2015 Advanced Elder Law Review January 27 & 28 Newport Beach, CA

Complex Planning with

IRAs
Overview of IRAs and Retirement Plans

Materials Prepared by: Stephen C. Hartnett, J.D., LL.M.

(in Taxation) & Dennis Sandoval, CELA

Updated and Presented by: Bradley Frigon, JD, LLM,

CELA, CAP

January 27, 2015

2007 Stephen C. Hartnett 1

1. Overview of Retirement Assets

What are Retirement Assets?

Individual Retirement Accounts

SEP-IRAs
Simple Plans
Keoghs
403(b) Plan
457 Plan
Qualified Plans
o Money Purchase
o Profit Sharing
o 401(k) Plan

Retirement Assets Are Income in Respect of a Decedent.

Retirement Assets are income in respect of a decedent. 1 Income in respect of a decedent, or

IRD, are all items of taxable income of a decedent that are not properly taxable to the decedent
on his or her last or prior income tax returns. In addition to retirement assets, income in respect
of a decedent can include compensation, bonuses, benefit plan distributions, partnership income,
interest, dividends, annuities and installment obligations. IRD items are not entitled to a step-up
in basis under IRC 1014. Therefore, IRD items are often the most heavily taxed assets in a
decedents estate, always subject to income tax and sometimes also subject to estate and
generation-skipping transfer taxes as well. The income tax on IRD assets is paid by the
beneficiary of the IRD asset.

Where an estate is taxable, the recipient of IRD assets may be eligible for an offsetting IRD
deduction for the federal estate taxes attributable to the IRD. 2 The deduction is taken as a
Schedule A itemization in an amount equal to the percentage of the IRD being brought into
taxable income in any given year (i.e., if 50% of IRD assets are distributed in the current year
and subject to income taxation, then 50% of the allowable IRD deduction can be taken in the
current year, with the balance carried forward to future years when additional IRD assets are
distributed). The amount of the IRD deduction is calculated by determining the federal estate tax
of the decedent with IRD assets included and with IRD assets excluded. The IRD deduction is
the difference between the two.3 For example, an unmarried participant dies in 2013 with an
IRA of $350,000, plus $5,600,000 in other assets. The participants total federal and state estate
tax is approximately $122,500. The entire estate tax is attributable to the IRA account because, if
that account were not included in the participants gross estate, there would be no estate tax.
(The entire estate tax would have been absorbed by the available applicable credit amount.)
When the IRA account is distributed to the participants beneficiaries, all amounts distributed are
included in the gross income of the beneficiaries. Taking into account the special deduction

1 IRC 691(a).
2 IRC 691(c).
3 Treas. Reg. 1.691(c)-1(a).

2007 Stephen C. Hartnett 2

allowed under IRC 691(c), and assuming the participants beneficiaries have an average rate of
income tax of 25%, the total income tax on the date of death IRA plan balance will be $48,125.
This is calculated as follows:

IRC 691 income: $350,000

Less IRC 691(c) deduction: $122,500

Taxable amount: $227,500

25% tax: $56,875

The total effective rate of tax (both income and estate) on the IRA account after the IRC 691(c)
deduction is 60%.

In the real world, the $691(c) deduction can be very complicated to calculate. A decedents
estate will have many different items of IRD, including accrued interest and dividends paid after
the date of death. Additionally, IRD is often received over a period of years and not all at once.
The deduction is often overlooked by the accountant unless the attorney administering the estate
alerts the beneficiaries to the deduction. Remember, the IRC 691(c) deduction is not available
if the IRD is not subject to estate tax.

Options for Distributions from Retirement Plans

There are a variety of distribution options available for qualified plans (although the participants
spouse will generally need to consent to the option chosen, as described more thoroughly below).
The most common options are:

Joint and Survivor Annuity

This option provides for a monthly annuity to the participant for life. Upon the
participants death, a percentage of the initial annuity amount (up to the whole thereof, but
usually 50%) is paid to the participants spouse for his or her life, assuming the spouse survives
the participant.

Single Life Annuity

This option provides for an annuity payment to be made only for the life of the
participant. Because the payments are made for only one life expectancy, they are greater than
the amount paid under a joint and survivor annuity option. Oftentimes, financial planners will
recommend choosing the option and using a portion of the greater cash flow to pay the premiums
on a life insurance policy, annuity or long term care policy on the participant. Of course, the
effectiveness of this strategy depends on the age and health of the participant, and well as the
performance of the annuity or life insurance policy selected.

