Life and Death Planning for Retirement Benefits

Natalie B. Choate

Life and Death

Planning

for Retirement

Benefits

Digital Edition 2017

Life and Death Planning for Retirement Benefits

The Essential Handbook for Estate Planners

Seventh Edition, Revised 2011

Natalie B. Choate

Ataxplan Publications, Boston, Massachusetts

Updates for this book are published at our website:

www.ataxplan.com

Life and Death Planning for Retirement Benefits

The Essential Handbook for Estate Planners Seventh edition, completely revised

By Natalie B. Choate

Published by: Ataxplan Publications Post Office Box 51371

Boston, Massachusetts 02205-1371

All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, or by any information storage and retrieval system without written permission from the author, except for the inclusion of brief quotations in a review.

Copyright © 2010 by Natalie B. Choate Printed in the United States of America

Publisher’s Cataloging-in-Publication Data Choate, Natalie B. Life and Death Planning for Retirement Benefits: The Essential Handbook for Estate Planners—7th ed. / Natalie B. Choate p. cm. Includes bibliographical references and index.

ISBN 978-0-9649440-4-6

1. Estate planning - United States. 2. Tax planning - United States. 3. Retirement income - Taxation - United States. 4. Inheritance and transfer tax - United States. I. Choate, Natalie B. II. Title

KF 6585 .C43 2010

Changes Corresponding to 7 th print edition (2011)

Date

Book Chapter/Section

Change

MAY, 2017

Chapter 2

Replaced with an updated and revised Chapter 2 (will appear in the 8 th Edition, 2017). Removed sections 7.7.07 and 7.7.08 following incorporation of similar material into section ¶ 7.6 Revised ¶ 1.8.02 to include discussion of 2001 ruling regarding establishment of separate accounts Added new ¶ 7.6 covering Qualified Charitable Distributions (QCDs) in detail, reflecting the permanent authorization of QCDs under the Internal Revenue Code in 2015. Prior ¶ 7.6 is renumbered as ¶ 7.7 Revised to reflect procedures for a direct rollover from a traditional IRA to a qualified plan set forth in Rev. Rul. 2014-9. Added 6.4.06A, discussing the impact of portability on estate planning for retirement benefits. Chapter 1 (7 th Edition 2011) REPLACED by updated and revised Chapter 1 (8 th Edition 2017) Revised section on How to Determine RMDs of the Surviving Spouse Added link to Q&A ( new ) regarding taking RMDs from multiple accounts New ¶ 2.7 provides a consolidated discussion of the details of the 60-day rollover deadline and its exceptions. This includes a discussion of the self-certification procedure for obtaining a hardship waiver set forth in an August, 2016 Revenue Procedure. Other portions of Chapter 2 are revised and re-numbered accordingly.

MAY, 2017

¶ 7.6 and ¶ 7.7

MAY, 2017

¶ 1.8.02

JAN, 2017

¶ 7.6 (new); ¶ 7.7

JAN, 2017

¶ 2.2.09

JAN, 2017

¶ 6.4.06

JAN, 2017

Chapter 1

DEC, 2016

¶ 1.6.03

NOV, 2016

¶ 1.3.04

¶ 2.7 ( new ); Chapter 2

SEP, 2016

Chapter 10 ( new )

2015

Added Chapter 10 to the Digital edition

Chapter 11 ( new )

2015

Added Chapter 11 to the Digital edition

2015

Chapter 7

Replaced print book chapter with an expanded version from current seminar outline. Includes Planning Uses and Pitfalls of QCDs (¶ 7.6.08), Putting it All Together ( ¶ 7.7 ), and an expanded version of Qualified Charitable Distributions (¶ 7.6.07), that are not included in the print book.

