IRA’s, Other Pensions and Non-Probate Assets: Beneficiary Designations

1. IRA’s, Other Pensions and Non-Probate Assets: Beneficiary Designations  Presented by: Dani Smith Strasburger & Price, LLP 2801 Network Blvd., Ste. 600 Frisco, Texas 75034 (469) 287-3918 dani.smith@strasburger.com

2. Minimum Distribution Rules Understanding the basic minimum distribution rules for qualified plans is necessary to understand the consequences of certain beneficiary designations. Permissible Distributions: • Distributions from a qualified plan may begin at age 59 ½ without penalty. • There is no restriction on how much can be withdrawn after attaining age 59 ½. • Distributions taken before attaining age 59 ½ are subject to a 10% excise tax (subject to exceptions set forth in IRC § 72(t)).

3. Minimum Distribution Rules Required Distributions: • The plan participant must begin taking distributions by April 1 of the calendar year following the year in which the plan participant reaches age 70 ½ (referred to as the Required Beginning Date “RBD”). Treas. Reg. §1.408-8. • There are no required distributions from ROTH IRA’s during the plan participant’s lifetime.

4. Minimum Distribution Rules • The penalty for failure to distribute the minimum required amount is 50% of the short fall. IRC § 4974. • There is no required distribution for active non-owner (less than 5%) employees who are still working. • not true for IRA’s. • Distributions are taxed to the recipient in the year of receipt.

5. Minimum Distribution Rules Amount of Distribution: • The annual minimum distribution is determined by using Uniform Life Expectancy Table based on participant’s age and a presumed beneficiary 10 years younger in age. Treas. Reg. §1.401(a)(9)-5. • The actual age of the presumed beneficiary or whether beneficiary is individual Trust or charity is irrelevant. • Exception: If the beneficiary is the participant’s spouse and the spouse is more than 10 years younger than the participant, the calculation table may incorporate the actual age of the spouse. Treas. Reg. §.401(a)(9)-4.

6. Minimum Distributions After Death of Participant • The commencement of the required minimum distributions depends upon: • Whether the plan participant died before or after his or her RBD; • Whether the beneficiary is a spouse; • Whether there is “Designated Beneficairy” which must be a Natural Person or a Qualifying Trust. Entities such as estates, charities, corporations and partnerships do not qualify as Designated Beneficiaries • The determination of Successor Beneficiaries is made as of Sept. 30 of calendar year following deat.

7. Presence of Nonqualified “Designated Beneficiary” Plan Participant Dies Before Reaching His or Her RBD: • Five Year Rule: All funds must be withdrawn by December 31 of the fifth calendar year following the calendar year of Account Owner’s death. Plan Participant Dies After Reaching His or Her RBD: • Successor Beneficiaries must take required minimum distributions using participant’s Life Expectancy (Using Single Life Table NOT Uniform Lifetime Table) for participant’s attained age in the calendar year following the calendar year of death and each subsequent year’s applicable divisor is equal to prior years minus one.

8. Presence of Nonqualified “Designated Beneficiary” • General Rule: Never name the estate as the beneficiary. • Strategies: Cash out Non-qualified successor designated beneficiaries. • Charitable Beneficiaries: Plan proceeds paid to a charity will not be subject to income tax. Participants who intend to benefit one or more charities should consider naming a charity as a beneficiary to receive a separate share of the plan.

9. Naming the Spouse as Beneficiary • A full marital deduction is available for estate tax purposes. • Surviving Spouse’s Options: • Tax-free rollover tax free into a spousal IRA. • Elect the Five-year payout. • Elect a payout based on the life expectancy of the surviving spouse, but payout must begin on or before the later of: • December 31 of the year following the year of participants death. • December 31 of the year participant would have attained age 70½ (i.e., the surviving spouse gets to wait until the participant would have reached his or her RBD).

10. Naming the Spouse As Beneficiary Spousal Rollover • Usually the optimal choice • Detriment of rollover: • Surviving Spouse cannot take distributions until age 59 ½without incurring penalty. • Planning Option: Elect to delay roll-over until Surviving Spouse attains age 59 1/2. There is a risk is that, if the Surviving Spouse dies before electing a roll-over, then successor beneficiaries who succeed to Surviving Spouse’s interest must continue taking Minimum Distributions using the Surviving Spouse’s life expectancy, calculated under the Fixed Method.

11. Alternatives For Benefit of Surviving Spouse Basic Rules for Designating Trusts as Beneficiary: • The trust must be valid under state law • The trust must be irrevocable or become irrevocable upon death of participant • The trust beneficiaries must be identifiable • A copy of trust document must be provided to the plan administrator or the IRA custodian by Oct. 31 of calendar year following calendar year of participant’s death.

12. Alternatives For Benefit of Surviving Spouse • Designation of QTIP Trust as Beneficiary: • Naming a QTIP Trust as beneficiary will qualify for full marital deduction from estate taxes if QTIP election is made. • Naming a QTIP Trust as beneficiary helps protect ultimate disposition of assets in accordance with participant’s desires. • Consideration must be given to community property interest of spouse, if applicable. May need to designate 50% to spouse and 50% to QTIP Trust. • A partial QTIP election can be made if necessary to maximize use of available estate exemption amount of participant.

