Retirement Planning

Retirement Planning Who Should be the Beneficiary of Your IRA? Lewis W. Dymond, Jr. WealthCounsel, LLC

Retirement Planning Recommended Reading: Life and Death Planning for Retirement BenefitsThe Essential Handbook for Estate PlannersNatalie ChoateAtaxplan Publications www.ataxplan.com

Retirement Planning Also Recommend: The Big IRA BookThe Ultimate Manualto help you manage your IRA practice and answer thequestion: Who Should be the Beneficiary of your IRA?Robert S. Keebler with Cecil D. Smith & Carol H. GonnellaTeton Publishers, LLC800.955.0554

Course Objectives Help you help your clients: • Pass more wealth to loved ones. • Integrate client’s IRA with their overall estate plan. • Evaluate whether a standalone retirement trust (“SRT”) is right for them and their families. • Use SRTs to protect and grow savings for their families. • Take advantage of the rules applying to separate accounts governing IRAs so that each beneficiary can control his or her own inheritance.

What Are We Talking About? Defined Contribution Plans: • Under these plans, an employer establishes a retirement account for each employee (“Participant”), and the account receives a “defined contribution” from the employer each year. • The Participant’s retirement income is based on withdrawals from this account, and the investment return. • These plans include profit-sharing plans, money sharing plans, 401(k) plans, thrift plans, ESOPs, SEPs, SIMPLE plans, and employer- funded 403(b) plans.

What Are We Talking About? And . . . Individual Retirement Arrangements (IRAs): • These plans are established by the taxpayer – not his or her employer. The taxpayer funds the plan either through personal contributions, as a rollover, or direct transfer from his or her employer’s defined contribution plan. • As a general rule, the same tax law applies to IRAs and to defined contribution plans. Reg§1.408-8 Q&A 1. • There are exceptions!

What Are We Talking About? Not . . . Defined Benefit Plans These are plans in which the employer expresses each eligible employee’s benefit as a defined amount paid in installments beginning at retirement. We sometimes call this arrangement a pension. Government Benefits Such as social security, railroad retirement, civil service benefits, etc.

Why You Need to Understand • “As of March 31, 2010, clients hold nearly $16.5 trillion in IRAs and Qualified Plans, and these assets now account for 36% of all household financial assets.”* • For a large number of clients, retirement plans may be largest asset held at death. • Retirement Plans were designed to accumulate wealth for retirement, not to accumulate for future generations – tax laws designed accordingly. *According to the Investment Company Institute

Fundamental Concepts Retirement Plans were designed to accumulate wealth for retirement, not to accumulate for future generations – tax laws designed accordingly.

Fundamental Concepts • Principle #1: Encourage people to contribute to IRAs and Qualified Plans. • How: • Contributions are made with pre-tax dollars. • Contributions compound in a tax-free environment. • Contributions and earnings are not taxed until withdrawn.

Fundamental Concepts • Principle #2: Discourage people from using money too soon. • How: • As a general rule, the Code imposes a 10% additional income tax on the taxable portion of a distribution made before the taxpayer reaches age 59½. • There are exceptions.

Fundamental Concepts • Principle #3: Penalize taxpayers who don’t use the money during retirement. • How: • Require that distributions begin at the earlier of age70½ or upon death of the taxpayer. • As a general rule, the Code imposes a 50% additional income tax on the excess of the amount required for distribution over the amount actually distributed. • Make things really complicated if a taxpayer dies with money remaining in the IRA or Qualified Plan.

Fundamental Concepts Principle #1: Encourage people to contribute through the “Power of Tax Deferral” • Tax Deferred Investment • $1 doubled every year for 20 years tax free • $1,048,567 Taxable Investment $1 doubled every year for 20 years taxable 29% tax rate ?

Assumes 12% annual return

Fundamental Concepts A “distribution calendar year” is the year for which the plan must make a distribution.Reg §1.401(a)(9)-5 Q&A 1(b) • The first distribution calendar year is the year in which the individual either reaches 70½ or retires. • Although the RBD is not until April 1 of the following year, the distribution required on that date is for the prior calendar year. • A distribution for the second distribution calendar year must be made before December 31 of the year in which the RBD falls. Reg §1.401(a)(9)-5 Q&A 1(c)

Fundamental Concepts The amount that the Participant must take out each year by and after the RBD is called the “required minimum distribution” (MRD*). * Yes, the correct acronym is MRD because we don’twant to confuse it with the RMD distribution method for SOSEPPs. And MRDs should not be confused with RBDs and the later discussed DBs . . . got it?

