IRA’s, Other Pensions and Non-Probate
Assets: Beneficiary Designations
Presented by:
Dani Smith
Strasburger & Price, LLP
2801 Network Blvd., Ste. 600
Frisco, Texas 75034
(469) 287-3918
dani.smith@strasburger.com
Minimum Distribution Rules
Understanding the basic minimum distribution rules for
qualified plans is necessary to understand the
consequences of certain beneficiary designations.
Permissible Distributions:
• Distributions from a qualified plan may begin at age
59 ½ without penalty.
• There is no restriction on how much can be
withdrawn after attaining age 59 ½.
• Distributions taken before attaining age 59 ½ are
subject to a 10% excise tax (subject to exceptions
set forth in IRC § 72(t)).
Minimum Distribution Rules
Required Distributions:
• The plan participant must begin taking
distributions by April 1 of the calendar year
following the year in which the plan participant
reaches age 70 ½ (referred to as the Required
Beginning Date “RBD”). Treas. Reg. §1.408-8.
• There are no required distributions from ROTH
IRA’s during the plan participant’s lifetime.
Minimum Distribution Rules
• The penalty for failure to distribute the
minimum required amount is 50% of the short
fall. IRC § 4974.
• There is no required distribution for active nonowner (less than 5%) employees who are still
working.
– not true for IRA’s.
• Distributions are taxed to the recipient in the
year of receipt.
Minimum Distribution Rules
Amount of Distribution:
• The annual minimum distribution is determined by
using Uniform Life Expectancy Table based on
participant’s age and a presumed beneficiary 10
years younger in age. Treas. Reg. §1.401(a)(9)-5.
• The actual age of the presumed beneficiary or
whether beneficiary is individual Trust or charity is
irrelevant.
• Exception: If the beneficiary is the participant’s
spouse and the spouse is more than 10 years
younger than the participant, the calculation table
may incorporate the actual age of the spouse. Treas.
Reg. §.401(a)(9)-4.
Minimum Distributions
After Death of Participant
• The commencement of the required minimum
distributions depends upon:
– Whether the plan participant died before or after his or
her RBD;
– Whether the beneficiary is a spouse;
– Whether there is “Designated Beneficairy” which must
be a Natural Person or a Qualifying Trust. Entities such
as estates, charities, corporations and partnerships do
not qualify as Designated Beneficiaries
• The determination of Successor Beneficiaries is made as
of Sept. 30 of calendar year following deat.
Presence of Nonqualified
“Designated Beneficiary”
Plan Participant Dies Before Reaching His or Her RBD:
• Five Year Rule: All funds must be withdrawn by
December 31 of the fifth calendar year following the
calendar year of Account Owner’s death.
Plan Participant Dies After Reaching His or Her RBD:
• Successor Beneficiaries must take required
minimum distributions using participant’s Life
Expectancy (Using Single Life Table NOT Uniform
Lifetime Table) for participant’s attained age in the
calendar year following the calendar year of death
and each subsequent year’s applicable divisor is
equal to prior years minus one.
Presence of Nonqualified
“Designated Beneficiary”
• General Rule: Never name the estate as the
beneficiary.
• Strategies: Cash out Non-qualified successor
designated beneficiaries.
• Charitable Beneficiaries: Plan proceeds paid to
a charity will not be subject to income tax.
Participants who intend to benefit one or more
charities should consider naming a charity as a
beneficiary to receive a separate share of the
plan.
Naming the Spouse as
Beneficiary
•
A full marital deduction is available for estate tax
purposes.
•
Surviving Spouse’s Options:
–
–
–
Tax-free rollover tax free into a spousal IRA.
Elect the Five-year payout.
Elect a payout based on the life expectancy of the surviving
spouse, but payout must begin on or before the later of:
•
December 31 of the year following the year of participants death.
•
December 31 of the year participant would have attained age
70½ (i.e., the surviving spouse gets to wait until the participant
would have reached his or her RBD).
