Life and Death Planning for Retirement Benefits

Natalie B. Choate

Life and Death Planning for Retirement Benefits

Digital Edition 2015

Life and Death Planning for Retirement Benefits

The Essential Handbook for Estate Planners

Seventh Edition, Revised 2011

Natalie B. Choate

Ataxplan Publications, Boston, Massachusetts

Updates for this book are published at our website:

www.ataxplan.com

Life and Death Planning for Retirement Benefits

The Essential Handbook for Estate Planners Seventh edition, completely revised By Natalie B. Choate

Published by: Ataxplan Publications Post Office Box 51371

Boston, Massachusetts 02205-1371

All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, or by any information storage and retrieval system without written permission from the author, except for the inclusion of brief quotations in a review.

Copyright © 2010 by Natalie B. Choate Printed in the United States of America

Publisher’s Cataloging-in-Publication Data Choate, Natalie B. Life and Death Planning for Retirement Benefits: The Essential Handbook for Estate Planners—7th ed. / Natalie B. Choate p. cm. Includes bibliographical references and index. ISBN 978-0-9649440-4-6 1. Estate planning - United States. 2. Tax planning - United States. 3. Retirement income - Taxation - United States. 4. Inheritance and transfer tax - United States. I. Choate, Natalie B. II. Title KF 6585 .C43 2010

To Ian

Warning and Disclaimer The rules applicable to qualified retirement plan benefits and IRAs are among the most complex in the tax code. I have read few works on this subject that were, in my view, completely accurate; in fact most that I have seen, including, unfortunately, earlier incarnations of this work, contain errors. Furthermore, even accurate information can become outdated quickly as IRS or Congressional policy shifts. Despite my best efforts, it is likely that this book, too, contains errors. Citations are provided so that practitioners can check any statements made in this book and reach their own conclusions regarding what the law is. This book is intended to provide general information regarding the tax and other laws applicable to retirement benefits, and to provide suggestions regarding appropriate estate planning actions for different situations. It is not intended as a substitute for the practitioner’s own research, or for the advice of a qualified estate planning or tax specialist. The author and publisher shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this book. About the author Natalie B. Choate is an attorney with the Boston law firm of Nutter McClennen & Fish. Her practice is limited to consultations on estate planning for retirement benefits. She has chaired the Boston Bar Estate Planning Committee, the Boston Bar Employee Benefits Committee, and the American College of Trust and Estate Counsel Employee Benefits Committee. The National Association of Estate Planners and Councils awarded her the “Distinguished Accredited Estate Planner” designation. She has published widely and lectured in 49 states (sorry Montana!). Her comments on estate and retirement planning have been quoted in The Wall Street Journal, Money, The New York Times, Newsweek, Forbes, Financial Planning and Financial World . A Boston native, Miss Choate is a graduate of Radcliffe College and Harvard Law School. If you do not wish to be bound by the above, you may return this book to the publisher for a full refund.

SUMMARY CONTENTS Introduction ................................................................................................................6 Abbreviations used in this book...............................................................................26 Chapter 1: The Minimum Distribution Rules .......................................................28 Chapter 2: Income Tax Issues...............................................................................91 Chapter 3: Marital Matters..................................................................................151 Chapter 4: Inherited Benefits: Advising Executors & Beneficiaries..................178 Chapter 5: Roth Retirement Plans ......................................................................226 Chapter 6: Leaving Retirement Benefits in Trust ...............................................278 Chapter 7: Charitable Giving ..............................................................................337 Chapter 8: Investment Issues; Plan Types ..........................................................387 Chapter 9: Distributions Before Age 59 ½ .........................................................407 Chapter 10: RMD Rules for “Annuitized” Plans..................................................423 Chapter 11: Insurance, Annuities, and Retirement Plans .....................................446 Appendix A: Tables ...............................................................................................471 Appendix B: Forms ................................................................................................474 Appendix C: Resources..........................................................................................497 Bibliography...........................................................................................................500