Fundamental Concepts Lifetime MRDs are determined annually by dividing the prior year-end account balance by a life expectancy factor supplied by the IRS. • Uniform Lifetime Table; or • Joint and Last Survivor Table, if the Participant’s sole beneficiary is his or her more-than-10 years –younger spouse. • Uses the recalculation method, will never divide by “1”; so Participant won’t outlive his or her retirement benefits if only taking MRD each year.

Age Divisor Age Divisor Age Divisor 70 27.4 86 14.1 102 5.5 71 26.5 87 13.4 103 5.2 72 25.6 88 12.7 104 4.9 73 24.7 89 12.0 105 4.5 74 23.8 90 11.4 106 4.2 75 22.9 91 10.8 107 3.9 76 22.0 92 10.2 108 3.7 77 21.2 93 9.6 109 3.4 78 20.3 94 9.1 110 3.1 79 19.5 95 8.6 111 2.9 80 18.7 96 8.1 112 2.6 81 17.9 97 7.6 113 2.4 82 17.1 98 7.1 114 2.1 83 16.3 99 6.7 115 and older 1.9 84 15.5 100 6.3 85 14.8 101 5.9 Fundamental Concepts Uniform Life Table (Reg. 1.401(a)(9)-9 Q&A 2)

Fundamental Concepts MRD for year of death: • If Participant had not yet taken the entire MRD for year of death, any remaining MRD must be taken by the beneficiary before the end of the year. • After death, the beneficiary owns the account and must take any of the Participant’s remaining RMDs. • If there are multiple beneficiaries, the MRD rules are satisfied as long as ANY beneficiary takes the balance of the year-of-death distribution. It does not need to be distributed pro rata among beneficiaries.

Fundamental Concepts MRDs after death: • After the Participant’s death, MRDs apply to the beneficiary. • MRDs for the beneficiary normally begin the year after the year of the Participant’s death. • Natalie Choate refers to this as the “Required Commencement Date.” • Participant’s MRD may be required for Participant in year of death. • Rules are different if spouse is the sole beneficiary.

Fundamental Concepts MRDs after death: • The after death MRD rules are more complicated than the lifetime MRD rules. • Based on three factors, one of which requires good planning and one of which trumps all else. • Death before or after the RBD of the Participant? • Who (or what) is the beneficiary? • What does the plan allow?

Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? • DB is Code-defined and does not simply mean any beneficiary who is designated by the Participant! • Understanding the meaning of DB is crucial to planning for and compliance with post-death MRDs.

Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? • The identity of the beneficiary is not finally fixed, for purposes of these rules, until September 30 of the year following the year of the Participant’s death, the “designation date.” Reg §1.401(a)(9)-4, A-4(a) • Natalie Choate refers to this as “Beneficiary Finalization Date.” • Important for separate account rules. • Important for clean-up strategies (removing non-qualified DBs before designation date).

Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? • Beneficiary means the person or persons (or entity or entities) who are entitled to the plan benefits upon the Participants death. • Retirement benefits generally pass as non-probate property, by contract, to the beneficiary named in the beneficiary designation form. • The provisions in the Participant’s will or RLT are irrelevant as to who receives the benefits, unless plan or beneficiary designation form provides otherwise.

Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? • Most IRAs and QRPs have printed forms they expect Participant to use. • Most (but not all) will accept attachments. • Some will accept a separate instrument. • When drafting beneficiary designations, make sure what you are trying to do is permitted under the terms of the plan.

Fundamental Concepts Who is the Participant’s “beneficiary” and is there a “Designated Beneficiary” (DB)? • Not every beneficiary is a Designated Beneficiary (DB). • A beneficiary might not be a DB, even if designated on a beneficiary designation form. • A beneficiary might be a DB, even if not designated by the Participant. • Reg §1.401(a)(9)-4 Q&As – Determination of designated beneficiary. Included in materials

Fundamental Concepts Keys to achieving Designated Beneficiary status: • Only individuals can be Designated Beneficiaries. • Estates, partnerships, corporations, LLCs, and charities do not qualify. • While a trust is not an individual, some trusts qualify for “look-through” status and the trust’s beneficiary(ies) qualify as DBs Reg §1.401(a)(9)-4 Q&A 5(a) and (b) (included in materials). • If there are multiple beneficiaries, all must be individuals and must be able to identify the oldest. • Need to determine if separate account rule applies. • The beneficiary must be designated either “by the terms of the plan” or (if plan allows) by the Participant.

