1 coordinating income and estate planning for iras and qualified plans presented by: robert s....

11

Coordinating Coordinating Income and Estate Income and Estate Planning for IRAs Planning for IRAs

and Qualified Plansand Qualified PlansPresented by:

Robert S. Keebler, CPA, MST1400 Lombardi Ave., Ste 200

P.O. Box 11997Green Bay, WI 54307-1997

Ph: (920) 490-5626Fax: (920) 499-1050

E-mail: [email protected]

22

Potential tax exposure to IRA without planning

Federal & State Estate Tax, 50.00%

Income Tax, 21.00%

Net to Family 29.00%

Why Retirement Distribution Planning is Important

33

IRAs Payable to Trusts

44

IRA distributions IRA distributions over the life over the life expectancy of the expectancy of the oldest beneficiaryoldest beneficiary

Trust

IRABeneficiary Designation Form

Spouse

Children

IRAs Payable to Trusts How an IRA is Payable to a TrustHow an IRA is Payable to a Trust

55

Spendthrift protectionSpendthrift protection Creditor protectionCreditor protection Divorce protectionDivorce protection Special needs Special needs Investment managementInvestment management Estate planningEstate planning ““Dead-hand” controlDead-hand” control

IRAs Payable to Trusts Benefits of Using a TrustBenefits of Using a Trust

66

Trust tax ratesTrust tax rates Legal and trustee feesLegal and trustee fees Income tax returnsIncome tax returns Greater complexityGreater complexity

IRAs Payable to Trusts Disadvantages of Using a TrustDisadvantages of Using a Trust

77

Older or unidentifiable contingent beneficiaryOlder or unidentifiable contingent beneficiary Estate as contingent beneficiaryEstate as contingent beneficiary Powers of appointmentPowers of appointment Failure of beneficiaries clauseFailure of beneficiaries clause Failure to provide trust document to custodian Failure to provide trust document to custodian

by October 31 of year following year of deathby October 31 of year following year of death Making lump sum distribution to trustMaking lump sum distribution to trust

IRAs Payable to Trusts Other ConsiderationsOther Considerations

88

IRAs Payable to Trusts Four Requirements of Four Requirements of AllAll IRA Trusts IRA Trusts

Trust is valid under state lawTrust is valid under state law Trust is irrevocable upon death of ownerTrust is irrevocable upon death of owner Beneficiaries of the trust are identifiable from the trust instrumentBeneficiaries of the trust are identifiable from the trust instrument Documentation requirement is satisfiedDocumentation requirement is satisfied

99

IRAs Payable to Trusts Types of IRA TrustsTypes of IRA Trusts

Accumulation TrustsAccumulation Trusts Conduit TrustsConduit Trusts

1010

IRAs Payable to Trusts Conduit TrustsConduit Trusts

A trust in which all distributions from the IRA A trust in which all distributions from the IRA are immediately distributed to the trust are immediately distributed to the trust beneficiary/beneficiariesbeneficiary/beneficiaries

1111

MotherAge 80

Trust

Discretionary Distributions, but no less than total withdrawals from IRA

Entire Trust outright upon Grandchildren reaching age 30

If Grandchildren die before reaching age 40

Mother is not “countable” for determining applicable life expectancy

Child – age 30

Child – age 30

IRA

IRAs Payable to Trusts Conduit Trusts – Example #1Conduit Trusts – Example #1

1212

Trust

To Red Cross

Child #1All distributionsfrom IRA

At Child #1’s death

IRA

IRAs Payable to Trusts Conduit Trusts – Example #2Conduit Trusts – Example #2

1313

A trust in which distributions from the IRA A trust in which distributions from the IRA are allowed to accumulate within the trustare allowed to accumulate within the trust

IRAs Payable to Trusts Accumulation TrustsAccumulation Trusts

1414

The key issue in analyzing an The key issue in analyzing an accumulation trust is to determine which accumulation trust is to determine which beneficiaries are “countable.”beneficiaries are “countable.”

All beneficiaries are countable unless All beneficiaries are countable unless such beneficiary is deemed to be a such beneficiary is deemed to be a “mere potential successor” beneficiary.“mere potential successor” beneficiary.

IRAs Payable to Trusts Accumulation TrustsAccumulation Trusts

1515

Mother Age 80

Trust

Discretionary Distributions



Mother is “countable” for determining applicable life expectancy

Child – age 30

Child – age 30

IRA

IRAs Payable to Trusts Accumulation Trusts – Example #1Accumulation Trusts – Example #1

1616

IRA

SisterAge 67

Grandchildren

Trust

Discretionary Distributions

Grandchildren



Accumulation Trust

Sister measuring life for determining required minimum distributions

IRAs Payable to Trusts Accumulation Trusts – Example #2Accumulation Trusts – Example #2

1717

In proper circumstances, the IRS allows In proper circumstances, the IRS allows the division of the IRA into separate the division of the IRA into separate shares per beneficiaryshares per beneficiary

In the case of an individual beneficiary, In the case of an individual beneficiary, this must be determined by December 31 this must be determined by December 31 of the year following the year of deathof the year following the year of death– Separate shares established when dividedSeparate shares established when divided

No separate shares available for estatesNo separate shares available for estates Disclaimer ruleDisclaimer rule Death by September 30Death by September 30

IRAs Payable to Trusts Separate SharesSeparate Shares

1818

Payable to single trustPayable to single trust

No separate shares identified in the No separate shares identified in the beneficiary designation formbeneficiary designation form