13. Naming QTIP Trust as Beneficiary • Naming a QTIP Trust as a beneficiary of a qualified plan involves complex estate planning. See IRC §2056. • A QTIP is usually designated as the beneficiary of a qualified plan only when outright gift is not feasible. • Careful drafting is required to ensure designation of QTIP Trust qualifies for marital deduction. Pursuant to Rev. Rul. 2000-2, the spouse must be able to compel distribution of income from the IRA through the QTIP Trust.

14. Sample QTIP Language For Qualified Plan Benefits “Special Provisions Regarding IRA and Qualified Plan Benefits. If the QTIP TRUST shall be the beneficiary of any benefits from a qualified plan as defined in Internal Revenue Code §401(a) or an individual retirement account (“IRA”) as defined in Internal Revenue Code §408(a), then Settlors direct the trustee to treat distributions from any qualified retirement plan or IRA as income of the QTIP TRUST to the extent of the greater of income generated or deemed to be generated by such plan or individual retirement account or the amount determined to be income under the Texas Trust Code. For purposes of determining income, fiduciary accounting principles shall be applied.

15. Sample QTIP Language For Qualified Plan Benefits(Cont’d) In determining the amount of income of the QTIP TRUST to be distributed to the surviving Settlor with respect to the qualified plan or IRA benefit, the trustee shall determine such income so that in all events the surviving Settlor shall have a qualifying income interest for life as provided in Internal Revenue Code §2056(b)(7). The trustee shall not charge to income any expense properly chargeable to the principal portion of any distribution. In addition, the trustee shall have the right in its discretion to: (a) Require the qualified plan trustee or IRA custodian to convert non-income-producing assets or low income-producing assets into income-producing assets or assets producing adequate income. (b) Withdraw any part or all of the remaining qualified plan benefit or IRA, including, but not limited to assets sufficient to meet the required minimum distribution rules.”

16. Naming QTIP Trust as Beneficiary • Detriments of designating a QTIP Trust as the plan beneficiary: • Minimum distributions are calculated on the spouse’s lifetime only; • Spouse cannot defer distributions until reaching age 70 ½ as with a spousal rollover; • Spouse cannot name younger individuals as designated beneficiaries (no stretch-out).

17. Alternatives For Benefit of Surviving Spouse • Designation of a Bypass Trust as Beneficiary • Naming Bypass Trust as beneficiary helps protect ultimate disposition of assets in accordance with participant’s desires. • Naming Bypass Trust as beneficiary maximizes use of available estate exemption amount of participant. • Designation of a Bypass Trust as the Contingent Beneficiary because of uncertainty of available exemption amount for estate tax purposes. Sample Designation: “Spouse, if he/she is then surviving; If Spouse is then surviving, but shall disclaim any portion of my account, then the disclaimed portion of the account is to be distributed to the Trustee of the Bypass Trust created under the _____ Family Trust dated January 1, 2011, as may be amended from time.”

18. Naming Bypass Trust as Contingent Beneficiary Detriments: • Distributions to a Bypass Trust will be subject to income tax thus reducing the ultimate funding of the trust. • Distributions from Bypass Trust are considered distributions of principal and not deductible by Trust. To avoid harsh results, language can be added to Bypass Trust to address deductibility of distributions. • Five year pay-out rule applies if Bypass Trust does not have a beneficiary that can be treated as the Designated Beneficiary. The existence of a power of appointment can create concern as to whether the trust can ever qualify as a Designated Beneficiary.

19. Naming Bypass Trust as Contingent Beneficiary Detriments (Cont’d): • If the surviving spouse is the oldest beneficiary, the pay-out is based on the surviving spouse’s life expectancy. • The surviving spouse cannot defer pay-out until reaching age 70½. • The distributions will be taxed at trust rates if not distributed to beneficiaries. • If distributions are based on surviving spouse’s life, the distribution schedule will not change at the death of the surviving spouse.

20. Sample Bypass Trust Language For Qualified Plan Benefits “Distributions to the Surviving Spouse. If this ____ Trust shall be the beneficiary of any benefits from a qualified plan as defined in Internal Revenue Code §401(a) or an individual retirement account (“IRA”) as defined in Internal Revenue Code §408(a), then the independent trustee shall treat distributions from any qualified retirement plan or IRA as income of such trust to the extent of the greater of income generated or deemed to be generated by such plan or individual retirement account or the amount determined to be income under the Texas Trust Code. For purposes of determining income, fiduciary accounting principles shall be applied. The trustee shall not charge to income any expense properly chargeable to the principal portion of any distribution. In addition, the trustee shall have the right in its discretion to:

21. Sample Bypass Trust Language For Qualified Plan Benefits (cont’d) In addition, the trustee shall have the right in its discretion to: • Require the qualified plan trustee or IRA custodian to convert non-income-producing assets or low income-producing assets into income-producing assets or assets producing adequate income. • Withdraw any part or all of the remaining qualified plan benefit or IRA, including, but not limited to assets sufficient to meet the required minimum distribution rules. To the extent necessary to cause the surviving Spouse to be deemed and maintain the status as the sole designated beneficiary” for the “required minimum distribution rules,” the independent trustee shall distribute to the surviving Spouse an amount of income necessary to meet such rules.”

