Estate Planning for Retirement Plans Gary Altman, JD, CFP, LLM (Tax) Rockville, Maryland

Why Retirement Distribution Planning is Important Coordinate estate plan under will or revocable trust Generally, the IRA or qualified plan is the largest asset of the estate To minimize income tax on distributions and thereby maximize deferral Maximize use of Unified Credit (where needed) Charitable Planning

Why Retirement Distribution Planning is Important Fluctuation in asset value Increase in the applicable exclusion amount under EGTRRA Fixed State applicable exclusion amount Perceived need of surviving spouse Tax apportionment

Wills control probate assets Basic Concepts Wills control probate assets Trusts control trust assets IRAs and qualified retirement plans are controlled by beneficiary designation form or default provisions of contract

IRAs are not taxed until distributed IRA Basics IRAs are not taxed until distributed Distributions must begin no later than one’s Required Beginning Date (RBD) IRA elections are required after death

Required Beginning Date Required Beginning Date (RBD): Generally, April 1 of the year following the year the owner turns age 70½ Once at RBD, required minimum distributions (RMD) must begin

Required Beginning Date - Example Example-Birthdate is Oct 18, 1937 Turn age 70 on October 18, 2007 Turn age 70½ on April 18, 2008 RBD -- April 1, 2009 Example-Birthdate is April 18, 1937 Turn age 70 on April 18, 2007 Turn age 70½ on October 18, 2007 RBD -- April 1, 2008

RMD Basics RMDs are calculated based upon prior year ending account balance divided by life expectancy factor Prior Year 12/31 Balance Life Expectancy Factor RMD =

Life expectancy tables Uniform Lifetime Table Single Life Table Joint and Last Survivor Table Available where the spouse is the sole beneficiary and is more than 10 years younger than the account owner

Designated Beneficiaries Post-death RMDs based on whether “designated beneficiary” exists Only “individuals” with quantifiable life expectancy can be “designated beneficiaries” If trust qualifies, look through to underlying trust beneficiaries Distribution out of trust to beneficiary does not make the beneficiary the “designated beneficiary”

Designated Beneficiaries Qualifying “designated beneficiaries”: Individuals Spouse Child Grandchild Parent Brother/sister Niece/Nephew Friend Certain Trusts

Designated Beneficiaries Non-qualifying “designated beneficiaries”: Estates Charities Most Trusts Partnerships, LLC and corporations

RMDs – Death before age 70 1/2 Life expectancy distributions if you have a designated beneficiary If no designated beneficiary, five-year rule Delayed distributions – spousal beneficiary Distributions must begin by December 31st of the year after death Failure to do so does not automatically cause the five-year rule to apply (PLR 200811028)

RMDs – Death before after 70 1/2 Life expectancy distributions if you have a designated beneficiary If no designated beneficiary, five-year rule or remaining life expectancy of IRA owner, whichever is longer Delayed distributions – spousal beneficiary Distributions must begin by December 31st of the year after death Failure to do so does not automatically cause the five-year rule to apply (PLR 200811028) Year of death distribution – life expectancy of IRA owner

RMDs _______________________________________ Death Before Required Beginning Date Death On or After Required Beginning Date Life Expectancy Rule Life Expectancy Rule Designated Beneficiary Owner’s “Ghost” Life Expectancy Rule Non-Designated Beneficiary Five-Year Rule

RMDs Generally, if individual beneficiaries exist, post-death RMDs are based upon oldest designated beneficiary’s life expectancy under the Single Life Table If separate shares are created by 12/31 of the year following the year of death, then each beneficiary’s life is used

Spousal rollover where spouse is “sole beneficiary” Rollover may occur at any time Non-spousal rollovers Not permitted But, direct transfers are permitted

Critical Dates Date at which the beneficiaries are identified September 30 of the year following the year of death Date at which the beneficiaries are identified October 31 of the year following the year of death Date at which trust documentation (in the case where a trust is named as a designated beneficiary) must be filed December 31 of the year following the year of death Date at which the first distribution must be made by each IRA beneficiary Date at which separate shares must be created