IRA paid over oldest life expectancyIRA paid over oldest life expectancy


1919

IRA payable to multiple sub-trustsIRA payable to multiple sub-trusts

Each trust named in Each trust named in

beneficiary designation formbeneficiary designation form

IRA paid trust beneficiary’s life IRA paid trust beneficiary’s life expectancyexpectancy


2020

Ruling 1:Ruling 1: Each Beneficiary’s Trust Share Each Beneficiary’s Trust Share Qualified for Maximum Stretch-out.Qualified for Maximum Stretch-out.– Upon the death of the Settlor, the IRA stand-alone trust Upon the death of the Settlor, the IRA stand-alone trust

creates separate shares for each beneficiary (in this creates separate shares for each beneficiary (in this case, separate shares for 9 beneficiaries), each trust case, separate shares for 9 beneficiaries), each trust share “treated effective ab initio to the date of the share “treated effective ab initio to the date of the Decedent’s death” and each share functioned as a Decedent’s death” and each share functioned as a “separate and distinct trust” for the beneficiary.“separate and distinct trust” for the beneficiary.

– The beneficiary designation form named each separate The beneficiary designation form named each separate share as a primary beneficiary of the IRA.share as a primary beneficiary of the IRA.

– Before the December 31Before the December 31stst deadline, the IRA was divided deadline, the IRA was divided into separate accounts for each share.into separate accounts for each share.

– Held:Held: Separate account treatment permitted; MRD of Separate account treatment permitted; MRD of the IRA for each separate trust share measured by the the IRA for each separate trust share measured by the lifetime of its sole beneficiary for whom the share was lifetime of its sole beneficiary for whom the share was created.created.

IRAs Payable to Trusts Separate Shares – PLR 200537044Separate Shares – PLR 200537044

2121

Ruling 2:Ruling 2: Allowance of One-Time “ Allowance of One-Time “ToggleToggle” ” Between Accumulation and Conduit Trust.Between Accumulation and Conduit Trust.– Each separate share in the IRA stand-alone trust had Each separate share in the IRA stand-alone trust had

language structuring the separate share as a conduit language structuring the separate share as a conduit trust.trust.

– The trust provided for an independent 3The trust provided for an independent 3rdrd party, as “trust party, as “trust protector” to transform each sub-trust to an protector” to transform each sub-trust to an accumulation trust in the protector’s sole discretion by accumulation trust in the protector’s sole discretion by voiding the conduit provisions voiding the conduit provisions ab initioab initio..

– Trust Protector had the authority to limit the initial trust Trust Protector had the authority to limit the initial trust beneficiary beneficiary ab initioab initio..

– After Participant’s date of death, Trust Protector After Participant’s date of death, Trust Protector exercised “toggle” and converted one share to an exercised “toggle” and converted one share to an accumulation trust.accumulation trust.

– Held:Held: Each share can use that the life expectancy of its Each share can use that the life expectancy of its initial beneficiary to measure the MRD for that share.initial beneficiary to measure the MRD for that share.

IRAs Payable to Trusts Separate Shares – PLR 200537044Separate Shares – PLR 200537044

2222

Ruling 3:Ruling 3: Payment of Expenses from IRA not Payment of Expenses from IRA not considered an accumulation.considered an accumulation.– The trust provided that “Trust expenses may be deducted The trust provided that “Trust expenses may be deducted

prior to any such payment to or for the benefit of the prior to any such payment to or for the benefit of the beneficiary of the trust share if the deduction does not beneficiary of the trust share if the deduction does not disqualify the status of the trust as a conduit trust. This disqualify the status of the trust as a conduit trust. This paragraph may be rendered void, paragraph may be rendered void, ab initioab initio, by the Trust , by the Trust Protector. . .”Protector. . .”

– Held:Held: Each share can use that the life expectancy of its Each share can use that the life expectancy of its initial beneficiary to measure the MRD for that share. initial beneficiary to measure the MRD for that share. Why? Even with the deduction for payment of trust Why? Even with the deduction for payment of trust expenses, no amounts distributed to the trust during the expenses, no amounts distributed to the trust during the beneficiary’s lifetime would be accumulated in the trust, beneficiary’s lifetime would be accumulated in the trust, and thus would not be kept in the trust for the benefit of and thus would not be kept in the trust for the benefit of any future beneficiaries. Treas. Reg. any future beneficiaries. Treas. Reg. § 1.401(a)(9)-5 Q&A § 1.401(a)(9)-5 Q&A 7(c)(3), Example 2.7(c)(3), Example 2.

Separate Shares – PLR 200537044Separate Shares – PLR 200537044IRAs Payable to Trusts

2323

Ruling 4:Ruling 4: The trust assets will not be included The trust assets will not be included in the estate of the primary beneficiary of a in the estate of the primary beneficiary of a share upon that beneficiary’s death.share upon that beneficiary’s death.– Each trust share would accumulate the net income Each trust share would accumulate the net income

of the trust, and distributions of income and of the trust, and distributions of income and principal could distribute accumulated income and principal could distribute accumulated income and principal to the primary beneficiary for his or her principal to the primary beneficiary for his or her health, education, maintenance and support only.health, education, maintenance and support only.

– The document did not grant any beneficiary a The document did not grant any beneficiary a general power of appointment over his or her share.general power of appointment over his or her share.

– Held: The provisions of the trust could not result in Held: The provisions of the trust could not result in estate inclusion for the estate of a primary estate inclusion for the estate of a primary beneficiary upon his death.beneficiary upon his death.