Naming the Spouse As
Beneficiary
Spousal Rollover
• Usually the optimal choice
• Detriment of rollover:
– Surviving Spouse cannot take distributions until age 59
½without incurring penalty.
• Planning Option: Elect to delay roll-over until
Surviving Spouse attains age 59 1/2. There is a risk
is that, if the Surviving Spouse dies before electing a
roll-over, then successor beneficiaries who succeed
to Surviving Spouse’s interest must continue taking
Minimum Distributions using the Surviving Spouse’s
life expectancy, calculated under the Fixed Method.
Alternatives For Benefit of
Surviving Spouse
Basic Rules for Designating Trusts as Beneficiary:
• The trust must be valid under state law
• The trust must be irrevocable or become
irrevocable upon death of participant
• The trust beneficiaries must be identifiable
• A copy of trust document must be provided to
the plan administrator or the IRA custodian by
Oct. 31 of calendar year following calendar year
of participant’s death.
Alternatives For Benefit of
Surviving Spouse
• Designation of QTIP Trust as Beneficiary:
– Naming a QTIP Trust as beneficiary will qualify for full
marital deduction from estate taxes if QTIP election is
made.
– Naming a QTIP Trust as beneficiary helps protect
ultimate disposition of assets in accordance with
participant’s desires.
– Consideration must be given to community property
interest of spouse, if applicable. May need to
designate 50% to spouse and 50% to QTIP Trust.
– A partial QTIP election can be made if necessary to
maximize use of available estate exemption amount of
participant.
Naming QTIP Trust as
Beneficiary
•
Naming a QTIP Trust as a beneficiary of a qualified
plan involves complex estate planning. See IRC
§2056.
•
A QTIP is usually designated as the beneficiary of a
qualified plan only when outright gift is not feasible.
•
Careful drafting is required to ensure designation of
QTIP Trust qualifies for marital deduction. Pursuant
to Rev. Rul. 2000-2, the spouse must be able to
compel distribution of income from the IRA through
the QTIP Trust.
Sample QTIP Language For
Qualified Plan Benefits
“Special Provisions Regarding IRA and Qualified Plan
Benefits. If the QTIP TRUST shall be the beneficiary of
any benefits from a qualified plan as defined in Internal
Revenue Code §401(a) or an individual retirement account
(“IRA”) as defined in Internal Revenue Code §408(a), then
Settlors direct the trustee to treat distributions from any
qualified retirement plan or IRA as income of the QTIP
TRUST to the extent of the greater of income generated or
deemed to be generated by such plan or individual
retirement account or the amount determined to be
income under the Texas Trust Code. For purposes of
determining income, fiduciary accounting principles shall
be applied.
Sample QTIP Language For
Qualified Plan Benefits(Cont’d)
In determining the amount of income of the QTIP TRUST to be
distributed to the surviving Settlor with respect to the qualified
plan or IRA benefit, the trustee shall determine such income so
that in all events the surviving Settlor shall have a qualifying
income interest for life as provided in Internal Revenue Code
§2056(b)(7). The trustee shall not charge to income any
expense properly chargeable to the principal portion of any
distribution. In addition, the trustee shall have the right in its
discretion to:
(a) Require the qualified plan trustee or IRA custodian to
convert non-income-producing assets or low incomeproducing assets into income-producing assets or assets
producing adequate income.
(b) Withdraw any part or all of the remaining qualified plan
benefit or IRA, including, but not limited to assets sufficient to
meet the required minimum distribution rules.”
Naming QTIP Trust as
Beneficiary
• Detriments of designating a QTIP Trust as the
plan beneficiary:
– Minimum distributions are calculated on the
spouse’s lifetime only;
– Spouse cannot defer distributions until reaching
age 70 ½ as with a spousal rollover;
– Spouse cannot name younger individuals as
designated beneficiaries (no stretch-out).
Alternatives For Benefit of
Surviving Spouse
• Designation of a Bypass Trust as Beneficiary
– Naming Bypass Trust as beneficiary helps protect ultimate disposition
of assets in accordance with participant’s desires.