TABLE OF CONTENTS: DETAILED Introduction ................................................................................................................................. 24 Terminology Used in this Book .............................................................................................. 25 Abbreviations and Symbols .................................................................................................... 26 CHAPTER 1: THE MINIMUM DISTRIBUTION RULES .................................................. 28 1.1 I NTRODUCTION TO THE RMD R ULES ................................................................................. 28 1.1.01 Where to find the law........................................................................................................ 28 1.1.02 Which plans are subject to the RMD rules ....................................................................... 29 1.1.03 RMD economics: The value of deferral............................................................................ 29 1.1.04 WRERA suspended RMDs for 2009 ................................................................................ 30 1.1.05 RMDs under defined plans, “annuitized” DC plans ......................................................... 31 1.2 RMD F UNDAMENTALS ........................................................................................................ 32 1.2.01 The 12 Fundamental Laws of the RMD Universe ............................................................ 32 1.2.02 Which distributions count towards the RMD ................................................................... 34 1.2.03 Tables to determine Applicable Distribution Period (ADP)............................................. 35 1.2.04 What is a person’s “age” for RMD purposes? .................................................................. 36 1.2.05 How to determine “account balance” for RMD purposes ................................................ 37 1.2.06 How rollovers and RMDs interact .................................................................................... 38 A. Adjustment required for outstanding rollovers. .................................................... 38 B. Other rollover effects on balance. ......................................................................... 38 C. Effect of rollover on Required Beginning Date (RBD). ....................................... 38 D. Rollover can change applicable RMD rules. ........................................................ 38 1.2.07 Post-year-end recharacterization of Roth conversion ....................................................... 39 1.2.08 Valuation rules for determining account balance ............................................................. 39 1.3 RMD S D URING P ARTICIPANT ’ S L IFE ................................................................................. 40 1.3.01 Road Map: How to compute lifetime RMDs ..................................................................... 40 1.3.02 The Uniform Lifetime Table: Good news for retirees ...................................................... 41 1.3.03 Lifetime RMDs: Much-younger-spouse method .............................................................. 42 1.3.04 Taking distributions from multiple plans.......................................................................... 42 1.3.05 Separate accounts within a single plan ............................................................................. 43 1.4 T HE RBD AND F IRST D ISTRIBUTION Y EAR ........................................................................ 44 1.4.01 Required Beginning Date (RBD); Distribution Year........................................................ 44 1.4.02 RBD for IRAs and Roth IRAs .......................................................................................... 44 1.4.03 QRPs: RBD for 5-percent owner ...................................................................................... 44 1.4.04 QRPs, cont.: RBD for non-5-percent owner ..................................................................... 45 1.4.05 RBD for 403(b) plans (including “grandfather rule”)....................................................... 46 1.4.06 What does “retires” mean?................................................................................................ 46 1.4.07 RBD versus first Distribution Year: The limbo period..................................................... 47 A. If the first year’s RMD is postponed..................................................................... 47 B. No rollover or conversion until RMD has been taken .......................................... 47 C. Death during the limbo period .............................................................................. 47

Table of Contents

7

1.4.08 Grandfather rule: TEFRA 242(b) elections ...................................................................... 48 1.4.09 Effect of 2009 one-year suspension of RMDs .................................................................. 49 1.5 RMD S AFTER THE P ARTICIPANT ’ S D EATH ........................................................................ 49 1.5.01 Post-death RMD rules: Basics and overview.................................................................... 50 1.5.02 Road Map for determining post-death RMDs .................................................................. 50 Step 1: Gather basic information ...................................................................................... 50 Step 2: Gather specialized information............................................................................. 51 Step 3: Determine whether the participant died before .................................................... 51 Step 4: Are you computing the RMD for the year of death.............................................. 52 Step 5: Are there are multiple beneficiaries? .................................................................... 52 Step 6: Do the benefits pass to a Designated Beneficiary ................................................ 52 Step 7: Compute the RMDs .............................................................................................. 52 1.5.03 Road Map , cont.: RMDs in case of death BEFORE the RBD .......................................... 53 A. RMD for year of death .......................................................................................... 53 B. Surviving spouse is sole beneficiary..................................................................... 53 C. Individual beneficiary who is not the surviving spouse........................................ 54 D. See-through trust. .................................................................................................. 54 E. Estate, non-see-through trust, or other nonindividual........................................... 54 F. Multiple beneficiaries. .......................................................................................... 54 1.5.04 Road Map , cont.: RMDs in case of death AFTER the RBD ............................................. 55 A. RMD for year of death (regardless of who is the beneficiary). ............................ 55 B. Surviving spouse is sole beneficiary..................................................................... 56 C. Individual beneficiary who is not the surviving spouse........................................ 56 D. See-through trust. .................................................................................................. 56 E. Estate, non-see-through trust, or other nonindividual........................................... 57 F. Multiple beneficiaries ........................................................................................... 57 1.5.05 RMDs based on life expectancy of Designated Beneficiary ............................................ 57 1.5.06 Death before the RBD: The 5-year (sometimes 6-year) rule ............................................ 59 1.5.07 Life expectancy or 5-year rule: Which applies? ............................................................... 60 Road Map: Three steps to tell whether the 5-year rule applies. ...................................... 60 1.5.08 Computing RMDs based on participant’s life expectancy ............................................... 62 1.5.09 Aggregation of inherited accounts for RMD purposes ..................................................... 63 1.5.10 Plan not required to offer stretch payout or lump sum ..................................................... 65 1.5.11 Switching between 5-year rule and life expectancy method ............................................ 65 1.5.12 Who gets the benefits when the beneficiary dies .............................................................. 66 1.5.13 What is the ADP after the beneficiary’s death? ................................................................ 67 1.6 S PECIAL R ULES FOR THE S URVIVING S POUSE ................................................................... 68 1.6.01 Road Map of the special spousal rules ............................................................................. 68 A. Lifetime distributions: Much-younger-spouse method......................................... 68 B. Postponed Required Commencement Date .......................................................... 68 C. Spouse’s life expectancy recalculated .................................................................. 69 D. Spouse can roll over inherited benefits ................................................................. 69 1.6.02 Definition of “sole beneficiary”........................................................................................ 69