Separate Shares – PLR 200537044Separate Shares – PLR 200537044IRAs Payable to Trusts

2424

Proper apportionment language regarding Proper apportionment language regarding payment of debts, expenses and taxes of payment of debts, expenses and taxes of estate (See PLR 9820021)estate (See PLR 9820021)

Recognition of income in respect of a Recognition of income in respect of a decedent (IRD) if pecuniary funding clause is decedent (IRD) if pecuniary funding clause is utilizedutilized

Unanticipated loss of designated beneficiary Unanticipated loss of designated beneficiary due to the inclusion of power of appointment due to the inclusion of power of appointment (general or limited)(general or limited)

Solution – stand-alone IRA trust such as “IRA Solution – stand-alone IRA trust such as “IRA Legacy Trust”Legacy Trust”

IRAs Payable to Trusts Naming a Revocable Trust as BeneficiaryNaming a Revocable Trust as Beneficiary

2525

Fractional v. Pecuniary clausesFractional v. Pecuniary clauses– Recognition of incomeRecognition of income

Entire trust irrevocable at death of IRA ownerEntire trust irrevocable at death of IRA owner No separate share treatmentNo separate share treatment Payment of debts, taxes, and expensesPayment of debts, taxes, and expenses

– Apportionment languageApportionment language– Firewall provisionFirewall provision

Powers of appointmentPowers of appointment Stand alone trust – highly recommendedStand alone trust – highly recommended Adoption of older individualsAdoption of older individuals


2626

Revocable trust should use a Revocable trust should use a fractional funding clause to fractional funding clause to determine the marital and bypass determine the marital and bypass sharesshares– PLRs in which pecuniary funding clause PLRs in which pecuniary funding clause

utilized and no IRD acceleration issue utilized and no IRD acceleration issue (PLRs 199912040, 9808043, 9744024)(PLRs 199912040, 9808043, 9744024)


2727

The Marital Share shall consist of assets in a pecuniary The Marital Share shall consist of assets in a pecuniary amount which, after taking into account all other amount which, after taking into account all other property included in the Settlor’s gross estate for property included in the Settlor’s gross estate for federal estate tax purposes which qualified for the federal estate tax purposes which qualified for the federal estate tax marital deduction and which passes federal estate tax marital deduction and which passes or has passed to the Settlor’s wife under this instrument or has passed to the Settlor’s wife under this instrument or in any other manner, is equal to the smallest amount or in any other manner, is equal to the smallest amount which will eliminate all federal estate tax payable by the which will eliminate all federal estate tax payable by the Settlor’s estate, or if that is not possible, the amount Settlor’s estate, or if that is not possible, the amount which will result in the least federal estate tax payable which will result in the least federal estate tax payable by the Settlor’s estate. In determining “federal estate by the Settlor’s estate. In determining “federal estate tax payable”, all credits and deductions against that tax tax payable”, all credits and deductions against that tax shall be taken into account, provided that the federal shall be taken into account, provided that the federal credit for state death taxes shall only be considered for credit for state death taxes shall only be considered for the extent it does not create or increase a state death the extent it does not create or increase a state death tax which is based on the federal credit for state death tax which is based on the federal credit for state death taxes.taxes.

Pecuniary Clause - SamplePecuniary Clause - Sample


2828

The Marital Share shall consist of that fractional share of the trust The Marital Share shall consist of that fractional share of the trust estate which shall be determined as follows:estate which shall be determined as follows:

(a) The numeration of the fraction shall be the smallest amount (a) The numeration of the fraction shall be the smallest amount which, which, after taking into account all other property included in the after taking into account all other property included in the Settlor’s Settlor’s gross estate for federal estate tax purposes which gross estate for federal estate tax purposes which qualifies for the qualifies for the federal estate tax marital deduction and federal estate tax marital deduction and which passes or has which passes or has passed to the Settlor’s wife under this passed to the Settlor’s wife under this instrument or in any other instrument or in any other manner, will eliminate all federal manner, will eliminate all federal estate tax payable by the Settlor’s estate tax payable by the Settlor’s estate, or if that is not estate, or if that is not possible, the amount which will result in the possible, the amount which will result in the least federal estate least federal estate tax payable by the Settlor’s estate. In determining tax payable by the Settlor’s estate. In determining “federal “federal estate tax payable”, all credits and deductions against that tax estate tax payable”, all credits and deductions against that tax

shall be taken into account, provided that the federal credit for shall be taken into account, provided that the federal credit for state state death taxes shall only be considered to the extent it does death taxes shall only be considered to the extent it does not create or not create or increase a state death tax which is based on the increase a state death tax which is based on the federal credit for state federal credit for state taxes.taxes.(b)(b) The denominator of the fraction shall be the value of the trust The denominator of the fraction shall be the value of the trust estateestate

Fractional Clause - SampleFractional Clause - Sample


2929

Disclaimers

3030

DisclaimersDisclaimers

Disclaimer must be “qualified.”Disclaimer must be “qualified.” IIn writingn writing Within 9 monthsWithin 9 months No acceptance of the interest or No acceptance of the interest or any of any of its benefits,its benefits, Interest passes without any Interest passes without any direction on direction on the part of the person the part of the person making the making the disclaimerdisclaimer

3131

Alex dies at age 70. Alex’s wife disclaims Alex dies at age 70. Alex’s wife disclaims amount of Alex’s unified credit to bypass amount of Alex’s unified credit to bypass trust for benefit of herself and their childrentrust for benefit of herself and their children

– Disclaimer must occur within nine months Disclaimer must occur within nine months from from date of deathdate of death– Disclaimer must be served to the IRA Disclaimer must be served to the IRA custodiancustodian– Disclaimer must be fractional to avoid Disclaimer must be fractional to avoid immediate immediate income taxationincome taxation

Disclaimers ExampleExample

3232

A beneficiary's disclaimer of a beneficial A beneficiary's disclaimer of a beneficial interest in a decedent's IRA is a qualified interest in a decedent's IRA is a qualified disclaimer even though, prior to making the disclaimer even though, prior to making the disclaimer, the beneficiary receives the disclaimer, the beneficiary receives the required minimum distribution for the year required minimum distribution for the year of the decedent's death from the IRA. of the decedent's death from the IRA.