2007 Stephen C. Hartnett 3

 Period Certain or Term Certain Annuity

When this option is selected, an annuity payment is made for a specified number of years
regardless of whether the participant is alive or not. If the participant dies before the period
expires, then the annuity payments continue to be made to the remainder beneficiary. If the
participant outlives the period certain, then he or she will be without a retirement income for the
balance of her life.

Lump Sum

Under this option, the distribution is made in a single sum.

The Retirement Equity Act, or REA, requires that distributions from a qualified plan in which
the participant is married must be paid in the form of a joint and survivor annuity. The annuity
must provide payments to the spouse of the participant for such spouses life that are equal to at
least fifty percent of the amounts payable to the participant during his or her life. 4 After the
participant has attained age 35, he or she may waive the requirement for a joint and survivor
retirement annuity under REA if the participants spouse consents to such waiver.

Rollover Options

Most types of distributions from a qualified plan or individual retirement account can be rolled
over into the same or a different qualified plan or individual retirement account without being
subject to income taxation or penalty, if done within sixty days. Examples of distributions from
qualified plans and individual retirement accounts that are NOT eligible for rollover treatment
include:

One of a series of payments taken over a single or joint life expectancy;

One of a series of payments received for a specified period often years or more;

A Required Minimum Distribution, or RMD5 (explained infra).

A rollover distribution from a retirement plan or IRA is subject to a 20% federal income tax
withholding requirement. The withholding requirement can cause forced income taxation of a
portion of the distribution where the participant does not have an alternative source to replace the
20% of the distribution withheld for taxes. For example, a participant requests a distribution of
$100,000 from her IRA, intending to roll it over before the expiration of sixty days to another
IRA custodian. The original IRA custodian withholds $20,000, as required under federal law, and
distributes $80,000 to participant. Participant does not have $20,000 from alternative sources and
so is only able to deposit $80,000 with the new IRA custodian. Participant will have $20,000 of
taxable income to report.

Under certain circumstances the IRS can waive the sixty-day requirement and allow a valid
rollover even if beyond sixty days. See Rev. Rul. 2003-16; IRC 40(d)(3)(I).

4 IRC 417(a)(7)(B).
5 IRC 402(c)(1) and (4).

2007 Stephen C. Hartnett 4

A method to avoid tax withholding is to use a trustee to trustee transfer rather than an IRA
rollover. Because the money is never distributed directly to the participant, a trustee to trustee
transfer is not subject to the otherwise mandatory withholding requirements.

Required Beginning Date

A participant must begin taking RMDs from his or her retirement assets by his or her Required
Beginning Date or RBD. The RBD is April 1st of the calendar year AFTER the calendar year in
which the participant reaches age 70. There is an exception for QUALIFIED PLANS only if
the participant is not retired at age 70 and the participant is not a five percent or greater owner
in the business in which he or she works, RBD can be postponed until April 1 st of the year after
the participant actually retires. RMDs from an IRA cannot be postponed beyond age 70, even if
the participant is continuing to defer distributions from the qualified plan.

Example:

Bob is born on 6/30/1942. Bob turns 70 on 6/30/2012.

Bob turns 70 on 12/30/2012. Bobs RBD is 4/01/2013.

Jane is born 7/1/1942. Jane turns 70 on 7/1/2012.

Jane turns age 70 on 1/1/2013. RBD is 4/1/2014.

Required Minimum Distributions

Once a participant has reached his RBD, then he must begin taking annual RMDs based on the
Uniform Table. The only exception to use of the Uniform Table by the participant is when the
participants spouse is more than ten years younger than the participant, in which case the
participant has the option to use the Joint Life Expectancy Table. The Uniform Table is
reproduced as Appendix A. A portion of the Joint Table is reproduced at Appendix B.

To use the Uniform Table, find the age of the participant for the calendar and determine the
factor to be used. For instance, the factor at age 73 is 24.7. The factor is then divided into the
balance of the participants retirement plan(s) as of December 31 of the previous calendar year.
This result is the RMD for that year.

