Life and Death Planning for Retirement Benefits

294

Life and Death Planning for Retirement Benefits

is higher than zero; then his choice is between a deductible traditional IRA contribution (which could save him some current income taxes) and the nondeductible Roth IRA contribution. He should consider the factors discussed at ¶ 5.8.01 – ¶ 5.8.04 in making this choice. B. Traditional CODA account vs. DRAC. Which participants in a cash-or-deferred arrangement (CODA) plan should choose the DRAC (¶ 5.7) ? By choosing the DRAC, the individual gives up the immediate tax savings of having the contribution excluded from his income in exchange for the hope of tax-free distributions later. The choice could be made considering whichever of the factors listed in ¶ 5.8.01 – ¶ 5.8.04 are applicable. Eric Example: Eric has a choice of building his savings either inside or outside retirement plans. He prefers to maximize his savings inside tax-favored retirement plans, because he believes such savings are safer from potential creditors and from his own tendency to overspend. He also finds investing easier inside a retirement plan, because there is no need to track the cost basis and holding period of each investment. He figures that by contributing $15,000 to a traditional 401(k) he’s really stashing away only about $10,000, because (based on his income tax bracket) the plan “owes” the government roughly 33 percent income tax on the contribution. He will have to pay that “debt” when he withdraws money from the traditional plan. With a Roth account, he is in effect increasing his plan contribution. Contributing $15,000 to a Roth plan is equivalent to contributing $22,500 to a traditional plan. Here are matters the estate planner needs to consider in connection with a client’s Roth plans or conversions. Note: Though qualified distributions from Roth IRAs and DRACs are exempt from income tax, these accounts are not exempt from estate tax; they are includible in the participant’s gross estate just as traditional plans and IRAs are (see ¶ 4.3 ). A. Choice of death beneficiary. Roth benefits generally should not be left to charity; there is no point in prepaying the income taxes on money being left to a tax-exempt entity. This principle may require an individual who participates in a CODA plan to designate different beneficiaries for his DRAC and traditional accounts in the plan. See Form 3.7, Appendix B . A Roth plan could ease the problems of leaving retirement benefits to a “qualified domestic trust” (QDOT; § 2056A ) for the benefit of a noncitizen spouse, as compared with leaving traditional (taxable) benefits to such a trust. Many of the problems of leaving traditional retirement benefits to a trust for a noncitizen spouse arise from the fact that such benefits are taxable as income in respect of a decedent; see the Special Report: Retirement Benefits and the Marital Deduction (Including Planning for the Noncitizen Spouse) ( Appendix C ). The Roth plan eliminates this problem. By leaving Roth plan death benefits (rather than traditional plan death benefits) to his grandchildren (or to a “see-through trust” for their benefit), the participant gives his beneficiaries the advantage of long-term tax-free investment accumulations and does not “waste” any of the GST exemption (see ¶ 6.4.07 ) paying income taxes. For economic advantages of a “stretch” payout of a retirement plan to young beneficiaries, see ¶ 1.1.03 ; for how to achieve a stretch payout for a trust named as beneficiary, see ¶ 6.2 – ¶ 6.3 . Roth plans and the estate plan