Disclaimers Revenue Ruling 2005-36Revenue Ruling 2005-36

3333

SCENARIO 1 – Pecuniary Disclaimer by SpouseSCENARIO 1 – Pecuniary Disclaimer by Spouse

IRA

Spouse

Child A

Primary Beneficiary

First Contingent Beneficiary – If spouse disclaimed IRA as Primary Beneficiary

Pecuniary disclaimer of IRA balance ($600,000) plus income earned since date of death ($12,000)

Required Minimum Distribution ($100,000)

Result: Spouse’s pecuniary disclaimer, after taking RMD, still results in a “qualified disclaimer”

Key assumptions:IRA Balance (date of death) - $2,000,000

IRA Balance (date of disclaimer) - $2,040,000

Required Minimum Distribution - $100,000


3434

SCENARIO 2 – Fractional Disclaimer by SpouseSCENARIO 2 – Fractional Disclaimer by Spouse

Primary Beneficiary

First Contingent Beneficiary – If spouse disclaimed IRA as Primary Beneficiary

Fractional disclaimer (30%) of net remaining IRA balance after RMD (including income attributable to RMD) plus income earned since date of death

Required Minimum Distribution ($100,000) plus income earned since date of death ($2,000)

Result: Spouse’s fractional disclaimer, after taking RMD (plus attributable income), still results in a “qualified disclaimer”


IRA

Spouse

Child A




3535

SCENARIO 3 – Full Disclaimer by SCENARIO 3 – Full Disclaimer by Child AChild A

Primary Beneficiary

First Contingent Beneficiary – If Child A disclaimed IRA as Primary Beneficiary

Full disclaimer of net remaining IRA balance after RMD (including income attributable to RMD) plus income earned since date of death

Required Minimum Distribution ($100,000) plus income earned since date of death ($2,000)

Result: Child A’s full disclaimer, after taking RMD (plus attributable income), still results in a “qualified disclaimer “


IRA

Spouse

Child A




3636

QTIP-IRA

3737

Qualifying for the marital deductionQualifying for the marital deduction Definition of “income”Definition of “income” Qualifying as a “designated beneficiary” Qualifying as a “designated beneficiary”

trusttrust

QTIP-IRA

3838

In general, in order for a QTIP trust to qualify for the In general, in order for a QTIP trust to qualify for the marital deduction under IRC §2056(b)(7), it must meet all marital deduction under IRC §2056(b)(7), it must meet all of the following requirements:of the following requirements:

All the property in the trust was received from the All the property in the trust was received from the deceased deceased spouse and was included in that spouse’s spouse and was included in that spouse’s taxable estate.taxable estate. The trust provides that during the lifetime of the The trust provides that during the lifetime of the surviving surviving spouse, all income is paid to that spouse at spouse, all income is paid to that spouse at least annually.least annually. No other person has any right or can receive any benefit No other person has any right or can receive any benefit from from the trust while the during the surviving spouse’s the trust while the during the surviving spouse’s lifetime.lifetime. A valid election must be made on the deceased spouse’s A valid election must be made on the deceased spouse’s estate estate tax return.tax return.

Qualifying for the Marital Qualifying for the Marital DeductionDeduction

QTIP-IRA

3939

Fiduciary accounting income is Fiduciary accounting income is governed by state law and the trust governed by state law and the trust instrumentinstrument

Tax accounting income is governed by Tax accounting income is governed by the federal income tax lawthe federal income tax law

QTIP-IRAFiduciary vs. Tax Accounting Fiduciary vs. Tax Accounting IncomeIncome

4040

InterestInterest– TaxableTaxable– Tax-exemptTax-exempt

DividendsDividends Rents (net of expenses)Rents (net of expenses) RoyaltiesRoyalties

QTIP-IRATraditional Types of “Income”Traditional Types of “Income”

4141

IRA value as of date of deathIRA value as of date of death Increases in asset value (i.e. growth)Increases in asset value (i.e. growth) Realized long-term capital gainRealized long-term capital gain Realized short-term capital gainRealized short-term capital gain Proceeds from covered call writingProceeds from covered call writing

Traditional Types of “Principal”Traditional Types of “Principal”QTIP-IRA

4242

Traditional fiduciary accounting income Traditional fiduciary accounting income Equitable adjustments under UPIA Equitable adjustments under UPIA §104(a)§104(a) Unitrust paymentsUnitrust payments ““10% rule” under UPIA 10% rule” under UPIA §409(c)§409(c) ““Savings clause” under UPIA §409(d)Savings clause” under UPIA §409(d)

QTIP-IRARevenue Ruling 2006-26Revenue Ruling 2006-26

4343

UPIA §104(a) provides trustees the power to UPIA §104(a) provides trustees the power to adjust between income and principal if a adjust between income and principal if a trust cannot be administered fairly between trust cannot be administered fairly between the income and remainder beneficiariesthe income and remainder beneficiaries

