North Carolina Estate Planning Blog : North Carolina Estate Planning Lawyer & Attorney : Trust Counsel, PA : Trust Administration : Serving Chapel Hill, Durham, Raleigh, Pittsboro, Orange County, Chatham County

Planning for tax-qualified plans, which includes IRAs, 401(k)s and qualified retirement plans, requires a careful examination of the potential taxes that impact these assets. Unlike most other assets that receive a “basis step up” to current fair market value upon the owner’s death, IRAs, 401(k)s and other qualified retirement plans do not step-up to the date-of-death value. Therefore, beneficiaries who receive these assets do so subject to income tax. If your estate is subject to estate tax, the value of these assets may be further reduced by the estate tax. And if you name grandchildren or younger generations as beneficiaries, these assets may additionally be reduced by the generation-skipping transfer tax. All tolled, these assets may be reduced by 70% or more.

There are several strategies available to help reduce the impact of these taxes:

• Structure accounts to provide the longest term payout possible (stretch).
• Name a Retirement Trust as Beneficiary
• Take the money out during lifetime and pay the income tax, then gift the remaining cash either outright or through an irrevocable life insurance trust.  Or consider a Roth conversion.
• Take the money out during lifetime and buy an immediate annuity to provide a guaranteed annual income, to pay the income tax, and to pay for insurance owned by a wealth replacement trust.
• Name a Charitable Remainder Trust as beneficiary with a lifetime payout to your surviving spouse. The remaining assets would pass to charity at the death of your spouse.
• Give the accounts to charity at death.

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From the IRS:

If you took an early distribution from your retirement plan, here are some things you need to know:

1. Payments you receive from your Individual Retirement Arrangement before you reach age 59 ½ are generally considered early or premature distributions.

2. Early distributions are usually subject to an additional 10 percent tax.

3. Early distributions must also be reported to the IRS.

4. Distributions you rollover to another IRA or qualified retirement plan are not subject to the additional 10 percent tax. You must complete the rollover within 60 days after the day you received the distribution.

5. The amount you roll over is generally taxed when the new plan makes a distribution to you or your beneficiary.

6. If you made nondeductible contributions to an IRA and later take early distributions from that same IRA, the portion of the distribution attributable to those contributions is not taxed.

7. If you received an early distribution from a Roth IRA the distribution attributable to contributions is not taxed.

8. If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan.

9. There are several exceptions to the additional 10 percent early distribution, such as when the distributions are used for purchase of a first home, certain medical and educational expenses or if you become disabled. Other exceptions can be found in IRS Publication 590, Individual Retirement Arrangements (IRAs).

10. More information about early distributions from retirement plans and the additional 10 percent tax can be found in IRS Publication 575, Pension and Annuity Income and Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available on IRS.gov or by calling 800-TAX-FORM (800-829-3676).
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Links:

• Publication 575, Pensions and Annuities (PDF 227K)
• Publication 590, Individual Retirement Arrangements (IRAs) (PDF 449K)  
• Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts   (PDF 72K)
• Form 5329 Instructions (PDF 40K)

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If you divorce, make sure that you change your retirement account beneficiaries!  As obvious as that advice sounds, it is not uncommon, particularly when there is no remarriage, for one to forget to designate a new beneficiary. Even a waiver signed by your former spouse may not be effective to prevent him or her from getting the benefits upon your death.  This report on a recent United States Supreme Court case is courtesy of the NAELA e-newsletter:

The decedent did not change the plan beneficiary after the divorce, but the executrix contended that the spouse waived her rights to plan benefits and thus the benefits reverted to the estate. The plan administrator argued that the waiver was an alienation of the benefits which was prohibited under the Employee Retirement Income Security Act of 1974, 29 U.S.C.S. § 1001 et seq. (ERISA), and that the waiver was not a qualified domestic relations order (QDRO) as required to be exempt from the anti-alienation provision. The Court unanimously held that the spouse's waiver did not violate the anti-alienation provision, but the administrator properly distributed benefits to the spouse. The spouse's waiver was not rendered invalid as an assignment or alienation of the benefits since the spouse did not attempt to direct her interest in the benefits to the decedent's estate or any other potential beneficiary. However, since the waiver was not a QDRO, the plan required the decedent to change the plan beneficiary or the spouse to expressly disclaim the benefits and, in the absence of either event, the administrator was required to distribute the benefits to the spouse as the named beneficiary under Egelhoff v. Egelhoff, 532 U. S. 141, 148 (2001).

Kennedy v. Dupont Savings and Investment Plan, 2009 U.S. LEXIS 869 (January 26, 2009)

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