8

Life and Death Planning for Retirement Benefits

1.6.03 Road Map: How to determine RMDs of surviving spouse ............................................... 70 1.6.04 Required Commencement Date: Distributions to spouse ................................................. 72 1.6.05 Special “(B)(iv)(II) rule” if both spouses die young......................................................... 72 1.6.06 When is a trust for the spouse the same as the spouse? .................................................... 75 1.7 T HE B ENEFICIARY AND THE “ D ESIGNATED B ENEFICIARY ” .............................................. 76 1.7.01 Significance of having a Designated Beneficiary............................................................. 76 1.7.02 Who is the participant’s beneficiary? ............................................................................... 76 1.7.03 Definition of Designated Beneficiary ............................................................................... 77 1.7.04 Estate cannot be a Designated Beneficiary....................................................................... 79 1.7.05 Multiple beneficiary rules and how to escape them.......................................................... 79 1.7.06 Multiple beneficiaries: Who must take the RMD? ........................................................... 80 1.7.07 Simultaneous and close-in-time deaths............................................................................. 81 1.8 M ODIFYING RMD R ESULTS AFTER THE P ARTICIPANT ’ S D EATH ..................................... 82 1.8.01 The separate accounts rule ................................................................................................ 82 A. IRS’s statement of the separate accounts rule....................................................... 82 B. Separate accounts for ADP purposes .................................................................... 83 C. Separate accounts for all other RMD purposes..................................................... 83 1.8.02 How do you “establish” separate accounts? ..................................................................... 84 1.8.03 “Removing” beneficiaries by Beneficiary Finalization Date............................................ 85 A. The Beneficiary Finalization Date ........................................................................ 85 B. Removal by distributing beneficiary’s share of benefits ...................................... 86 C. Effect of death prior to the BFD ........................................................................... 87 1.9 E NFORCEMENT OF THE RMD R ULES ................................................................................. 87 1.9.01 Who enforces the minimum distribution rules.................................................................. 87 1.9.02 Failure to take an RMD: 50% penalty and other effects................................................... 87 1.9.03 IRS waiver of the 50 percent penalty................................................................................ 88 1.9.04 Statute of limitations on the 50 percent penalty................................................................ 89 CHAPTER 2: INCOME TAX ISSUES ................................................................................... 91 2.1 I NCOME T AX T REATMENT : G ENERAL &M ISCELLANEOUS ............................................. 91 2.1.01 Plan distributions taxable as ordinary income .................................................................. 91 2.1.02 Post-2010 tax increases; surtax on investment income..................................................... 92 2.1.03 When does a “distribution” occur? ................................................................................... 93 2.1.04 Actual distributions and deemed distributions.................................................................. 94 2.1.05 Whose income is it? Community property etc.................................................................. 95 2.1.06 List of no-tax and low-tax distributions............................................................................ 95 A. Roth plans ............................................................................................................. 96 B. Tax-free rollovers and transfers ............................................................................ 96 C. Life insurance proceeds, contracts ........................................................................ 96 D. Recovery of basis .................................................................................................. 96 E. Special averaging for lump sum distributions ...................................................... 96 F. Net unrealized appreciation of employer securities (NUA) ................................. 96 G. No tax on distribution of annuity contract ............................................................ 96

