St Cloud Attorneys

by Kevin A. Spellacy

January 5, 2012

I.          IRA Distribution Planning Considerations – an Overview

            A.        Objectives of the Regulations

IRA and qualified plan assets represent a substantial share of the wealth of individuals and couples.  Planning for the distribution of benefits from these plans during and after the client’s life is an important aspect of the estate planning process.  These materials describe the rules, which govern required minimum distributions and will address recurring planning issues and opportunities. 

In 2002, the IRS issued final retirement plan distribution regulations which eliminated many of the problems with the earlier regulations.  The regulations and the statutes upon which they are based reflect a determination by Congress to collect income taxes from IRAs[1] and qualified plans over a period determined by the life expectancies of identifiable individuals.  A common theme which runs through the rules, accordingly, is that the burden is upon the owners of IRAs and their beneficiaries to make elections and designations which allow the IRS to identify beneficiaries with precision and determine their life expectancies so that the income tax “pay back” period can be established. 

Another theme which runs through the rules is that Congress and the IRS have created special planning opportunities for surviving spouses which are not available to other persons who inherit IRA and retirement plan balances.  With proper planning, the surviving spouse has the opportunity to “step into the shoes” of the deceased owner of the IRA.

            B.        Employer Retirement Plans

Congress recognizes that employer provided retirement plans play a crucial role in the American retirement system.  While the new IRA minimum distribution rules provide opportunities to stretch IRA balances, the regulations do not require employers to incorporate those rules in their qualified plans.  Most employers will not amend their qualified plans to allow the families of deceased employees to stretch out their plan balances because of the costs, administrative problems and potential legal liability associated with long term administration of the required minimum distribution rules.  Departing employees or their spouses are almost always better off rolling their plan balances into a rollover IRA as soon as they are permitted to do so under the provisions of the employer plan. 

            C.        Importance of Designated Beneficiary Planning

The centerpiece of effective IRA distribution planning is the preparation of an effective beneficiary designation document which will allow the client and her family to maximize the opportunities afforded by the regulations by having a designated beneficiary.  In many cases, effective IRA distribution planning which results in a designated beneficiary recognized by the IRS and the use of IRA stretch opportunities may provide more financial security for a client and his or her family than any other estate planning activity.

            D.        Some Definitions

A few definitions are in order.  Unless otherwise noted, the following materials treat employer retirement plans and IRAs interchangeably and they will be referred to as IRAs. 

• The owner of the IRA is the “participant”.  A surviving spouse who takes advantage of his right to rollover a deceased participant’s IRA is treated as the “participant” of his new rollover IRA. 

• “Beneficiaries” inherit a participant’s IRA and are relegated to minimum distribution rules which are substantially less flexible and favorable than those available to the participant.

• While a beneficiary designation document may have the ingredients to allow a participant and his family to obtain the maximum “stretch” opportunities afforded by the rules, whether that actually occurs depends upon whether the IRA has a designated beneficiary by the designated beneficiary deadline imposed by the rules. 

• The “required beginning date” (RBD) is the date which establishes the year when the mandatory distributions to the participant must commence. 

• The mandatory distributions are referred to as “required minimum distributions” (RMD). 

II.         Required Minimum Distribution Rules Overview.

            The IRS regulations offer a simple method for calculating required minimum distributions to participants and their beneficiaries.  Set forth below is a basic statement of the rules: 

                        A.        Distribution Penalties.

Subject to certain exceptions, an individual under 59 ½ who wants to withdraw money from his or her IRA faces a 10 percent penalty which is imposed on early withdrawals.  Code §72(t).  The 10 percent penalty is calculated on the portion of the distribution which is includable in gross income.  Code §72(t)(1).  Another penalty tax is imposed in each distribution year if a participant does not withdraw the required minimum distribution; it equals to 50 percent of the amount of the shortfall between the actual distributions taken and the required minimum distribution for that year.  Code §4974.

