Source: http://www.taxprofessionalsresource.com/articles/view.php?article_id=12888
Timestamp: 2019-04-21 11:20:02+00:00

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In the estates of many highly compensated employees and professionals, an interest in a qualified plan or in an IRA (often a rollover from a qualified plan) may be the single largest asset and may be a very large proportion of the entire estate. For other estates, such interests will often be quite significant even if outweighed by other assets. Tax deductible contributions and tax free growth make qualified plans and IRAs a preferred form of retirement savings vehicle. For professionals in particular, but for others as well, the asset protection features of qualified plans (and to a lesser extent IRAs) can be of enormous significance. However, in order to obtain these beneficial features of such programs, the employee or professional must endure the statutory schemes which make them possible. We will generally discuss in this outline traditional IRAs and qualified plans, which are the programs estate planners encounter the most, but with an occasional tip of the hat mention of some other types of retirement-related programs.
1. An Overview of Challenges. These statutory schemes create some unusual challenges for the estate planner. Some of these challenges are quite similar for qualified plans and IRAs, while others are unique to qualified plans.
a. Initial Qualification and Buildup Variations. Although we will in this outline focus on death and after death planning, estate planners should have a sound background of knowledge about the requirements for plan qualification and for contributions to plans and IRAs.
i. IRAs. IRAs come in a few varieties, typically traditional (with deductible or nondeductible contributions, tax-free buildup, taxed on withdrawal), or Roth (with nondeductible contributions, tax-free buildup, not taxed on withdrawal), or education (Coverdell) (nondeductible contributions, tax-free buildup, not taxed on use for qualified expenses), and within those varieties are not very flexible. Traditional IRAs are the backbone of simplified employee pensions (SEP plans) and savings incentive match plan for employees (SIMPLE plans), but the contribution levels are somewhat different; the simplicity of these plans is derived from their lack of flexibility.
ii. Qualified Plan Flexibility. On the other hand, there is a lot of flexibility in qualified plans. (Qualified plans are covered by the federal law known as ERISA (Employee Retirement Income Security Act of 1974), which is a combination of tax and labor rules.) For example, qualified plans come in a number of varieties and have a number of features and requirements which can vary significantly from plan to plan. Among others, the various kinds of qualified plan features and requirements of interest to estate planners may include: defined benefit plans (true pensions which require annuity payment options), defined contribution plans (which may be subject to the annuity rules in a number of circumstances, but some of which are not subject to such rules), maximum benefit or contribution levels and limits (plans may be less generous than the maximums), defined contribution cash or deferred elective contribution features (i.e., Internal Revenue Code ("IRC") ' 401(k) features subject to further contribution limits, which may be matched or unmatched by the employer), special contribution limits and other restrictions for plans for self-employed individuals or partners (generally including limited liability company (LLC) members as well), benefit accrual requirements (defined benefit plans and hybrid defined contribution plans have required benefit accruals mandating certain levels of company contributions, but other defined contribution plans may have mandated contributions or may be totally discretionary), plan investment options (plans may be employee stock ownership plans, with a number of special rules for dealing with the employer=s stock, or plan investments may be participant designated with a very wide range or a rather narrow range of choices, or plan investments may be selected by a fiduciary), available nonannuity payment options such as lump sum or installment distributions (plans need not offer a full range of options), qualified domestic relations order requirements (known as QDROs, typically used in divorces) beneficiary designation and fall-back beneficiary rules, spousal consent rules, minimum age for distribution without triggering the 10% tax penalty for premature distribution (IRC ' 72(x); with a number of exceptions) (generally age 59 2, but not all qualified plans allow distributions at that age but may impose a retirement age requirement, typically age 65), plan loan or hardship distribution features (not all plans offer these), age weighted benefits or contributions, or contribution formulas integrated with Social Security, and so on.
iii. Planner Review. The estate planner will need to review at least the summary plan description (sometimes called an SPD), and often will need to review more plan related documentation, in order to understand what kind of qualified plan the client participates in where a plan is an important part of the client=s estate. With ERISA-exempted governmental and church plans, etc., and with unqualified top-hat employee plans, and other employee deferred compensation programs not covered by ERISA, the review will generally need to be more extensive because the plan and benefit structures which have developed under ERISA for qualified plans will not apply, although they will provide some analogies. The client usually will not have the knowledge to describe the situation properly, except possibly as to IRAs.
b. Minimum Payment and Required Beginning Date Requirements. Both traditional IRAs and qualified plans are subject to rules which force certain minimum levels of distributions at what is called the required beginning date. This allows deferred income tax to be collected sooner. Failure to timely make such minimum distributions will trigger steep penalty taxes (IRC ' 4974(a); 50% of the excess of the amount required over the amount actually distributed). The applicable rules have changed importantly over the years from the 1987 proposed regulations to the 2001 proposed regulations, to the 2002 final regulations, but we will keep things simple by dealing in this outline with the present rules generally effective on and after January 1, 2003; however, some payouts may still be subject to the rules in effect earlier.
i. Required Beginning Date. The required beginning date is generally April 1 of the year following the year in which the participant reaches age 70 2, but for a qualified plan it can be the later of that date or within the calendar year of retirement except for a participant who is a 5% owner of the employer, a sole proprietor, or a partner who are stuck with the age 70 2 rule alone. IRC '' 401(a)(9)(A) and (C), 408 (a)(6).
ii. Distributions. Starting at the required beginning date, regular minimum distributions are mandated (as described below), but larger distributions may be made. Early distributions over the minimum are not a credit for later minimum distributions, although the earlier amount will reduce the balance and thus may have a (usually) modest effect on calculating later minimum distributions.
iii. Effect of Date of Death. The date of a participant=s death, before or after the required beginning date, will have an effect on the time over which beneficiaries may spread further minimum distributions. If a participant is receiving benefits after normal retirement age (often age 65, but a plan may provide an earlier normal retirement date) but before the required beginning date, the participant is deemed to have died before having commenced distributions under IRC ' 401(a)(9)(A)(ii) unless an irrevocable annuity is involved, in which case the participant is treated as dying after the required beginning date. This will have some effect on the timing of required distributions for beneficiaries.