NOTENOTE: Revenue Ruling 2006-26 holds that, : Revenue Ruling 2006-26 holds that, notwithstanding a trustee’s application of notwithstanding a trustee’s application of UPIA §104(a), a trust will qualify the marital UPIA §104(a), a trust will qualify the marital deductiondeduction


Equitable AdjustmentEquitable Adjustment

4444

Revenue Ruling 2006-26 approves unitrust Revenue Ruling 2006-26 approves unitrust trust payments paid pursuant to UPIA trust payments paid pursuant to UPIA §409(c) under applicable state law§409(c) under applicable state law

ExampleExample: : IRA is valued at $1,000,000. Pursuant IRA is valued at $1,000,000. Pursuant to state law, the trust is makes a unitrust to state law, the trust is makes a unitrust distribution of 4% ($40,000). In this case, the distribution of 4% ($40,000). In this case, the $40,000 is a qualified “income” interest.$40,000 is a qualified “income” interest.

Unitrust PaymentUnitrust Payment


4545

UPIA §409(c) provides that 10% of IRA UPIA §409(c) provides that 10% of IRA (and other qualified plan) distributions (and other qualified plan) distributions are considered to be “income”are considered to be “income”

ExampleExample: : RMD from IRA is $40,000. Pursuant to UPIA RMD from IRA is $40,000. Pursuant to UPIA §409(c), $4,000 ($40,000 x 10%) is considered to be §409(c), $4,000 ($40,000 x 10%) is considered to be “income”.“income”.

WARNINGWARNING: This type of clause may not qualify as : This type of clause may not qualify as “income” under Rev. Rul. 2006-26. “income” under Rev. Rul. 2006-26.

UPIA “10% Rule”UPIA “10% Rule”


4646

IRA has a current value of $1,000,000 and interest and dividend income of $60,000. RMD is $50,000.

Fiduciary Fiduciary Accounting Accounting

IncomeIncome 4% Unitrust4% Unitrust

10% Rule 10% Rule Under UPIA Under UPIA

§409(c)§409(c)

Distributable Distributable IncomeIncome $60,000$60,000 $40,000$40,000 $5,000$5,000

$50,000 RMD x 10%

Distributable QTIP-IRA “Income”Distributable QTIP-IRA “Income”QTIP-IRA

4747

UPIA §409(d) provides trustees the UPIA §409(d) provides trustees the discretion to make additional payments discretion to make additional payments in order to qualify the payments as in order to qualify the payments as “income” for purposes of the marital “income” for purposes of the marital deduction. deduction.

WARNINGWARNING: This type of clause may not : This type of clause may not save the QTIP election under Rev. Rul. save the QTIP election under Rev. Rul. 2006-26.2006-26.

QTIP-IRASavings ClauseSavings Clause

4848

Other IRA Planning Issues

4949

Income in respect of a decedent (IRD)Income in respect of a decedent (IRD) – is – is all items of gross income in respect of a all items of gross income in respect of a decedent which were not properly decedent which were not properly included as taxable income in a tax included as taxable income in a tax period falling on or before a taxpayer’s period falling on or before a taxpayer’s death and are payable to his/her estate death and are payable to his/her estate and/or another beneficiaryand/or another beneficiary

Other IRA Planning IssuesIncome in Respect to a Decedent (IRD)Income in Respect to a Decedent (IRD)

5050

Specific Items of IRDSpecific Items of IRD

IRAs and other qualified retirement plansIRAs and other qualified retirement plans Unpaid salaries/wages at the time of deathUnpaid salaries/wages at the time of death Dividends and interest earned, but not taxed, Dividends and interest earned, but not taxed,

prior to deathprior to death Unrecognized capital gain on an installment Unrecognized capital gain on an installment

note at the time of the seller’s deathnote at the time of the seller’s death Net Unrealized Appreciation (NUA) on employer Net Unrealized Appreciation (NUA) on employer

securities (see later discussion)securities (see later discussion)

Other IRA Planning IssuesIncome in Respect to a Decedent (IRD)Income in Respect to a Decedent (IRD)

5151

To the extent that a decedent’s taxable To the extent that a decedent’s taxable estate includes items of IRD and a federal estate includes items of IRD and a federal estate tax is assessed, the estate and/or estate tax is assessed, the estate and/or its beneficiaries are entitled to an income its beneficiaries are entitled to an income tax deduction for the estate tax tax deduction for the estate tax attributable to IRDattributable to IRD– This deduction is a miscellaneous itemized This deduction is a miscellaneous itemized

deduction deduction NOTNOT subject to the 2% AGI subject to the 2% AGI limitationlimitation

Other IRA Planning IssuesIRC IRC §691(c) Deduction§691(c) Deduction

5252

The income tax deduction computation The income tax deduction computation for estate taxed paid on IRD is for estate taxed paid on IRD is determined on a “with and without” determined on a “with and without” basisbasis– In essence, the total deduction allowed is In essence, the total deduction allowed is

the difference between: (a) the estate tax the difference between: (a) the estate tax liability liability withwith all items of IRD included in the all items of IRD included in the taxable estate and (b) the estate tax liability taxable estate and (b) the estate tax liability withoutwithout the IRD included in the taxable the IRD included in the taxable estateestate

Other IRA Planning IssuesIRC IRC §691(c) Deduction§691(c) Deduction

5353

ExampleExample

Non-IRD IRD TotalCash & money market 15,000$ -$ 15,000$ Accrued interest - 100 100 Marketable securities (non-qualified) 750,000 - 750,000 Accrued interest & dividends - 9,900 9,900 IRA - 1,500,000 1,500,000 Primary Residence 350,000 - 350,000 Cottage 150,000 - 150,000 Personal property 50,000 - 50,000 TOTALS 1,315,000$ 1,510,000$ 2,825,000$