                        B.        Required Beginning Date.

A participant who has attained age 59½ may withdraw money from his or her IRA in any amount without penalty up to the year when the participant reaches age 70½. The year when the participant attains age 70½ is the first distribution year in which he or she must withdraw a required minimum distribution.  The participant is allowed to delay the date of that first required minimum distribution until April 1 of the year following the year that participant attains age 70 ½.  Reg. §1.408-8, Q&A-3.  Therefore, the participant has a choice to take his or her first required minimum distribution on December 31 of the year the participant attains 70 ½ or by April 1 of the following year.  The required minimum distribution must be taken by December 31 of each year thereafter.  A participant who delays the first required minimum distribution until April 1 of the following year will have to take two distributions in that second year (on April 1 and December 31).  There may be income tax bracket planning reasons for a participant to delay taking the first RMD.

                       C.        Calculating the Required Minimum Distribution (RMD).

(1)       RMD requirements during the participant’s life.

(a)       With a limited exception, all participants use the following Uniform Lifetime Table to compute their RMD for each Distribution Year:  Reg. §1.401(a)(9) – 9,A-2. The Uniform Lifetime Table is set forth on page 19.

(b)       To compute the RMD, the participant needs to know the value of his or her IRA on December 31 of the preceding year and the applicable divisor from the Uniform Table. The participant divides the preceding year December 31 balance of his IRA by the divisor next to the participant’s age, and the result is the RMD for the distribution year.  Reg. §1.408-8 Q&A-6. During the following year the participant goes through the same process and uses the divisor applicable to his age during that year.

(c)       The RMDs permitted by the Uniform Table are the result of using a divisor for each age based on the joint life expectancy recalculated each year for the participant and a hypothetical surviving beneficiary who is 10 years younger. Because the divisor is recalculated on that basis each year, withdrawal of RMDs should never exhaust the IRA during the participant’s life if the participant withdraws no more than the required minimum distribution. If a participant is currently withdrawing under the pre-2002 rules, she should consider reducing the distribution to the smaller amounts permitted under the new table.

(d)       The one exception to the use of the Uniform Table applies if the participant’s spouse is more than ten years younger than the participant; in that case the participant is permitted to use the longer distribution period measured by the actual joint and survivor life expectancy of the participant and the spouse.  Reg. §1.401(a)(9) – 5, A-4(b).

(e)       A participant is entitled to use the Uniform Table and achieve a lifetime distribution period regardless of whether his beneficiary designation documents qualify as a designated beneficiary.

(2)       RMD rules after a participant dies – beneficiary rules.

The distribution period which will be applied to beneficiaries after the participant dies depends upon whether the participant’s beneficiary designation documents qualify as a designated beneficiary. The following is a summary of the differing outcomes depending upon whether the beneficiary designation documents qualify as a designated beneficiary.

(a)       The participant’s beneficiary documents do not qualify as a designated beneficiary - If the participant died prior to the year in which she would have attained 70½ and if her beneficiary designation documents fail to qualify as a designated beneficiary, her non-spousal individual beneficiaries[2] must cash in the IRA death benefit in its entirety by December 31 of the year which is the fifth anniversary of her death. This is the five year rule. It is the worst potential outcome under the required minimum distribution rules and results in the least amount of after-tax dollars for the participant’s beneficiaries.

If the participant’s documents fail to qualify as a designated beneficiary and if he dies after attaining age 70½, any share of the IRA death benefit designated for non-spousal individual beneficiaries must be distributed in annual installments over the participant’s remaining life expectancy using the Single Life table which is reproduced as exhibit B.  This table prescribes a substantially shorter distribution period then the Uniform Lifetime table which was used by the participant while he was living.  The outcome which occurs when a participant dies after attaining age 70½ without a qualifying designated beneficiary is more lenient than the five year outcome prescribed in the preceding paragraph. The remaining life expectancy, under the Single Life table, of a participant who died at age 73 is 15 years. The beneficiaries will have an extra ten years to cash in the IRA death benefit, but the distribution period is, nevertheless, substantially shorter than would be the case if the participant’s documents qualify as a designated beneficiary.