A. Death After Required Beginning Date. Where the participant dies on or after the required beginning date, distributions must continue at least as rapidly as under the method in effect at death (there may be more than one method from which to chose), subject to some rules which could accelerate payment and to some spousal rollover rules which could defer payment.
B. Death Before Required Beginning Date. Where participant dies on or before the required beginning date, distributions of the entire balance must be made by December 31 of the year that contains the fifth anniversary of the death, subject to an exception generally allowing a designated beneficiary to take payments over his or her life expectancy and subject to some special rules providing additional options where a spouse is the beneficiary.
iv. Grandfathering Rule. There is a special grandfathering rule allowing distributions not meeting the minimums for participants in plans before January 1, 1984 who made a special election and where the benefits have not voluntarily been transferred by the participant to another plan, and the form of payment or the payment period has not changed. Treasury Regulations ("Regs.") ' 1.409(a)(9)-8.
v. Minimum Payments. Starting with the required beginning date, payments must be made in a lump sum or annually over the life of the participant or the joint lives of the participant and a designated beneficiary (the designated beneficiary concept is discussed below). The payment amount is determined by the payment period available.
A. Life Distributions. There is a Uniform Distribution Table (Regs. ' 1.40(a)(9)-9, Q&A-2) which applies for distributions made during the life of the participant unless the designed beneficiary is the spouse who is more than 10 years younger than the participant. (The uniform table becomes irrelevant after the participant dies.) Some examples from the table show that where the participant is age 75, the distribution period is 22.9 years and 4.3668% of the account must be distributed annually; where the participant is 80, the period is 18.7 years and the percentage would be 5.3476%; where the participant is 85, the period is 14.8 years and the percentage would be 6.7568%. The table assumes a beneficiary ten years younger than the participant. The uniform table applies whether or not the beneficiary is a designated beneficiary. The identity of the beneficiary simply does not matter for lifetime distributions, except only where there is a 10 year younger spouse who is the beneficiary.
B. Life Distributions with Younger Spouse. For a more than 10 years younger spouse who is the designated beneficiary, however, the payment period will be the joint and survivor expectancy of the participant and the spouse, recalculated annually, and thus will result in a longer payout period. Regs. ' 1.401(a)(9)-5, Q&A-4. A joint life expectancy factor under Regs. ' 1.40(a)(9)-9, Q&A-3 (pursuant to a life table) is used instead of the uniform table.
C. Recalculation. The uniform table also uses an annual recalculation but only for the participant=s life; during life, the participant=s age on his or her birthday in each year is looked up, and the resulting time is thus determined and the resulting percentage can be calculated. Also, dividing the account balance by the table period will provide the amount to be distributed. On death, the time period becomes fixed at the then life expectancy of the designated beneficiary (not the table period), except for spouses more than ten years younger who are beneficiaries where recalculation will continue. When such a surviving younger spousal beneficiary dies, his or her remaining life expectancy, unrecalculated, is then the distribution period. Annual recalculation may extend payments because, for example, someone who has reached age 65 may be expected to live until, say, 80, but someone who has reached age 66 may then be expected to live until, say, 82, and someone who has reached age 80 may be expected to live until, say, 88. At the younger age, the quick diers and the long livers of a population are all included; at a later age, the quick diers are gone, and the longer livers are those who are left and are alive and can, on average, be expected to stay alive at least a while longer. Thus, as a participant or a beneficiary age, the time will adjust, and the amount required to be paid will also adjust, as long as annual recalculations are allowed.
D. Death Distributions After Required Beginning Date. If a participant dies on or after the required beginning date without a designated beneficiary, the participant=s remaining unrecalculated life expectancy becomes the distribution period. Regs. ' 1.401(a)(9)-5, Q&A-5(a)(2). A single life table is used (not the uniform table). Regs. ' 1.40(a)(9)-9, Q&A-1. If, however, there is a designated beneficiary, the period of distribution is the longer of the participant=s remaining life expectancy or the designed beneficiary=s remaining life expectancy. A single life table is used, but in each year after the death the factor is reduced by the number 1. Recalculation does not apply.
E. Death Distributions Before Required Beginning Date. The five year distribution rule generally applies where the participant=s death is before the required beginning date. In order for the life of the designated beneficiary to be used in the exceptions to the five year distribution rule where death occurs before the required beginning date, the first payment for the designated beneficiary must be made before December 31 of the year after the participant=s death, except that where the surviving spouse is the designated beneficiary, the first payment must be by the later of that December 31 or the December 31 of the year in which the participant would have reached age 70 2. IRC ' 401(a)(9)(B)(iv); Regs. ' 1.401(a)(9)-3, Q&A-1. Where there is such a designated beneficiary, the factor under a single life table is used reduced by the number 1 each year, except that for a spouse who is a designed beneficiary, the recalculation method is used instead.
F. Separate Accounts. In applying the period determination rules to designated beneficiaries, each separate account or separate share is treated separately; where there is more than one designated beneficiary, the shortest life expectancy is used. Thus, it may be wise to separate accounts or shares in certain cases, so at least some beneficiaries may stretch out the minimum payments.
vi. Designated Beneficiaries. Beneficiaries are entitled to benefits even if they are not Adesignated [email protected] The designated beneficiary concept is, however, applicable to determining the payment period, including whether the general five-year distribution rule applies, where death of the participant is before the required beginning date. The existence of a designated beneficiary may allow deferral beyond the otherwise applicable periods of the end of the year in which occurs the fifth anniversary of the participant=s death.
A. Individuals and Some Trusts Only. Only individuals (not determined solely by state law) or the individual beneficiaries of trusts meeting certain requirements, will qualify as designated beneficiaries. Estates, charities, and other sorts of trusts do not qualify, for example. Designations may be made by the participant or spouse, or may be determined under the terms of a plan or account if no other designation is applicable to the plan or account.
B. Determination Date. The designation must be determined by the September 30 of the year after the participant=s death; this is required in order to allow sufficient time for a required distribution before the end of the year. Regs. ' 1.401(a)(9)-4, Q&A-2 and Q&A-4. If a designated beneficiary who is alive at the participant=s death dies before that September 30, the deceased beneficiary is still the designated beneficiary used in determining the distribution period, not the successor beneficiary. Regs. ' 1.401(a)(9)-4, Q&A-4(c). A beneficiary may, however, disclaim, and if the disclaimer meets the requirements of a qualified disclaimer under IRC ' 2518, it will be effective. Regs. ' 1.401(a)(9)-4, Q&A-4(a).
