Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

property under state law, § 408(g) provides that § 408 (governing the tax treatment of IRAs) “shall be applied without regard to any community property laws.” Thus, even if the spouses are co- owners of the IRA under their state’s law, the Tax Court has ruled that distributions from the IRA are gross income of the participant only under federal income tax law. Angela C. Morris , TC Memo 2002-17; Bunney , 114 T.C. 259 (2000). A worker’s IRA can be recognized as community property belonging half to the worker’s spouse, but if the spouse transfers “her half” to an IRA in her own name the event is taxed as a distribution to the worker of the transferred half of the account. PLR 1999-37055. See also PLR 2009-23027 (IRA paid to alimony trust for participant’s spouse taxable to participant despite § 682 ) (“Income of an estate or trust in case of divorce”) and PLR 2016-23001 (interest in deceased husband’s IRA awarded to wife in satisfaction of community property rights was deemed a taxable distribution to the named beneficiary of the account, not to wife). Though retirement plan distributions are generally taxable to the participant or beneficiary who receives them as ordinary income ( ¶ 2.1.01 ), there are exceptions. Here are the situations in which a distribution may be wholly or partly tax-free or may be taxed more favorably than as ordinary income: A. Roth plans. Qualified distributions from a Roth retirement plan are tax-free. ¶ 5.2.03 , ¶ 5.7.04 . B. Tax-free rollovers and transfers . A distribution can be “rolled over” tax-free to the same or another retirement plan if various requirements are met. See ¶ 2.6 for rollovers by the participant, ¶ 3.2 for rollovers by the surviving spouse, and ¶ 4.2.04 for rollovers by other beneficiaries. See ¶ 2.6.07 for why certain IRA-to-IRA transfers are not taxable because they are not considered to be distributions at all. C. Life insurance proceeds, contracts. Distributions of life insurance proceeds from a QRP (after the participant’s death) are partly tax-free; distribution of a life insurance policy on an employee’s life to that employee may be partly tax-free as a return of basis. See the Special Report: When Insurance Products Meet Retirement Plans ( Appendix C ). D. Recovery of basis. If the participant has made or is deemed to have made nondeductible contributions to his plan account or IRA, these become his “basis” (investment in the contract) in the retirement benefits. This basis is nontaxable when distributed to the participant or beneficiary. See ¶ 2.2 . E. Special averaging for lump sum distributions . Certain QRP lump sum distributions of the benefits of individuals born before January 2, 1936, are eligible for reduced tax. ¶ 2.4.06 . F. Net unrealized appreciation of employer securities (NUA) . Certain distributions of employer stock from a QRP are eligible for deferred taxation at long-term capital gain rates rather than immediate taxation at ordinary income rates. See ¶ 2.5 . List of no-tax and low-tax distributions