9/30 Determination Date “Designated beneficiary” is not determined until September 30 of the year following the year of the IRA owner’s death Treas. Reg. § 1.401(a)(9)-4, Q&A 4(a) Allows for disclaimer planning If a beneficiary dies before the September 30 date without disclaiming, such beneficiary continues to be treated as a beneficiary in determining the designated beneficiary Treas. Reg. § 1.401(a)(9)-4, Q&A 4(c)

9/30 Determination Date Example 1 Jane names a charity (10%) and a trust (90%) as beneficiary of her IRA. The trust is payable to her children over their lifetimes. If the charity’s 10% is paid out by September 30th of the year following the year of Jane’s death, the charity’s interest will not taint the distribution to the children through the trust (which will be payable over the lifetime of the oldest child).

9/30 Determination Date Example 2 John names his sister as primary beneficiary of his IRA and his nephew as contingent beneficiary. If John’s sister dies before September 30th of the year following the year of John’s death without performing a qualified disclaimer, RMDs are still calculated based on the sister’s life expectancy.

9/30 Determination Date Example 3 John names his wife as primary beneficiary of his IRA and his grandchild as contingent beneficiary. If John’s wife performs a qualified disclaimer by September 30th of the year following the year of John’s death, RMDs can be calculated based on the grandchild’s life expectancy.

Weaving the IRA Beneficiary Designation Form into the Overall Plan Contingent beneficiaries Trust as beneficiary Second marriage issues Creditor protection issues Charitable bequests

“Inherited IRA”

“Inherited IRA” IRA Distribution Flowchart

“Inherited IRA” Objective: Prolong IRA payments over longest possible period of time, thus increasing wealth to future generations

“Inherited IRA” An IRA is treated as “inherited” if the individual for whose benefit the IRA is maintained acquired the IRA on account of the death of the original owner Under the tax law the IRA assets can be distributed based upon the life expectancy of the designated beneficiary

Spousal Beneficiary Two Strategies Advantages Spousal Rollover Inherited IRA Advantages Rollover delays RMD until spouse’s own RBD Inherited IRA provisions allow beneficiary’s life expectancy to be used for distributions after death of IRA owner

Spousal Beneficiary Rollover Exception to Inherited IRA rules Only available to surviving spouse Allows spouse to roll over assets received as beneficiary to a new IRA in his/her own name. Surviving spouse’s age used to determine when required minimum distributions must begin Surviving spouse may use the Uniform Lifetime Table to determine distributions

Spousal Rollover Trap Spousal rollover before age 59 ½ Solution Will cause pre-59 ½ distributions to be subject to the 10% early distribution penalty If no rollover occurred, pre-59 ½ distributions can be taken penalty free Solution Do not perform spousal rollover until spouse reaches age 59 ½

Child or Grandchild Beneficiary Trumps the five year rule Achieves “Inherited IRA” to the degree that distributions occur over life expectancy of the designated beneficiary The life expectancy factor of beneficiary is determined by reference to the Single Life Table beginning in the year following the year of death. Each year thereafter the life expectancy divisor is reduced by one

Pension Protection Act of 2006 Beginning in tax years after 12/31/2006, non-spousal beneficiaries (e.g. children, grandchildren, friends, etc.) are permitted to “transfer” a qualified retirement plan (e.g. 401(k)), via a trustee-to-trustee transfer, into an “inherited” IRA “Designated beneficiary” trusts are also permitted to transfer qualified retirement plans to “inherited” IRAs Notice 2008-30: If plan permits, can transfer qualified plan to Roth IRA (normal income tax limits apply)

Key Issues Beneficiary Designation Forms Child vs. Grandchildren as Beneficiary Tax Apportionment Careful drafting in Revocable Trust Standalone IRA Trust Irrevocable Life Insurance Trust (ILIT)

Common Mistakes Incorrect titling Failure to take RMDs Failure to utilize disclaimers when appropriate Failure to analyze contingent beneficiaries when utilizing disclaimers Failure to analyze or consider contingent beneficiaries in trust documents Spousal rollover before age 59 ½ Taking a lump-sum distribution