(b)       The participant’s documents qualify as a designated beneficiary - if the participant’s beneficiary designation document qualifies as a designated beneficiary, any non-spousal individual beneficiaries who are designated by the participant in her beneficiary designation document may take the IRA benefit over a distribution period determined by the life expectancy of the oldest individual in the group, using the Single Life table, unless one or more of the individuals effectively separates his or her share.  Each individual beneficiary who successfully separates his or her share may use his or her own life expectancy under the Single Life Table.[3] 

(c)       If the participant’s beneficiary designation document qualifies as a designated beneficiary, the starting point for a non-spousal beneficiary determination of his required minimum distributions involves determining his or her life expectancy under the Single Life table, set forth on page 20. This is a one-time determination. It is based upon the non-spousal beneficiary’s age during the year following the year in which the owner died.

The non-spousal beneficiary shall determine his life expectancy during the first distribution year (the year after the year when the participant died) from the Single Life table. He thereafter divides his inherited IRA account balance which existed at the end of the preceding year by his life expectancy divisor taken from the Single Life table. In the second distribution year, the non-spousal beneficiary reduces his divisor by one. He thereafter divides the prior year end IRA account balance by the new divisor number, and so on.

For example, Jack attains age 55 during the year following the year of his father’s death. His life expectancy number under the Single Life table is 29.6. If the balance of his inherited IRA at the end of the preceding year is $100,000, Jack’s resulting required minimum distribution during his first distribution year is $3,378. Jack’s divisor during his second distribution year will be 28.6, and he will divide his balance at the end of the prior year by 28.6; during the following third year it will be reduced to 27.6, and so on.

(d)       The above required minimum distribution rules carry out the policy of the IRS to collect deferred tax dollars after the death of the participant over the life expectancy of identifiable individuals, based upon the Single Life table.  The Uniform Life table, used for participants while they are living, reflects a liberalized policy by the IRS to reduce required minimum distributions and essentially eliminate the risk that a participant or his spouse (who rolls over the IRA after the participant dies) might out live his IRA.  The rules applicable to non-spousal beneficiaries are not as liberal as those which apply to participants and their spouses. Non-spousal beneficiaries will, generally, exhaust their inherited IRAs as they approach age 85.  They would benefit from a plan which involves re-investing the after-tax portion of the RMD’s which they took during years when the RMDs were not needed for annual living expenses.

            III.       Determination of Designated Beneficiary.

A.        What do we mean by designated beneficiary?

(1)       IRA custodians and employer plan sponsors maintain beneficiary designation documents for the participant.  If she fails to make a designation, the plans often have default provisions which may specify “issue” or “estate”.  The mere fact that a participant has filled out a beneficiary designation document does not mean that it will qualify as a designated beneficiary under the required minimum distribution rules.  The designated beneficiary qualification reflects, as noted above, the policy of Congress and the IRS to require that IRA benefits be distributed to identifiable, living individuals over a period which does not exceed their life expectancies.  The designated beneficiary qualification, accordingly, is the key to the IRA minimum distribution rules which allow participants and beneficiaries to stretch out the tax deferral of IRAs for the longest period available under the rules. 

(2)       A designated beneficiary must be an individual or a group of individuals. Code §401(a)(9)(E).  Entities, such as estates, charities, or corporations cannot qualify as a designated beneficiary because they do not have life expectancies. A trust, is, likewise, not an individual and cannot be a designated beneficiary. However, beneficiaries of certain types of trusts described later in these materials may be treated as designated beneficiaries.  Reg. §1.401(a)(9)-4, Q&A5 and 6.   If a deceased participant named her estate, a charity, a corporation, or some entity other than an individual or group of individuals as her beneficiary, and if any of these entities retains a share of the IRA death benefit after the designated beneficiary deadline, the participant is treated as having no designated beneficiary and the benefits must be distributed by the end of the fifth year after her death or over her remaining life expectancy, depending upon whether the participant died before or after the year when she attained age 70½.

(3)       The old minimum required distribution rules imposed a harsh cut-off date for the determination of designated beneficiary which was the participant’s required beginning date.  A defective beneficiary designation document could not be salvaged after that date.  The rules finalized in 2002 allow the participant to cure a defective beneficiary designation document with new documents at any time up to his death.  If the participant named at least one individual in the beneficiary designation document, that beneficiary will have the opportunity to stretch out her share of the IRA benefit, if the beneficiary designation document is “cleaned up” on or prior to the designated beneficiary deadline set forth below through distributions to or disclaimers by non qualifying entities.  See Section B immediately below.