C. Mixed Beneficiaries. Absent separate shares or accounts, if some beneficiaries may otherwise qualify but others will not qualify, there is no designated beneficiary. Regs. '' 1.401(a)(9)-4, Q&A-3 and 1.409(a)(9)-5, Q&A-7(a).
D. No Trust Distribution Required. If a trust is qualified as a designated beneficiary and receives a payment, it need not distribute it, but may accumulate it until needed or until an age or other condition is met. Regs. ' 1.401(a)(9)-8, Q&A-11.
E. Beneficiary Changes. Beneficiaries can be changed after the required beginning date, and this will not affect payments unless the change involves a spouse more than 10 years younger than the participant because under the applicable table all other beneficiaries are treated as 10 years younger than the participant. However, if the beneficiary can be changed after the participant=s death, the beneficiary is not a designated beneficiary. Under the 1987 regulations, there was an exception with respect to beneficiaries after the spouse=s death. This provision did not continue in the final regulations (was this an intended change?).
(4) the plan administrator has been provided with a list of beneficiaries (including contingent and remainder beneficiaries) or with a copy of the trust instrument with all amendments. The plan administrator which receives a list of beneficiaries may require the full trust instrument which must then be provided. Regs. ' 1.401(a)(9)-4, Q&A-5(b). The requirements for providing the list of beneficiaries or the trust instrument must be met as of October 31 of the year after the participant=s death, except where the surviving spouse is the beneficiary and is more than 10 years younger than the participant in which event the requirements must be met by the required beginning date.
vii. Separate Shares. Separate shares or accounts have separate designated beneficiaries (if any).
A. What Are Separate. A separate account is a separate portion of a participant=s benefit reflecting the beneficiary=s separate interest under the plan at the date of the participant=s death, where separate accounting is maintained for each account which allocates to each all post-death investment results, contributions, and forfeitures for the period prior to the establishment of the account in a reasonable and consistent pro rata manner. Regs. ' 1.401(a)(9)-8, Q&A-3. A designation of a percentage in a defined contribution plan or IRA should be sufficient.
B. When Are They Separate. Separate shares may be created before or after the required beginning date (Regs. ' 1.401(a)(9)-8, Q&A-2), but such shares will affect the required minimum distributions only after the later of the year of the participant=s death (before or after the required beginning date) or the year the separate accounts are established, which if other beneficiaries are to be disregarding, must be by the end of the year following the year of the participant=s death.
viii. Special Spousal Rules. After a participant=s death, as we have seen, spouses who are designated beneficiaries use the recalculation method of determining the life expectancy for pay-out, while nonspouse=s use the reduce by one method. Following the spouse=s death, the reduce- by- one method again will apply. In addition, surviving spouses have some other options. The designated beneficiary spouse may choose to rollover the benefit into the spouse=s own account in an IRA, a qualified plan, an IRC ' 403(b) plan, or a governmental IRC ' 457 plan. (The participant=s required minimum distribution for the year of death may not be rolled over, however.) After the rollover, the spouse=s own required minimum distributions apply and the spouse can name a beneficiary, including a new designated beneficiary, for that account. Only surviving spouses can use the rollover rules for plan benefits on a participant=s death. Such rules generally apply to the spouse the same as they would have to the participant. The rollover may be accomplished even where the participant named his or her estate on a trust as beneficiary, but only if the spouse is the beneficiary of the estate or trust and controls the disposition of the estate or trust assets. See PLR 9752072 and PLR 9801051, and compare to PLR 9750063 (where the spouse lacked sole discretion over estate assets).
c. Retirement Plan Spousal Protection and Annuity Rules. All qualified plans, and certain other employer retirement plans, too, may be subject to rules requiring that payments be made either in the form of an annuity for the participant=s spouse where the participant dies before the annuity is started (a qualified preretirement survivor annuity) or in the form of a qualified joint and survivor annuity for the participant and spouse where the participant lives to receive the annuity. Where there is no spouse, an annuity for the participant or beneficiary may be required. The annuity form of payment rules are not too difficult to deal with when there is no spouse with an interest which must be waived; they can become very difficult to deal with where there is a spouse. Qualified plans are subject to such rules unless a special exception for profit sharing plans applies, but a profit sharing plan may choose to provide such annuities or may fail to qualify for, or may lose, the exception. Even without being subject to annuity rules not waivable without spousal consent, plans may be required to have, or may choose to have, other spousal consent requirements as to beneficiaries, distributions, plan loans, etc. The spousal annuity and spousal protection rules thus create some issues for estate planners which must be considered in every employer plan case. IRAs are not required to provide annuities unless the participant has purchased an IRA annuity.
i. Retirement Plan Rules. Employer retirement plans, and spousal rights under them, are generally governed by federal law, either ERISA (Employee Retirement Income Security Act of 1974) or a federal employee retirement statute codified in the United States Code ("USC") and subject to federal regulations codified in the Code of Federal Regulations ("CFR") (such as Civil Service Retirement System, 5 USC '' 8301, et seq., particularly '' 8339, 8341; Federal Employees Retirement System, 5 USC '' 8401, et seq., particularly '' 8416, 8442, 5 CFR ' 838.101 et seq.; Federal Thrift Savings Plan, 5 USC ' 8351, 5 CFR '' 1650.1, et seq.; Uniformed Services Former Spouses= Protection Act, 10 USC ' 1408; military retirement system, 10 USC '' 1447, 1448; Foreign Service Retirement and Disability System, 22 USC '' 4041 et seq., particularly '' 4046(b), 4044(13), 22 CFR ' 19.1, et seq.; Foreign Service Pension System, 22 USC ' 4071, 22 CFR ' 19.1, et seq.; Railroad Retirement System, 45 USC ' 231), which all require special spousal consents to waivers of certain rights designed to protect surviving spouses, particularly death benefits. Plans for governmental employees, church plans, and unfunded private excess benefit plans are not covered by ERISA. 29 USC ' 1003(b). However, they, too, may have spousal consent requirements built into the plan. Our focus will be on ERISA plans which are qualified for certain tax benefits for the plan and its participants, usually known as ERISA qualified plans or simply qualified plans.