On July 1, 2007, Jackie passed away leaving the On July 1, 2007, Jackie passed away leaving the following assets:following assets:

IRC IRC §691(c) Deduction§691(c) DeductionOther IRA Planning Issues

5454

Subsequent to her death, the personal representative withdrew Subsequent to her death, the personal representative withdrew $50,000 from Jackie’s IRA. Accordingly, the IRC $50,000 from Jackie’s IRA. Accordingly, the IRC §691(c) §691(c) attributable to the $50,000 distribution would be as follows:attributable to the $50,000 distribution would be as follows:

With IRD Without IRDGross Estate 2,825,000$ 1,315,000$ Less: Exemption (2,000,000) (2,000,000) Taxable Estate 825,000$ -$

Estate Tax 371,250$ -$

Gross IRC §691(c) Deduction 371,250$ (Difference between estate tax with and without IRD)

Example (cont.)Example (cont.)IRC IRC §691(c) Deduction§691(c) DeductionOther IRA Planning Issues

5555

IRD

Allocable IRC §691(c) Deduction

Interest - Cash & money market 100$ 25$ Interest & dividends - Brokerage account 9,900 2,434 IRA 1,500,000 368,791 TOTAL 1,510,000$ 371,250$

Gross IRA distribution 50,000$ IRC §691(c) apportionment percentage (i.e. $368,791/$1,510,000) 24.423%IRC §691(c) deduction 12,212$

Other IRA Planning Issues

Example (cont.)Example (cont.)IRC IRC §691(c) Deduction§691(c) Deduction

5656

A 50% penalty is assessed to the extent that A 50% penalty is assessed to the extent that a taxpayer has not taken his/her RMD for the a taxpayer has not taken his/her RMD for the tax year.tax year.

ExampleExample

Assume Peter was required to take out $30,000 from Assume Peter was required to take out $30,000 from his IRA in 2007, but only withdrew $20,000. In this his IRA in 2007, but only withdrew $20,000. In this case, Peter would be subject to a $5,000 [($30,000 - case, Peter would be subject to a $5,000 [($30,000 - $20,000) x 50%] excess accumulations penalty. $20,000) x 50%] excess accumulations penalty. Further, Peter would still be required to withdraw the Further, Peter would still be required to withdraw the $10,000 deficiency from his IRA.$10,000 deficiency from his IRA.

Excess Accumulations PenaltyExcess Accumulations PenaltyOther IRA Planning Issues

5757

Under IRC §4974(d), the tax may be waived if the Under IRC §4974(d), the tax may be waived if the taxpayers can establish that the shortfall in taxpayers can establish that the shortfall in distributions distributions was due to reasonable error and was due to reasonable error and reasonable steps are reasonable steps are being taken to remedy the being taken to remedy the shortfall. An accumulation shortfall. An accumulation occurs because of occurs because of “reasonable error" when it occurs “reasonable error" when it occurs through no fault of through no fault of the plan participant. the plan participant. Complete Form 5329Complete Form 5329 Attach letter requesting waiverAttach letter requesting waiver

Other IRA Planning IssuesExcess Accumulations PenaltyExcess Accumulations Penalty

Requesting a WaiverRequesting a Waiver

5858

Roth IRAs

5959

Roth IRAs

100% of growth is tax-exempt100% of growth is tax-exempt No required minimum distributions at age 70½No required minimum distributions at age 70½

– NOTE: Distributions from Roth IRAs cannot be used NOTE: Distributions from Roth IRAs cannot be used to fulfill the RMD from a traditional IRAto fulfill the RMD from a traditional IRA

$100,000 Modified Adjusted Gross Income $100,000 Modified Adjusted Gross Income (MAGI) limitation (MAGI) limitation

RMDs on Inherited Roth IRAsRMDs on Inherited Roth IRAs Roth 401(k) plansRoth 401(k) plans

6060

Starting in 2010, the $100,000 Adjusted Starting in 2010, the $100,000 Adjusted Gross Income (AGI) limitation no longer Gross Income (AGI) limitation no longer appliesapplies– The tax incurred on a Roth IRA conversion in The tax incurred on a Roth IRA conversion in

2010 may be spread over the following two tax 2010 may be spread over the following two tax years (i.e. 2011 and 2012)years (i.e. 2011 and 2012)

Married Filing Separately taxpayers can Married Filing Separately taxpayers can convert to a Roth IRAconvert to a Roth IRA

Roth IRAs

6161

Convertible accountsConvertible accounts– Traditional IRAsTraditional IRAs– 401(k) plans (Starting in 2008)401(k) plans (Starting in 2008)– Profit sharing plans (Starting in 2008)Profit sharing plans (Starting in 2008)– 403(b) annuity plans (Starting in 2008)403(b) annuity plans (Starting in 2008)– 457 plans (Starting in 2008)457 plans (Starting in 2008)

Non-Convertible accountsNon-Convertible accounts– ““Inherited” IRAsInherited” IRAs– Education IRAsEducation IRAs

Roth IRAs

6262

Basis Can be Withdrawn Tax-Free (FIFO Method)Basis Can be Withdrawn Tax-Free (FIFO Method) Distributions are not subject to income tax if they do Distributions are not subject to income tax if they do

not exceed aggregate contributions and/or not exceed aggregate contributions and/or conversions to the Roth IRAconversions to the Roth IRA

Withdrawals made within five years of conversion if Withdrawals made within five years of conversion if owner under age 59½ and no other exception owner under age 59½ and no other exception appliesapplies

Five-year period independent of five-year period for Five-year period independent of five-year period for qualified distributionqualified distribution

Taxation of DistributionsTaxation of DistributionsRoth IRAs

6363

(1)(1) Taxpayers have special favorable tax attributes Taxpayers have special favorable tax attributes including including charitable deduction carry-forwards, charitable deduction carry-forwards, investment tax credits, investment tax credits, etc. etc.