22. Non-Spouse Qualified Designated Beneficiaries Plan Participant Dies Before Reaching His or Her RBD: • If there is only a single Designated Beneficiary, the required distribution period is based upon the Designated Beneficiary’s life expectancy. • If there are multiple Designated Beneficiaries, then the General Rule is that the required distribution period is based on the life expectancy of the oldest Designated Beneficiary.

23. Non-Spouse Qualified Designated Beneficiaries Plan Participant Dies After Reaching His or Her RBD: • OLD GENERAL RULE. Must distribute balance as least a rapidly as method in effect at participant’s death. IRC §401(a)(9)(B)(i). Exception created in year 2002. • If plan has a single Designated Beneficiary, the required distribution period is the longer of: • The remaining life expectancy of the Designated Beneficiary; or • The remaining life expectancy of the participant. . • If the plan has multiple Designated Beneficiaries, the General Rule is that the payout of benefits is based on the remaining life expectancy of oldest Designated Beneficiary if longer than the life expectancy of the participant.

24. Non-Spouse Qualified Designated Beneficiaries Creating Separate Payout Periods for each beneficiary: • Although difficult, you may allow each Designated Beneficiary to utilize their own life expectancy as the payout period by dividing plan assets into separate shares before death of participant. • Provide for separate shares for each intended beneficiary upon death of participant. Example separate share language for outright bequests: “If Spouse is not then surviving, in separate shares for the following individuals in the percentages shown: 50% to Daughter 50% to Son.”

25. Non-Spouse Qualified Designated Beneficiaries • Con’t: Example Separate Share language where trusts are to be utilized: “If Spouse is not then surviving, to the Trustee of each separate trust for issue established under the Smith Family Trust dated January 1, 2011, as may be amended from time; each trust to receive the share allocated to issue perstirpes.” • May utilize post death disclaimers of eldest Designated Beneficiaries.

26. Sample Conduit Trust Language For Qualified Plan Benefits “Special Provisions Regarding IRA and Qualified Plan Benefits. To the extent not otherwise provided herein, if any trust shall be the beneficiary of any benefits from a qualified plan as defined in Internal Revenue Code §401(a) or an individual retirement account (“IRA”) as defined in Internal Revenue Code §408(a), then Settlors direct the trustee to treat distributions from any qualified retirement plan or IRA as income of such trust to the extent of the greater of income generated or deemed to be generated by such plan or individual retirement account or the amount determined to be income under the Texas Trust Code. For purposes of determining income, fiduciary accounting principles shall be applied. The trustee shall not charge to income any expense properly chargeable to the principal portion of any distribution. In addition, the trustee shall have the right in its discretion to:

27. Sample Conduit Trust Language For Qualified Plan Benefits (cont’d) (a) Require the qualified plan trustee or IRA custodian to convert non-income-producing assets or low income-producing assets into income-producing assets or assets producing adequate income. (b) Withdraw any part or all of the remaining qualified plan benefit or IRA, including, but not limited to assets sufficient to meet the required minimum distribution rules. To the extent necessary to cause the current beneficiary of a trust to be deemed and maintain the status as the sole “designated beneficiary” for the “required minimum distribution rules,” the independent trustee shall distribute to such current beneficiary an amount of income necessary to meet such rules.”

28. Beneficiary Designations For Other Non-Probate Assets Life Insurance and Bank Accounts: A. Spouse as Beneficiary: • Qualifies for full marital deduction. • Alternative: With proper estate planning in place which includes a trust that provides for creation of a bypass trust, a QTIP trust and/or a surviving spouse’s trust, then the “umbrella” trust can be named as the beneficiary. This will allow the trustee to allocate the proceeds to the proper trust and will allow maximum use of the available estate tax exemption for the insured/account owner.

29. Beneficiary Designations For Other Non-Probate Assets A. Spouse as Beneficiary (Cont’d): 3. Alternative: A Bypass Trust can be named as the contingent beneficiary if insurance proceeds are needed to maximize use of estate tax exemption. Example language for beneficiary designation of insurance: “Spouse, if he/she is then surviving; If Spouse is then surviving, but shall disclaim any portion of my account, then the disclaimed portion of the account is to be distributed to the Trustee of Trust B (Bypass Trust) under the Smith Family Trust dated January 1, 2011, as may be amended from time.”

30. Beneficiary Designations For Other Non-Probate Assets B. Children as Beneficiaries: • Naming minor children as beneficiaries may result in need for a guardianship. • Naming an adult beneficiary to receive on behalf of a minor child, but failing to provide for custodianship may result in the adult beneficiary having to make a gift to minor child (or keeping insurance proceeds/account assets for him or herself). • Naming a trust as a beneficiary for each child may provide necessary or desired management and creditor protection regardless of age of child.