ii. Qualified Plan Spousal Benefits. Qualified plans are required to provide certain benefits for surviving spouses. Generally, such plans must provide an annuity for spouses of participants who die before the retirement annuity starting date. This is a qualified preretirement survivor annuity. IRC '' 401(a)(11)(A)(ii), 417(c); 29 USC ' 1055(a)(2). Also, on the retirement of an employee participant who is then married, the plan generally must provide a qualified joint and survivor annuity for the participant and the participant=s spouse. IRC '' 401(a)(11)(A)(i), 417(b); 29 USC ' 1055(a)(1). Some plans are not subject to these annuity rules, in particular pure profit sharing-type plans which have never had an annuity requirement and which have not accepted rollovers from plans which had an annuity requirement. However, these plans, not subject to the annuity requirement, must provide for a lump-sum benefit payment to the surviving spouse at the participant=s death. 29 USC ' 1055(b)(4). Also, special spousal waivers of beneficiary rights are required to name someone else as a beneficiary or for the participant to receive a plan loan or take other action which could affect the spouse=s rights.
A. Spouse. A plan may limit a spouse=s annuity rights to a spouse married to the participant for at least a year. 29 USC ' 1055(b)(4).
B. Entire Benefit. A spouse=s rights extend to the entire accrued benefit of the participant, not just to those accrued during marriage. Boggs v. Boggs, 520 U.S. 833 (1997).
(1) The spouse (if there is one) who has been married for a year, must be the death beneficiary and the only death beneficiary unless the spouse consents to some other beneficiary. This provides spousal protection without the annuity, and may be stronger than an annuity where under the annuity the spouse may only receive 50% on the death of the participant.
(2) The participant has never elected a life annuity.
(3) There is no offset arrangement with a plan subject to IRC ' 417 (annuity rules).
(4) There has been no transfer from any plan subject to the annuity rules. The transfer can be direct or indirect as to a particular participant or as to a group of participants, for example, by plan merger, spinoff, or conversion. A rollover is not a transfer which subjects the recipient plan to the annuity rules. Regs. ' 1.40(a)-20, Q&A 3 and 5. Other participants in the plan do not become subject to the survivor requirement solely by reason of the transfer. The transfer of a part that is subject to the annuity requirements will subject all the participant=s account to the requirements unless there is separate accounting in which event the rest of the account need not be subject to the requirements. IRC ' 401(a)((1)(B)(iii); Regs. ' 1.40(a)-20, Q&A-5(b). Not all plans are willing to provide a separate accounting.
iv. IRAs. IRAs and SEPs, even rollover IRAs from plans subject to annuity rules, are not themselves subject to the annuity rules. However, a participant could purchase an IRA annuity, in which event the terms of the annuity would apply.
v. Waiver of Spousal Rights in Qualified Plans. In order to protect the spousal benefits, there are special rules regarding their waiver.
A. Premarital Agreement Ineffective on Death. These rights to death benefits (annuity or lump sum) cannot be waived in a premarital agreement, since they can only be waived by a spouse. Regs. ' 1.401(a)-20, Q&A 28; Pedro Enterprises v. Perdue, 998 F.2d 491 (7th Cir. 1993); Hurwitz v. Sher, 982 F.2d 778 (2d Cir. 1992); Howard v. Branham & Baker Coal Co., 968 F.2d 1214 (6th Cir. 1992). Subsequent action to execute proper waivers after marriage is mandatory.
B. Divorce Rule Different on Premarital Agreements. A right to receive a division of benefits on divorce, may be waived by a premarital agreement. 29 USC ' 1056(d). ERISA defers to state law here. See In Re Marriage of Rahn, 914 P.2d 463 (Colo. Ct. App. 1995). A similar rule appears to apply to federal government employee retirement benefits in divorce, as well (see 5 USC ' 8345(j), 5 USC ' 8467, 5 USC ' 8435(c)(2), and 10 USC ' 1048), except under the Foreign Service Act of 1980 which provides 10-year spouses a pro rata share of benefits accrued during marriage, absent spousal agreement or court order. 22 USC '' 4054(a)(1), 4060(b)(1)(A).
C. Spousal Consent to Waive Death Benefits. The waiver, executed during marriage, by a spouse as to survivor benefits must designate a beneficiary (or form of benefits) which may not be changed without spousal consent (or the consent of the spouse expressly permits designations by the participant without any requirement of further consent by the spouse), and must acknowledge the effect of the participant=s election not to provide a survivor benefit. IRC ' 417(a); 29 USC ' 1055(c). It must be in writing and notarized or witnessed by a plan representative. Thus, any postmarital agreement or waiver needs to be notarized. See Lasche v. George W. Lasche Basic Profit Sharing Plan, 111 F.3d 863 (11th Cir. 1997).
(1) QPSA. A preretirement annuity cannot be waived by a spouse until the participant reaches age 35. 29 USC ' 1055(c)(7)(B).
(2) QJSA. A joint and survivor annuity can only be waived within the 90 days prior to the annuity starting date. 29 USC ' 1055(c)(7)(A).
(3) Enforcement. An action for specific enforcement of the marital agreement waiver may be necessary. See Barnett v. Barnett, 67 S.W.3d 107 (Tex. 2001). But if the participant dies without an effective waiver on file with the plan, the plan will be required to pay the spouse. Hurwitz v. Sher, 982 F.2d 778 (2d Cir. 1992), cert. denied, 508 U.S. 912 (1993).
(4) Election of Benefits. The agreement may require a spouse to elect between benefits under the plan or other, waivable, benefits. A proper disclaimer by the spouse of plan benefits can be followed by the plan administrator without violation of duty. 29 USC ' 1104(a)(1)(D); Engeloff v. Engeloff, 532 U.S. 141 (2001).