Inherited IRA Title For non-spousal beneficiaries, it is critical to keep inherited IRA in the name of the deceased IRA owner. Example: John Smith, deceased, IRA, for the benefit of James Smith

IRAs Payable to Trusts - Basic

Benefit of Using a Trust Minors Creditor or Predator Protection Inherited IRAs not creditor protected Divorce Protection Special Needs Investment Management Estate Planning Payment of Estate Taxes Irresponsible Beneficiaries or Control from the Grave Per Stirpes generally not allowed

Disadvantages of Utilizing a Trust Trust Income Tax Rates Legal and Trustee Fees Trust Income Tax Returns 1041 1099 K-1 Greater Complexity

Trust An IRA Can Be Payable to a Trust Naming a Trust as a “Designated Beneficiary” An IRA Can Be Payable to a Trust IRA Beneficiary Designation Form Trust IRA distributions over the life expectancy of the oldest beneficiary Spouse Children

Four Requirements for ALL Trusts Trust is valid under state law Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(1) Trust is irrevocable upon death of owner Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(2) Beneficiaries of the trust are identifiable from the trust instrument Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(3) Documentation requirement is satisfied Treas. Reg. § 1.401(a)(9)-4, Q&A 5(b)(4)

Types of Testamentary Trusts Unified Credit Trust Marital Trust QTIP Trust Trust for single individual Trust for multiple individuals Generation Skipping Trusts

Types of Inter Vivos Trusts Revocable Trust Standalone IRA Trust

Two Types of Trusts Accumulation Trusts Conduit Trusts Treas. Reg. § 1.401(a)(9)-4, Q&A 5 requirements apply to both types

A trust in which distributions Accumulation Trust A trust in which distributions from the IRA are allowed to accumulate within the trust

Conduit Trust A trust in which all distributions from the IRA are immediately distributed to the trust beneficiary(ies)

Accumulation Trust The key issue in analyzing an accumulation trust is to determine which beneficiaries are “countable” All beneficiaries are countable unless such beneficiary is deemed to be a “mere potential successor” beneficiary

Trust Accumulation Trust Example #1 Child – age 30 Child – age 30 IRA Mother is “countable” for determining applicable life expectancy See PLR 200228025 and Treas. Reg. § 1.401(a)(9)-5 Q&A 7 IRA Discretionary Distributions Child – age 30 Entire Trust outright upon Grandchildren reaching age 30 Child – age 30 If Grandchildren die before reaching age 40 Mother – Age 80

Accumulation Trust Example #2 IRA Trust Sister Age 67 Sister measuring life for determining required minimum distributions Facts same as PLR 200228025 Trust IRA Discretionary Distributions Grandchildren Entire Trust outright upon Grandchildren reaching age 30 Grandchildren If Grandchildren die before reaching age 30 Sister Age 67

Trust Accumulation Trust Example #3 Child #1 To Red Cross Discretionary Distributions Trust IRA Child #1 Contingent beneficiary must be counted. Non-individual contingent beneficiary. No designated beneficiary status. At Child #1’s death To Red Cross

QTIP Trust Accumulation Trust Example #4 Spouse At spouse’s death IRA All income Spouse Contingent beneficiaries must be counted. Possible non-individual contingent beneficiaries. General Power of Appointment disqualifies accumulation trust. At spouse’s death Issue of IRA owner in such a manner (in trust or otherwise) as the surviving spouse appoints by will.

Conduit Trust Allows for easier identification of beneficiaries Do not have to consider contingent or remote beneficiaries

Trust Conduit Trust Example #1 Child – age 30 Child – age 30 IRA Mother is not “countable” for determining applicable life expectancy Treas. Reg. § 1.401(a)(9)-5 Q&A 7 Discretionary Distributions, but no less than total withdrawals from IRA Child – age 30 Entire Trust outright upon Grandchildren reaching age 30 Child – age 30 If Grandchildren die before reaching age 40 Mother Age 80

See Treas. Reg. § 1.401(a)(9)-5 Q&A 7 Conduit Trust Example #2 All distributions from IRA Trust IRA Child #1 At Child #1’s death To Red Cross See Treas. Reg. § 1.401(a)(9)-5 Q&A 7

