Retirement Asset Planning
On April 16, 2002, the IRS issued new proposed regulations for lifetime and after death distributions from Individual Retirement Accounts (IRAs) and qualified retirement plans such as 401(k) plans and profit sharing plans. The final regulations were effective January 1, 2003, and must be used for all distributions from all types of retirement plans and IRAs for 2003 and later years. After death distributions must be determined under the final regulations regardless of when the original participant or account owner died. The final regulations use the term "employee" to describe both a qualified retirement plan participant and an Individual Retirement Account owner.
The final regulations specify the way lifetime and after death required minimum distributions from IRAs and qualified retirement plans are calculated. Lifetime required minimum distributions specify the minimum an employee must withdraw each year from his IRA or retirement plan while he is living. After death required minimum distributions specify the minimum amount the employee's beneficiaries must withdraw each year from the balance left in an IRA or retirement plan after the employee's death. The employee or the beneficiaries may always withdraw more than an annual required minimum distribution amount. However, if the employee or the beneficiaries withdraw less than an annual required minimum distribution amount, a penalty will be imposed of 50% of the amount of the required annual minimum distribution not withdrawn. The final regulations permit employees to significantly reduce required annual minimum distributions during their life. They also reduce the required annual minimum distributions for the employee's beneficiaries after the employee's death. The reductions in required minimum distributions will permit the employee or his beneficiaries to stretch out the periods of withdrawals and reduce income taxes paid each year on the withdrawals.
Under the previous regulations, the employee's choices as to designated beneficiary and calculation options for determining minimum distributions became irrevocable when the employee reached his required beginning date (April 1 following the calendar year the employee turn 70½). Also, under the old regulations, the wrong choice of a beneficiary or a failure to designate a beneficiary or choose a calculation option before the employee's required beginning date meant certain default options would be automatically applied. These default options required the employee to take accelerated distributions during his lifetime and resulted in the highest taxation of the employee's remaining retirement assets after the employee's death.
The final regulations make it much easier to stretch out the payments of an employee's IRA or qualified retirement plan to his children or grandchildren and reduce the income taxes they will pay. The following is a summary of the final regulations with respect to minimum distributions.
The fundamental principle of IRAs and qualified retirement plans is that they are designed to provide tax-deferred earnings and growth for retirement purposes. They are not the best assets to leave to heirs. The tax-deferral that provides these assets their retirement planning benefits causes them to be the most highly taxed asset upon death. An employee's heirs must pay both estate and income taxes on the IRAs and qualified retirement plan accounts left to them. Without good advice and planning, the total of these taxes may be as high as 70%!
Under the final regulations, the required beginning date (April 1 of the year following the year the employee becomes 70½) has lost much of its importance. It is no longer a point where the employee must make irrevocable decisions that will impact both his lifetime minimum distributions and the payout of his account balances after death. The employee must still begin taking minimum distributions by the required beginning date, but his choice of a designated beneficiary on that date no longer irrevocably determines his lifetime minimum distributions or fixes the period of payments of any account balances left at his death.
When an employee reaches his required beginning date, his lifetime minimum distributions are calculated from the uniform table set forth at the end of this section. This uniform table determines minimum distributions on a joint-life expectancy of the employee and a hypothetical beneficiary that is 10 years younger than the employee. Using this uniform table, an employee's required minimum distributions at age 70½ will be 1/27.4 or 3.649% of his account balance. The next year's minimum distribution (at age 71) would be 1/26.5 or 3.773% of the employee's account balance. The table automatically recalculates minimum distributions each year giving the employee the benefit of the fact that the longer he lives the longer his life expectancy becomes. Even a person 115 years old has a remaining life expectancy of 1.9 years and only has to withdraw 52.631% of his account balance.
The only time an employee does not use the uniform table is if his spouse is more than ten years younger than him. In that event, the employee's minimum distributions are based on the actual joint life expectancy of the employee and his spouse recalculated annually. This will provide even lower required minimum distributions than under the uniform table.