2015

All

Changed terminology “minimum required distribution” (MRD) to “required minimum distribution” (RMD) to conform with more common usage These sections were completely rewritten to reflect the IRS's September 2014 rule reversal which now allows tax- free Roth conversions of after-tax money in a client's IRA or qualified plan. Updated to reflect significant 2015 change in the "one per year" IRA-to-IRA rollover rules as a result of the "Bobrow" case

2015

¶ 2.2.04 , ¶ 2.2.05

2015

¶ 2.6.05

To Ian

Warning and Disclaimer The rules applicable to qualified retirement plan benefits and IRAs are among the most complex in the tax code. I have read few works on this subject that were, in my view, completely accurate; in fact most that I have seen, including, unfortunately, earlier incarnations of this work, contain errors. Furthermore, even accurate information can become outdated quickly as IRS or Congressional policy shifts. Despite my best efforts, it is likely that this book, too, contains errors. Citations are provided so that practitioners can check any statements made in this book and reach their own conclusions regarding what the law is. This book is intended to provide general information regarding the tax and other laws applicable to retirement benefits, and to provide suggestions regarding appropriate estate planning actions for different situations. It is not intended as a substitute for the practitioner’s own research, or for the advice of a qualified estate planning or tax specialist. The author and publisher shall have neither liability nor responsibility to any person or entity with respect to any loss or damage caused, or alleged to be caused, directly or indirectly by the information contained in this book. About the author Natalie B. Choate is an attorney with the Boston law firm of Nutter McClennen & Fish. Her practice is limited to consultations on estate planning for retirement benefits. She has chaired the Boston Bar Estate Planning Committee, the Boston Bar Employee Benefits Committee, and the American College of Trust and Estate Counsel Employee Benefits Committee. The National Association of Estate Planners and Councils awarded her the “Distinguished Accredited Estate Planner” designation. She has published widely and lectured in 49 states (sorry Montana!). Her comments on estate and retirement planning have been quoted in The Wall Street Journal, Money, The New York Times, Newsweek, Forbes, Financial Planning and Financial World . A Boston native, Miss Choate is a graduate of Radcliffe College and Harvard Law School. If you do not wish to be bound by the above, you may return this book to the publisher for a full refund.

SUMMARY CONTENTS

Introduction ............................................................................................................8

Abbreviations used in this book ............................................................................28

Chapter 1: The Minimum Distribution Rules .....................................................30

Chapter 2: Income Tax Issues ..........................................................................106

Chapter 3: Marital Matters ...............................................................................170

Chapter 4: Inherited Benefits: Advising Executors & Beneficiaries .................197

Chapter 5: Roth Retirement Plans ....................................................................245

Chapter 6: Leaving Retirement Benefits in Trust .............................................297

Chapter 7: Charitable Giving ...........................................................................357

Chapter 8: Investment Issues; Plan Types ........................................................409

Chapter 9: Distributions Before Age 59 ½ .......................................................429

Chapter 10: RMD Rules for “Annuitized” Plans ................................................445

Chapter 11: Insurance, Annuities, and Retirement Plans ....................................468

Appendix A: Tables ............................................................................................493

Appendix B: Forms.............................................................................................496

Appendix C: Resources.......................................................................................519

Bibliography .......................................................................................................522

TABLE OF CONTENTS: DETAILED

CHANGES CORRESPONDING TO 7 TH PRINT EDITION (2011) ...............................................3

INTRODUCTION ..............................................................................................................................26

Terminology Used in this Book...................................................................................................27 Abbreviations and Symbols .........................................................................................................28