Conduit Trust Example #2 As all distributions from the IRA are required to be distributed to the beneficiary; if Child #1 lives to his or her life expectancy, the entire IRA will be distributed to Child #1. Therefore, Child #1 is the only “countable” beneficiary and the Red Cross can be ignored

Trust Conduit Trust Example #3 Child #1 At Child #1’s death All distributions from IRA IRA Trust Child #1 At Child #1’s death To my lineal descendants as appointed by Child #1 in his/her last will and testament

Conduit Trust Example #3 Lineal descendants can be ignored because all distributions are paid through the trust to Child #1 Where a conduit trust is used, potential appointees under a power of appointment can be ignored

QTIP Trust Conduit Trust Example #4 Spouse At spouse’s death IRA Greater of RMD or all income IRA Spouse At spouse’s death Issue of IRA owner in such a manner (in trust or otherwise) as the surviving spouse appoints by will.

Conduit Trust Example #4 The QTIP trust is designed as requiring the “greater of income or RMD” be distributed. Additional distributions may occur and be trapped inside the trust, therefore, the trust is not a conduit trust but rather must be tested as a lifetime distribution trust. Better language : “Greater of income or total withdrawals from IRA”

IRAs Payable to Trusts - Advanced

Solution – Stand alone IRA trust such as IRA legacy trust Standard Issues With Naming a Revocable Living Trust as a “Designated Beneficiary” The need for proper apportionment language regarding payment of debts, expenses and taxes of estate (See PLR 9820021) Recognition of income in respect of a decedent (IRD) if pecuniary funding clause is utilized Unanticipated loss of designated beneficiary due to the inclusion of power of appointment (general or limited) Solution – Stand alone IRA trust such as IRA legacy trust

Fractional v. Pecuniary clauses Standard Issues With Naming a Revocable Living Trust as a “Designated Beneficiary” Fractional v. Pecuniary clauses Recognition of income Entire trust irrevocable at death of IRA owner No separate share treatment Payment of debts, taxes, and expenses Apportionment language Firewall provision Powers of appointment Stand alone trust – highly recommended Adoption of older individuals

Revocable Living Trust as “Designated Beneficiary” Revocable trust should use a fractional funding clause to determine the marital and bypass shares

IRAs Payable to Trusts Common Mistakes Older or unidentifiable contingent beneficiary Estate as contingent beneficiary Powers of appointment Failure of beneficiaries clause Failure to provide trust document to custodian by October 31 of year following year of death Making lump sum distribution to trust

Separate Share Rule In proper circumstances, the IRS allows the division of the IRA into separate shares for each beneficiary In the case of an individual beneficiary, this must be determined by December 31 of the year following the year of death Separate shares established when divided No separate shares available for estates Disclaimer rule Death by September 30

Separate Share Rule Payable to single trust No separate shares identified in the beneficiary designation form IRA paid over oldest life expectancy

Separate Share Rule IRA payable to multiple trusts Each trust named in beneficiary designation form IRA divided into separate shares and each share paid to each trust over oldest beneficiary’s life expectancy of each trust

Charity as Beneficiary Where a charity is named as one of many beneficiaries, must pay out charity by September 30 Must divide IRA by December 31

Disclaimer Planning for IRAs

Disclaimer must be “qualified.” Disclaimer Planning Disclaimer must be “qualified.” In writing Within 9 months No acceptance of the interest or any of its benefits, Interest passes without any direction on the part of the person making the disclaimer

Disclaimer Planning - Example Alex dies at age 70. Alex’s wife disclaims amount of Alex’s unified credit to bypass trust for benefit of herself and their children Disclaimer must occur within nine months from date of death Disclaimer must be served on the IRA custodian Disclaimer must be fractional to avoid immediate income taxation

Disclaimer Planning IRA Disclaimer must be Qualified Disclaimer Life Expectancy of Oldest Beneficiary of Trust Spouse Spouse Disclaims Trust FBO Children

Disclaimer Planning DB Status – Trust is Irrevocable IRA No Separate Share Treatment Life Expectancy of Oldest Beneficiary Mother and Spouse Disclaim 100% Oldest Child is DB IRA LEGACY Trust F/B/O SPOUSE and CHILDREN Contingent = Mother Age 88

