Estate Planning Guide
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What To Do With Those Retirement Assets Examine your own estate. Chances are your largest asset is your retirement plan. For years, the government, as well as competent financial planners have encouraged Americans to make early, regular deposits to a tax deferred retirement arrangement such as an IRA, pension plan, 401(k) plan, Keogh plan, or 403(b) annuity. With retirement plans that are tax deferred, the advantage of continued deferral is that dollars, which otherwise would have been sent to Washington and state capitals in the form of income taxes and would otherwise cease earning income for the account holder, stay invested and produce income. By delaying the payment of taxes, dollars are earned that would otherwise never have existed. It is true of course that those earnings will also be taxed when withdrawn (except for a qualified distribution from a Roth IRA) but the accumulation of income on income tax dollars which is deferred and which is in turn invested and compounded year after year, through succeeding generations after the death of the account holder, presents a very favorable tax strategy. When to Start Distributions The law requires that an individual start making required minimum distributions from qualified retirement plans by April 1st of the year following the year in which the individual attains age 70½. The equation for calculating required distributions at age 70½ is really quite simple. There are, as you might expect, exceptions and special rules and other regulatory garble, but the basic rule is that there is a pool of assets which is subject to a requirement that part of the pool must be distributed each year beginning on a certain date and continuing each year thereafter. Each year the pool of assets is divided by a number to get the required distribution. This divisor changes and the pot of money into which the number is divided changes. It is necessary to comment at this point about the April 1st required beginning date. The April 1st required beginning date is a special grace extended to taxpayers for the first year that they start paying taxes on their retirement plans. In fact, if the individual uses the April 1st grace period for the first required distribution, TWO distributions must be made in that year, one for the year in which age 70½ occurred (which the April 1st rule allowed to be postponed to the next succeeding year) and one for the regular distribution for that year. How to Prolong the Distributions to Defer Taxes Section 401(a)(9) of the Internal Revenue Code permits required distributions to be made over a period not exceeding the life expectancy of the plan participant or IRA account owner and his or her beneficiary. Since the life expectancy of two persons is a longer period than one person, those interested in establishing the longest possible distribution period and, thereby slowing the required distributions as much as possible (thereby deferring income tax and enabling further compounding), have a vested interest in making sure that the life expectancy of a younger beneficiary (as well as the participant or account owner) can be used. Usually, for a married couple, the desired beneficiary is the spouse. An individual can change his or her beneficiary at any time. However, the beneficiary of record on the date when the plan participant or IRA account owner attains 70½ is the one which will control (i) whether the beneficiary is a Designated Beneficiary; and (ii) the amount of additional life expectancy which may be added to the participant's life expectancy for required distribution purposes. Among the possible beneficiaries a participant may chose, special advantages (i.e., the ability to use the beneficiary's life expectancy for required distribution purposes) are accorded to a specially defined Designated Beneficiary. A "Designated Beneficiary" is a living individual who can be ascertained as of the Required Beginning Date. Such a beneficiary must be ascertainable so that the beneficiary's life expectancy can be calculated. The beneficiary can be made by the plan participant or IRA account holder on a form provided by the plan or IRA sponsor, or if there is a default provision in the plan or IRA document naming a specific individual (e.g., spouse, or children by right of representation) that will do as well. An estate (e.g., estate of the participant or IRA account holder), is not a designated beneficiary even though a person's heirs or legatees are ascertainable at the Required Beginning Date. The problem from the IRS's point-of-view is that the heirs may be quite different when, after the Required Beginning Date, the participant or account holder actually dies. In fact, naming the participant's estate is a poor choice for a variety of reasons. Not only is there no Designated Beneficiary thereby accelerating distributions, but the plan or IRA assets are also subject to probate expenses and creditor's claims. If an estate is named as beneficiary, it should be well down the line of contingent beneficiaries. If a group of beneficiaries is named for a single IRA account or qualified plan (e.g., "my children by right of representation"), the life expectancy of the oldest of the group is used for calculating distributions to all members of the group. Charities are not Designated Beneficiaries. Accordingly a participant who names a charity as a primary beneficiary at the Required Beginning Date will be forced to use his or her own single life expectancy for required distribution purposes. Naming a charity as a beneficiary along with individuals, such as children, who would be eligible to be Designated Beneficiaries make the whole lot ineligible to be Designated Beneficiaries. The way to maximize the benefits where you wish to use several Designated Beneficiaries is to use separate IRA accounts. If you have three children and your church which you wish to list as Designated Beneficiaries, then create four separate IRA accounts. Then, you can name a child as beneficiary of the first three accounts (and, accordingly, use each of their individual lives in calculating the Required Minimum Distribution for each account), and use the charity as the beneficiary of the remaining account (requiring distribution to be made based on your life expectancy alone). Note that once the Required Beginning Date has come and gone it does not matter if the Designated Beneficiary dies thereafter. Payouts are still made as if the Designated Beneficiary is still alive. Funding your Estate Tax Exemption with Retirement Assets Unfortunately, many people do not have enough other assets to fully utilize each spouse's unified credit (the exemption from federal estate taxes which is currently $1,000,000) if IRA or qualified plan assets are paid to the surviving spouse. On the other hand, shifting assets to accommodate the shortage runs the risk that if the anticipated order of death does not occur the other spouse will be short of assets to fund his or her trust. For example, if the husband has a $1.2 million IRA account, in addition to the family's $200,000 home and $300,000 of other assets, there is no way to fully use the husband's tax exemption if he dies first listing his wife as the beneficiary of his IRA. The $1.2 million IRA account passes estate tax free to his wife (there is an unlimited marital deduction from estate taxes) thus leaving only one-half of the house ($100,000) and one-half of the other assets ($150,000) to offset against the estate tax exemption. Then, when the wife dies after the husband, she then has the $1.2 million IRA, the $200,000 home and $300,000 of other assets for a total estate of $1,700,000, and a rather large estate tax problem. In Oklahoma, one solution at least for half of the problem involves naming the spouse as the IRA or qualified plan beneficiary with a qualified disclaimer back to the credit shelter trust of the plan participant or IRA holder. A "qualified disclaimer" has many requirements to make it effective and it must be exercised timely. However, such a disclaimer can help equalize the estate size. If the deceased IRA holder or plan participant has sufficient other assets to fund his or her credit trust then the surviving spouse accepts all of the IRA and qualified plan benefits that are payable to him or her and rolls them over, deferring tax and distributions as discussed. If, however, the deceased plan participant or IRA account holder would not have sufficient assets to fully use his or her credit shelter trust (the amount that can be passed or "sheltered" with estate taxed) and if the assets of the surviving spouse when augmented by the qualified plan or IRA assets (including future growth) would exceed his or her exemption equivalent ($1.5 million for 2005), then a timely disclaimer by the surviving spouse, causing assets to be paid to the credit shelter trust may be advisable. In the example above, the wife (surviving her deceased husband) can disclaim $450,000 of the IRA, thus leaving her with a total estate of $900,000, and giving her husband an estate of $800,000 so that neither of them will pay estate taxes. Note that if disclaimed assets are held in the credit shelter trust, the surviving spouse may not have a limited power of appointment over the disclaimed assets, as is usually the case with the credit shelter trust. The retention of such a power violates the qualified disclaimer requirement that the disclaimant may not retain power over the disclaimed assets. If such a limited power of appointment does exist, it too must disclaimed. However, absent other problems, the spouse may exercise powers as trustee of the trust under an ascertainable standard, such as for health, education, support and maintenance. If the non-participant spouse does not have sufficient assets to fully fund his or her estate tax exemption, there are some options available for plan assets or IRA accounts:
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