CHAPTER 1: THE MINIMUM DISTRIBUTION RULES...........................................................30

1.1 I NTRODUCTION TO THE RMD R ULES ........................................................................................30 Where to find the law.............................................................................................................30 Which plans are subject to the RMD rules ...........................................................................31 RMD economics: The value of deferral ...............................................................................31 WRERA suspended RMDs for 2009 ....................................................................................32 RMDs under DB plans and “annuitized” DC plans .............................................................33 Planning for change?..............................................................................................................34 1.2 RMD F UNDAMENTALS ..............................................................................................................34 The 12 Fundamental Laws of RMDs ....................................................................................34 Which distributions do or do not count towards the RMD..................................................36 Tables to determine Applicable Distribution Period (ADP) ...............................................37 Meaning of “age”, “methods of computing “life expectancy” ............................................38 How to determine “account balance” for RMD purposes ...................................................39 How rollovers impact calculation of RMD ..........................................................................40 Adjustment for post-year-end recharacterizations ...............................................................42 Valuation rules for determining account balance.................................................................42 1.3 RMD S D URING P ARTICIPANT ’ S L IFE ........................................................................................44 Road Map: How to compute lifetime RMDs .......................................................................44 The Uniform Lifetime Table: Good news for retirees .........................................................45 Lifetime RMDs: Much-younger-spouse method .................................................................46 Taking distributions from multiple plans .............................................................................48 Separate accounts within a single plan .................................................................................49 1.4 T HE RBD AND F IRST D ISTRIBUTION Y EAR ...............................................................................49 Required Beginning Date (RBD); Distribution Year...........................................................50 RBD for IRAs and Roth IRAs...............................................................................................50 QRPs: RBD for 5-percent owner ..........................................................................................51 QRPs, cont.: RBD for non-5-percent owner.........................................................................51 RBD for 403(b) plans (including “grandfather rule”)..........................................................52 What “retires” means; rollover in retirement year ...............................................................53 RBD versus first Distribution Year: The limbo period........................................................54 Grandfather rule: TEFRA 242(b) elections ..........................................................................56 1.5 RMD S AFTER THE P ARTICIPANT ’ S D EATH ................................................................................57 Overview of the post-death RMD rules ................................................................................58 Road Map for determining post-death RMDs ......................................................................59 Road Map, cont.: RMDs in case of death BEFORE the RBD ............................................61

Table of Contents

9

Road Map, cont.: RMDs in case of death AFTER the RBD ...............................................63 RMDs based on life expectancy of Designated Beneficiary ...............................................66 Death before the RBD: The 5-year rule................................................................................68 Life expectancy or 5-year rule: Which applies?...................................................................69 Computing RMDs based on participant’s life expectancy ..................................................71 Aggregation of inherited accounts for RMD purposes ........................................................73 Plan not required to offer stretch payout or lump sum ........................................................75 Switching between 5-year rule and life expectancy method ...............................................76 Who gets the benefits when the beneficiary dies? ...............................................................76 What is the ADP after the beneficiary’s death? ...................................................................78 1.6 S PECIAL R ULES FOR THE S URVIVING S POUSE ...........................................................................79 Overview of the special spousal rules...................................................................................79 Definition of “sole beneficiary” ............................................................................................80 How to determine RMDs of the surviving spouse ...............................................................80 Required Commencement Date: Distributions to spouse ....................................................84 If both spouses die before the participant reached 70 ½: The (B)(iv)(II) rule ...................85 When is a trust for the spouse the same as the spouse? .......................................................87 1.7 T HE B ENEFICIARY AND THE “D ESIGNATED B ENEFICIARY ”......................................................89 Significance of having a Designated Beneficiary ................................................................89 Who is the participant’s beneficiary?....................................................................................89 Definition of Designated Beneficiary ...................................................................................90 Estate cannot be a Designated Beneficiary...........................................................................92 Multiple beneficiary rules and how to escape them.............................................................92 Multiple beneficiaries: Who must take the RMD? ..............................................................93 Simultaneous and close-in-time deaths.................................................................................94 1.8 M ODIFYING RMD R ESULTS AFTER THE P ARTICIPANT ’ S D EATH .............................................95 The separate accounts rule .....................................................................................................95 How do you “establish” separate accounts? .........................................................................98 “Removing” beneficiaries by Beneficiary Finalization Date ..............................................99 1.9 E NFORCEMENT OF THE RMD R ULES .......................................................................................101 Who enforces the minimum distribution rules? .................................................................101 Failure to take an RMD: 50% excise tax, other effects .....................................................102 IRS waiver of the 50 percent excise tax .............................................................................103 Statute of limitations on the 50 percent excise tax.............................................................104 2.1 I NCOME T AX T REATMENT : G ENERAL &M ISCELLANEOUS ...................................................106 Plan distributions taxable as ordinary income....................................................................106 3.8% additional tax on net investment income...................................................................107 When does a “distribution” occur? .....................................................................................108 Actual distributions and deemed distributions ...................................................................108 Whose income is it? Community property etc. ..................................................................109 List of no-tax and low-tax distributions..............................................................................110 CHAPTER 2: INCOME TAX ISSUES .........................................................................................106