(5) Repeated Action. The spousal consent process is needed any time the participant takes a plan loan, takes a new job with a different plan, receives a nonannuity distribution, and 90 days before the QJSA starting date or before the nonannuity distribution (e.g., at retirement or (if allowed) at an in-service distribution).
vi. Waiver of Spousal Rights in Federal Plans. Under at least some federal retirement programs, there may be more flexibility as to early, even premarital, waivers, even irrevocable waivers. For example, under the Civil Service Retirement System, premarital agreements are not specifically dealt with but may be possible. See 5 USC ' 8345(d). This may allow an irrevocable waiver. See Shell v. Office of Personnel Mngmt. 88 MSRP224 (Merit Systems Protection Board 2001); Worley v. Off. Pers. Mngmt., 86 MSPR237 (Merit Systems Protection Board 2000). See also, 5 USC ' 8339(j)(1) and 5 CFR ' 831.611(a) (which do not limit the period when the waiver must be executed). The waiver would need to be filed before retirement or death, whichever is earlier. Naturally, each separate program has separate rules on waivers which will need to be consulted.
d. Anti-Assignment Rules. The antiassignment rules of qualified plans provide strong creditor protection. See Patterson v. Shumate, 504 U.S. 753 (1992) (plan benefits not in bankruptcy estate); Guidry v. Sheet Metal Workers National Pension Fund, 493 U.S. 365 (1990) (even on embezzlement, an employer may not take plan assets from participant). The rules are also a qualification requirement the violation of which will disqualify a plan. IRC ' 401(a)(13); ERISA ' 206(d); Regs. ' 1.401(a)-13(c)(1). The rules also prevent transfers for planning purposes, and thus must be worked around by the estate planner. The rules generally do not apply to IRAs (although IRA annuities have some such provisions in them).
i. General Exceptions. There are, however, some exceptions to the anti-assignment rules which can be important.
(5) The assignment is revocable by the participant at any time.
B. Benefits in Pay Status with Acknowledgment. Also, a revocable voluntary assignment can be made if the recipient acknowledges in writing to the plan administrator no later than 90 days after the assignment that the recipient has no enforceable right beyond payments actually received. Regs. ' 1.401(a)-13(e).
C. Plan Loans. If the plan allows participant loans, the plan account can be pledged to the plan as security for the loan under the generally applicable plan loan rules. See IRC ' 4975(d)(1) and Regs. ' 1.401(a)-13(d)(2). Depending on the terms of the loan policy of the plan, this may allow access to some plan funds for certain purposes. The spousal consent requirements would apply, however.
ii. QDROs. A very significant exception to the anti-assignment rules is for qualified domestic relations orders which typically apply in the event of divorce or separation.
A. Individual Retirement Accounts. Qualified domestic relations order rules do not apply to IRAs because IRAs generally can be assigned (subject to penalty tax prior to age 59 2). IRC ' 408(d)(6) provides nonrecognition on transfers of IRA accounts or annuities to a spouse or former spouse under a qualified divorce or separate maintenance decree (IRC ' 71(b)(2)(A)); the transferee will be treated as the owner. A settlement agreement not confirmed by a court decree will not be enough for safely making a tax free transfer.
B not alter the amount or form of benefits. Thus the decree could not provide a type or form of benefit not in the plan itself, provide benefits exceeding the actuarial value of the participant's benefits, or conflict with benefits under a previous QDRO.
a. Beneficiary Designations. Beneficiary designations are quite critical, as we have seen, because the naming of a person who qualifies as a Adesignated [email protected] directly or through an allowable trust, can make a big difference for income tax deferral. Naturally, such a designation is important to make sure the benefits go where they are supposed to go on the death of the participant. The spousal protection rules discussed above are a very significant limitation on planning through beneficiary designations for qualified plans and some other types of retirement plans, governmental plans in particular, but not for IRAs.
i. Spouse as Beneficiary. In most cases, the spouse will be named as beneficiary. If the plan or account is large, adjustments to the treatment of other assets may be needed. A spouse who is the beneficiary (and a U.S. citizen will obtain the benefit of the estate tax marital deduction where the spouse has the right to a lump sum payment or the right to withdraw the plan benefit or IRA account balance. The spouse may also roll over the benefit into the spouse=s own IRA, allowing greater income tax deferral. The risk of a spouse as sole beneficiary is the possibility of overfunding the marital deduction, thus destroying to some extent the benefit of the unified credit, which eliminates tax in the spousal generation, where there are not sufficient other assets to make up the amount covered by the unified credit ($2 Million in 2008; $3.5 Million in 2009). The marital deduction only postpones tax until the death of the second spouse. Also, if there are children from a prior marriage, the family plan may become unbalanced. Further, if trust management is desired, a direct beneficiary designation places the assets in the beneficiary=s hands and the beneficiary may not choose trust management or some other prudent form of asset management.
ii. Other Beneficiaries. Someone other than a spouse may be a beneficiary. In order to obtain income tax deferral, the beneficiary would need to qualify as a designated beneficiary. See also the discussion of trusts at d. below.
i. Disclosures. Disclosure is very important to assure enforceability. See Matter of Estate of Beesley, 883 P.2d 1343 (Ut. 1994) (regarding materiality of disclosure); Pierce v. Pierce, 994 P.2d 193 (Ut. 2000) (relating to postnuptial agreement enforceability).
ii. Contract Consideration. In both Beesley and Pierce, the court was concerned, among other things, about consideration for a marital agreement, at least where no statute eliminates the requirement. See further, Reese v. Reese, 984 P.2d 987 (Ut. 1999) (in postnuptial agreement case, the court is jealous of its equitable powers which should not be unreasonably constrained).
iii. Burden of Proof. Also, burdens of proof may shift in the case of confidential relationships or undue influence. See Baker v. Pattee, 685 P.2d 632 (Ut. 1984) (effect of confidential relationship discussed, but the relationship not found in that case); Robertson v. Campbell, 674 P.2d 1226 (Ut. 1983) (undue influence shifted burden of proof).
iv. Clarity. Waivers, particularly general waivers, need to meet a certain level of clarity. See Estate of Anello v. McQueen, 953 P.2d 1143 (Ut. 1998); Culbertson v. Continental Assurance Co., 631 P.2d 906 (Ut. 1981). It is important to be as specific as possible and not to rely on overly broad, generalized language because the courts will insist on a good deal of clarity before allowing such a waiver.