The final regulations permit an employee to change his designated beneficiary before or after his required beginning date without any impact upon his lifetime required minimum distributions. In addition, after death distributions are not determined by the designated beneficiary at the required beginning date. Instead, they will be determined by the designated beneficiaries the employee had at his death as finally determined by September 30th of the year after death. As an example, suppose an employee had his spouse as the first beneficiary and his children as equal share contingent beneficiaries of his IRA at the time of his death. If the employee's spouse had sufficient property of her own and decided she did not need the remainder of his IRA, she could disclaim or refuse the IRA and it would go to the children. In that case, the payout to the children would not be based on the wife's life expectancy as it would have been under the old rules, but on the children's individual life expectancies. This result occurs because the spouse's disclaimer made the children the only remaining designated beneficiaries on September 30th of the year after the employee's death.
This change in the date to determine designated beneficiaries provides a tremendous opportunity for post mortem planning. The final regulations permit the elimination of some date of death beneficiaries through disclaimers and by distribution of their benefit before the September 30 date. However, a new beneficiary cannot be added after the date of death. To take advantage of this opportunity, it is very important for the employee to make proper primary and contingent beneficiary selections for all his IRAs and retirement plans. If an employee has a spouse, children, and grandchildren, he may want to consider naming his spouse the first beneficiary, his children or separate share trusts for them as the second beneficiaries, and separate share trusts for his grandchildren as the third beneficiaries. Such beneficiary designations would preserve optimal flexibility for making adjustments after the employee's death.
Trust as Beneficiary
If a trust established by the employee or the employee's estate is the plan or account designated benficiary at death, the final regulations do not permit the executor or trustee to change the designated beneficiary by making distributions of plan or account benefits to individual beneficiaries of the estate or trust. Also, if a trust for several individuals is the designated beneficiary at the employee's death, a later division of the trust into separate trusts for each beneficiary does not permit each beneficiary to take distributions over his or her life expectancy. Life expectancy distributions must be made over the life expectancy of the oldest trust beneficiary.
Designating the employee's spouse as the beneficiary of a retirement account or plan still provides significant opportunities under the final regulations. When a spouse is the beneficiary, the spouse may rollover the account and treat it as his or her own after the employee's death. This rollover option permits the spouse to reassess the family situation during his or her remaining life and make adjustments in primary and contingent beneficiaries to receive any remaining balances after her death. After a spousal rollover, the spouse may use the uniform table to determine her lifetime payments and plan to extend income tax deferral after her death by designating the children or grandchildren or a trust for them as her beneficiaries.
The rules for making a trust the designated beneficiary of retirement accounts or plans only changed slightly under the final regulations. An employee is no longer required to give his IRA custodian or qualified plan administrator a copy of his trust by his required beginning date. A copy of the trust does not have to be provided until October 31 of the year following the year of the employee's death. When a trust is the designated beneficiary, the trust beneficiary with the shortest life expectancy will be used to determine the beneficiaries' minimum distributions. If an employee wishes to create separate accounts for trusts, a proper method is to name each individual trust as a separate beneficiary to receive a specified percentage or fraction of the employee's retirement plan or account benefit at his death. As long as those separate trusts are created and funded by December 31 of the year following the year of the employee's death, the individual beneficiaries of the trusts will be able to elect life expectancy distributions based on their individual ages.
Charity as Beneficiary
If a charity or corporation is a beneficiary of a retirement account or plan either directly or through a trust, it will still be considered to have a zero life expectancy. However, if the employee died after his required beginning date, the beneficiaries of the estate or the charity may take their distributions over the employee's remaining life expectancy as of the date of his death. If any employee dies before his required beginning date, the charity or estate beneficiaries may take distributions over a five-year period beginning with the year of the employee's death.
However, a charity or corporation may be eliminated as a counted beneficiary, if the share of the charity or corporation is distributed prior to September 30 of the year following the employee's death. If only individual beneficiaries remain after elimination of the charity or corporation, the life expectancies of the individuals will be used to determine their required minimum distributions. To avoid the possibility that a share for a charity may not be paid out by September 30 of the year following the employee's death, the employee may want to designate the charity as the beneficiary of a separate account or separate trust. As long as the separate account or trust for the charity is created and funded by December 31 of the year following the employee's death, the share of the charity will have no impact on availability of life expectancy distributions for individual beneficiaries.
In 2006 the Pension Protection Act was established. The Act contained a provision that provided an incentive for taxpayers to make charitable donations of their IRA assets. The IRA Charitable Rollover provision allowed a taxpayers, age 70 ½ or older, to donate up to $100,000 from their IRAs to public charities without the inclusion of the withdrawal as taxable income to the taxpayer. In the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 the IRA Charitable Rollover provision was reinstated for the tax years 2010 and 2011 and is currently being proposed as a permanent change to the IRA tax laws.