10

Life and Death Planning for Retirement Benefits

A. Roth plans.................................................................................................................110 B. Tax-free rollovers and transfers ..............................................................................110 C. Life insurance proceeds, contracts..........................................................................110 D. Recovery of basis.....................................................................................................110 E. Special averaging for lump sum distributions .......................................................110 F. Net unrealized appreciation of employer securities (NUA) ..................................110 G. No tax on distribution of annuity contract .............................................................111 H. Return of IRA contribution .....................................................................................111 I. Income tax deduction for certain beneficiaries ......................................................111 J. Distribution to charitable entity ..............................................................................111 K. Qualified Health Savings Account Funding Distributions....................................111 L. QDROs and divorce-related IRA divisions............................................................111 Plan loans: Income tax treatment, RMDs, etc. ..................................................................111 Excess IRA contributions; corrective distributions............................................................113 Distributions made in error: Wrong amount, person, etc. ................................................117 2.2 I F THE P ARTICIPANT H AS A FTER - TAX M ONEY IN THE P LAN OR IRA ....................................118 Road Map: Tax-free distribution of participant’s “basis” .................................................118 General rule: The “cream-in-the-coffee rule” of § 72........................................................119 Participant’s basis in a QRP or 403(b) plan .......................................................................119 QRP distributions from account that contains after-tax money ........................................120 Partial and split rollovers, conversions: QRP distributions ..............................................123 A. Introduction: Please read this first. .........................................................................123 B. Part direct rollover to Roth IRA, part direct rollover to traditional IRA. ............124 C. Part outright distribution, part direct rollover into any IRA(s) .............................125 D. Distribution outright to participant followed by one or more 60-day rollover(s)125 E. Direct rollover into multiple traditional (or Roth) IRAs .......................................127 F. How these options apply to QRP beneficiaries......................................................128 G. Effective date and retroactivity of Notice 2014-54 ...............................................128 Participant’s basis in a traditional IRA ...............................................................................128 Beneficiary’s basis in an inherited IRA ..............................................................................129 How much of a traditional IRA distribution is basis?........................................................130 A. The cream-in-the-coffee formula............................................................................130 B. Distribution Amount................................................................................................130 C. Year-end Account Balance .....................................................................................131 D. Total Nondeductible Contributions ........................................................................132 E. Outstanding Rollovers .............................................................................................132 F. The aggregation rule: Which IRAs must be aggregated .......................................132 G. Cream-in-the-coffee formula: Examples................................................................133 Exceptions to the cream-in-the-coffee rule for IRAs.........................................................134 Partial rollovers and conversions: IRA distributions ........................................................134 2.3 I NCOME T AX W ITHHOLDING ...................................................................................................135 Withholding of federal income taxes: overview ................................................................135 Periodic, nonperiodic, and eligible rollover payments ......................................................136

