Life and Death Planning for Retirement Benefits

242

Life and Death Planning for Retirement Benefits

his son Alex. Alex pays the federal estate tax of $897,500. The § 691(c) deduction goes to Jill because she received the IRD, even though Alex paid the estate tax.

IRD deduction for deferred payouts

Calculating the § 691(c) deduction is easy when the beneficiary receives a distribution of the entire benefit all at once, but what if the retirement benefit is distributed in installments over the life expectancy of the beneficiary? Clearly the deduction will also be spread out; but how much of the deduction is allocated to each payment? How much of each distribution represents “IRD” that was included in the gross estate, and how much represents income earned by the retirement plan after the date of death? When IRD is in the form of a joint and survivor annuity, the Code requires that the deduction be amortized over the surviving annuitant’s life expectancy and apportioned equally to the annuity payments received by the survivor. § 691(d) . No official source discusses the allocation of the deduction to nonannuity payouts, such as instalment payments. For discussion of possible alternative methods, see Christopher Hoyt articles cited in the Bibliography . For possible future developments in this area, keep an eye on regulations and rulings under § 2056A , where the question of which retirement plan distributions constitute IRD and which constitute post-death earnings is critical to application of the deferred estate tax on a “qualified domestic trust” (QDOT). Meanwhile, the method used by many practitioners could be called the “IRD comes out first” method: All distributions from the retirement plan are assumed to be coming out of the IRD (rather than out of the post-death earnings of the plan) until the § 691(c) deduction has been entirely used up. Jack Example, continued: In the Jack Example, assume that the total § 691(c) deduction was $427,600, which is 42.76 percent of the total $1 million IRA. Suppose the IRA has grown to be worth $1.2 million by the time Jill takes her first withdrawal of $30,000. She assumes the distribution comes entirely from the $1 million original principal of the IRA (from the IRD, in other words) and none of it from the $200,000 of post-death earnings, so Jill takes a deduction equal to 42.76 percent of her $30,000 distribution, or $12,801. She keeps doing this until she has received a total of $1 million of distributions from the IRA, at which point she has used up all of her $427,600 § 691(c) deduction. A beneficiary can “lose” his IRD deduction if the value of the inherited IRD declines. Suppose that, instead of increasing in value after his death, Jack’s IRA had declined in value from the $1 million used for estate tax purposes to just $400,000 a year after his death. Jill cashes out the IRA, receiving $400,000. It seems as if this distribution should be tax-free, because Jill was entitled to a $427,600 IRD deduction and she received only $400,000 total from the IRA ...but the IRD deduction doesn’t work that way. Jill is entitled to a deduction of only 42.76 percent of each distribution she receives. Her IRD deduction on the $400,000 IRA distribution is only $171,040. What happened to the rest of Jill’s IRD deduction? It just disappeared. After all, the purpose of the IRD deduction is to ease the pain of including the IRD in income. If the IRD ceases to exist due to a decline in value, the beneficiary does not suffer the pain of including it in income and so does not need the deduction. See IRS Publication 559, “Survivors, Executors and Administrators” (2009), page 12.