Table of Contents

9

H. Return of IRA contribution................................................................................... 96 I. Income tax deduction for certain beneficiaries ..................................................... 96 J. Distribution to charitable entity ............................................................................ 96 K. Qualified Health Savings Account Funding Distributions ................................... 97 L. QDROs and divorce-related IRA divisions .......................................................... 97 2.1.07 Income tax, RMD, and estate planning aspects of plan loans .......................................... 97 2.1.08 Excess IRA contributions; corrective distributions .......................................................... 99 2.2 I F THE P ARTICIPANT H AS A FTER - TAX M ONEY IN THE P LAN OR IRA ............................ 102 2.2.01 Road Map: Tax-free distribution of participant’s “basis” ............................................ 102 2.2.02 General rule: The “cream-in-the-coffee rule” of § 72 .................................................... 103 2.2.03 Participant’s basis in a QRP or 403(b) plan.................................................................... 103 2.2.04 QRP distributions from account that contains after-tax money...................................... 104 A. Separate employee contribution accounts may be distributed separately........... 105 B. “Cream” rule exception for pre-1987 balances................................................... 105 C. One “distribution” may be sent to multiple destinations .................................... 106 2.2.05 Partial and split rollovers, conversions: QRP distributions ........................................... 107 A. Introduction: Please read this first ...................................................................... 107 B. Part direct rollover to Roth IRA, part direct rollover to traditional IRA ............ 108 C. Part outright distribution, part direct rollover into any IRA(s) ........................... 109 D. Distribution outright to participant followed by one or more 60-day rollover(s)110 E. Direct rollover into multiple traditional (or Roth) IRAs..................................... 111 F. How these options apply to QRP beneficiaries................................................... 112 G. Effective date and retroactivity of Notice 2014-54............................................. 112 2.2.06 Participant’s basis in a traditional IRA ........................................................................... 115 2.2.07 Beneficiary’s basis in an inherited IRA .......................................................................... 115 2.2.08 How much of a traditional IRA distribution is basis?..................................................... 116 A. The cream-in-the-coffee formula ........................................................................ 116 B. Distribution Amount ........................................................................................... 117 C. Year-end Account Balance ................................................................................. 117 D. Total Nondeductible Contributions..................................................................... 118 E. Outstanding Rollovers ........................................................................................ 118 F. The aggregation rule: Which IRAs must be aggregated ..................................... 118 G. Cream-in-the-coffee formula: Examples ............................................................ 119 2.2.09 Partial rollovers and conversions: IRA distributions ...................................................... 120 2.2.10 Exceptions to the cream-in-the-coffee rule for IRAs...................................................... 120 A. IRA-to-nonIRA-plan rollovers............................................................................ 121 B. Return of IRA contribution before tax return due date....................................... 121 C. QHSAFDs ........................................................................................................... 121 D. Qualified Charitable Distributions ...................................................................... 121 2.3 I NCOME T AX W ITHHOLDING ............................................................................................ 121 2.3.01 Withholding of federal income taxes: overview............................................................. 121 2.3.02 Periodic, nonperiodic, and eligible rollover payments ................................................... 121 2.3.03 Exceptions and special rules ........................................................................................... 123

