Life and Death Planning for Retirement Benefits

Chapter 11: Insurance, Annuities, and Retirement Plans

489

The potential of a stretch payout does not do the beneficiary any good if the beneficiary must withdraw from the plan shortly after the participant’s death to pay the participant’s debts, expenses, or estate taxes, or even to pay for the beneficiary’s own needs or wants. By purchasing life insurance inside an irrevocable trust for the benefit of his beneficiaries, the participant can assure that the beneficiaries will have enough money on hand to satisfy all these requirements, so they can leave the inherited retirement plan intact and get the deferral benefits of the stretch payout. Another view is that the stretch payout may be eliminated by new legislation and replaced by a five-year payout. Life insurance is a way to compensate for the potential loss of the stretch due to changes in the law. Parents of young children generally want to leave their assets in trust for their children in the event that both parents die while the children are too young to manage the money. Unfortunately, the IRS makes it extremely difficult to leave retirement benefits to a “normal” minor’s trust or “family pot” trust and still have such benefit qualify for favorable the life- expectancy-of-the-beneficiary payout method (sometimes called the “stretch payout”) that is available under the Tax Code for death benefits paid to or for the benefit of young individuals. In order to make the trust qualify as a so-called “see-through trust” under the IRS’s minimum distribution rules, the parents typically would have to include provisions or beneficiaries that they would not otherwise put into their trusts. See ¶ 6.2 and ¶ 6.3 . One way to solve this dilemma is with life insurance. Young parents of young children might consider drafting their children’s trust to say exactly what the parents want it to say , ignoring the see-through trust requirements, and purchasing term life insurance to assure adequate funds for payment of any extra income taxes caused by loss of see-through status. This may make more sense than accepting the drawbacks of a conduit trust, or naming wipe-out beneficiaries the donors don’t want to name. For young parents: Dump the stretch, buy life insurance A surviving spouse is generally entitled to roll over retirement benefits inherited from the decease spouse into (among other possible destinations) a traditional or Roth IRA in the surviving spouse’s own name. See ¶ 3.2 . Any “designated beneficiary” of a deceased employee can cause inherited qualified retirement plan benefits to be “rolled over” (via direct transfer) from the plan to an inherited traditional or Roth IRA. See ¶ 4.2.04 . These options raise the intriguing question whether a surviving spouse or a nonspouse designated beneficiary could roll over life insurance proceeds paid to such beneficiary as part of his or her inherited death benefits under a qualified retirement plan. If such a rollover is possible, rolling to a traditional IRA would be tax-free, but it is not clear how if at all the beneficiary could establish a “basis” or “investment in the contract” in the IRA with respect to the tax-free insurance proceeds rolled into the IRA. For that reason, it is probably inadvisable to seek to roll life insurance proceeds to a traditional IRA. Rolling to a Roth IRA, if it is possible, would cause the beneficiary to be immediately taxed on the pretax portion of the rolled distribution (see ¶ 11.2.06 ) because he or she has done a “Roth conversion” (see ¶ 5.4 regarding Roth conversions), but would allow all the insurance proceeds to grow tax-free thereafter in the Roth environment. Though the life insurance death benefit could presumably be paid to a different destination than the rest of the decedent’s plan account, and Can a beneficiary roll over life insurance proceeds?