B.        Determination of designated beneficiary – deadline and salvage.

(1)       The designated beneficiary deadline - To qualify as a designated beneficiary, one or more individuals must be identified in the beneficiary designation documents on the date of the participant’s death and on September 30 of the year following the year of the participant’s death.   Reg. §1.401(a)(9)-4, A-4(a).  Importantly, no one can be added as a beneficiary after the participant’s death, but one or more of the non-qualifying beneficiaries can be removed before September 1 of the year following the year of the participant’s death.

(2)     Opportunity to “clean up” and salvage a potentially defective beneficiary designation document - The rules provide a major planning opportunity following the death of a participant, if the participant named at least one individual.  Non-qualifying beneficiaries, such as charities, or other entities may be removed from the beneficiary designation during the period running from the date of the participant’s death to September 30 of the year following the year of the participant’s death. Following is a list of some of the actions which may be taken to salvage a beneficiary designation document so that the IRA will have a designated beneficiary. 

(a)       An individual will be removed as a beneficiary if she has received full distribution of her share of the IRA death benefit.

(b)       An individual will be removed as a beneficiary if he disclaims his interest in the IRA death benefit.

(c)       If the participant named a charity, partnership, corporation or a non-qualifying trust among the group of beneficiaries, those entities may be cashed out or may disclaim their shares prior to the designated beneficiary deadline.

(C)      Multiple individual beneficiaries – stretch rules

(1)       If the beneficiary designation document includes multiple individuals and, as of the designated beneficiary deadline, does not include any prohibited entity, the IRA will be treated as having a designated beneficiary.  The individuals will draw their benefits over a distribution period determined by the life expectancy of the oldest individual in the group, unless they establish separate accounts.  Reg. §1.401(a)(9)-8, A-2(a). 

(2)       The deadline for establishing separate accounts is December 31 of the year following the year in which the participant died.  Importantly, the beneficiary designation document must specify that each individual receives a fractional or a percentage share of the benefit.  If an individual’s share is expressed in dollars, e.g. $10,000, that individual must be cashed out or disclaim prior to the designated beneficiary deadline or the group will not be able to separate themselves and establish separate accounts. 

(3)       The rules are unclear about what steps an individual must take to establish her separate account but it is reasonably safe to say that the best approach for each individual is to fill out and file, with the custodian, the forms furnished by the custodian to establish her separate account.

(4)       Multiple individual beneficiaries who fail to separate their shares prior to the December 31 deadline set forth above may still separate their shares after the deadline if they wish – however, all individuals who failed to separate their shares will be treated as a group and each of them will have the applicable distribution period determined by the life expectancy of the oldest individual in the group. 

IV.       Special Rules for the Participant’s Surviving Spouse.

A participant’s surviving spouse enjoys special protection under the rules.  Following is a list of provisions available to spouses.

A.        If the participant names her surviving spouse as a beneficiary for all or an identifiable share of the IRA death benefit, the surviving spouse may rollover his share of the death benefit to a new IRA in his own name. A rollover confers the following benefits.

(1)       A surviving spouse who is under age 70½ at the time of the rollover may postpone taking distributions from her rollover IRA until she reaches her required beginning date. Until such time that surviving spouse rolls over his or her inherited IRA, he or she will be subject to the non-spousal rules governing the required beginning date.

(2)       If surviving spouse rolls over his share of the IRA death benefit to a new IRA, the required minimum distributions for the surviving spouse (after he reaches his own required beginning date) are calculated by using the same Uniform Lifetime Table which was used by the participant.

(3)       A surviving spouse who rolls over her share of the IRA death benefit to a new IRA can establish her own designated beneficiary, which allows a new round of IRA distribution planning, including, possibly, shares for children, grandchildren, etc.  Beneficiaries other than the surviving spouse may designate someone who will receive the beneficiary’s remaining share of the death benefit in the event of the beneficiary’s death, but all benefits will continue to be paid over the life expectancy of the beneficiary.  A surviving spouse who rolls over an IRA has the opportunity to stretch out the IRA death benefit over a much longer period than that of a non-spousal beneficiary.