10

Life and Death Planning for Retirement Benefits

2.3.04 Mutually voluntary withholding ..................................................................................... 124 2.3.05 How withheld income taxes are applied ......................................................................... 124 2.4 L UMP S UM D ISTRIBUTIONS ............................................................................................... 124 2.4.01 Introduction to lump sum distributions........................................................................... 124 2.4.02 First hurdle: Type of plan ............................................................................................... 125 2.4.03 Second hurdle: “Reason” for distribution ....................................................................... 125 2.4.04 Third hurdle: Distribution all in one taxable year........................................................... 126 2.4.05 Exceptions to the all-in-one-year rule............................................................................. 128 2.4.06 Special averaging: Participant born before 1936 ............................................................ 129 2.5 N ET U NREALIZED A PPRECIATION OF E MPLOYER S TOCK ............................................... 129 2.5.01 NUA: Tax deferral and long-term capital gain ............................................................... 129 2.5.02 Reporting NUA distributions .......................................................................................... 130 2.5.03 Distributions after the employee’s death ........................................................................ 130 2.5.04 Basis of stock distributed in life, held until death........................................................... 131 2.5.05 Election to include NUA in income................................................................................ 132 2.5.06 Should employee keep the LSD or roll it over?.............................................................. 132 2.5.07 NUA and partial rollovers............................................................................................... 133 2.6 R OLLOVERS AND P LAN - TO -P LAN T RANSFERS ................................................................. 134 2.6.01 Definitions: rollovers, trustee-to-trustee transfers, etc.................................................... 135 A. Background: Rollover vs. trustee-to-trustee transfer. ......................................... 135 B. Definition of “rollover” and “rollover contribution.” ......................................... 135 C. Direct rollovers ................................................................................................... 136 D. Definition of “60-day” (indirect) rollover........................................................... 136 E. Trustee-to-trustee transfer ................................................................................... 136 2.6.02 Distributions that can (or can’t) be rolled over ............................................................... 137 A. Inherited plans..................................................................................................... 137 C. Series payments .................................................................................................. 137 D. Corrective and deemed distributions .................................................................. 137 E. Hardship distributions ......................................................................................... 137 F. 12-month limitation on IRA rollovers ................................................................ 137 G. Plan loans ............................................................................................................ 137 H. After-tax money .................................................................................................. 137 2.6.03 Rollover in a year in which a distribution is required..................................................... 138 A. Everybody: First distribution of the year is the RMD ........................................ 138 B. Everybody: Missed RMDs from prior years....................................................... 138 C. Participant only: Plan can assume there is no DB .............................................. 139 D. Participant only: Rollovers in the age-70½ year................................................. 139 E. Beneficiaries only: Rollover and the 5-year rule ................................................ 139 F. Exceptions to the no-rollover-of RMDs rule ...................................................... 139 2.6.04 60-day rollover: Must roll over same property received ................................................ 140 2.6.05 60-day rollovers: Only one IRA-to-IRA rollover in 12 months ..................................... 140 2.6.06 60-day rollover deadline; exceptions and blanket waivers ............................................. 142 2.6.07 Hardship waiver of 60-day rollover deadline ................................................................. 143

Table of Contents

11

2.6.08 Avoid some rollover requirements with IRA-to-IRA transfer........................................ 146 2.7 R ETIREE R OAD M AP ........................................................................................................... 147 2.7.01 Plan-related issues to discuss with your client................................................................ 147 2.7.02 Reasons to roll money from one plan or IRA to another ................................................ 148 2.7.03 Best how-to rollover tips................................................................................................. 149 2.7.04 How many IRAs should a person own?.......................................................................... 149 2.7.05 How to take RMDs and other distributions .................................................................... 150 CHAPTER 3: MARITAL MATTERS ................................................................................... 151 3.1 C ONSIDERATIONS FOR M ARRIED P ARTICIPANTS ............................................................ 151 3.1.01 Road Map: Advising the Married Participant ................................................................ 151 3.1.02 Road Map: Advising the Surviving Spouse .................................................................... 152 3.1.03 Simultaneous death clauses............................................................................................. 153 3.2 S POUSAL R OLLOVER ; E LECTION TO T REAT D ECEDENT ’ S IRA AS S POUSE ’ S IRA ........ 154 3.2.01 Advantages and drawbacks of spousal rollover.............................................................. 154 3.2.02 Spousal rollover: QRPs and 403(b) plans ....................................................................... 155 3.2.03 Rollover (or spousal election) for IRA or Roth IRA ...................................................... 156 A. Spousal election: Code and regulations .............................................................. 156 B. Spousal election for inherited Roth IRA............................................................. 156 C. Conditions that must be met ............................................................................... 157 D. How spouse makes the election .......................................................................... 157 E. When spousal election may be made .................................................................. 158 F. Rollovers also permitted ..................................................................................... 158 3.2.04 Roth conversion by surviving spouse ............................................................................. 158 3.2.05 Rollover or election by spouse’s executor ...................................................................... 159 3.2.06 Deadline for completing spousal rollover....................................................................... 159 3.2.07 Plans the spouse can roll benefits into ............................................................................ 160 3.2.08 Rollover if spouse is under age 59½............................................................................... 161 3.2.09 Spousal rollover through an estate or trust ..................................................................... 162 3.3 Q UALIFYING FOR THE M ARITAL D EDUCTION .................................................................. 164 3.3.01 Road Map: Leaving Benefits to Spouse or Marital Trust ............................................... 164 3.3.02 Leaving retirement benefits to a QTIP trust ................................................................... 165 3.3.03 IRS regards benefits, trust, as separate items of QTIP ................................................... 166 3.3.04 Entitled to all income: State law vs. IRS ........................................................................ 167 3.3.05 Ways to meet the “entitled” requirement; Income vs. RMD.......................................... 168 3.3.06 Distribute all income to spouse annually ........................................................................ 169 3.3.07 Do not require stub income to be paid to spouse’s estate!.............................................. 170 3.3.08 Combination marital deduction-conduit trust ................................................................. 171 3.3.09 General Power marital trust ............................................................................................ 171 3.3.10 Automatic QTIP election for “survivor annuities” ......................................................... 171 3.3.11 Marital deduction for benefits left outright to spouse..................................................... 172 3.4 REA ’84 AND S POUSAL C ONSENT ..................................................................................... 172 3.4.01 Introduction to the Retirement Equity Act of 1984 ........................................................ 172

