Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

§ 2056 , which creates the federal estate tax marital deduction, provides a general rule (the deduction is allowed for the value of property “which passes or has passed from the decedent to his surviving spouse”; § 2056(a) ), followed by an exception to the general rule (no deduction is allowed if the property that passes to the surviving spouse is a “life estate or other terminable interest”; § 2056(b)(1) ), followed by several exceptions to the exception (certain terminable interests do qualify for the marital deduction after all!). The key to qualifying for the marital deduction, therefore, is to make sure that any property left to the surviving spouse either (1) is not a “terminable interest,” or (2) if it is a terminable interest, it qualifies for one of the exceptions to the “terminable interest rule.” Here are the steps to follow: A. Choose a method. Benefits can qualify for the marital deduction if left to the spouse outright ( ¶ 3.3.11 ), to a “QTIP” marital trust ( ¶ 3.3.02 ), to a “General Power” marital trust ( ¶ 3.3.09 ), or in certain forms of annuity ( ¶ 3.3.10 ). B. If using a trust, take three extra steps. If leaving benefits to a QTIP or General Power marital trust, you need to cover three additional points to make sure the benefits qualify for the marital deduction. First, you need to understand the IRS’s concept of how the “terminable interest rule” applies to retirement benefits payable to a marital trust; see ¶ 3.3.03 . Second, you need to assure that the “income of the retirement plan” is determined correctly for marital deduction purposes; see ¶ 3.3.04 . Third, you must make sure the spouse is “entitled” to all that income; see ¶ 3.3.05 – ¶ 3.3.08 . C. Don’t forget RMDs. Work out how the minimum distribution rules ( Chapter 1 ) will work with the method you have chosen. See comments under each method, and ¶ 3.3.07 – ¶ 3.3.09 . D. Pay attention to funding formula. If the benefits are payable to a trust that is to be divided, at the participant’s death, between a “marital trust” and a “credit shelter” (or bypass) trust, it is recommended that either the division be by means of a “fractional” (rather than a “pecuniary”) formula, or, if a pecuniary formula is used, that the benefits be made payable directly to the marital trust so they don’t become subject to the pecuniary formula; see ¶ 6.5.08 .

E. Spousal consent. Finally, under certain types of retirement plans, benefits cannot be left to a trust without the consent of the participant’s spouse. See ¶ 3.4 .

Leaving retirement benefits to a QTIP trust

The most popular method of leaving retirement benefits to benefit the surviving spouse is leaving the benefits to her outright ( ¶ 3.3.11 ). The second most popular is to leave benefits to a “qualified terminable interest property” (QTIP) trust. The “classic” QTIP trust provides for all income of the trust to be paid to the surviving spouse for her life, with the principal being paid to the donor’s issue on the spouse’s death. The spouse may or may not be given access to the principal of the trust during her life (such as through a standard based on health and support, or in the trustee’s discretion, or through a 5-and-5 power). The spouse may or may not be given a limited power to appoint the principal at her death.