Disclaimer Planning Life Expectancy of Oldest Beneficiary of Family Trust = Spouse IRA Fractional Disclaimer Spouse Primary Beneficiary Disclaimer Marital Deduction Trust First Contingent Beneficiary – If spouse disclaimed IRA as Primary Beneficiary Family Trust Second Contingent Beneficiary – If spouse disclaimed IRA and Benefit under First Contingent Beneficiary Children in same fashion as provided under the Family Trust as if spouse had died Third Contingent Beneficiary – If spouse disclaims IRA and Benefit under First and Second Contingent Beneficiary

Revenue Ruling 2005-36 A beneficiary's disclaimer of a beneficial interest in a decedent's IRA is a qualified disclaimer even though, prior to making the disclaimer, the beneficiary receives the required minimum distribution for the year of the decedent's death from the IRA.

Marital Planning for IRAs

Spousal Rollover Planning Through Estate Surviving spouse is executor Estate IRA Spouse sole residuary beneficiary PLR 200644031

Spousal Rollover Planning Through Trust Spouse is trustee vested with power to allocate assets among trusts. IRA Rev. Trust Marital Trust GPA Credit Shelter Trust Spouse Trustee of GPA Trust PLR 199942052 Rollover Allowed

Spousal Rollover Planning Through Trust Surviving spouse is sole executor IRA Estate of IRA owner Pour over will Spouse is sole trustee Revocable Trust All to spouse unless disclaimed

Spousal Rollover Planning Through Trust Spouse and sons co-trustees; only spouse has right to allocate assets IRA Trust Marital Trust Credit Shelter Trust GPA vested in spouse PLR 9851049 Rollover Allowed

Spousal Rollover Planning Through Trust Non-spouse trustees IRA Trust Formula Funding GPA Marital Credit Shelter Trust PLRs 9145041 & 9303031 Rollover Not Allowed

Spousal Rollover Planning Through Trust IRA Estate By will Credit Shelter Spouse and issue disclaim interest in credit shelter trust and allow IRA to be payable to spouse by intestate succession. See PLRs 9401039, 9450041 and 9820010 Rollovers Allowed

Roth IRAs

Roth IRAs 100% of growth is tax-exempt No required minimum distributions at age 70½ $100,000 Modified Adjusted Gross Income (MAGI) limitation RMDs on Inherited Roth IRAs Roth 401(k) plans

Roth IRAs Starting in 2010, the $100,000 Adjusted Gross Income (AGI) limitation no longer applies The tax incurred 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

Seven Reasons to Convert to a Roth IRA Taxpayers have special favorable tax attributes including charitable deduction carry-forwards, investment tax credits, etc. (2) Suspension of the minimum distribution rules at age 70½ provides a considerable advantage to the Roth IRA holder. (3) Taxpayers benefit from paying income tax before estate tax (when a Roth IRA election is made) compared to the income tax deduction obtained when a traditional IRA is subject to estate tax. (4) Taxpayers who can pay the income tax on the IRA from non IRA funds benefit greatly from the Roth IRA because of the ability to enjoy greater tax-free yields. (5) Taxpayers who need to use IRA assets to fund their $2,000,000 unified credit bypass trust are well advised to consider making a Roth IRA election for that portion of their overall IRA funds. (6) Taxpayers making the Roth IRA election during their lifetime reduce their overall estate, thereby lowering the effect of higher estate tax rates. (7) Because federal tax brackets are more favorable for married couples filing joint returns than for single individuals, Roth IRA distributions won’t cause an increase in tax rates for the surviving spouse when one spouse is deceased because the distributions are tax-free. Affect of new regulations

Roth IRA Conversions - Tactical Considerations Utilize unused charitable contribution carryovers Offset current year ordinary losses Utilize current year Net Operating Losses (NOL) or carryovers from prior years Utilize Alternative Minimum Tax (AMT) carryovers

Roth IRA Conversions - Tactical Considerations Taxpayers may recharacterize (i.e. “undo”) the Roth IRA conversion in current year or by the filing date of the current year’s tax return - Recharacterization can take place as late as 10/15 in the year following the year of conversion Taxpayers may choose to “reconvert” their recharacterization - 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 recharacterization