v. Fallback Beneficiary. The effect of spousal waivers on fall-back beneficiary designations contained in a plan or account which name the spouse as beneficiary when no other beneficiary is named, can create difficult issues of intent and interpretation. See Kinkle v. Kinkle, 699 N.E. 2d 41 (Ohio 1998). The lesson of Kinkle and similar cases is to always have a backup beneficiary named so the fallback does not apply.
vi. Marital Agreements. Prenuptial or postnuptial agreements may be useful for defining rights, particularly as to qualified plans. As mentioned earlier, only a spouse can waive spousal rights, so if a prenuptial agreement is used, subsequent action will be needed.
c. Wills. For the transfer of property at death, wills are the classic instruments to use. Generally, plan and IRA benefits should not be made payable to the participant=s estate to pass under the will (or by intestacy) unless the participant is comfortable with a shorter required payment term and consequent speedier payment of income taxes.
d. Trusts. However, revocable or, where appropriate, irrevocable, trusts may be named as beneficiaries at death and if meeting the requirements as a designated beneficiary, could allow for longer payment terms and deferred income tax. Trusts also provide management, spendthrift creditor protection, and other benefits. The plan or IRA benefits received by the trust need not be actually distributed to the beneficiary right away, but could be held until needed.
i. Fractional Shares. If there is more than one beneficiary of the trust, it may be best to use separate shares, defined by fractional shares rather than pecuniary amounts. This would help meet the separate share rules for naming designated beneficiaries, thus enabling a longer deferral of income tax. Also, such fractional shares will help prevent the recognition of income in respect of a decedent under IRC ' 691 which can be triggered by the satisfaction of a pecuniary devise. See Regs. ' 1.661(a)-2(f), Kenan v. Com=r, 114 F.2d 217 (2d Cir. 1940) (property used to satisfy pecuniary bequest triggers gain); Internal Legal Memorandum 200644020 (the general result of satisfying a pecuniary gift (i.e., gain recognition) is not prevented by the words Apaid or [email protected] in IRC ' 408(d)(1) (an IRA provision) which only prevents constructive receipt). Compare Rev. Rul. 55-117, 1955-1 CB 233 (gift of 25% of corpus is not a pecuniary amount and does not trigger gain).
ii. Special Powers. It may also be a good idea to give the beneficiary in some cases (especially a spousal beneficiary) or the trustee, the ability to cause a trust distribution and rollover into a spousal or other IRA. This may allow longer income tax deferrals. Some express provisions granting the trustee discretion in dealing with plan and IRA benefits may be a useful part of general trust terms.
iii. Marital Trust Use. The trust could place the plan benefit or IRA into a QTIP marital trust. With respect to a qualified plan, a spousal consent and waiver of any annuity would be necessary. Although a power of appointment marital trust could be used, this may not meet the participant=s desires for trust management or to benefit others on the spouse=s death.
A. Income. The income for life requirement for a marital trust means that the income may need to be drawn before the otherwise applicable required beginning date (under a qualified plan, this could be when the participant would have attained age 70 2 ). Also, the income drawn may not be sufficient to meet the required minimum and thus require a principal distribution to make up the difference, or the income drawn may exceed the otherwise required minimum distribution (for example, where the surviving spouse has a long life expectancy); either way, the plan may need to adjust.
B. Productive Assets. If other assets are available from the marital trust, such other assets may be distributed in lieu of converting under-productive assets (the spouse will generally have the right to require conversion to productive assets under the terms of the marital trust). See Regs. '' 20.2056(b)-5(f)(4) and (5) and 20.2056(b)-7(d)(2). Thus, to protect a QTIP (qualified terminal interest property) marital deduction, the trustee should have the power to accelerate withdrawals which exceed the minimum required distribution in order to satisfy the spouse=s productivity request.
C. Other Steps. Also, some other steps are advisable to protect a QTIP marital trust holding plan or IRA benefits. See Rev. Rul. 2000-2, 2000-3 IRB 305. These include a separate QTIP election for the IRA or plan and for the trust, and a spousal right to compel the trustee to withdraw from the plan or IRA assets, and pay to the spouse, an amount equal to all income earned on those assets in a year.
iv. QTIP Income Tax Deferral. Where the QTIP trust is the beneficiary, the income tax on the principal paid into the trust can be deferred so long as the income for life standard can be met. The principal would be available for meeting the needs of the spouse under a health, support, maintenance, or education ascertainable standard, or could be available for remainder beneficiaries. However, the extra deferral of a spousal rollover IRA would not be available without a spousal right to revoke or withdraw. The QTIP trust should be able to meet the requirements for treating the spouse as a designated beneficiary in order to avoid the five-year payout rule for a participant death before the required beginning date and to allow the spouse=s life expectancy to be used in the event of the participant=s death on or after the required beginning date.
v. Where Marital Trust Is Overfunded. In case of marital trust overfunding, the spouse could disclaim to a backup trust from which the spouse may receive benefits, or the personal representative could make only a partial QTIP election, thus accomplishing the same goal: to use the unified credit of the deceased participant and to reduce the gross estate of the surviving spouse.
vi. Credit Shelter Trust Use. Having some plan or IRA benefits pass by beneficiary designation to a family trust for use of the unified credit equivalent (sometimes called a credit shelter trust) would require a spousal consent as to a qualified plan (such a consent should not trigger inclusion in the spouse=s estate under IRC '' 2036(a) or 2038, however), and would not provide income tax deferral where it has multiple beneficiaries and cannot qualify as a designated beneficiary as to separate shares; a spousal rollover would not be available absent a spousal withdrawal right or a power in the trustee to disclaim where the disclaimed rights pass to the spouse.
vii. Credit Shelter and Income Tax Deferral. Where it is desirable to benefit remainder beneficiaries (such as children), it is best that plan and IRA amounts not be paid to the credit shelter trust because they will be subject to income tax as income in respect of a decedent, reducing the ultimate benefit. Having such assets pass to the marital trust to obtain at least some income tax deferral may be the better choice in many cases. The surviving spouse=s gross estate is reduced by the income tax payable.
