Magazine article The CPA Journal

Estate Planning for Retirement Benefits

Magazine article The CPA Journal

Estate Planning for Retirement Benefits

Article excerpt

Estates consisting largely of retirement benefits are often difficult to plan because of the inherent tension between income tax planning and estate tax planning. Given the extremely complex rules governing qualified plans and IRA distributions, careful consideration should be given to the plan owner's wishes in choosing plan beneficiaries as well as the structure of the estate plan.

The Spouse as Beneficiary

The simplest and most common approach is to name the taxpayer's spouse as beneficiary, which allows the spouse to roll the benefits over into her own IRA, defer both the income and estate taxes, elect new beneficiaries, select a new payout method, and potentially convert to a Roth IRA.

Indeed, there are numerous private letter rulings in which someone other than the spouse was the beneficiary, and the interested parties attempted, sometimes successfully and sometimes unsuccessfully, to get the IRA to the spousethrough disclaimer, intestacy, elective share, community property, or an estate or trust-so that the spouse could do a rollover.

The QTIP Trust as Beneficiary

Take the example of Vincent, who wants his wife, Wendy, to receive the income from his IRA but does not want her to manage it or to control the ultimate disposition of the principal. Instead, he wants to preserve the principal for his children. As with his other assets, Vincent can leave his IRA benefits to a qualified terminable interest property (QTIP) trust.

The trustees of the QTip trust will take distributions from the IRA based upon the usual IRA distribution rules, generally over Wendy's life expectancy. However, if Vincent has reached his life expectancy and has been using the term certain formula for his life expectancy, then distributions would be made over Vincent and Wendy's joint and survivor life expectancy. If Wendy is more than 10 years younger than Vincent, then the minimum distribution incidental benefit (MDIB) rules with respect to the children may apply. The QTIP strategy achieves some income tax deferral, although not as much as if Vincent left his IRA to Wendy and she rolled it over into her own IRA.

Wendy must be entitled to all of the income of the trust. If the internal income of the IRA exceeds the minimum required distribution (MRD), which is most likely to occur if she is young or the IRA is invested largely for income, Wendy may be able to roll the excess over into her own IRA (PLR 9649045; contra, PLR 9145041). Alternatively, if the trust permits, the trustees can retain the excess income in the IRA, unless Wendy demands that the trustees withdraw the income from the IRA and distribute it to her.

For fiduciary accounting purposes, the trustees must determine the amount of income to which Wendy is entitled. Ignoring any basis, all distributions from an IRA are treated as income for income tax purposes (IRC sections 72 and 408(d). For fiduciary accounting purposes, however, the trustees must distinguish between income and principal. In New Jersey and Florida, receipts from a qualified plan or IRA are principal except to the extent of interest or other income earned after death [N.J.S.A. section 3B:19A-lOa(3) and F.S.A. section 738.04(2Xc)]. In some states, 10% of each required distribution is allocable to income, unless a larger allocation is necessary to obtain the marital deduction [Uniform Principal and Income Act (1997) sections 409(b) and (c)]. New York law is silent on this point [N.Y. EPTL section 11-2.1(c)(2)].

Regardless of state law, a taxpayer leaving IRA benefits to a QTIP trust may wish to include unitrust or similar provisions in the QTIP trust.

The Credit Shelter Trust as Beneficiary

What happens when there are not enough nonretirement assets to fully fund the credit shelter trust? As the credit shelter amount increases and more people convert to Roth IRAs, using their other assets to pay the income tax on the conversion, this situation will occur more frequently. …

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