12

Life and Death Planning for Retirement Benefits

3.4.02 Plans subject to full-scale REA requirements................................................................. 173 3.4.03 REA requirements for “exempt” profit-sharing plans .................................................... 173 3.4.04 IRAs, Roth IRAs, and 403(b) plans ................................................................................ 174 3.4.05 Various REA exceptions and miscellaneous points........................................................ 174 3.4.06 Requirements for spousal consent or waiver .................................................................. 175 3.4.07 Spousal waiver or consent: Transfer tax aspects ............................................................ 176 CHAPTER 4: INHERITED BENEFITS: ADVISING EXECUTORS AND BENEFICIARIES ..................................................................................................................... 178 4.1 E XECUTOR ’ S R ESPONSIBILITIES ....................................................................................... 178 4.1.01 The Executor’s Road Map .............................................................................................. 178 4.1.02 Recharacterizing the decedent’s Roth conversion .......................................................... 178 4.1.03 Who can make or withdraw decedent’s IRA contribution?............................................ 180 4.1.04 Completing rollover of distribution made to the decedent ............................................. 181 4.1.05 Executor’s responsibilities regarding decedent’s RMDs ................................................ 183 4.2 P OST -D EATH T RANSFERS , R OLLOVERS , & R OTH C ONVERSIONS ................................... 185 4.2.01 How to title an inherited IRA.......................................................................................... 185 4.2.02 Post-death distributions, IRA-to-IRA transfers .............................................................. 186 A. Nonspouse beneficiary cannot roll over a distribution received......................... 186 B. Post-death IRA-to-IRA transfers permitted ........................................................ 187 C. What can go wrong ............................................................................................. 188 4.2.03 Combining inherited IRAs .............................................................................................. 189 4.2.04 Nonspouse beneficiary rollovers from nonIRA plans .................................................... 189 A. Legislative background ....................................................................................... 189 B. Types of nonIRA plans ....................................................................................... 190 C. Available only to a Designated Beneficiary ....................................................... 190 D. Direct rollovers only ........................................................................................... 190 E. Must roll to an “inherited IRA.” ......................................................................... 190 F. Applies to post-2006 post-death distributions .................................................... 191 G. Cannot use rollover to “fix” the estate plan ........................................................ 191 H. Limits on the plan’s obligations.......................................................................... 191 I. Plan must distribute RMD before the transfer .................................................... 191 J. Beneficiary’s RMDs after the transfer ................................................................ 192 4.2.05 Nonspouse beneficiary Roth conversions ....................................................................... 192 4.3 F EDERAL E STATE T AX I SSUES .......................................................................................... 194 4.3.01 Retirement benefits on the estate tax return.................................................................... 194 4.3.02 Problems paying the estate tax........................................................................................ 194 4.3.03 Alternate valuation method (AVM) for retirement benefits ........................................... 195 4.3.04 AVM, cont.: Distributions, other IRA events as “disposition”....................................... 195 4.3.05 AVM, cont.: Sale of assets inside the IRA ..................................................................... 198 4.3.06 Federal estate tax exclusion for retirement benefits ....................................................... 198 4.3.07 Valuation discount for unpaid income taxes................................................................... 198 4.3.08 Deaths in 2010: One-year “repeal” of the federal estate tax........................................... 199