– Naming Bypass Trust as beneficiary maximizes use of available estate
exemption amount of participant.
• Designation of a Bypass Trust as the Contingent
Beneficiary because of uncertainty of available exemption
amount for estate tax purposes. Sample Designation:
“Spouse, if he/she is then surviving;
If Spouse is then surviving, but shall disclaim any portion of my
account, then the disclaimed portion of the account is to be
distributed to the Trustee of the Bypass Trust created under
the _____ Family Trust dated January 1, 2011, as may be
amended from time.”
Naming Bypass Trust as
Contingent Beneficiary
Detriments:
• Distributions to a Bypass Trust will be subject to
income tax thus reducing the ultimate funding of the
trust.
• Distributions from Bypass Trust are considered
distributions of principal and not deductible by Trust.
To avoid harsh results, language can be added to
Bypass Trust to address deductibility of distributions.
• Five year pay-out rule applies if Bypass Trust does
not have a beneficiary that can be treated as the
Designated Beneficiary. The existence of a power of
appointment can create concern as to whether the
trust can ever qualify as a Designated Beneficiary.
Naming Bypass Trust as
Contingent Beneficiary
Detriments (Cont’d):
• If the surviving spouse is the oldest beneficiary,
the pay-out is based on the surviving spouse’s
life expectancy.
• The surviving spouse cannot defer pay-out until
reaching age 70½.
• The distributions will be taxed at trust rates if
not distributed to beneficiaries.
• If distributions are based on surviving spouse’s
life, the distribution schedule will not change at
the death of the surviving spouse.
Sample Bypass Trust Language
For Qualified Plan Benefits
“Distributions to the Surviving Spouse. If this ____ Trust
shall be the beneficiary of any benefits from a qualified
plan as defined in Internal Revenue Code §401(a) or an
individual retirement account (“IRA”) as defined in
Internal Revenue Code §408(a), then the independent
trustee shall treat distributions from any qualified
retirement plan or IRA as income of such trust to the
extent of the greater of income generated or deemed to
be generated by such plan or individual retirement
account or the amount determined to be income under the
Texas Trust Code. For purposes of determining income,
fiduciary accounting principles shall be applied. The
trustee shall not charge to income any expense properly
chargeable to the principal portion of any distribution. In
addition, the trustee shall have the right in its discretion
to:
Sample Bypass Trust Language For
Qualified Plan Benefits (cont’d)
In addition, the trustee shall have the right in its
discretion to:
– Require the qualified plan trustee or IRA custodian to
convert non-income-producing assets or low incomeproducing assets into income-producing assets or
assets producing adequate income.
– Withdraw any part or all of the remaining qualified
plan benefit or IRA, including, but not limited to assets
sufficient to meet the required minimum distribution
rules.
To the extent necessary to cause the surviving Spouse to
be deemed and maintain the status as the sole designated
beneficiary” for the “required minimum distribution rules,”
the independent trustee shall distribute to the surviving
Spouse an amount of income necessary to meet such
rules.”
Non-Spouse Qualified
Designated Beneficiaries
Plan Participant Dies Before Reaching His or Her
RBD:
• If there is only a single Designated Beneficiary,
the required distribution period is based upon
the Designated Beneficiary’s life expectancy.
• If there are multiple Designated Beneficiaries,
then the General Rule is that the required
distribution period is based on the life
expectancy of the oldest Designated
Beneficiary.
Non-Spouse Qualified
Designated Beneficiaries
Plan Participant Dies After Reaching His or Her RBD:
• OLD GENERAL RULE. Must distribute balance as least a
rapidly as method in effect at participant’s death. IRC
§401(a)(9)(B)(i). Exception created in year 2002.
• If plan has a single Designated Beneficiary, the required
distribution period is the longer of:
– The remaining life expectancy of the Designated Beneficiary; or
– The remaining life expectancy of the participant.
.
• If the plan has multiple Designated Beneficiaries, the
General Rule is that the payout of benefits is based on
the remaining life expectancy of oldest Designated
Beneficiary if longer than the life expectancy of the
participant.
