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ESTATE PLANNING ISSUES 3:
THE “RETIREMENT ASSET WILL”
The retirement asset as contained in a qualified plan or a traditional IRA may be the largest asset in your estate. It should not be assumed that it will pass under your Last Will or Revocable Trust. There are at least seven different ways that retirement assets are quite different from your other assets. If you have a sizable IRA, you should consider having your attorney draft a special “Retirement Asset Will”. Because there is more flexibility with an IRA and because qualified plan benefits can generally be changed to an IRA, the IRA is the plan of choice.
An IRA is a contract and the death benefits pass by contract. The death benefits do not pass by your Last Will, no matter what the Last Will says. Second, they do not receive a “step-up” in cost basis at the death of the owner as do the other assets in your estate. Third, they do not receive the favorable capital gains treatment when liquidated, as your other assets may. Fourth, the ownership of them cannot be transferred to your living trust during your lifetime. Fifth, the ownership of them cannot be gifted to your heirs during your lifetime. Any change of ownership results in an immediate and complete distribution such that ordinary income taxation will be then due.
The sixth difference is that they are governed by a whole different set of tax rules for lifetime and death distribution. This is the price we pay for not paying income tax on the funds when earned, but being able to defer income taxation until our retirement. The seventh difference is that unlike almost every other requirement of tax laws which each have their own IRS forms, the lifetime and death distribution rules of IRAs do not have any IRS published forms to simply complete. Retirement Assets require their own specialized plan for distribution after your death apart from, but coordinated with, your estate plan. This is where you should use a “Retirement Asset Will”.
However, unlike most wills which can be revoked or amended at any time while competent prior to death, once an owner turns age 70_, many of the provisions and elections regarding retirement assets are IRREVOCABLE.
The “Retirement Asset Will” is a 10 to 20 page document signed by the owner of the retirement asset and presented to and accepted by the trustee or custodian of the IRA or plan. It makes several choices or elections you have the privilege to make, but which if you fail to make prior to your death may be made contrary to your best interests by either the IRS or your plan custodian. These elections include whom you will designate as your primary and contingent “designated beneficiary”, whether you choose single or joint life expectancies, and whether you choose term certain or “recalculation”. These choices result in at least eight mind boggling combinations. Even if you die prior to your required beginning date, the choices you made or failed to make will effect the tax consequences for your beneficiaries.
Our goal is generally to continue compounded tax deferred growth for as long as possible. The very worst thing you can do is to name your “estate” as your beneficiary, since all deferred tax will be due in one year. This mistake will bunch the tax obligation into the highest bracket and end compounded tax deferral. If you do nothing, chances are your plan documents have already named your “estate” as beneficiary. If you choose to “recalculate” your single life expectancy, chances are your beneficiary will also have to pay the income taxes prematurely. The rules to prevent premature taxation and preserve tax deferral are so maddeningly complex that you should consult a professional, especially if you are considering the creation of multiple IRA’s, use of a spousal roller strategy, use of a multigenerational strategy, involvement of a charitable beneficiary, or life insurance planning.
Although your trust can never be the owner of your IRA, a strategy of last resort may involve naming a family bypass trust or a marital trust as your beneficiary, but certain rules must be carefully followed to make your trust a “qualified trust” meeting recent IRS guidelines. Even if your trust is your beneficiary, your Retirement Asset Will should make that designation as well as additional elections and choices which will directly impact your estate and income tax situation, including clauses dealing with such issues as presumption of death, per stirpes, disclaimers, and very important beneficiary rights.
With proper planning, you can convert the double-tax erosion into a family legacy of tax-deferred growth.
William Edy
Attorney/CFP
Read More:
ESTATE PLANNING ISSUES 1 | ESTATE PLANNING ISSUES 2 | ESTATE PLANNING ISSUES 3
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