Table of Contents

13

4.4 Q UALIFIED D ISCLAIMERS OF R ETIREMENT B ENEFITS .................................................... 200 4.4.01 Post-mortem disclaimer Checklist .................................................................................. 200 4.4.02 Requirements for qualified disclaimer: § 2518............................................................... 201 4.4.03 Income tax treatment of disclaimers ............................................................................... 201 4.4.04 What constitutes “acceptance” of a retirement benefit ................................................... 202 4.4.05 Effect of taking a distribution; partial disclaimers.......................................................... 204 4.4.06 Deadline for qualified disclaimer.................................................................................... 205 4.4.07 To whom is the disclaimer delivered? ............................................................................ 206 4.4.08 Who gets the disclaimed benefits and how do they get them? ....................................... 206 A. Property must pass to “someone other than” disclaimant................................... 206 B. Property must pass “without direction” by disclaimant...................................... 207 C. How to determine who gets the disclaimed benefits .......................................... 207 4.4.09 Disclaimers, ERISA, and the plan administrator ............................................................ 208 A. Disclaimers and ERISA’s anti-alienation rule .................................................... 208 B. Disclaimers and the plan document .................................................................... 209 C. Effect of the plan’s “state law” provision ........................................................... 210 4.4.10 Disclaimers and the minimum distribution rules ............................................................ 210 4.4.11 How a disclaimer can help after the participant’s death ................................................. 210 4.4.12 Double deaths: Disclaimer by beneficiary’s estate ......................................................... 211 A. Who is the successor beneficiary? ...................................................................... 212 B. If the fiduciary is also a beneficiary.................................................................... 212 4.4.13 Building disclaimers into the estate plan: Checklist ...................................................... 212 4.5 O THER C LEANUP S TRATEGIES ......................................................................................... 214 4.5.01 Check the plan’s default beneficiary............................................................................... 215 4.5.02 Invalidate the beneficiary designation ............................................................................ 215 4.5.03 Spousal election to take share of estate........................................................................... 215 4.5.04 Will (or beneficiary designation form) contest ............................................................... 216 4.5.05 Reformation of beneficiary designation form................................................................. 216 4.5.06 Reformation of trust or will ............................................................................................ 217 4.5.07 Choose the right cleanup strategy ................................................................................... 218 A. When to seek reformation and avoid disclaimer................................................. 219 B. When and how to use disclaimer ........................................................................ 219 4.6 I NCOME IN R ESPECT OF A D ECEDENT (IRD) ................................................................... 219 4.6.01 Definition of IRD; why it is taxable ............................................................................... 220 4.6.02 When IRD is taxed (normally when received) ............................................................... 220 4.6.03 Tax on transfer of the right-to-receive IRD .................................................................... 220 A. Gift of right-to-receive IRD................................................................................ 221 B. Transfer from estate or trust to beneficiary......................................................... 221 C. Transfer to a 100 percent grantor trust................................................................ 221 4.6.04 Income tax deduction for estate tax paid on IRD ........................................................... 221 4.6.05 Who gets the § 691(c) (IRD) deduction.......................................................................... 222 4.6.06 IRD deduction for deferred payouts ............................................................................... 223 4.6.07 IRD deduction: Multiple beneficiaries or plans.............................................................. 224

14

Life and Death Planning for Retirement Benefits

4.6.08 IRD deduction on the income tax return......................................................................... 224 4.7 R OAD M AP : A DVISING THE B ENEFICIARY .......................................................................... 224 CHAPTER 5: ROTH RETIREMENT PLANS .................................................................... 226 5.1 R OTH P LANS : I NTRODUCTION .......................................................................................... 226 5.1.01 Introduction to Roth retirement plans ............................................................................. 226 5.1.02 Roth retirement plan abuses............................................................................................ 226 5.2 R OTH IRA S : M INIMUM D ISTRIBUTION AND I NCOME T AX A SPECTS .............................. 227 5.2.01 Roth (and deemed Roth) IRAs vs. traditional IRAs ....................................................... 227 5.2.02 Roth IRAs and the minimum distribution rules.............................................................. 228 A. No lifetime required distributions ....................................................................... 228 B. Post-death RMD rules DO apply ........................................................................ 228 C. Roth distributions do not fulfill RMD for traditional IRA ................................. 228 D. RMDs and recharacterizations. ........................................................................... 228 E. RMDs and Roth conversions. ............................................................................. 228 5.2.03 Tax treatment of Roth IRA distributions: Overview ...................................................... 229 5.2.04 Qualified distributions: Definition.................................................................................. 230 5.2.05 Computing Five-Year Period for qualified distributions ................................................ 231 A. Five-Year Period for participant ......................................................................... 231 B. Five-Year Period for beneficiaries...................................................................... 232 5.2.06 Tax treatment of nonqualified distributions.................................................................... 233 5.2.07 The Ordering Rules......................................................................................................... 234 5.3 H OW TO F UND A R OTH IRA; R EGULAR AND E XCESS C ONTRIBUTIONS ......................... 235 5.3.01 The eight ways to fund a Roth IRA ................................................................................ 235 5.3.02 “Regular” contributions from compensation income ..................................................... 235 5.3.03 Applicable Dollar Limit for regular contributions .......................................................... 236 5.3.04 Who may make a “regular” Roth IRA contribution ....................................................... 237 A. No age limit......................................................................................................... 237 B. Participation in an employer plan is irrelevant ................................................... 237 C. Income must be below certain levels .................................................................. 237 D. Regular traditional IRA contribution followed by conversion ........................... 238 5.3.05 Penalty for excess Roth IRA contributions..................................................................... 239 5.4 C ONVERSION OF T RADITIONAL P LAN OR IRA TO A R OTH IRA ..................................... 239 5.4.01 What type of plan may be converted to a Roth IRA....................................................... 239 A. Individual retirement accounts............................................................................ 240 B. NonIRA plans ..................................................................................................... 240 5.4.02 Who may convert: age, plan participation, income, etc.................................................. 241 A. Age: Under 59½, over 70½, or in between ......................................................... 241 B. Participation in other plan(s)............................................................................... 241 C. Prior conversion .................................................................................................. 241 D. Filing status ......................................................................................................... 241 E. Income limit ........................................................................................................ 241 5.4.03 Tax treatment of converting traditional IRA to Roth IRA.............................................. 242