Fundamental Concepts MRDs after death: Death Before Required Beginning Date Death On or After Required Beginning Date Fixed Term Method(aka “Life Expectancy Rule.”)* Fixed Term Method(aka “Life Expectancy Rule.”)** Designated Beneficiary Participant’s Life Expectancy (aka “Ghost Life Expectancy”) Non-Designated Beneficiary Five Year Rule

Fundamental Concepts Fixed-Term aka “Life Expectancy Rule”: • Use the DB’s age to determine the DB’s life expectancy from the Treasury Department’s Single Life Table. • Calculate the MRD for the first year by dividing the account balance by the DB’s life expectancy. • Each subsequent year, calculate the MRD by dividing the remaining account balance by the prior year’s divisor minus “1”. • This is said to be a “Stretch-Out” and is, in most cases, a big tax advantage. Under this method, a beneficiary may have to withdraw all of the retirement benefits before he dies.

Fundamental Concepts Single Life Table – Reg. 1.401(a)(9)-9 Q&A1

Fundamental Concepts Post Death MRDs - “Five-Year Rule”: • The entire plan balance must be distributed to the beneficiary(ies) by December 31 of the year of the 5th anniversary of the Participant’s death. • Annual distributions are not required. • Ceases to have any application once the Participant reaches his RBD. • Since a Roth IRA has no RBD, the five-year rule is still applicable to Roth IRAs with no DB even if the Participant has reached his RBD for other IRAs or QRPs. • Distributions from a Roth IRA cannot satisfy MRDs fromnon-Roth IRAs.

Fundamental Concepts Post Death MRDs - “Five-Year Rule”: • Under IRC §401(a)(9)(B): • The life expectancy method automatically applies if there is a DB; and • The 5-year rule only applies when there is no DB.

Fundamental Concepts Post-Death MRDs - “Five-Year Rule”: • However under the Treasury Regulations, the plan can permit the DB to choose between the 5-year rule and the life expectancy method where the Participant died before the RBD. Reg §1.40(a)(9)-3, Q&A-1 • This is the ONLY minimum distribution rule that bases post death MRDs on an election by distributee. • Election becomes irrevocable by the deadline for making the election, and is applicable for all later years. • Plan can provide a default rule if no election made by beneficiary. • If plan does not specify a default rule; the default rule is life expectancy method.

Fundamental Concepts Post-Death MRDs – Participant’s life expectancy method (“Ghost life expectancy”): • Only payout option available if the Participants dies after RBD with no DB. Reg §1.401(a)(9)-5, Q&A-5(a)(2) • If the benefits are left to a DB, then the longer of the life expectancy method or Participant’s life expectancy method is used. Reg §1.401(a)(9)-5, Q&A-5(a)(3) • Calculate the Participant’s remaining life expectancy using the IRS’s Single Life Table based on the age the Participant attained (or would have attained) on the Participant’s birthday in the year of death. Reg §1.401(a)(9)-5, Q&A-5(c)(3)

Fundamental Concepts Special situations and rules: • Multiple beneficiaries • Surviving spouse as beneficiary • Separate account rule • Lifetime Rollovers • Roth IRAs • Trust as beneficiary

Fundamental Concepts • Multiple Beneficiaries: • No Designated Beneficiary unless all of the beneficiaries are individuals (Reg §1.401(a)(9)-4 Q&A-3); and • If all of the beneficiaries are individuals, life expectancy divisor is that of the oldest beneficiary. • Two escape hatches: • Separate Accounts Rule. • Ability to “remove” a beneficiary through disclaimer or distribution of that beneficiary’s share by the Designation Date (September 30 of the year following the year of death).

Fundamental Concepts Separate Accounts Rule: • If Participant’s benefits under a plan are divided into separate accounts with different beneficiaries, the post death MRD rules apply separately to each account. Reg §1.401(a)(9)-8 Q&A – 2(a)(2) • This regulation does NOT apply to multiple beneficiaries who take their interests through a trust that is named as beneficiary of the plan. • Powerful tool when planning for retirement benefits. • Allows multiple beneficiaries to each use their own life expectancy in determining post-death MRDs.

Fundamental Concepts Separate Accounts Rule - compliance: • Pro rata sharing in gains and loses. • Normally fractional or percentage division. • Pecuniary gift would not meet the definition unless (under local law or beneficiary designation) the gift shares in post-death gains and losses pro rata with the other beneficiaries’ shares. • Pecuniary gifts can be eliminated by distributing the pecuniary gift before the Designation Date. • Accounts must be “established” by December 31 of the year following the year of death to use separate life expectancies. • If established later, the separate accounts are still effective for all other purposes.