(2) Suspension of the minimum distribution rules at age (2) Suspension of the minimum distribution rules at age 70½ 70½ provides a considerable advantage to the Roth provides a considerable advantage to the Roth IRA holder. IRA holder.

(3) Taxpayers benefit from paying income tax before (3) Taxpayers benefit from paying income tax before estate estate tax (when a Roth IRA election is made) tax (when a Roth IRA election is made)

compared to the compared to the income tax deduction income tax deduction obtained when a traditional IRA is obtained when a traditional IRA is subject to estate subject to estate tax.tax.

(4) Taxpayers who can pay the income tax on the IRA (4) Taxpayers who can pay the income tax on the IRA from non from non IRA funds benefit greatly from the Roth IRA IRA funds benefit greatly from the Roth IRA because of the because of the ability to enjoy greater tax-free ability to enjoy greater tax-free yields.yields.

Roth IRAs Seven Reasons to Convert to Roth IRAsSeven Reasons to Convert to Roth IRAs

6464

(5) Taxpayers who need to use IRA assets to fund their (5) Taxpayers who need to use IRA assets to fund their Unified Unified Credit bypass trust are well advised to Credit bypass trust are well advised to consider consider making a making a Roth IRA election for that Roth IRA election for that portion of their overall IRA funds. portion of their overall IRA funds.

(6) Taxpayers making the Roth IRA election during their (6) Taxpayers making the Roth IRA election during their lifetime reduce their overall estate, thereby lifetime reduce their overall estate, thereby

lowering the lowering the effect of higher estate tax rates. effect of higher estate tax rates. (7) Because federal tax brackets are more favorable for (7) Because federal tax brackets are more favorable for

married couples filing joint returns than for single married couples filing joint returns than for single individuals, Roth IRA distributions won’t cause an individuals, Roth IRA distributions won’t cause an increase in tax rates for the surviving spouse increase in tax rates for the surviving spouse

when one when one spouse is deceased because the spouse is deceased because the distributions are tax-distributions are tax- free.free.

Roth IRAs Seven Reasons to Convert to Roth IRAsSeven Reasons to Convert to Roth IRAs

6565

The key to successful Roth IRA The key to successful Roth IRA conversions conversions is to keep as much of the is to keep as much of the conversion income conversion income as possible in the as possible in the current marginal tax current marginal tax bracketbracket

– However, there are times when it may make However, there are times when it may make sense to convert more and go into higher tax sense to convert more and go into higher tax bracketsbrackets

Roth IRAs Understanding the MechanicsUnderstanding the Mechanics

6666

In simplest terms, a traditional IRA will In simplest terms, a traditional IRA will produce the same after-tax result as a produce the same after-tax result as a Roth IRA provided that:Roth IRA provided that:– The annual growth rates are the sameThe annual growth rates are the same– The tax rate in the conversion year is the The tax rate in the conversion year is the

same as the tax rate during the withdrawal same as the tax rate during the withdrawal yearsyears

(i.e. A x B x C = D; A x C x B = D)(i.e. A x B x C = D; A x C x B = D)


6767

Traditional IRA Roth IRA2007 Account Balance 100,000$ 100,000$ Less: Income Taxes @ 40% - (40,000) Net Balance 100,000$ 60,000$

Growth Until Death 300.00% 300.00%

Account Balance @ Death 300,000$ 180,000$ Less: Income Taxes @ 40% (120,000) - Net Account Balance to Family 180,000$ 180,000$


ExampleExample

6868

Critical decision factorsCritical decision factors– Tax rate differentialTax rate differential

• Year of conversion vs. withdrawal yearsYear of conversion vs. withdrawal years

– Use of “outside funds” (i.e. non-qualifiedUse of “outside funds” (i.e. non-qualifiedretirement retirement accounts) to pay the income tax accounts) to pay the income tax liabilityliability

– Time horizonTime horizon– IRC IRC §691(c) “affect”§691(c) “affect”


6969

The key to successful Roth IRA The key to successful Roth IRA conversions conversions is to keep as much of the is to keep as much of the conversion income conversion income as possible in the as possible in the current marginal tax bracketcurrent marginal tax bracket

– However, there are times when it may make However, there are times when it may make sense to convert more and go into higher sense to convert more and go into higher tax bracketstax brackets


7070

SingleMarried

Filing JointlyHead of

Household

10% $7,825 $15,650 $10,750

15% $31,850 $63,700 $42,650

25% $77,100 $128,500 $110,100

28% $160,850 $195,850 $178,350

33% $349,700 $349,700 $349,700

35% > $349,700

> $349,700 > $349,700

Roth IRAs

Tax Brackets (2007)Tax Brackets (2007)Understanding the MechanicsUnderstanding the Mechanics

7171

10% tax 10% tax bracketbracket






Current Current taxable taxable incomeincome

Target Roth IRA Target Roth IRA conversion amountconversion amount

Optimum Roth IRA Optimum Roth IRA conversion amount?conversion amount?