Table of Contents

15

5.4.04 Tax treatment of converting nonIRA plan to Roth IRA ................................................. 243 5.4.05 Income spreading for conversions in 1998 or 2010........................................................ 244 5.4.06 Failed conversions .......................................................................................................... 245 5.4.07 Mechanics of traditional IRA-to-Roth IRA conversions ................................................ 246 5.4.08 Mechanics of conversion from other traditional plans ................................................... 246 5.5 R OTH P LANS AND THE 10% P ENALTY F OR P RE -A GE 59½ D ISTRIBUTIONS ................... 247 5.5.01 Penalty applies to certain Roth plan distributions........................................................... 247 A. Qualified distribution .......................................................................................... 247 B. Nonqualified distribution from Roth IRA........................................................... 247 C. Nonqualified distribution from DRAC ............................................................... 247 D. Conversion followed by distribution within five years....................................... 248 5.5.02 Roth conversion prior to reaching age 59½ .................................................................... 248 A. Penalty does not apply to a Roth conversion ...................................................... 248 B. Penalty applies to certain distributions within five years after a conversion...... 248 C. Penalty applies to failed conversion ................................................................... 249 5.5.03 Conversion while receiving “series of equal payments” ................................................ 249 5.6 R ECHARACTERIZING AN IRA OR R OTH IRA C ONTRIBUTION ........................................ 250 5.6.01 Which IRA contributions may be recharacterized.......................................................... 250 5.6.02 Income attributable to the contribution........................................................................... 251 5.6.03 How to recharacterize certain IRA/Roth IRA contributions........................................... 252 5.6.04 Partial recharacterizations ............................................................................................... 253 5.6.05 Deadline for Roth IRA contributions and conversions................................................... 254 5.6.06 Recharacterization deadline: Due date “including extensions” ...................................... 255 5.6.07 Same-year and immediate reconversions banned ........................................................... 257 5.7 D ESIGNATED R OTH A CCOUNTS ........................................................................................ 257 5.7.01 Meet the DRAC: Roth 401(k)s, 403(b)s, 457(b)s........................................................... 257 5.7.02 DRAC contributions: Who, how much, how, etc. .......................................................... 258 A. Who may contribute............................................................................................ 258 B. How much may be contributed ........................................................................... 259 C. Election is irrevocable......................................................................................... 259 D. What may be contributed to a DRAC................................................................. 259 5.7.03 RMDs and other contrasts with Roth IRAs .................................................................... 260 5.7.04 DRACs: Definition of “qualified distribution”............................................................... 260 A. Qualified distribution triggering events .............................................................. 260 B. How the Five-Year Period is computed for a DRAC ......................................... 261 C. List of never-qualified distributions.................................................................... 261 D. QDROs and payments to beneficiaries ............................................................... 262 5.7.05 Nonqualified DRAC distributions .................................................................................. 262 5.7.06 Rollovers of DRAC distributions: General rules ............................................................ 263 5.7.07 DRAC-to-DRAC rollovers ............................................................................................. 264 A. May roll to any other DRAC .............................................................................. 264 B. Direct rollover ..................................................................................................... 264 C. Total direct rollover preserves basis in excess of value...................................... 264