Table of Contents

11

Exceptions and special rules................................................................................................138 Mutually voluntary withholding..........................................................................................138 How withheld income taxes are applied .............................................................................138 2.4 L UMP S UM D ISTRIBUTIONS ......................................................................................................138 Introduction to lump sum distributions...............................................................................139 First hurdle: Type of plan ....................................................................................................139 Second hurdle: “Reason” for distribution ...........................................................................139 Third hurdle: Distribution all in one taxable year ..............................................................141 Exceptions to the all-in-one-year rule.................................................................................143 Special averaging: Participant born before 1936 ...............................................................143 2.5 N ET U NREALIZED A PPRECIATION OF E MPLOYER S TOCK .......................................................143 NUA: Tax deferral and long-term capital gain ..................................................................143 Reporting NUA distributions; finding plan’s basis............................................................144 Distributions after the employee’s death ............................................................................145 Basis of stock distributed in life, held until death ..............................................................145 Election to include NUA in income ....................................................................................145 Should employee keep the LSD or roll it over? .................................................................146 NUA and partial rollovers ...................................................................................................147 2.6 R OLLOVERS AND P LAN - TO -P LAN T RANSFERS ........................................................................149 Definitions: rollovers, trustee-to-trustee transfers, etc.......................................................149 A. Background: Rollover vs. trustee-to-trustee transfer.............................................149 B. Definition of “rollover” and “rollover contribution.”............................................149 C. Direct rollovers ........................................................................................................150 D. Definition of “60-day” (indirect) rollover ..............................................................150 E. Trustee-to-trustee transfer .......................................................................................150 Distributions that can (or can’t) be rolled over ..................................................................151 A. Inherited plans..........................................................................................................151 C. Series payments .......................................................................................................151 D. Corrective and deemed distributions ......................................................................151 E. Hardship distributions .............................................................................................151 F. 12-month limitation on IRA rollovers ....................................................................151 G. Plan loans .................................................................................................................152 H. After-tax money .......................................................................................................152 Rollovers in an RMD year: RMD cannot be rolled over! .................................................152 A. Everybody: First distribution of the year is the RMD ...........................................152 B. Everybody: Missed RMDs from prior years ..........................................................153 C. Participant only: Plan can assume there is no DB .................................................153 D. Participant only: Rollovers in the age-70½ year....................................................153 E. Beneficiaries only: Rollover and the 5-year rule ...................................................153 F. Exceptions to the no-rollover-of RMDs rule .........................................................154 Must roll over (only) same property received ....................................................................154 Limit of one IRA-to-IRA rollover in 12 months................................................................154 Earliest date a rollover can be made ...................................................................................157

12

Life and Death Planning for Retirement Benefits

Avoid some rollover requirements with IRA-to-IRA transfer ..........................................157 2.7 T HE 60- DAY R OLLOVER D EADLINE .........................................................................................158 Computation of the 60 days.................................................................................................158 Does the deadline apply to direct rollovers? ......................................................................159 How does the deadline apply to lost checks? .....................................................................159 Non-hardship exceptions to the 60-day deadline ...............................................................160 A. First-time homebuyer ..............................................................................................160 B. Disaster-based extensions .......................................................................................160 C. Qualified reservist distribution ...............................................................................160 D. Frozen deposits ........................................................................................................160 E. Automatic waiver for certain financial institution errors ......................................161 Hardship waivers of 60-day rollover deadline: General ....................................................161 Hardship waiver, method #1: Self-certification .................................................................162 Hardship waiver, method #2: Apply to the IRS .................................................................164 3.1 C ONSIDERATIONS FOR M ARRIED P ARTICIPANTS ....................................................................170 Road Map: Advising the Married Participant ....................................................................170 Road Map: Advising the Surviving Spouse .......................................................................171 Simultaneous death clauses .................................................................................................172 3.2 S POUSAL R OLLOVER ; E LECTION TO T REAT D ECEDENT ’ S IRA AS S POUSE ’ S IRA ................173 Advantages and drawbacks of spousal rollover .................................................................173 Spousal rollover: QRPs and 403(b) plans...........................................................................174 Rollover (or spousal election) for IRA or Roth IRA .........................................................175 A. Spousal election: Code and regulations..................................................................175 B. Spousal election for inherited Roth IRA ................................................................175 C. Conditions that must be met....................................................................................176 D. How spouse makes the election ..............................................................................176 E. When spousal election may be made......................................................................177 F. Rollovers also permitted..........................................................................................177 Roth conversion by surviving spouse .................................................................................177 Rollover or election by spouse’s executor ..........................................................................178 Deadline for completing spousal rollover...........................................................................178 Plans the spouse can roll benefits into ................................................................................179 Rollover if spouse is under age 59½ ...................................................................................180 Spousal rollover through an estate or trust .........................................................................181 3.3 Q UALIFYING FOR THE M ARITAL D EDUCTION .........................................................................183 Road Map: Leaving Benefits to Spouse or Marital Trust ..................................................183 Leaving retirement benefits to a QTIP trust .......................................................................184 IRS regards benefits, trust, as separate items of QTIP ......................................................185 Entitled to all income: State law vs. IRS ............................................................................186 Ways to meet the “entitled” requirement; Income vs. RMD.............................................187 Distribute all income to spouse annually ............................................................................189 CHAPTER 3: MARITAL MATTERS...........................................................................................170