e. Disclaimers. Spouses of participants may make disclaimers without violation of the antiassignment rules, which rules only apply to participants. See Fox Valley & Vicinity Constr. Workers Pension Fund v. Brown, 897 F.2d 275 (7th Cir. 1990) (the case involved a decree of divorce where the former spouse waived pension benefits); see also PLRs 9710034, 9551015, 9537005, 9037048. Other beneficiaries may also disclaim. The disclaimer can be made as a qualified disclaimer under IRC ' 2518 and thus avoid a gift by a disclaiming party and also avoid an assignment of income. GCM 39858 (9/9/91); PLRs 200444033-034 (the private letter rulings do not express an opinion as to whether a prohibited assignment or alienation would exist). The nine-month period for a qualified disclaimer should run from the date of the participant=s death (rather than earlier), so long as the participant could change beneficiaries and had not made an irrevocable beneficiary designation. See GCM 39858 (9/9/91).
i. Designated Beneficiary Effect. A disclaiming beneficiary is not the designated beneficiary if the disclaimer occurs on or before the required date for determination (i.e., September 30 of year following the participant=s death). See Rev. Rul. 2005-36, 2005-26 IRB 1368.
ii. Allowable Power to Disclaim. Also, any disclaimer would need to be allowable under the terms of the plan or account. See Nickel v. Estes Estate, 122 F.3d 294 (5th Cir. 1997) (deceased beneficiary=s representative lacked power under plan to disclaim).
f. QDROs. Some planners have considered the use of obtaining a qualified domestic relations order ("QDRO") from a court even where there is no divorce or separation. This may help with the enforcement of a premarital agreement to waive plan benefits. However, particularly absent a bona-fide dispute, there is a risk the Service could, with respect to tax effects, view the proceedings as a sham without economic substance to avoid the general antiassignment of income rules and the 10% penalty tax on early distributions (i.e., prior to age 59 2 ), or for other tax purposes. The risk may be greater in a common law property jurisdiction than in a community property jurisdiction where spouses obtain vested property rights on earnings during marriage.
i. Community Property. The case of Boggs v. Boggs, 520 U.S. 833 (1997) rev=g 82 F.3d 90 (5th Cir. 1996) held that ERISA preempted community property law as to the annuity requirements. However, where a spouse dies before the participant, the spouse may not have any rights absent an agreed exchange of rights in something else for the annuity rights voluntarily waived. The rights under a QDRO protecting what would otherwise be community property thus may be superior to those under a survivor annuity. See IRC ' 414(p)(5). Also, a spouse=s successors cannot obtain a QDRO, only a spouse, former spouse, child, or dependent can. IRC ' 414(p)(8). Thus, an agreed QDRO could have some economic substance in preserving community property rights which may be otherwise lost under Boggs.
ii. QDRO Benefits. If the QDRO plan worked, the spouse could receive distributions on the divided share even while the participant remained an active employee, so long as the participant has reached the earliest retirement age under the plan, and could roll over the benefits into an IRA. The benefits would be retained even though the spouse failed to survive the participant. See, however, Ablamis v. Roper, 937 F.2d 1450 (9th Cir. 1991) (QDRO is only for divorce separation, and child support, not probate purposes) and Department of Labor advisory opinions 90-46A and 90-47A (12/4/90) (a probate order cannot be a QDRO).
g. Plan Distribution Requests and Creditor Protection. There is no particular tax reason to leave benefits in a qualified plan rather than roll them over into an IRA at the appropriate time. However, there may be nontax reasons not to take qualified plan distributions for rollover into an IRA or to roll the plan benefits over into another qualified plan instead of into an IRA. A rollover to another plan is best done by trustee-to-trustee direct rollover transfer rather than a nondirect rollover or through a conduit IRA.
i. Plan Protection. Qualified plans receive better protection from creditors than IRAs under both the U.S. Bankruptcy Code and ERISA (Employee Retirement Income Security Act of 1974). The Bankruptcy Code ("BC") is codified at 11 USC ' 101 et seq. ERISA is generally codified at 29 USC ' 1001 et seq.
A. Protective Rules. The plan benefits will not be part of a bankruptcy estate (BC ' 541(c)(2) and Patterson v. Schumate, 504 U.S. 753 (1992) and In re Harline, 950 F.2d 669 (10th Cir. 1991)) and, under the antiassignment rules of ERISA and the Internal Revenue Code (IRC ' 401(a)(13); ERISA ' 206(d)), cannot be seized by creditors with very few exceptions, such as for federal (not state) taxes.
B. Tax Exception. As to federal tax seizures, see IRC ' 6331, Regs. ' 1.401(a)-13(b)(2), U.S. v. Sawaf, 74 F.3d 119 (4th Cir. 1996). The Chief Counsel for the Service has indicated that the Service will no longer argue that plan assets excluded from the bankruptcy estate are nevertheless in the value of the secured claim under BC ' 506(a); however, the tax lien is not extinguished and will continue to exist outside the bankruptcy proceeding. Notice CC-2004-033. Retirement plans will be one of the last assets seized by the Service. On a federal tax seizure, the plan can only distribute as a joint and survivor annuity where the participant is married and the annuity rules apply. See FSA 199936042.
C. Potential Exposure of Plans. There may be exposure, however, where significant ERISA provisions either do not apply or are not met.
(1) Single Participant Plan. If the plan only covers the business owner and the business owner=s spouse, the plan may be deemed a single participant plan not subject to all of ERISA, this may bring the plan account into the owner=s bankruptcy estate, but an exemption may still apply. See, under Utah exemption law, for example, UCA '' 78-23-5(1)(a)(xiv) and (xv), 78-23-5(1)(b), and under the Bankruptcy Code, BC ' ' 522(b)(3)(C) or 522(d)(12). See also Yates v. Hendon, 541 U.S. 1 (2004) (coverage by plan of one or more employees other than professional and his spouse enabled protection under ERISA).
(2) Not Qualified. Protection may also be lost or if the plan fails an antidiscrimination test or other qualification requirement (this may bring the plan account into the bankruptcy estate and destroy the exemption). The issue of when a plan is qualified can raise complex, legal, and factual issues. See, e.g., In re Hall, 151 B.R.. 412 (Bnkr. W.D. Mich. 1993) (analyzing qualification issues), and compare with In re Youngblood, 29 F.3d 225 (5th Cir. 1994) (the court need not and should not look beyond a Service determination of qualification) and In re Rueter, 11 F.3d 850 (9th Cir. 1993). However, the exemption maybe allowed where the debtor is not materially responsible for a failure to substantially comply with applicable requirements of the Code. BC ' 522(b)(4)(B)(ii)(II). However, a facially qualified plan which is abused by the debtor might not be excluded from the bankruptcy estate under a substance over form analysis. See In re Goldschein, 244 BR 595 (Bnkr. D. Md. 2000).