Roth IRAs
Roth IRAs continue to have lifetime and estate planning benefits not available in traditional IRAs and qualified retirement plans. Contributions to a Roth IRA are not tax deductible, but all earnings and growth of a Roth IRA are income tax free. Also, there is no age limit for making contributions to a Roth IRA. An employee can continue making contributions to a Roth IRA as long as he has earned income.
There is no requirement to take minimum distributions from a Roth IRA when an employee reaches the age of 70½. In fact, there is no requirement for minimum distributions from a Roth IRA during an employee's lifetime or during the lifetime of his surviving spouse. The final regulations do apply to Roth IRAs to determine designated beneficiaries and the required minimum distributions beneficiaries must take after the employee's death.
Unlike traditional IRAs, Roth IRAs are not subject to both estate tax and income tax after the employee's death. A Roth IRA remains free from income tax even after the employee dies, however, if the deceased employee has a large enough estate to warrant estate tax, the Roth IRA will be included in the property subject to estate tax.
If a traditional IRA is a substantial part of your estate, the opportunity to convert to a Roth IRA offers some unique estate planning benefits. Conversion to a Roth IRA requires payment of income tax on the deferred earnings and growth of the IRA being converted, but once the conversion is completed the IRA is free of income tax forever. If after retirement you expect to be in an income tax bracket equal to or close to your present bracket, conversion to a Roth IRA could save you significant after retirement income taxes. You may also convert to a Roth IRA to elect out of minimum distribution requirements. For example, if you are already past 70½ and required to take minimum distributions that you neither need nor want, you can end the distributions by converting the IRA to a Roth. You could also reduce the size of your estate and convert your IRAs to tax free assets by making the conversion and paying any tax due from other assets.
Effective in 2010, a change to the Roth IRA conversion eligibility requirements now provides a unique opportunity to convert a traditional IRA to a Roth IRA. Previous to 2010 there existed an income limit on who could convert their traditional IRA to a Roth IRA. Taxpayers earning more than $100,000, whether single or married, were not allowed to make the conversion. However, beginning in 2010, any taxpayer may convert to a Roth IRA, regardless of their income. Further, the tax consequences of such conversion may be stretched over a two-year period. For example, the income tax due for a Roth IRA conversion occurring in 2010 could be paid partially in 2011 and partially in 2012.
Conclusion
Estate planning for retirement accounts is far too complex to make specific recommendations. Making the right beneficiary choices, converting existing IRAs to Roth IRAs, and integrating retirement assets into your estate planning can save thousands of dollars in taxes. If your employment give you the opportunity to participate in a retirement plan or you own IRAs, make sure you fully inform your estate planning attorneys of these assets. Also, make sure that you consult with an estate planning attorney who understands retirement account estate planning. This consultation is critical to insure you make the right choices to avoid excessive taxation after your death.
Table for Determining Required Minimum Distributions
|
Age |
Divisor |
|
Age |
Divisor |
|
70 |
27.4 |
|
93 |
9.6 |
|
71 |
26.5 |
|
94 |
9.1 |
|
72 |
25.6 |
|
95 |
8.6 |
|
73 |
24.7 |
|
96 |
8.1 |
|
74 |
23.8 |
|
97 |
7.6 |
|
75 |
22.9 |
|
98 |
7.1 |
|
76 |
22.0 |
|
99 |
6.7 |
|
77 |
21.2 |
|
100 |
6.3 |
|
78 |
20.3 |
|
101 |
5.9 |
|
79 |
19.5 |
|
102 |
5.5 |
|
80 |
18.7 |
|
103 |
5.2 |
|
81 |
17.9 |
|
104 |
4.9 |
|
82 |
17.1 |
|
105 |
4.5 |
|
83 |
16.3 |
|
106 |
4.2 |
|
84 |
15.5 |
|
107 |
3.9 |
|
85 |
14.8 |
|
108 |
3.7 |
|
86 |
14.1 |
|
109 |
3.4 |
|
87 |
13.4 |
|
110 |
3.1 |
|
88 |
12.7 |
|
111 |
2.9 |
|
89 |
12.0 |
|
112 |
2.6 |
|
90 |
11.4 |
|
113 |
2.4 |
|
91 |
10.8 |
|
114 |
2.1 |
|
92 |
10.2 |
|
115 and older |
1.9 |