Table of Contents

13

Do not require stub income to be paid to spouse’s estate! ................................................189 Combination marital deduction-conduit trust.....................................................................190 General Power marital trust .................................................................................................190 Automatic QTIP election for “survivor annuities” ............................................................190 Marital deduction for benefits left outright to spouse........................................................191 3.4 REA ’84 AND S POUSAL C ONSENT ...........................................................................................191 Introduction to the Retirement Equity Act of 1984 ...........................................................192 Plans subject to full-scale REA requirements ....................................................................192 REA requirements for “exempt” profit-sharing plans .......................................................192 IRAs, Roth IRAs, and 403(b) plans ....................................................................................193 Various REA exceptions and miscellaneous points...........................................................194 Requirements for spousal consent or waiver ......................................................................194 Spousal waiver or consent: Transfer tax aspects................................................................195 CHAPTER 4: INHERITED BENEFITS: ADVISING EXECUTORS AND BENEFICIARIES ............................................................................................................................................................197 4.1 E XECUTOR ’ S R ESPONSIBILITIES ..............................................................................................197 The Executor’s Road Map ...................................................................................................197 Recharacterizing the decedent’s Roth conversion .............................................................197 Who can make or withdraw decedent’s IRA contribution? ..............................................199 Completing rollover of distribution made to the decedent ................................................200 Executor’s responsibilities regarding decedent’s RMDs...................................................202 4.2 P OST -D EATH T RANSFERS , R OLLOVERS , & R OTH C ONVERSIONS ...........................................204 How to title an inherited IRA ..............................................................................................204 Post-death distributions, IRA-to-IRA transfers..................................................................205 A. Nonspouse beneficiary cannot roll over a distribution received...........................205 B. Post-death IRA-to-IRA transfers permitted ...........................................................206 C. What can go wrong..................................................................................................207 Combining inherited IRAs...................................................................................................208 Nonspouse beneficiary rollovers from nonIRA plans .......................................................208 A. Legislative background ...........................................................................................208 B. Types of nonIRA plans............................................................................................209 C. Available only to a Designated Beneficiary ..........................................................209 D. Direct rollovers only................................................................................................209 E. Must roll to an “inherited IRA.” .............................................................................209 F. Applies to post-2006 post-death distributions .......................................................210 G. Cannot use rollover to “fix” the estate plan ...........................................................210 H. Limits on the plan’s obligations..............................................................................210 I. Plan must distribute RMD before the transfer .......................................................210 J. Beneficiary’s RMDs after the transfer ...................................................................211 Nonspouse beneficiary Roth conversions...........................................................................211 4.3 F EDERAL E STATE T AX I SSUES .................................................................................................213 Retirement benefits on the estate tax return .......................................................................213