7272

Taxpayers may recharacterize (i.e. “undo”) the Taxpayers may recharacterize (i.e. “undo”) the Roth IRA conversion in current year or by the Roth IRA conversion in current year or by the filing date of the current year’s tax returnfiling date of the current year’s tax return– Recharacterization can take place as late as 10/15 in Recharacterization can take place as late as 10/15 in

the year following the year of conversion the year following the year of conversion Taxpayers may choose to “reconvert” their Taxpayers may choose to “reconvert” their

recharacterizationrecharacterization– Reconversion may only take place at the later of the Reconversion may only take place at the later of the

following two dates:following two dates:• The tax year following the original conversion The tax year following the original conversion OROR• 30 days after the recharacterization30 days after the recharacterization


7373

Conversion Period Recharacterization Period

1/1/2007 – First day

conversion can take place

2007

12/31/2007 – Last day

conversion can take place

4/15/2008 – Normal filing date for 2007

tax return

10/15/2008 – Latest filing

date for 2007 tax return / last day to

recharacterize 2007 Roth IRA

conversion

12/31/2008

2008

Roth IRAs Roth IRA Conversion TimetableRoth IRA Conversion Timetable

7474

Taxpayers cannot recharacterize a portion Taxpayers cannot recharacterize a portion of a Roth conversion by “cherry picking” of a Roth conversion by “cherry picking” only those stocks that decline in value only those stocks that decline in value

(IRS Notice 2000-39)(IRS Notice 2000-39)

All gains and losses to the entire Roth IRA, All gains and losses to the entire Roth IRA, regardless of the actual stock or fund re-regardless of the actual stock or fund re-characterized, must be pro-rated characterized, must be pro-rated

Roth IRAs Anti “Cherry-Picking” RuleAnti “Cherry-Picking” Rule

7575

Traditional IRAABC Fund: $250,000YYZ Fund: $250,000

STEP 1 – Convert Traditional IRA Into Two STEP 1 – Convert Traditional IRA Into Two Separate Roth IRAsSeparate Roth IRAs

Roth IRA #1ABC Fund: $250,000

Roth IRA #2YYZ Fund: $250,000

Roth IRAs Roth IRA Segregation Conversion StrategyRoth IRA Segregation Conversion Strategy

7676

STEP 2 – Payment of Income Taxes on Roth STEP 2 – Payment of Income Taxes on Roth IRA ConversionIRA Conversion

IRSTaxpayerIncome tax liability due on

$500,000 conversion amount

April 15, 2008*

* NOTE: Either a tax return or an extension must be filed by this date. Regardless of what is chosen, the tax liability due on the Roth IRA conversion must be remitted by this date in order to avoid late payment penalties and interest.

Roth IRA Segregation Conversion StrategyRoth IRA Segregation Conversion StrategyRoth IRAs

7777

STEP 3 – Recharacterization of Roth IRA ConversionSTEP 3 – Recharacterization of Roth IRA Conversion

Roth IRA #1ABC Fund: $125,000

(Current Value)

Roth IRA #2YYZ Fund: $275,000

(Current Value)

Traditional IRA #1ABC Fund: $125,000

(Current Value)

Recharacterization of IRA using the value at the date of

conversion (e.g. $250,000)

October 15, 2008*

* NOTE: October 15, 2008 is the latest date for which a 2007 recharacterization can take place (either by filing extensions or by filing an amended return).


7878

STEP 4 – Refund on Overpayment of Income STEP 4 – Refund on Overpayment of Income Taxes Paid on Roth IRA ConversionTaxes Paid on Roth IRA Conversion

IRSTaxpayer

October 15, 2008Refund of overpayment on

recharacterization of Roth IRA conversion


7979

Additional IRA ResourcesAdditional IRA Resources

BooksBooks: : − ““Life and Death Planning for Retirement Benefits” by Life and Death Planning for Retirement Benefits” by

Natalie ChoateNatalie Choate− ““The Retirement Savings Time Bomb … and How to The Retirement Savings Time Bomb … and How to

Defuse It” by Ed SlottDefuse It” by Ed Slott− ““Individual Retirement Account Answer Book” by Fleisher, Individual Retirement Account Answer Book” by Fleisher,

Lippe and LevyLippe and Levy

WebsitesWebsites::− www.ataxplan.com (Natalie Choate’s website)www.ataxplan.com (Natalie Choate’s website)− www.wealthcounsel.com www.wealthcounsel.com − www.IRAhelp.comwww.IRAhelp.com

Training / CLE:Training / CLE:− ““Practice Building Bootcamp” (presented by Phil Kavesh)Practice Building Bootcamp” (presented by Phil Kavesh)− WealthCounsel’s Two-Day IRA SeminarWealthCounsel’s Two-Day IRA Seminar

8080

Training CDsTraining CDs: : − ““IRAs Payable to Trusts” (offered through WealthCounsel)IRAs Payable to Trusts” (offered through WealthCounsel)

SoftwareSoftware::− WealthDocsWealthDocsTM TM byby WealthCounselWealthCounsel− Inherited IRA Analysis by Robert S. KeeblerInherited IRA Analysis by Robert S. Keebler

NewslettersNewsletters::− ““Ed Slott’s IRA Advisor”Ed Slott’s IRA Advisor”− ““Choate’s Notes” by Natalie ChoateChoate’s Notes” by Natalie Choate− ““Employee Benefits and Retirement Planner Newsletter” by Employee Benefits and Retirement Planner Newsletter” by

Leimberg Information Services Inc. (e-mail only)Leimberg Information Services Inc. (e-mail only)

Additional IRA ResourcesAdditional IRA Resources

1 coordinating income and estate planning for iras and qualified plans presented by: robert s....

Documents