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Estate Planning Series Part 7: What should be done with retirement plan benefits?

The Traditional Treatment of a Retirement Plan 

The surviving spouse has always been the favored beneficiary of a decedent's retirement plan.  A rollover of the decedent's qualified plan or IRA to a surviving spouse enjoys the marital deduction to avoid estate tax (Code Section 2056) and special rules to defer the income tax on the rollover (Code Section 408(d)).  Where possible, spouses have typically favored a distribution of a retirement plan to the surviving spouse to take advantage of these tax benefits.  Under the SECURE Act of 2019, a spouse is an eligible designated beneficiary, entitled to use his or her life expectancy for minimum required distribution purposes. 

A problem has sometimes arisen for larger taxable estates where the decedent's retirement plan is one of the major assets of the decedent's estate.   In these situations, the only way to fund a bypass trust reasonably is to use the decedent's plan.  When this is done, the applicable exclusion protects the plan from estate tax, but the inability to accomplish a spousal rollover results in immediate commencement of income taxation of the plan benefits based on the minimum distribution requirements for the oldest trust beneficiary. 

Using Portability Again 

Where the decedent's estate will not be subject to taxation, and portability would allow the bypass trust to be avoided, the recommended planning strategy would be to leave the retirement plan and IRA benefits directly to the surviving spouse to gain the advantages of income and estate tax deferral at the first death, and then to rely on portability to be able to utilize the deceased spouse's unused estate tax exclusion amount at the surviving spouse's subsequent death. 

The IRS has eased the concerns about making certain that the rollover to the spouse occurred within sixty days of receiving the distributed funds with the issuance of Rev. Proc. 2016-47 (August 24, 2016).  If the sixty day rollover is not completed in a timely fashion, it may no longer be necessary to apply for a private letter ruling and pay a user fee to fix the problem.   A person may self certify that the 60 day period may be waived, and the IRS has issued a form letter to use in the process. 

The IRS can audit a return and decide the self certification is not appropriate, leading to the reminder to clients that the safest way to accomplish a rollover is always through a direct trustee to trustee transfer.  

Retirement Plan can be Transferred to the Trust

Management, creditors or blended families should also be considered in the context of retirement plan distribution.  Where the protection of the trust is desired, the retirement plan assets could be left to a QTIP trust, but such a designation involves a fair amount of administrative and drafting complexity.  (Rev. Rul. 2006-26).  

Distributions from a retirement plan are income in respect of a decedent, so there is no basis step up when the decedent dies.  The distributions are not considered net investment income so they are not subjected to the 3.8 percent net investment income tax.   The withdrawal of funds from a traditional IRA or qualified retirement plan account is taken into consideration in determining if adjusted gross income and taxable income thresholds have been reached. 

SECURE Act of 2019

Attention must be given to the changes brought about by the SECURE Act of 2019.  Regardless of the wealth or income tax bracket of a retirement plan beneficiary, the SECURE Act provides that life expectancy may no longer be used as the standard for minimum distributions from retirement plans for most beneficiaries.  Instead, the Act provides for a required withdrawal within ten years of the year of death of the plan participant.  The withdrawal may be taken in equal or unequal installments or at any time during the ten year time frame.  Exceptions are provided to allow for minimum distributions over the life expectancy of surviving spouses, minor children of the plan participant, beneficiaries subject to disability or chronic illness and persons born within ten years of the plan participant. 

The Roth Conversion Opportunity 

Consider converting a qualified plan or traditional IRA to a Roth IRA to both avoid having withdrawals be included in adjusted gross income beyond the year of actual conversion and to avoid required minimum distributions if not needed.  

The next Estate Planning Series, 8 will address the SECURE Act and how it impacts retirement accounts. 

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