14

Life and Death Planning for Retirement Benefits

Problems paying the estate tax ............................................................................................213 Alternate valuation method (AVM) for retirement benefits..............................................214 AVM, cont.: Distributions, other IRA events as “disposition” .........................................214 AVM, cont.: Sale of assets inside the IRA .........................................................................217 Federal estate tax exclusion for retirement benefits...........................................................217 Valuation discount for unpaid income taxes ......................................................................217 Deaths in 2010: One-year “repeal” of the federal estate tax .............................................218 4.4 Q UALIFIED D ISCLAIMERS OF R ETIREMENT B ENEFITS ............................................................219 Post-mortem disclaimer checklist .......................................................................................219 Requirements for qualified disclaimer: § 2518 ..................................................................220 Income tax treatment of disclaimers ...................................................................................220 What constitutes “acceptance” of a retirement benefit ......................................................221 Effect of taking a distribution; partial disclaimers .............................................................223 Deadline for qualified disclaimer ........................................................................................224 To whom is the disclaimer delivered? ................................................................................225 Who gets the disclaimed benefits and how do they get them? ..........................................225 A. Property must pass to “someone other than” disclaimant .....................................225 B. Property must pass “without direction” by disclaimant ........................................226 C. How to determine who gets the disclaimed benefits .............................................226 Disclaimers, ERISA, and the plan administrator ...............................................................227 A. Disclaimers and ERISA’s anti-alienation rule .......................................................227 B. Disclaimers and the plan document ........................................................................228 C. Effect of the plan’s “state law” provision ..............................................................229 Disclaimers and the minimum distribution rules ...............................................................229 How a disclaimer can help after the participant’s death ....................................................229 Double deaths: Disclaimer by beneficiary’s estate ............................................................230 A. Who is the successor beneficiary? ..........................................................................231 B. If the fiduciary is also a beneficiary .......................................................................231 Building disclaimers into the estate plan: Checklist ..........................................................231 4.5 O THER C LEANUP S TRATEGIES .................................................................................................233 Check the plan’s default beneficiary...................................................................................234 Invalidate the beneficiary designation ................................................................................234 Spousal election to take share of estate...............................................................................234 Will (or beneficiary designation form) contest ..................................................................235 Reformation of beneficiary designation form ....................................................................235 Reformation of trust or will .................................................................................................236 Choose the right cleanup strategy .......................................................................................237 A. When to seek reformation and avoid disclaimer ...................................................238 B. When and how to use disclaimer ............................................................................238 4.6 I NCOME IN R ESPECT OF A D ECEDENT (IRD) ...........................................................................238 Definition of IRD; why it is taxable....................................................................................239 When IRD is taxed (normally when received) ...................................................................239 Tax on transfer of the right-to-receive IRD........................................................................239

Table of Contents

15

A. Gift of right-to-receive IRD ....................................................................................240 B. Transfer from estate or trust to beneficiary ............................................................240 C. Transfer to a 100 percent grantor trust ...................................................................240 Income tax deduction for estate tax paid on IRD ...............................................................240 Who gets the § 691(c) (IRD) deduction..............................................................................241 IRD deduction for deferred payouts....................................................................................242 IRD deduction: Multiple beneficiaries or plans .................................................................243 IRD deduction on the income tax return.............................................................................243 4.7 R OAD M AP : A DVISING THE B ENEFICIARY ...............................................................................243 5.1 R OTH P LANS : I NTRODUCTION ..................................................................................................245 Introduction to Roth retirement plans .................................................................................245 Roth retirement plan abuses ................................................................................................245 5.2 R OTH IRA S : M INIMUM D ISTRIBUTION AND I NCOME T AX A SPECTS ......................................246 Roth (and deemed Roth) IRAs vs. traditional IRAs ..........................................................246 Roth IRAs and the minimum distribution rules .................................................................247 A. No lifetime required distributions...........................................................................247 B. Post-death RMD rules DO apply ............................................................................247 C. Roth distributions do not fulfill RMD for traditional IRA....................................247 D. RMDs and recharacterizations. ...............................................................................247 E. RMDs and Roth conversions. .................................................................................247 Tax treatment of Roth IRA distributions: Overview .........................................................248 Qualified distributions: Definition ......................................................................................249 Computing Five-Year Period for qualified distributions ...................................................250 A. Five-Year Period for participant .............................................................................250 B. Five-Year Period for beneficiaries..........................................................................251 Tax treatment of nonqualified distributions .......................................................................252 The Ordering Rules ..............................................................................................................253 5.3 H OW TO F UND A R OTH IRA; R EGULAR AND E XCESS C ONTRIBUTIONS .................................254 The eight ways to fund a Roth IRA ....................................................................................254 “Regular” contributions from compensation income.........................................................254 Applicable Dollar Limit for regular contributions .............................................................255 Who may make a “regular” Roth IRA contribution ..........................................................256 A. No age limit..............................................................................................................256 B. Participation in an employer plan is irrelevant ......................................................256 C. Income must be below certain levels......................................................................256 D. Regular traditional IRA contribution followed by conversion .............................257 Penalty for excess Roth IRA contributions ........................................................................258 5.4 C ONVERSION OF T RADITIONAL P LAN OR IRA TO A R OTH IRA .............................................258 What type of plan may be converted to a Roth IRA ..........................................................258 A. Individual retirement accounts................................................................................259 B. NonIRA plans ..........................................................................................................259 CHAPTER 5: ROTH RETIREMENT PLANS .............................................................................245