B.        Timing of the Rollover - A surviving spouse does not have a rollover deadline but there are practical reasons to proceed promptly.  First, the surviving spouse may die before completing the rollover.  Secondly, if the participant reached his required beginning date prior to his death, his spouse will have to take the initial minimum required distribution in the year following the participant’s death and every year thereafter until such time that she completes the rollover. 

C.        A surviving spouse is not required to rollover an IRA which he or she inherits from the participant. Instead, the surviving spouse may draw the IRA death benefit from the participant’s IRA as the beneficiary of that IRA.  If the surviving spouse chooses this course, he will use a special table for calculation of minimum required distributions which is less favorable than the Uniform Lifetime table which is available if he rolls over the IRA but which is more favorable than the Single Life table which must be used by non-spouse beneficiaries. 

D.        The optimal IRA distribution plan, in almost all cases, involves a spousal rollover. 

            V.        Non Spousal Beneficiary Rollover.

The Pension Protection Act of 2006 (Act) enacted IRC 402(c)(11) closes an existing gap in qualified retirement distribution planning for single employees who die prior to separation from their employer.  Prior to the enactment of Section 402(c)(11), the beneficiaries of such employees had no opportunity to rollover their share of the employee’s plan balance to an inherited IRA.  Section 11 of the Act allows this opportunity.  Following are the requirements:

A.        The employer must transfer the deceased employee’s plan balance directly to an individual retirement plan established in the name of the deceased employee for the benefit of the beneficiary. 

B.        The inherited individual retirement account required minimum distribution rules will be applied.  See RMD rules after a participant dies – beneficiary rules at page 4 of these materials. 

C.        The participant’s beneficiary designation documents must be sufficient to qualify as a designated beneficiary.  See designated beneficiary rules at page 7 of these materials.

D.        Irrevocable trusts which comply with the “look through” rules may be used.  See Section VI below. 

VI.       Naming Irrevocable Trusts as Beneficiaries.

A.        Only individuals may be treated as designated beneficiaries.  While a trust itself will not be treated as a designated beneficiary, the individuals who are beneficiaries of that trust may be treated as designated beneficiaries if certain requirements, referred to as the “look through” rules, are met.  Reg. §1.401(a)(9)-4,Q&A-6.  These rules are complex and care must be taken to assure that the trust complies with the rules or there will be no designated beneficiary.  The rules may be generally stated as follows:

(1)       The trust is a valid trust under state law.

(2)       The trust is irrevocable or it will become irrevocable upon the death of the employee.

(3)       The beneficiaries of the trust are identifiable from the trust instrument.

(4)       The employer retirement plan administrator or the IRA custodian receives the required documentation concerning the trust and its beneficiaries by October 31 of the year following the year of the participant’s death.               

B.        Special Trust Planning Issues. 

Naming a trust as the beneficiary of an IRA can be problematic, because all of the current and remainder beneficiaries of the trust who could possibly receive any of the retirement benefits must be identifiable individuals.  A class of individuals may be named, e.g. “my descendants”, but the individual with the shortest life expectancy must be identifiable.  Moreover, the IRS will consider all current and remainder beneficiaries to determine whether they are individuals and to identify the individual with the shortest life expectancy which will establish the distribution period for the trust.

(1)       The Problem. 

Naming a charity or a charitable remainder trust as a trust beneficiary (even a contingent remainder beneficiary) can cause the trust to fail the definition of designated beneficiary because the trust beneficiaries are not all individuals.  If the trust grants a beneficiary a power to appoint trust distributions to charitable organizations, to individuals older than those already named in the trust or to another trust, the trust beneficiaries may also fail the definition of designated beneficiary, because the beneficiaries are not all identifiable from the trust instrument and the IRS will not be able to identify the individual with the shortest life expectancy.  Accordingly, there is a high likelihood that the trust will flunk the “look through” rules and the participant’s IRA will have no designated beneficiary. 

