tax deferral can extend over 3 lives
– vital to understand
• minimum distribution rules under IRC Sec. 401(a)(9)
• after-death distribution rules for death before and after required
beginning date (RBD) for minimum distributions
Copyright 2009, The National Underwriter Company
21
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
After-death Minimum Distributions:
Special Rules for 2009
Required minimum distribution for 2009 is waived.
Five year rule is extended to six years if one of the five
years is 2009.
Copyright 2009, The National Underwriter Company
22
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
After-death Minimum Distributions:
Beneficiary is Participant’s Spouse
Surviving Spouse Makes Spousal Rollover to IRA
– minimum distributions for surviving spouse can begin April 1
of year following the year the surviving spouse attains 70½
– surviving spouse’s minimum distribution option is as if
surviving spouse were the participant
– surviving spouse can name new beneficiary
Copyright 2009, The National Underwriter Company
23
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
After-death Minimum Distributions:
Beneficiary is Participant’s Spouse (cont)
No Rollover to IRA
– distributions must begin by December 31 of the year
following the participant's death
- if deceased participant had not reached age 70½,
distributions can be deferred to December 31 of the year the
deceased participant would have been 70½
Copyright 2009, The National Underwriter Company
24
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
After-death Minimum Distributions:
Beneficiary is Participant’s Spouse (cont)
No Rollover to IRA (cont)
– if surviving spouse lives until date participant was or would
have been 70½, minimum distributions determined over
surviving spouse life expectancy, recalculated annually
– at death of surviving spouse, distribution period reverts to
fixed period based on spouse life expectancy
– special rules apply if surviving spouse dies before participant
would have been 70½
• spouse treated as if he or she is participant,
• however, if spouse remarries and then dies, no spousal rollover
treatment for his or her surviving spouse
Copyright 2009, The National Underwriter Company
25
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
After-death Minimum Distributions:
Nonspouse Individual Beneficiary
• minimum distributions
– must begin by end of year following death
– are made over fixed period (based on life expectancy of
beneficiary in year after death), even if named beneficiary
dies and leaves proceeds to another
• if distributions do not begin at end of year following
death, distributions follow the 5-year rule
Copyright 2009, The National Underwriter Company
26
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
After-death Minimum Distributions:
No Individual Beneficiary
Death before RBD
Entire balance must be distributed by December 31 of fifth year
following participant’s death.
Death on or after RBD
Distribution period is participant’s life expectancy in year of death,
reduced by 1 for each subsequent year.
Copyright 2009, The National Underwriter Company
27
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Beneficiary Designation
Designated beneficiary
must be individual (not charity or estate), for minimum
distributions to be based on an individual life expectancy
For multiple designated beneficiaries: life expectancy of
oldest used to determine required distributions.
Separate accounts may result in ability to use own life
expectancies.
Copyright 2009, The National Underwriter Company
28
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Trust as a Designated Beneficiary
When certain requirements met, beneficiary’s life
expectancy can be used to determine minimum
distributions
If multiple beneficiaries, age of oldest used to determine
minimum distribution
Copyright 2009, The National Underwriter Company
29
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Trust as a Designated Beneficiary (cont)
Requirements for beneficiary of trust to be treated as
designated beneficiary under minimum distribution rules
– beneficiaries of trust must be identifiable from trust
instrument
– trust must be valid trust under state law
– trust must be irrevocable or become irrevocable upon death
– documentation of trust provisions provided to plan
administrator
Copyright 2009, The National Underwriter Company
30
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Estate Planning for Qualified Plan and IRA
Accumulations
Outright gift to spouse
– eliminates federal estate tax at participant’s death through
marital deduction
– some income tax deferral can be preserved during surviving
spouse’s life
Copyright 2009, The National Underwriter Company
31
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Estate Planning for Qualified Plan and IRA
Accumulations (cont)
Leaving as QTIP
– QTIP can be used if outright gift to spouse is unsuitable
– rules governing use of QTIP as beneficiary are complex
Copyright 2009, The National Underwriter Company
32
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Estate Planning for Qualified Plan and IRA
Accumulations (cont)
Bypass Trust
Qualified plan or IRA benefits should be paid to
bypass trust only if no other assets to fund trust
– must pay income taxes on qualified plan benefits
– reserve unified credit for appreciating assets
– with trust, spouse loses way to extend income tax deferral
on IRA benefits
Copyright 2009, The National Underwriter Company
33
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Summary
Goal: maximize income tax deferral
Can “stretch” the IRA if spouse
– named as beneficiary
– survives participant
– rolls over participant’s account into own IRA
– names younger child or other heir as beneficiary
Copyright 2009, The National Underwriter Company
34
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Summary (cont)
Difficulties with this means of further tax deferral
– spouse must survive participant
– payment of estate taxes may deplete potentially taxdeferrable qualified plan funds
Copyright 2009, The National Underwriter Company
35
Estate and Retirement
Chapter 9
Planning With Qualified Plans
Employee Benefit & Retirement Planning
and IRAs
Summary (cont)
Possible remedies:
– using “game theory,” determine probable date of death for
participant and spouse and design plan to maximize taxes
for the “most likely” event
– use part of plan balance during life of participant and spouse
to purchase life insurance to replace assets lost to federal
estate taxation
Copyright 2009, The National Underwriter Company
36