16

Life and Death Planning for Retirement Benefits

Who may convert: age, plan participation, income, etc.....................................................260 A. Age: Under 59½, over 70½, or in between ............................................................260 B. Participation in other plan(s) ...................................................................................260 C. Prior conversion .......................................................................................................260 D. Filing status ..............................................................................................................260 E. Income limit .............................................................................................................260 Tax treatment of converting traditional IRA to Roth IRA ................................................261 Tax treatment of converting nonIRA plan to Roth IRA ....................................................262 Income spreading for conversions in 1998 or 2010 ...........................................................263 Failed conversions................................................................................................................264 Mechanics of traditional IRA-to-Roth IRA conversions...................................................265 Mechanics of conversion from other traditional plans ......................................................265 5.5 R OTH P LANS AND THE 10% P ENALTY F OR P RE -A GE 59½ D ISTRIBUTIONS ...........................266 Penalty applies to certain Roth plan distributions ..............................................................266 A. Qualified distribution...............................................................................................266 B. Nonqualified distribution from Roth IRA..............................................................266 C. Nonqualified distribution from DRAC...................................................................266 D. Conversion followed by distribution within five years .........................................267 Roth conversion prior to reaching age 59½........................................................................267 A. Penalty does not apply to a Roth conversion .........................................................267 B. Penalty applies to certain distributions within five years after a conversion .......267 C. Penalty applies to failed conversion .......................................................................268 Conversion while receiving “series of equal payments” ...................................................268 5.6 R ECHARACTERIZING AN IRA OR R OTH IRA C ONTRIBUTION .................................................269 Which IRA contributions may be recharacterized .............................................................269 Income attributable to the contribution...............................................................................270 How to recharacterize certain IRA/Roth IRA contributions .............................................271 Partial recharacterizations....................................................................................................272 Deadline for Roth IRA contributions and conversions......................................................273 Recharacterization deadline: Due date “including extensions” ........................................274 Same-year and immediate reconversions banned ..............................................................276 5.7 D ESIGNATED R OTH A CCOUNTS ...............................................................................................276 Meet the DRAC: Roth 401(k)s, 403(b)s, 457(b)s ..............................................................276 DRAC contributions: Who, how much, how, etc. .............................................................277 A. Who may contribute ................................................................................................277 B. How much may be contributed ...............................................................................278 C. Election is irrevocable .............................................................................................278 D. What may be contributed to a DRAC.....................................................................278 RMDs and other contrasts with Roth IRAs ........................................................................279 DRACs: Definition of “qualified distribution” ..................................................................279 A. Qualified distribution triggering events .................................................................279 B. How the Five-Year Period is computed for a DRAC ............................................280 C. List of never-qualified distributions .......................................................................280