ABA RPTE professors corner Retirement Accounts: Planning for a Lifetime ... and More! PROF. JONATHAN FORMAN University of Oklahoma College of Law PROF. CHRISTOPHER HOYT University of Missouri (Kansas City) School of Law MODERATOR: PROF. AMY MORRIS HESS University of Tennessee College of Law

Planning FOR Retirement

Longevity Risk Risk of outliving your retirement savings Life expectancy varies with such demographic factors as gender, income, educational level & race − 65-year-old American man: 50% chance of living to 82; 20% chance of living to 89 − 65-year-old American woman: 50% chance of living to 85; 20% chance of living to 92 − 65-year-old American couple: 50% chance that at least one will live to age 88; 30% chance that at least one will live to 92 Retirements can last for 30 years or more

Demographics of Life Expectancy Life expectancy varies with such demographic factors as gender, income, educational level & race − Women live longer than men − Rich live longer than poor

Retirement Income in the U.S. 48.6 million retirees in 2014 − 66.4 million in 2025 − 82.1 million in 2040 Sources of Retirement Income − Social Security − Pensions − Individual Retirement Accounts (IRAs) − Annuities − Individual savings & a savings withdrawal plan

Social Security Social Security − Inflation-adjusted pension benefits − 40.2 million retirees − $1,344 per month, average benefit Supplemental Security Income for the poor − 2.1 million elderly beneficiaries − $435 per month, average benefit

THREE STAGES OF A RETIREMENT ACCOUNT Accumulate Wealth Retirement Withdrawals Distributions After Death

THREE STAGES OF A RETIREMENT ACCOUNT Accumulate Wealth Retirement Withdrawals Distributions After Death

Pensions, IRAs & Annuities $27.3 Trillion Retirement Savings − $11.3 trillion in defined benefit plans − $6.3 trillion in defined contribution plans − $7.4 trillion in IRAs − $2.3 trillion in annuities

A Voluntary Retirement Savings System At any point in time, only about half of American workers have a pension − 66% of private-sector workers have access − 49% participated − Greater coverage among older workers, whites, highly educated workers, full-time workers, higher-income workers & workers at larger firms Participation in IRAs is even lower Individuals rarely buy annuities

Pensions: Favorable Tax Treatment Employer contributions to a pension are not taxable to the employee The pension fund’s earnings on those contributions are tax-exempt Employees pay tax only when they receive distributions of their pension benefits in retirement

Defined Benefit (DB) Plans In a defined benefit plan, an employer promises employees a specific benefit at retirement − e.g., a worker who retires after 30 years of service with final pay of $50,000 could receive a pension of $30,000 = 2% × 30 years × $50,000 final pay

Defined Benefit Plans Traditional DB plans pay out as lifetime annuities − Qualified joint-and-survivor annuity (QJSA) for married couples − Lump sums are often available

Defined Contribution (DC) Plans In a DC plan, the employer & employee can contribute to an individual investment account for the worker − e.g., a worker who earned $50,000 in a given year might have $5,000 contributed to an individual investment account for her ($5,000 = 10 percent × $50,000). − Her benefit at retirement would be based on all such contributions plus investment earnings.

Defined Contribution Plans Major shift from DB plans to DC plans 401(k) plans are the most popular − Allow individuals to tax-shelter up to $18,000/year in 2017 Workers over the age of 50 can contribute another $6,000 DC plans usually make distributions as lump sums or periodic distributions, but lifetime annuities are possible

Individual Retirement Accounts (IRAs) In 2017, individuals can contribute and deduct up to $5,500 to an IRA (plus $1,000 if over age 50) − Spouses can do the same Like private pensions, IRA earnings are tax-exempt, & distributions are taxable

Roths Since 1998, individuals have been permitted to set up Roth IRAs. − Unlike regular IRAs, contributions to Roth IRAs are not deductible. Instead, withdrawals are tax-free. Like regular IRAs, however, Roth IRA earnings are tax-exempt. Roth 401(k)s and Roth 403(b)s have similar tax features: − No exclusion for contributions, but account earnings & withdrawals are tax-free

Annuities Also, annuities get somewhat favorable tax treatment (IRC § 72) − No tax until distributions begin, and then only a portion of each annuity payment is taxable The original investment is recovered tax-free Today, a $100,000 would buy a 65-year-old man a lifetime annuity that paid $6,540 a year (6.54%)

Retirement Withdrawals THREE STAGES Accumulate Wealth Retirement Withdrawals Distributions After Death

TAXATION OF DISTRIBUTIONS General Rule – Ordinary income – 100% exempt from 3.8% NIIT Special Rules: -- Tax-free return of capital -- NUA for appreciated employer stock -- Roth distributions are tax-free

Objective of Tax Laws: Provide Retirement Income Consequently, there are laws to: Discourage distributions before age 59½ Force distributions after age 70½