            The regulations provide a narrow window for relief from the problems set forth in the preceding paragraph through a rule which provides that successor (remainder) beneficiaries will be ignored by the IRS if the trust instrument includes “conduit” language described in the following subparagraph (2).  Without such language, the drafter of the trust can never be certain whether she has adequately identified every possible remainder beneficiary with sufficient precision so that the beneficiary’s life expectancy can be determined.  A trust with remainder beneficiaries (almost all trusts have these!) will usually flunk the designated beneficiary rules.

(2)       The Solution – Use a Conduit Trust as a safe harbor. [4]

Treasury Regulation §1.401(a)(9)-5,A-7(c)(3) Example 2 provides a safe harbor that guarantees that a trust’s beneficiaries will qualify as designated beneficiaries for purposes of using their life expectancies to stretch the taxation of the IRA benefits.  This safe harbor is known as a “conduit trust” and requires that the trustee withdraw the RMD from the IRA over the life expectancy of the individual trust beneficiary (or the oldest of a group of trust beneficiaries) and distribute such RMD out to the trust beneficiary or beneficiaries each year.  When conduit language is included in the trust instrument, the remainder beneficiaries are disregarded.  This gives the settlor of the trust the opportunity to provide for a charity (or charities) as a remainder beneficiary or grant trust beneficiaries powers of appointment without disqualifying the trust beneficiaries from designated beneficiary status. 

(3)       Multiple Beneficiary Rule and Separate Account Rule Applied to Trusts. 

The separate account rules under Reg. §1.401(a)(9)-8,A-2 are not available when a trust is named as beneficiary of an IRA, even if the trust instrument divides its property into shares for multiple beneficiaries and holds them in separate trusts.  Reg.  §1.401(a)(9)-4,A-5(c).  In such cases, the life expectancy of the oldest trust beneficiary must be used for RMD purposes.       

(4)       Planning Opportunities With Trusts. 

Trusts can play an important role in IRA distribution planning if the following drafting techniques are employed:

(a)       The beneficiary designation document must identify the individual or classes of individuals who will receive fractional or percentage shares of the death benefit.

(b)       The beneficiary designation document must provide that shares otherwise payable to certain individuals, for example, those who have not attained a certain age, shall instead be distributed to the trustees of a trust. 

(c)       The trust instrument must include a “conduit” provision which requires that each required minimum distribution shall be distributed, annually, to the beneficiary or group of beneficiaries, as applicable.

VII.      Charitable Planning.

A.        If a participant designates a charity as the beneficiary of a portion (or all) of his or her IRA death benefit, such a designation will have no effect on the participant’s lifetime RMDs because the participant is allowed to use of the Uniform Table in all cases.  

B.        When a charity is the participant’s sole beneficiary, the IRA will be considered to have no designated beneficiary on the participant’s death.  As a practical matter, because charities are tax-exempt, most will wish to take a lump sum distribution of their entire interest in the participant’s IRA as soon as possible.

C.        When one or more charities (including charitable remainder trusts) are named on the beneficiary designation documents as beneficiaries along with one or more individuals, the best way to avoid RMD requirements under the no designated beneficiary rules is for the participant, prior to her death, to establish separate IRAs for the charitable and the individual beneficiaries. If a single IRA is preferable, the charitable beneficiaries should be cashed out before September 30 of the year following the year of the participant’s death so that only individual beneficiaries remain. 

D.        A charitable remainder unitrust (CRT) may, under some limited circumstances, provide a longer payment period than the liberalized IRA rules.  A participant may name a CRT as the sole beneficiary of his IRA.  On the other hand, the participant may designate the CRT as one of several beneficiaries on his beneficiary designation document with the expectation that the share of the IRA allocated to the CRT will be distributed to the CRT prior to September 30 of the year following the year of his death.  See subpart C above.  After the participant’s death, the IRA will be distributed to the CRT in an income tax free transaction because the CRT is a tax exempt entity.  The required minimum distribution rules do not apply to the CRT.  Instead, the CRT is governed by the statute and regulations applicable to such trusts. 

The CRT may name one or more living individuals who will receive annual distributions from the CRT during their lives, i.e. to “John for life, and after his death, to Jean for her life.”  The CRT, under some circumstances, may provide a longer stretch than the IRA for the stretch period of the IRA, following the death of the participant, is limited to the life expectancy of the oldest beneficiary.