Roth IRA Conversion Dilemma Taxpayers cannot recharacterize a portion of a Roth conversion by “cherry 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

Roth IRA Conversion Dilemma – Example On January 2, 2006, when John Smith’s IRA was worth $500,000, he converted the entire amount to a Roth IRA. John will owe ordinary income tax on the entire $500,000. The IRA consisted of 50% ABC Fund ($250,000) and 50% YYZ Fund ($250,000). As of April 15th, 2007 the ABC fund had declined in value to $125,000, while the YYZ fund had increased in value to $275,000. Thus, the total value of the IRA account declined in value to $400,000. Even though John would like to re-characterize all of his ABC fund and leave the YYZ fund in his Roth IRA, he must allocate the total loss to each fund pro-ratably. As a result of this loss allocation, John may only recharacterize $156,250 (31.25% * $500,000) instead of $250,000.

Other IRA Planning Issues

Other IRA Planning Issues Estate tax exclusion QTIP-IRA Planning Income in Respect to a Decedent (IRD) / IRC §691(c) deduction Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Charitable Remainder Trust (CRT) Traps for the unwary

Traps for the Unwary Prohibited IRA investments Prohibited transactions Unrelated Business Taxable Income (UBTI) 60 Day Rollover Period IRC §72(t) Excess Accumulations Tax Pecuniary bequests to charity

Prohibited Transactions Any direct or indirect sale or exchange, or leasing, of any property between a plan and a “disqualified person”. Residence or cottage Business interest Investment real estate

Section 72(t) 10-percent penalty for early withdrawals from IRAs and qualified plans Technically, the 10-percent is not a penalty; rather, it is an additional tax. Therefore, there is no excuse for reasonable cause. The code section itself provides all the exceptions to the tax.

Exceptions to the Penalty Death Disability Medical expenses that exceed 7.5 percent of income Age 55 or older in year of separation from service (not applicable to IRAs)

Exceptions to the Penalty Qualified higher education expenses (IRAs only) First time home purchase, limited to $10,000 lifetime (IRAs only) Payment of health insurance by unemployed individuals Series of Substantially Equal Periodic Payments (SEPPs)

Series of Substantially Equal Periodic Payments (SEPPs) Required Minimum Distribution (RMD) method Fixed amortization method Fixed annuitization method

Series of Substantially Equal Periodic Payments Payments must continue under the LATER of age 59½ or five years If payments are substantially modified prior to that point, the 10-percent additional tax will be imposed on all pre-59½ withdrawals In addition to the 10-percent additional tax, an additional amount is added to reflect the interest on the penalty from the original year of withdrawal

Revenue Ruling 2002-62 One-time election to switch to RMD method No 10% additional tax if funds run out before end of series Annual recalculation under annuity or amortization method is no longer available New prescribed “reasonable” interest rate must be used 120% of the mid-term AFR (by reference to the two months preceding the first distribution month) Three possible life expectancy tables Single life table Joint life table Uniform Lifetime table

Excess Accumulation Penalty Requesting a Waiver Under IRC § 4974(d), the tax may be waived if the taxpayers can establish that the shortfall in distributions was due to reasonable error and reasonable steps are being taken to remedy the shortfall. An accumulation occurs because of “reasonable error" when it occurs through no fault of the plan participant. Complete Form 5329 Attach letter requesting waiver

Charitable Bequests Pecuniary bequest to charitable beneficiary Acceleration of income No 642(c) deduction - terms of trust did not direct or require that the trustee pay the pecuniary legacies from the trust's gross income.

Charitable Bequests Using fractional funding clause Name charities as beneficiaries directly in beneficiary designation form Use language in trust directing or requiring the trustee to pay the pecuniary legacies from the trust's gross income

(301) 468-3220 gary@altmanassociates.net www.altmanassociates.net Gary Altman Altman & Associates 11300 Rockville Pike Suite 605 Rockville, Maryland 20852 (301) 468-3220 gary@altmanassociates.net www.altmanassociates.net