USUAL OBJECTIVE: Defer paying income taxes in order to get greater cash flow Principal 10% Yield Pre-Tax Amount $ 100,000 $ 10,000 Income Tax on Distribution (40%) 40,000 Amount Left to Invest $ 60,000 $ 6,000

REQUIRED MINIMUM DISTRIBUTION (“RMD”) BACKGROUND: 50% penalty if not receive distribution from IRA, 401(k), etc: #1 – lifetime distributions from own IRA: beginning after age 70½ #2 – an inherited IRA, 401(k), etc –  beginning year after death

REQUIRED MINIMUM DISTRIBUTIONS *LIFETIME DISTRIBUTIONS* Age of Account Owner Required Payout 70 1/2 3.65% 75 4.37% 80 5.35% 85 6.76% 90 8.75% 95 11.63% 100 15.88%

ADVANTAGES OF ROTH IRAs Unlike a regular IRA, no mandatory lifetime distributions from a Roth IRA after age 70½ Yes, there are mandatory distributions after death

Distributions After Death THREE STAGES Accumulate Wealth Retirement Withdrawals Distributions After Death

Distributions After Death Income taxation Mandatory ERISA distributions Estate taxation Asset Protection (Clark v. Ramaker) Collision of four legal worlds at death

Distributions After Death >Income taxation Mandatory ERISA distributions

INCOME IN RESPECT OF A DECEDENT - “IRD” – Sec. 691 No stepped up basis for retirement assets After death, payments are income in respect of a decedent (“IRD”) to the beneficiaries Common mistake in the past: children liquidate inherited retirement accounts.

Distributions After Death >Income taxation > Mandatory ERISA distributions

Distributions After Death After death, must start liquidating the account Federal tax law provides that the maximum time period to liquidate an inherited account is either: Five years -- or -- Remaining life expectancy of the beneficiary

Distributions After Death Company policy may require faster liquidation Employer might require account of deceased employee to liquidated in just one year No such problem with IRAs Beneficiary of employer plan account can compel transfer to an inherited IRA

Distributions After Death Tax planning for inherited accounts: * DEFER distributions as long as possible – greater tax savings * Make payments over the beneficiary’s life expectancy - “Stretch IRA”

Distributions After Death “ life expectancy“ Oversimplified: Half of population will die before that age, and half will die after

REQUIRED MINIMUM DISTRIBUTIONS *LIFE EXPECTANCY TABLE* Age of Beneficiary Life Expectancy 30 83 53.3 more years 40 83 43.6 50 84 34.2 60 85 25.2 70 87 17.0 80 90 10.2 90 96 5.5

REQUIRED MIN. DISTRIBUTIONS *LIFE EXPECTANCY TABLE* “STRETCH IRAS” Age of Beneficiary Life Expectancy 30 53.3 more years 40 43.6 50 34.2 60 25.2 70 17.0 80 10.2 90 5.5

REQUIRED MIN. DISTRIBUTIONS *LIFE EXPECTANCY TABLE* “STRETCH IRAS” Age of Beneficiary Life Expectancy 30 1.9% 53.3 more years 40 2.3% 43.6 50 2.9% 34.2 60 4.0% 25.2 70 5.9% 17.0 80 10.0% 10.2 90 18.2% 5.5

REQUIRED MINIMUM DISTRIBUTIONS * DEFINITIONS * Required Beginning Date (“RBD”) April 1 in year after attain age 70½ Designated Beneficiary (“DB”) A human being. An estate or charity can be a beneficiary of an account, but not a DB. Determination Date September 30 in year after death.

HOW TO ELIMINATE BENEFICIARIES BEFORE DETERMINATION DATE Disclaimers Full distribution of share Divide into separate accounts

REQUIRED DISTRIBUTIONS IF NO DESIGNATED BENEFICIARY Death Before RBD Death After RBD Remaining life FIVE expectancy of YEARS someone who is decedent’s age at death

REQUIRED DISTRIBUTIONS IF ALL BENEFICIARIES ARE DESIGNATED BENEFICIARIES Death Before RBD Death After RBD Maximum term is the life expectancy of the oldest beneficiary of the account. Exception if DB is older than decedent If establish separate account for each beneficiary, then each beneficiary can use own life expectancy.

MARRIED COUPLES: RETIREMENT ASSETS Surviving spouse has an option that no other beneficiary has: a rollover of deceased spouse’s retirement assets to her or his own new IRA (creditor protection, too!) Other beneficiaries only option: an inherited IRA

REQUIRED DISTRIBUTIONS IF SOLE BENEFICIARY IS SURVIVING SPOUSE Spouse can recalculate life expectancy IRAs only: Spouse can elect to treat IRA as her own Decedent die before 70½? Can wait for distribution

MEDIAN AGE AT DEATH ON FEDERAL ESTATE TAX RETURNS: Age 80 – Men Age 84 - Women

MARRIED COUPLES: RETIREMENT ASSETS Should the estate plan provide: -- a rollover of deceased spouse’s retirement assets to a new IRA? -- or -- -- the deceased spouse’s retirement assets are payable to a trust for the surviving spouse?