Non-Spouse Qualified
Designated Beneficiaries
Creating Separate Payout Periods for each
beneficiary:
• Although difficult, you may allow each Designated
Beneficiary to utilize their own life expectancy as the
payout period by dividing plan assets into separate
shares before death of participant.
• Provide for separate shares for each intended
beneficiary upon death of participant. Example
separate share language for outright bequests:
“If Spouse is not then surviving, in separate shares for the
following individuals in the percentages shown:
50% to Daughter
50% to Son.”
Non-Spouse Qualified
Designated Beneficiaries
• Con’t: Example Separate Share language where
trusts are to be utilized:
“If Spouse is not then surviving, to the Trustee
of each separate trust for issue established under
the Smith Family Trust dated January 1, 2011, as
may be amended from time; each trust to receive
the share allocated to issue per stirpes.”
• May utilize post death disclaimers of eldest
Designated Beneficiaries.
Sample Conduit Trust Language
For Qualified Plan Benefits
“Special Provisions Regarding IRA and Qualified Plan
Benefits. To the extent not otherwise provided herein, if
any trust shall be the beneficiary of any benefits from a
qualified plan as defined in Internal Revenue Code
§401(a) or an individual retirement account (“IRA”) as
defined in Internal Revenue Code §408(a), then Settlors
direct the trustee to treat distributions from any qualified
retirement plan or IRA as income of such trust to the
extent of the greater of income generated or deemed to
be generated by such plan or individual retirement
account or the amount determined to be income under the
Texas Trust Code. For purposes of determining income,
fiduciary accounting principles shall be applied. The
trustee shall not charge to income any expense properly
chargeable to the principal portion of any distribution. In
addition, the trustee shall have the right in its discretion
to:
Sample Conduit Trust Language
For Qualified Plan Benefits (cont’d)
(a) Require the qualified plan trustee or IRA custodian to
convert non-income-producing assets or low incomeproducing assets into income-producing assets or assets
producing adequate income.
(b) Withdraw any part or all of the remaining qualified plan
benefit or IRA, including, but not limited to assets
sufficient to meet the required minimum distribution rules.
To the extent necessary to cause the current beneficiary
of a trust to be deemed and maintain the status as the
sole “designated beneficiary” for the “required minimum
distribution rules,” the independent trustee shall distribute
to such current beneficiary an amount of income
necessary to meet such rules.”
Beneficiary Designations For
Other Non-Probate Assets
Life Insurance and Bank Accounts:
A.Spouse as Beneficiary:
1. Qualifies for full marital deduction.
2. Alternative: With proper estate planning in place
which includes a trust that provides for creation
of a bypass trust, a QTIP trust and/or a surviving
spouse’s trust, then the “umbrella” trust can be
named as the beneficiary. This will allow the
trustee to allocate the proceeds to the proper
trust and will allow maximum use of the
available estate tax exemption for the
insured/account owner.
Beneficiary Designations For
Other Non-Probate Assets
A.Spouse as Beneficiary (Cont’d):
3. Alternative: A Bypass Trust can be named as the
contingent beneficiary if insurance proceeds are
needed to maximize use of estate tax
exemption. Example language for beneficiary
designation of insurance:
“Spouse, if he/she is then surviving;
If Spouse is then surviving, but shall disclaim any portion of
my account, then the disclaimed portion of the account is to
be distributed to the Trustee of Trust B (Bypass Trust) under
the Smith Family Trust dated January 1, 2011, as may be
amended from time.”
Beneficiary Designations For
Other Non-Probate Assets
B. Children as Beneficiaries:
1. Naming minor children as beneficiaries may result in
need for a guardianship.
2. Naming an adult beneficiary to receive on behalf of a
minor child, but failing to provide for custodianship
may result in the adult beneficiary having to make a
gift to minor child (or keeping insurance
proceeds/account assets for him or herself).
3. Naming a trust as a beneficiary for each child may
provide necessary or desired management and
creditor protection regardless of age of child.