E.         A one or more charities could be named as remainder beneficiaries of a conduit trust. See VI, B(2) on page 13 above.

            VIII.     Roth IRAs. 

A.        The participant of a Roth IRA does not have to take required minimum distributions during her lifetime.  Accordingly, her Roth IRA can grow income tax-free until the death of the participant. 

B.        Distributions from a Roth IRA are excluded from income of the participant if they occur at least five years after contributions to the Roth IRA began and at least one of the following four criteria are met:

            (1)       The participant is at least 50½ years old;

            (2)       The participant has died;

            (3)       The participant has suffered a disability; or

            (4)       The distribution is used to pay qualified first time home buyer expenses. 

C.        After the death of the participant, the minimum distribution rules apply. If a spouse inherits the Roth IRA, he may use the special “in-between” life expectancy table or the spouse may rollover the balance to a new Roth in the spouse’s name.  Other beneficiaries must withdraw the balance of the Roth over the life expectancy of the oldest individual beneficiary, using the standard table.

            IX.       Use of an IRA for Estate Tax Planning.

A married couple with a combined estate of sufficient size to be subject to estate taxes which includes a substantial IRA presents a special estate tax/income tax planning challenge.  The essential ingredient of basic estate tax planning is the maximum use, by each spouse, of his and her applicable credit amount, and this is often accomplished through the use of a credit shelter trust for the surviving spouse, and the children.  Following is a discussion of competing considerations.

A.        The primary goal is the surviving spouse’s financial security and well being. 

B.        A second goal is the maximum utilization of the applicable exclusion amount of the first spouse to die through the use of a credit shelter trust for the benefit of the surviving spouse, and possibly, descendants.

C.        A third goal is maximum income tax deferred growth of the IRA which is accomplished by having the surviving spouse receive the IRA outright so that he can roll the IRA over to a new IRA and name children or grandchildren.  As the participant of his new IRA, surviving spouse is allowed to use the uniform table and therefore achieve maximum income tax deferral and growth of the IRA. 

D.        The second and third goals conflict with each other.  Achievement of maximum estate tax savings (where the IRA is a significant asset for one or the other spouse) require funding the credit shelter trust with all or a substantial part of the IRA.  The trust may comply with the designated beneficiary “look through” rules if appropriate “conduit” language is used, but the annual required minimum distributions will have to be calculated using the shorter standard table, based upon the spouse’s life expectancy.  The result is a significant loss of income tax deferred growth for the IRA.  On the other hand, outright distribution of the IRA to surviving spouse may result in the failure to effectively use the estate tax credit of the first spouse to die, thus incurring a substantial estate tax on the death of the second spouse.

E.         A determination of the best overall IRA growth/estate tax result for families with estate tax exposure requires a complex series calculations to determine the total tax burden to the family, taking into account the income tax deduction for federal estate tax paid and the comparative amounts of wealth available to the family if estate tax avoidance (with less IRA growth) or maximum IRA growth (with estate tax exposure) are the alternative objectives. 

F.         It is probably not possible to predict the best course of action for a participant and his family prior to the death of the participant.  Accordingly, the best planning approach is the use of a beneficiary designation document which provides that the IRA benefit shall go, in the following order:  (1) to the trustee of the participant’s revocable trust (so that all or part of the IRA may be used to fund the credit shelter trust, if that is the best course), (2) to the surviving spouse, and (3) to the participant’s descendants. 

The trustees will be in a position to evaluate the family tax circumstances and disclaim all or a part of the IRA balance if it is not needed for estate planning purposes.  The surviving spouse will receive the IRA balance disclaimed and can then exercise the full range of income tax saving options available to him or her. 

Disclaimer

These materials are intended to provide good information, rather than specific legal advice.  Readers should not act upon any information without professional counsel. 

If you have questions concerning the information provided, please feel free to contact Kevin Spellacy at (320) 251-1414 or kspellacy@quinlivan.com

Exhibit A

Uniform Lifetime Table

Exhibit B

Single Life Table

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