Life and Death Planning for Retirement Benefits

Chapter 5: Roth Retirement Plans

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Whenever a client is leaving retirement benefits to a trust that is likely to accumulate some of the plan distributions, be aware that a trust goes into the highest income tax bracket (and will become subject to the 3.8% investment income “surtax”; ¶ 2.1.02 ) at a very low level of taxable income (see ¶ 6.5.01 ). If the client can prepay the income tax at a lower rate by converting the plan to a Roth IRA that option should be considered. Using a Roth IRA to fund a credit shelter trust for the life benefit of the participant’s surviving spouse, or a QTIP trust, does not make best use of the Roth IRA, for the following reason. The way to maximize the tax-free accumulation in a Roth IRA is to leave it outright to the participant’s surviving spouse, who then rolls it over to her own Roth IRA and takes no distributions from it during her lifetime. At her death she leaves it to a younger beneficiary for a stretched-out tax-free life expectancy payout. This approach allows total accumulation of all earnings inside the tax-free Roth as long as either spouse is living, with a life expectancy payout to a younger beneficiary after both spouses’ deaths. In contrast, the longest distribution period possible for a Roth IRA left to a trust for the benefit of the spouse is the spouse’s life expectancy; the account will be distributed over her life expectancy (not accumulated during her lifetime), and be reduced to zero at the end of her li fe expectancy. See ¶ 3.3.02 (B). B. Document changes needed to anticipate Roth conversion. The client’s durable power of attorney should give the power-holder the power to convert any traditional plan or IRA to a Roth IRA and to recharacterize any IRA contribution made by the client. See Form 5.1, Appendix B . Since the client’s executor may have the power to recharacterize a Roth conversion made by the client (see ¶ 4.1.02 ), the client’s estate planning documents may need to be amended to guide the executor or facilitate (or inhibit) a post-mortem recharacterization. Consider:  Including in the will an equalizing bequest to the Roth IRA beneficiary to compensate him for loss of the account’s tax-free status if the executor recharacterizes.  Including in the beneficiary designation form language that will prevent the Roth IRA beneficiary from blocking the executor’s recharacterization of a Roth conversion.  Giving the executor instructions, guidance, and/or protection regarding the recharacterization decision. Approaches that various practitioners have suggested include requiring recharacterization if the account value drops by more than certain percentage (and forbidding it otherwise), or requiring recharacterization if requested by certain beneficiaries. See Form 5.3, Appendix B . C. Gifts with Roth IRAs. Depositing money in a Roth IRA for teenage children, grandchildren, etc., has appeal as a gifting technique if the young family members have summer or after-school jobs that generate compensation income on which an IRA contribution can be based. The projections of what a $5,000 contribution will grow to by the time the 15-year-old child reaches age 65 can be staggering. What gives pause is that there is no way to prevent the donee from taking the money out of the account once he reaches the age of majority.