Exception: “Look-through” trust if four conditions FUNDING TRUSTS General Rule: Trust is not DB Exception: “Look-through” trust if four conditions Types: -- “accumulation trusts” -- “conduit trusts”

USUAL OBJECTIVE: Defer paying income taxes in order to get greater cash flow Principal 10% Yield Pre-Tax Amount $ 100,000 $ 10,000 Income Tax on Distribution (40%) 40,000 Amount Left to Invest $ 60,000 $ 6,000

REQUIRED MINIMUM DISTRIBUTIONS *LIFE EXPECTANCY TABLE* Age of Beneficiary Life Expectancy 30 53.3 more years 40 43.6 50 34.2 60 25.2 70 17.0 80 10.2 more years 90 5.5 more years

MANDATORY DISTRIBUTIONS [Assume inherit IRA at age 80 and die at 92] ROLL - Accumulation Conduit AGE OVER Trust Trust . 80 5.35% 9.80% 9.80% 85 6.76% 19.23% 13.16% 90 8.78% 100.00% 18.18% 91 9.26% empty 19.23% 92 9.81% empty 20.41%

MANDATORY DISTRIBUTIONS [Assume inherit IRA at age 80 and die at 92] ROLL - Accumulation Conduit AGE OVER Trust Trust . 80 5.35% 9.80% 9.80% 85 6.76% 19.23% 13.16% 90 8.78% 100.00% 18.18% 91 9.26% empty 19.23% 92 9.81% empty 20.41%

MANDATORY DISTRIBUTIONS [Assume inherit IRA at age 80 and die at 92] ROLL - Accumulation Conduit AGE OVER Trust Trust . 80 5.35% 9.80% 9.80% 85 6.76% 19.23% 13.16% 90 8.78% 100.00% 18.18% 91 9.26% empty 19.23% 92 9.81% empty 20.41%

MANDATORY DISTRIBUTIONS [Assume inherit IRA at age 80 and die at 92] ROLL - Accumulation Conduit AGE OVER Trust Trust . 80 5.35% 9.80% 9.80% 85 6.76% 19.23% 13.16% 90 8.78% 100.00% 18.18% 91 9.26% empty 19.23% 92 9.81% empty 20.41%

IRS PLRs: Surviving Spouse Rollover 10 IRS Private Letter Rulings - 2015 &2014 Surviving spouse can rollover deceased spouse’s IRA, even when the account is payable to: Trust for the spouse The estate, with estate pour-over into a trust for the spouse The estate, where the spouse is the sole or residuary beneficiary of the estate

SENATE PROPOSAL: LIQUIDATE ALL INHERITED IRAs IN FIVE YEARS 2012 – Highway Bill – not enacted President Obama budget proposal June, 2014 – Sen. Wyden adds to Highway Bill Sept, 2016 – Senate finance committee action EXCEPTIONS -- Spouse -- minor child -- disabled -- Person not more than ten years younger .

Age of Beneficiary Life Expectancy 40 2.3% 43.6 50 2.9% 34.2 REQUIRED MINIMUM DISTRIBUTIONS Example: Death at age 80? CURRENT LAW: *Life Expectancy Table* Age of Beneficiary Life Expectancy 30 1.9% 53.3 more years 40 2.3% 43.6 50 2.9% 34.2 60 4.0% 25.2 70 5.9% 17.0 80 10.0% 10.2 90 10.0% 5.5 * [10.2 yrs]

Age of Beneficiary Life Expectancy 40 5 50 5 60 5 70 5.9% 17.0 REQUIRED MINIMUM DISTRIBUTIONS Example: Death at age 80? PROPOSED: FIVE YEARS if >10 yrs younger Age of Beneficiary Life Expectancy 30 5 years 40 5 50 5 60 5 70 5.9% 17.0 80 10.0% 10.2 90 10.0% 5.5 * [10.2 yrs]

SENATE PROPOSAL: LIQUIDATE ALL INHERITED IRAs IN FIVE YEARS EXCEPTIONS -- Spouse -- minor child -- disabled -- Person not more than ten years younger TAX TRAP: Does naming a trust for a spouse (e.g., QTIP trust; credit shelter trust) as an IRA beneficiary mean required liquidation in 5 years?

SENATE PROPOSAL: LIQUIDATE ALL INHERITED IRAs IN FIVE YEARS IMPLICATIONS FOR CHARITIES Donors more likely to consider Outright bequests Retirement assets to tax-exempt CRT Child: income more than 5 years; then charity Spouse only (marital estate tax deduction) Spouse & children (no marital deduction)

ABA RPTE professors corner Retirement Accounts: Planning for a Lifetime ... and More! PROF. JONATHAN FORMAN University of Oklahoma College of Law PROF. CHRISTOPHER HOYT University of Missouri (Kansas City) School of Law MODERATOR: PROF. AMY MORRIS HESS University of Tennessee College of Law