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________________________________________________ Estate Planning
Strategies / Retirement
An individual retirement account (IRA) or other retirement plan
is often an individual's largest and most difficult-to-handle asset.
Decisions regarding when and how to take distributions, distribution
amounts, and choice of beneficiaries all affect both income and
estate taxes. While changes in the Taxpayer Relief Act of 1997 have
eased the tax bite on IRAs, the rules remain complicated. The Internal
Revenue Service (IRS) has, however, simplified the requirements
for treating trusts as designated beneficiaries for distribution
rule purposes. The
Regulations In 1987, the IRS issued proposed regulations to explain the then recent amendments to the Internal Revenue Code (IRC) relating to required distributions from qualified plans and IRAs. The regulations stated that: Distributions to a plan participant (or IRA owner) cannot generally begin without penalty before the participant reaches age 591/2.
A
Question of Trusts The IRC defines"designated beneficiary" as an individual
designated as a beneficiary by the participant. The term "individual"
generally rules out the possibility of naming a trust, the participant's
estate or a charity as a designated beneficiary. Under the 1987
regulations, however, a trust can be a designated beneficiary for
minimum distribution purposes if it meets the following requirements: 1. The trust is valid under state law. As a result of these requirements, naming a revocable trust did
not appear to be an option. While naming the revocable trust was
arguably a viable option if a plan participant died prior to the
required beginning date (since, on the death of the participant,
the trust would become irrevocable), this would not be possible
for a participant who is approaching or has reached age 701/2. Revocable
Trusts Allowed After more than 10 years, the IRS has determined that allowing
a revocable trust to be a designated beneficiary makes sense and
adopted revised requirements in December, 1997. Under the modified
proposed regulations, a trust can either be irrevocable or become
irrevocable, by its terms, on the death of the participant. In addition,
the rule saying a copy of the trust instrument must be provided
to the plan administrator has also been revised to allow alternate
methods for satisfying the documentation requirement. The preamble to the proposed regulations indicates that taxpayers
may rely on the revised proposed regulations pending the issuance
of final regulations. Also, note that the IRS did not indicate that
the revised regulations should apply prospectively only. It would,
therefore, appear that these proposed changes apply retroactively
to the effective date of the existing proposed regulations. Careful
Planning Is Key We have only touched on the issues regarding distributions from IRAs and other qualified plans. The importance of proper IRA distribution planning cannot be over emphasized. We would be pleased to discuss these issues with you in greater detail. Rules
For Spousal Beneficiaries The rules relating to a spouse as a designated beneficiary are
somewhat different than the general rules. Specifically, if a participant's
spouse is named as a beneficiary of the IRA, the spouse has several
options. One is to transfer and rollover the IRA benefits into his
or her own IRA, allowing the spouse to defer taking distributions
until he or she reaches age 701/2, if desired. This also allows
the spouse to designate a new IRA beneficiary, potentially allowing
further deferral until after that beneficiary's death. If the spouse
is older, he or she can also elect to retain the participant's IRA
and defer taxable distributions until the participant would have
reached age 701/2. Another benefit: Naming a spouse as beneficiary not only means possible tax advantages, but also allows you to use the marital deduction for estate tax purposes. However, if you do not want your spouse to have full control over your IRA benefits on death, you should consider other alternatives. Penalties
Loosened Under the prior rules, not only are issues regarding the timing
of distributions and the designated beneficiary complex, but severe
penalties were imposed when a participant took out too much from
the plan in any given year (excess distributions) or died with too
much in the plan (excess accumulations). Changes made by Taxpayer
Relief Act of 1997 repealed the excise tax on both excess retirement
distributions and excess retirement accumulations for distributions
after 1996 and for taxpayers dying after 1996. Other penalties and
excise taxes still apply however: 1. With limited exception, a 10% additional income tax is imposed
on distributions made prior to the time when the participant reaches
age 591/2. An
Example Dan Jones, who will reach age 701/2 in 1998, named as his IRA beneficiary
a revocable trust for the benefit of his sister, Melissa. The terms
of the trust provide that it becomes irrevocable at Dan's death.
Dan has provided a copy of the trust agreement to the plan administrator.
Under the proposed regulations as modified in December, 1997, Melissa
will be treated as Dan's designated beneficiary, so distributions
can be made over their joint lives or life expectancies. Under the
prior proposed regulations, Melissa would not have been treated
as Dan's designated beneficiary unless Dan amended the trust to
make it irrevocable by his required beginning date.
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Copyright 2001 Fahlman & Olson. All rights reserved.
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