Retirement Accounts and Third Party SNTs Bradley J. Frigon, CELA, JD, LLM 6500 S. Quebec St. Suite 330 Englewood, CO 80111 720-200-4025 frigonlaw@qwest.net www.bjflaw.com

Multiple Beneficiaries and the Separate Account Rule If you can divide each beneficiary’s share into a separate account then each beneficiary can use own life expectancy. You must contact the custodian and physically divide the accounts. Must be completed by December 31 of the year following the participant’s death

Separate account rule and Trusts Note the separate account rule does NOT apply to multiple beneficiaries who take their interest through a trust. Several PLRs ruled that if a trust was to be divided into sub trusts for each beneficiary after the settlor’s death, every sub trust must calculate RMDs based upon oldest beneficiary of the original trust. See PLR 2005537044.

Naming a Third Party SNT as the Beneficiary of a Qualified Retirement Account The Trust must be valid under state law, or would be but for the fact that there is no corpus; The trust is irrevocable or will, by its terms, become irrevocable upon the death of the participant; The beneficiaries of the trust must be “identifiable from the trust instrument”; and Certain documentation must be provided to the plan administrator.

DB and RMD Rules for Trusts First Step: If a participant names a qualified trust as the beneficiary of an eligible retirement plan, then the trust beneficiaries will be treated as the beneficiaries of the account for purposes of determining whether there is a designated beneficiary and who it is. Second Step: Once the trust qualifies as a qualified trust and a beneficiary is identified as a designated beneficiary, then you must determine the applicable measuring life.

Conduit Trust With a conduit trust the trustee is required, by the terms of the trust, to pass all plan distributions out to the individual trust beneficiary. The IRS considers the conduit beneficiary as the sole beneficiary of the trust. Remainder beneficiaries are disregarded for purposes of calculating RMDs even if reminder beneficiaries are not DBs.

Accumulation Trust A SNT is an accumulation trust because the trustee has the discretion to distribute income and principal to the beneficiary. With an accumulation trust, we must look at the life expectancy of the special needs beneficiary and remainder beneficiaries to determine measuring life for calculating RMDs.

Case Study Father establishes a SNT for his special needs son A and designates the SNT as the primary beneficiary of his IRA. The father’s IRA has a $1,000,000 balance at the time of his death. Upon A’s death, the balance of the assets of the SNT go to A’s siblings, B and C. A is 20, B is 40, and C is 45 at their father’s death.

Calculating RMDs for an Accumulation Trust In this case, the RMD rules require A, B, and C to be considered as beneficiaries. C’s life expectancy is used to determine RMDs because C is the oldest. The factor for C at age 45 is 38.8. Using a factor of 38.8 creates a RMD for the initial year of the trust of $25,773.20 ($1,000,000÷ 38.8). If RMDs are based on A’s life expectancy, a factor of 63 is used. A factor of 63 decreases RMDs to $15,873.02 ($1,000,000 ÷ 63). By naming C as a remainder beneficiary, the RMD increased by $9,900.18.

Case Study Husband and Wife – Husband substantial assets in retirement accounts. Due to loss of investment value of accounts, wife is unsure if she has sufficient assets to live after husband passes away. If assets are sufficient, wife wants to provide for son with a disability. Disclaimer beneficiary forms. Allows wife second look to determine what if any should she disclaim. See beneficiary designation form.

Deadlines See State Statute for Disclaimer deadline – Usually Nine months from DOD. Beneficiary finalization date is September 30th of the year following the plan participant’s death. Documents required to be furnished: Either a copy of trust documents and all amendments, or A list of all trust beneficiaries, including contingent and remainder beneficiaries and a statement as to the circumstances under which they will take.

Check Lists Distribution Needs of the SNT Beneficiary. Age of Remainder beneficiaries. Is a Charity listed as a remainder beneficiary? Income taxed to Trust. Do we have a qualified disability trust (QDT) ?

Standalone SNT For Roth IRA Funding a Standalone third party SNT with a Roth IRA has multiple benefits. Although RMDs are still required to be made to the Standalone SNT after the account owner’s death, all RMDs will be paid income tax free. In short, you receive tax free growth with tax free distributions. Additionally, the trust does not need to worry about accumulating taxable income at the trust level. For example, the following illustrates the vast benefits that can be obtained from a stretch Roth IRA. Assume Bob, age 65, converted his traditional IRA to a Roth IRA in 2009. If Bob dies in 2010 and leave his $500,000 Roth IRA to a stand alone third party snt for the benefit of his son Max. Assume Max is age 40 and his age is used for purposes of calculating RMDs. The trust would be able to accumulate, on a tax-free basis, $1,549,243 in fifteen years, in addition to the tax-free distributions made to the trust. This is shown in the following table:

Year Life Expectancy Factor Beginning Roth IRA Value Growth Annual Tax-Free Distribution Ending Roth IRA Value 2010 43.6 $500,000 $50,000 $ - $550,000 2011 42.6 $55,000 $12,911 $592,089 2012 41.6 $59,209 $14,233 $637,065 2013 40.6 $63,707 $15,691 $685,080 2014 39.6 $68,508 $17,300 $736,289 2015 38.6 $73,629 $19,075 $790,843 2016 37.6 $79,084 $21,033 $848,894 2017 36.6 $84,889 $23,194 $910,589 2018 35.6 $91,059 $25,578 $976,070 2019 34.6 $97,607 $28,210 $1,045,467 2020 33.6 $104,547 $31,115 $1,118,898 2021 32.6 $111,890 $34,322 $1,196,466 2022 31.6 $119,647 $37,863 $1,278,250 2023 30.6 $127,825 $41,773 $1,364,302 2024 29.6 $136,430 $46,091 $1,454,641 2025 28.6 $145,464 $50,862 $1,549,243