D. Exemption. Qualified plans also receive protection under the Bankruptcy Code as an asset which may be exempted (BC ' 522), and traceable proceeds may continue to be exempt from creditors under state law in some states, including Utah. UCA ' 78-23-9(2).
E. Generally Best Protection in Plans. Qualified plans are generally the best form of retirement program for creditor protection; they have protection under ERISA in every state, are entitled to bankruptcy exclusion or exemption without dollar limit or a showing of need, allow for the largest amounts of tax-favored retirement savings, and are relatively flexible. However, as we have seen, such plans contain strong spousal protection provisions, and they are still subject to federal tax claims, but they are one of the last assets seized. They are not subject to seizure for state tax claims.
ii. IRA Protection. IRAs may receive protection under the Bankruptcy Code, but, as described in D. below, generally are exempt from creditors only to the extent reasonably necessary for support (where not necessarily tax favored) or subject to dollar limits (where the IRA is tax favored but is not a SEP or similar arrangement). Rousey v. Jacoway, 544 U.S. 320 (2005); BC ' 522(d)(10)(E). See also In re Carmichael, 100 F.3d 375 (5th Cir. 1996) (good policy analysis of exempting IRAs). In many states, IRAs may receive some level of state law protection as well; this protection is rather good in Utah. UCA ' 78-23-5(1)(a)(xiv).
A. Inherited IRAs. However, some bankruptcy courts have found nonspousal inherited IRAs not to be true IRAs because they have different distribution requirements. See In re Jarboe, 365 BR 717, 2007 WL 987314 (Bnkr. S.D. Tx. 2007), In re Kirchen 344 BR 908 (Bnkr. E.D. Wis. 2006). This issue turns on the wording of the state law exemption statute and the court=s attitude toward exemptions for unearned amounts. Utah=s exemption law, for example, may be sufficiently well worded not to have these concerns. For example, the Texas statute in Jarboe exempted an IRA unless it Adoes not qualify under the applicable provisions of the Internal Revenue Code of 1986" and the court found an inherited IRA under IRC ' 408(d)(3)(C)(ii) sufficiently different that it Adoes not [email protected] Also, these cases are based on a reluctance to exempt nondebtor-funded IRAs and seem poorly reasoned, both as a policy matter and even more so as a statutory interpretation matter. Thus, they might not be followed elsewhere, but several bankruptcy judges, in cases cited in Jarboe (some from before the 2005 Bankruptcy law changes) have issued decisions adverse to the exemption of inherited IRAs. Given the various limits on the exemptions (see D. below; also note the limits on contributions to IRAs and the mandatory distribution requirements), a strained interpretation of the statutes does not seem justified. This issue raises concerns, as well, for spousal IRAs particularly those held as inherited IRAs and not rolled into the spouse=s own IRA. For spouse beneficiaries, it would be best to transfer the inherited IRA into the spouse=s separate IRA, but it is not clear that the issue will not follow the transfer anyway.
B. Rollover. To protect rollovers which have been made to IRAs from qualified plans, it is best to use direct, trustee-to-trustee, transfers rather than indirect rollovers on the initial transfer or on further rollovers when changing from one IRA to another.
C. Tax Claims. IRAs are easy targets for any federal or state levy and the levy is treated as a taxable distribution. Schroeder v. Com=r, TC Memo, 1999-335 (1999). The Service generally does not seize IRA corpus except in flagrant cases (IRM 5.11.6.2; but note that the Internal Revenue Manual is not binding on the Service at the insistence of a taxpayer. See First Federal Savings and Loan Assoc. of Pittsburgh v. Goldman, 644 F. Supp. 101 (W.D. Pa. 1986)).
D. Limits. IRAs may be subject to either of two limits on protection, depending on the type of IRA and the Bankruptcy Code provision applicable to the exemption.
(1) Dollar Amount. Under BC ' 522(n), there is a cap of $1 Million (adjusted periodically every three years under BC ' 104 for changes in the Consumer Price Index; the amount was $1,095,000 as of April 1, 2007) on the value of the debtor=s interest in accounts covered by IRC '' 408 (traditional IRAs) or 408A (Roth IRAs), which is exempt under BC ' 522(d)(12) or BC ' 522 (b)(3)(C). The cap does not apply to SEP IRA accounts (IRC ' 408(k) or SIMPLE accounts (IRC ' 408(p)) or to IRC '' 403(b) or 457 plans, for which the debtor may claim an exemption. The cap applies without regard to roll over contributions and earnings on them. The cap may be increased in the interests of justice. P.L. 109-8, ' 224(e)(2); BC ' 522(n).
(2) Support. The exemption under BC ' 522(d)(12) or 522(b)(3)(C) (subject to the IRA dollar cap) for tax favored plans or accounts, is in addition to the separate exemption under BC ' 522(d)(10)(E), which exemption is limited to amounts reasonably necessary for the support of the debtor the debtor=s dependents but the account need not be tax exempt under the Code. The BC ' 522(d)(10)(E) exemption, however, does not apply to plans established by an insider that employed the debtor. BC ' 522(d)(10)(E)(i) to (iii). For an application of factors relating to what is reasonably necessary for support, see In re Vickers, 954 F.2d 1426 (8th Cir. 1992), In re Hoppes, 202 BR 595 (Bnkr. N.D. Ohio 1996).
iii. Education IRAs. Under BC ' 541(a)(5) and (6), certain education IRAs (Coverdell accounts under IRC ' 530(b)(1) and (g)) and tuition plans (IRC ' 529) may be excluded from the bankruptcy estate up to the tax contribution limits for the type of plan, where contributed not later than a year before the bankruptcy petition, and not over $5,000 (indexed; the amount was $5,475 as of April 1, 2007) for each type where contributed not later than one year before and not earlier than two years before the petition. State law protection is not certain in most states. For example, they are not mentioned in the Utah exemption law. See UCA ' 78-23-5(1)(a).

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