NOTE: Where a participant has multiple IRA accounts, it is not necessary that a prorated portion
of the RMD be taken from each IRA. The total RMD can be taken from one IRA and the other
IRAs can be left to accumulate tax-deferred. Where the participant has different types of
retirement plans, however, such as an IRA, 401(k) and profit sharing plan, the RMD may not be
aggregated it must be taken on a pro rata basis from each type of retirement plan. Take, for
instance, the example of a participant who has two IRAs totaling $50,000 and a 401(k) with a
value of $50,000. If the participant is age 73, the RMD would be $4,049 ($100,000 / 24.7). The
distribution must come one-half from the 401(k) plan and one-half from either one or both of the
IRAs.

CAUTION: If the first RMD is postponed until April 1 of the calendar year after the participant
turns age 70, then two RMDs must be made in the first year one by April 1 to cover the RMD
for the previous calendar year in which the participant turned 70 and a second by no later than
December 31, to cover the RMD for the current calendar year. Only one RMD would be required

2007 Stephen C. Hartnett 5

for each year thereafter. To avoid this result, the participant must take her first RMD in the year
she turns age 70, and not in the following calendar year.

Penalties

The penalty for failing to take a RMD is 50% of the amount of the RMD. 6 The IRS, in limited
cases, may waive the penalty where reasonable cause is shown.

There is also a 10% penalty for taking distributions from an IRA or qualified plan prior to age
59 (premature withdrawal penalty).7 There are several exceptions to the application of this
penalty, including:

Distributions due to your death or disability;

Distributions for payment of unreimbursed medical expenses that exceed 7.5% of your
AGI;

Distributions for the payment of health insurance premiums for certain unemployed
individuals;

Distributions for the payment of qualified higher education expenses;

Distributions consisting of substantially equal periodic payments;

Distributions to a qualified first-time homebuyer; and

Distributions due to an IRS levy on the IRA.

If you do not meet one of the above exceptions, you can avoid paying the 10% penalty tax if you
redeposit the early distribution amount within 60 days of the distribution.

2. Distributions at Death

Determination of Beneficiary

The determination of the identity of the beneficiary of a retirement plan is often critical as to
what distribution options are available, as will be discussed further below. The beneficiary of an
IRA or retirement plan must be determined by no later than September 30 of the calendar year
after the participants death. This means that the participant can change beneficiaries during his
lifetime and his RMD will not change, because it will be calculated using the Uniform Table in
almost all events. The only exception would be if the participant changes the beneficiary
designation to a spouse who is more than ten years younger than the participant and the
participant chooses to use the Joint Table.

6 IRC 4974.
7. IRC 72.

2007 Stephen C. Hartnett 6

The period between date of death of the participant and September 30 of the following calendar
year is sometimes referred to as the shake-out period. The nickname arose because during that
period the beneficiary can be changed (such as by disclaimer) or an undesirable beneficiary can
be removed in order to maximize stretch distributions. For example, the devise to an
undesirable beneficiary can be removed from consideration by satisfying the devise prior to
September 30. This time period can also be used to create separate accounts where there are
multiple beneficiaries designated under the IRA or retirement plan. In some circumstance, the
creation of separate accounts allows for the age of each beneficiary to be used in determining
RMDs from his or her share. The concepts of stretch distributions and separate shares are
discussed further below.

Spouse as Beneficiary

When a spouse is named as the beneficiary of an IRA or retirement plan, the spouse has many
options.

Rollover

A spouse may rollover an inherited retirement asset into an IRA in his or her own name.
In order for the spouse to rollover the inherited retirement assets, he or she must be the sole
beneficiary of the retirement asset. So, if an IRA named a spouse and child as beneficiaries,
spouse would only be the sole beneficiary as to half of the IRA. Therefore, the spouse could
rollover half of the IRA into an IRA in her name and child could take the other half as an
inherited IRA. If the beneficiary of the retirement asset was a trust whose sole beneficiary was
the spouse and where spouse is the trustee or has withdrawal power over the trust assets, then
spouse could roll over the retirement assets to an IRA in her name. If however, the trust named
spouse as income beneficiary and spouse and descendants as discretionary beneficiaries of
principal for health, education, maintenance and support then spousal rollover would not be
available.

If a spouse elects to rollover an inherited IRA, she can defer taking distributions until she reaches
her RBD. If the surviving spouse is under age 59 1/2, rolling over the IRA may not be an
appropriate option if the surviving spouse needs any of the IRA funds for the surviving spouses
support before reaching that age. If distributions are taken, IRC 72 may impose a 10% penalty
tax may be imposed because the surviving spouse will be treated as an owner and not a
beneficiary after the rollover. When RMDs begin, they will be based on the Uniform Table. She
can name new death beneficiaries to her IRA.