The Basics of Roth IRA Planning 100% of growth is tax exempt No required minimum distributions at age 70 ½ for the account owner. (Note: Distributions from Roth IRAs cannot be used to fulfill the RMD from a traditional IRA) RMDs on inherited Roth IRAs Roth 401(k) plans

The Basics of Roth IRA Planning Starting in 2010, the $100,000 Adjusted Gross Income (AGI) limitation no longer applies. The taxable income recognized on a Roth IRA conversion in 2010 may be spread over the following two tax years (i.e. 2011 and 2012) Married Filing Separately taxpayers can convert to a Roth IRA.

The Basics of Roth IRA Planning Convertible Accounts: Traditional IRAs 401(k) plans Profit sharing plans 403(b) annuity plans 457 plans “Inherited” 401(k) plans (see Notice 2008-30) Non-convertible accounts: “Inherited” IRAs Education IRAs

Roth IRA Planning Critical decision factors: - Tax rate differential (year of conversion vs. withdrawal years) - Use of “outside funds” to pay the income tax liability - Need for IRA funds to meet annual living expenses - Time horizon

Roth IRA Planning Generally, the key to successful Roth IRA conversions is to keep as much of the conversion income as possible in the current marginal tax bracket.

Married Filing Jointly Roth IRA Planning 2010 Tax Brackets Single Married Filing Jointly Head of Household 10% $8,375 $16,750 $11,950 15% $34,000 $68,000 $45,550 25% $82,400 $137,300 $117,650 28% $171,850 $209,250 $190,550 33% $373,650 35% >$373,650

Roth IRA Planning Taxpayers may “re-characterize” (i.e. undo) the Roth IRA conversion in current year or by the filing date of the current year’s tax return. - Re-characterization can take place as late as 10/15 in the year following the year of conversion. Taxpayers may choose to “reconvert” their re-characterization. - Reconversion may only take place at the later of the following two dates: 1) The tax year following the original conversion OR 2) 30 days after the re-characterization.

Re-characterization Timeline Conversion Period Re-characterization Period Tax Payment Period 2010 2011 2012 2013 1/1/2010 First day a 2010 conversion can take place 12/31/2010 Last day a 2010 conversion can take place 4/15/2011 Normal filing date for 2010 tax return. 10/15/2011 Latest filing date for 2010 tax return. Last day to re-characterize 2010 Roth IRA conversion. 4/15/2012 Normal filing date for 2011 tax return. Date of first tax payment on 2010 conversion 4/15/2013 Normal filing date for 2012 tax return. Date of last tax payment on 2010 conversion

“Anti-Pick and Choose” Rule Taxpayers cannot re-characterize a portion of a Roth conversion by picking only those stocks that decline in value (IRS Notice 2000-39) All gains and losses to the entire Roth IRA, regardless of the actual stock or fund re-characterized, must be pro-rated.

Create Separate IRA for each asset Investment Asset Class. STEP 1: Create separate IRAs for each asset, asset class or investment fund to avoid anti-pick and choose rule. Roth IRA #1 ABC Fund: $350,000 Traditional IRA ABC Fund: $350,000 XYZ fund: $350,000 Roth IRA #2 XYZ Fund: $350,000

Roth Segregation Conversion Strategy STEP 2: Pay income tax on Roth IRA conversion April 15 2010* Income tax liability due on $700,000 conversion amount Taxpayer IRS *NOTE: Either a tax return or an extension must be filed by this date. The tax liability due on the Roth IRA conversion must be remitted by this date in order to avoid late payment penalties and interest. Taxpayer will need to adjust estimate tax payments.

Separate Asset Class Roth Strategy STEP 3: Re-characterize Roth IRA conversion for Accounts that lost Value. October 15, 2011* Re-characterization of IRA using the value at the date of conversion Traditional IRA #1 ABC Fund: $100,000 Roth IRA #1 ABC Fund: $100,000 Roth IRA #2 XYZ Fund: $400,000 *NOTE: October 15, 2011 is the latest date for which a 2010 re-characterization can take place (either by filing extensions or by filing an amended return).

Roth Segregation Strategy STEP 4: File (or amend) income tax return claiming refund for re-characterization. October 15, 2011 Refund of overpayment on re-characterization of Roth IRA conversion. Taxpayer IRS

Roth IRA Check List Check beneficiary designation forms. Use Roth IRA accounts to fund Credit Shelter – GST Trust-Standalone Third Party SNT. Check tax apportionment clauses in estate planning documents. Do NOT want estate taxes paid from Roth accounts. Consider charitable lead trust planning to provide current charitable deduction against extra income from Roth conversion. Lead Trusts will pay to Stand alone SNT upon expiration of lead term Make sure durable power of attorney documents allow agent to make tax elections for Roth conversion and re- characterizations. Make sure Successor Trustee and/or PR has authority to re-characterize under trust and/or will.