Fundamental Concepts Review of Critical Dates: • September 30 of the year following the year of death. • Designation date – the date at which the beneficiaries are identified. • Eliminate non-DBs by disclaimer or satisfaction of bequest. • October 31 of the year following the year of death. • Date by which trust documentation must be filed in the case where a trust is named as DB. • December 31 of the year following the year of death. • Required Commencement Date – the date by which the first distribution must be made. • Date by which separate accounts must be created.

Fundamental Concepts Surviving Spouse as Sole Beneficiary: • Lifetime distributions – more-than-10-year-younger spouse, use of Joint and Survivor Table.

Fundamental Concepts Surviving Spouse as Sole Beneficiary: • Spouse can rollover inherited benefits to spouse’s own retirement plan or elect to treat an inherited IRA as spouse’s own IRA. Reg §1.408-8 Q&A 5(a) • A spouse who is under 70½ can postpone distribution from his or her IRA until he or she reaches own RBD. • Spouse can take MRDs using the “recalculate method” from the Uniform Lifetime Table. • Spouse can name his or her own DBs. • There is no “deadline” in which the spouse must make the rollover except as to benefits already distributed.

Fundamental Concepts Surviving Spouse as Sole Beneficiary: • Postponed Required Commencement Date when Participant dies before his or her RBD, if spouse remains the beneficiary. • Annual distributions do not have to begin until the end of the latter of the year following the year in which the Participant died, or the year in which the Participant would have reached 70½. Reg§1.401(a)(9)-3 Q&A 3(b) • If the spouse dies before the date he or she is required to take distributions, then MRDs will not be based on the Spouse’s remaining life expectancy – instead, a new period starts using either the 5-year rule or, if the spouse has a DB, the fixed-term method. Reg §1.401(a)(9)-3 Q&A 5 and 6

Fundamental Concepts Surviving Spouse as Sole Beneficiary: • If spouse remains the beneficiary, spouse’s MRDs are calculated using recalculation method. • Life expectancy is determined using the Single Life Table. • Upon the spouse’s death, benefits are paid over the spouse’s remaining life expectancy under the fixed-term method.

Trust as Beneficiary Two biggest myths about estate planning for QRPs and IRAs • You can’t name a trust and get a stretch-out. • Naming an individual will result in a stretch-out.

Trust as Beneficiary Twenty-five year old inherits a $100,000 IRA has two choices • $60,000 automobile • $400,000 after tax income over life expectancy • Based on anticipated growth rate of 5% • Combined state and federal income tax rate of 35%

Trust as Beneficiary Can a trust be named as a beneficiary? • Normally a trust is a non-individual and therefore can not qualify for Designated Beneficiary status. • 5 Year if Participant dies before RBD • Ghost life expectancy, if after RBD • HOWEVER, under the regulations, it is possible to name a trust as beneficiary and still have a Designated Beneficiary for purposes of determining MRDs. • But special rules apply.

Trust as Beneficiary Reg §1.401(a)(9)-4, Q&A-5(b) • A “see-through trust” – look through the trust and treat the trust beneficiaries as the Participant’s Designated Beneficiaries, just as if they had been named directly as beneficiaries by the Participant. • Two exceptions: • Spousal rollover not available. • “Separate Accounts” treatment not available.Reg §1.401(a)(9)-4, Q&A 5(c)

Trust as Beneficiary Qualifying as a see-through trust: • The trust must be valid under state law. • Trust is irrevocable or will, by its terms, become irrevocable upon the death of the Participant. • Certain documentation must be provided to the plan administrator by October 31 of the year after the year of the Participant’s death. • Beneficiaries must be identifiable from the trust instrument and all must be individuals.

Trust as Beneficiary The trust must be irrevocable:Reg §1.401(a)(9)-4 Q&A 5(b)(2) • “The trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.” • Including the statement, “This trust becomes irrevocable upon my death” probably not be necessary in a revocable living trust or testamentary trust under a will. • WealthDocx™ includes out of caution and for benefit of plan provider. • Choate: “A Trustee’s power, after the Participant’s death, to amend administrative provisions of the trust should not be considered a power to revoke.” See PLRs 200537004 and 200522012.

Trust as Beneficiary Beneficiaries must be identifiable and all must be individuals: Reg §1.401(a)(9)-4 Q&A 5(b)(3) • “The beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the employee's benefit are identifiable within the meaning of A-1 of this section from the trust instrument.” • “A designated beneficiary need not be specified by name in the plan or by the employee to the plan in order to be a designated beneficiary so long as the individual who is to be the beneficiary is identifiable under the plan. • “The members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible, to identify the class member with the shortest life expectancy.”

Retirement Planning