Also if the surviving were to die before reaching age 70 , the surviving spouse would be treated
as the IRA owner, rather than as a beneficiary. Thus, if he or she has not designated a succeeding
beneficiary of the IRA, the IRA will be distributed after the surviving spouses death as if there
were no beneficiary (i.e. to his or her estate). The MRDs will be higher in this situation and the
assets will be subject to the surviving spouses creditors.

In addition to when the surviving spouse is under 59 , another situation in which allowing a
surviving spousal rollover might not be desirable is where the participant is in a second plus
marriage and would like assurance that the retirement assets will benefit children from a prior
marriage after the death of the surviving spouse. A QTIP trust is usually the recommended

2007 Stephen C. Hartnett 7

method to make sure the retirement account will eventually pass to the deceased spouses
children. Although a QTIP trust will ensure that property is left to the children of the deceased
spouse, the income tax benefits from designating a QTIP trust as a beneficiary will usually be
less than what can be achieved from a rollover to a surviving spouse.

Additionally, a rollover might not be desirable if the combined estates of the husband and wife
might be subject to estate tax at the death of the surviving spouse. This situation may require
using all or part of a spouses retirement account to fund a credit shelter trust.

Inherited IRA Death Before Required Beginning Date

Another option is for the spouse to treat the IRA as an inherited IRA. If this option is
chosen and the participant died before his or her RBD, then the surviving spouse will take
distributions from the IRA based on her life expectancy using the IRS Single Life Expectancy
Table (see Appendix C). To use the table, the spouse will find the factor associated with her
age at the date of the participants death and use that factor. She is the only death beneficiary
that is allowed to recalculate when using the Single Life Expectancy Tables, so she will return to
the tables each year to determine her RMD. For instance, if the spouse is age 65 when the
participant dies, the factor for determining the first RMD (payable by December 31 of the first
calendar year after the calendar year of the participants death) would be 21. The following year
the spouse would look at the table again and determine the factor is 20.2. In the third year the
factor is 19.4.

In an exception to the rule that all inherited retirement assets must begin distributing to
beneficiaries no later than December 31st of the calendar year after the year of the participants
death, where the participant dies before his or her RBD (i.e. deceased spouse was 65 at date of
death), a surviving spouse who elects to treat the participant spouses retirement asset as an
inherited retirement may defer taking his or her first RMD until the deceased spouse would have
been required to take his or her first RBD.

Inherited IRA Death After Required Beginning Date

If the participant died after his or her RBD, and the spouse wants to treat the IRA as an
inherited IRA, then she will have the option of taking distributions from the IRA based on the
greater of her life expectancy using the IRS Single Life Expectancy Table (recalculated), or the
life expectancy of the participant (but in this case the life expectancy would not be recalculated
instead the life expectancy for the participant would be determined as of his year of death and
one would be subtracted from the number each year thereafter). For instance, if the participant
died at age 75, then the first RMD would be 13.4. The following years distribution would be
calculated using a factor of 13.4 1, or 12.4. Accordingly, the IRA would be fully distributed at
the end of 14 years.

All Other Qualified Beneficiaries

Before the Pension Protection Act of 20068 (PPA), non-spouse beneficiaries were only allowed to
authorize a plan-to-plan transfer from one IRA inherited from a participant to another inherited

8 Pub. L. 109-280 (August 17, 2006)

2007 Stephen C. Hartnett 8

IRA in the name of the same participant and payable to that same beneficiary. 9 After the PPA,
non-spouse beneficiaries may also rollover a distribution from an eligible retirement plan to an
IRA, thereby allowing a non-spouse to defer distributions. This new non-spousal rollover must
be completed by a direct trustee-to-trustee transfer. The same minimum distribution rules that
apply to an inherited IRAs will apply to rollover IRAs for a non-spouse. The recipient IRA is
treated as an inherited IRA that must be titled in the name of the participant, and the non-spouse
beneficiary must qualify as a designated beneficiary. Transfers may also be made to inherited
IRAs that are held by trusts for the benefit of a non-spouse beneficiary.10

Inherited IRA Death Before Required Beginning Date

Option 1 Distributions Over Beneficiarys Life Expectancy

When the participant dies before the RBD and the beneficiary is other than the surviving
spouse, RMDs are based on the beneficiarys life expectancy using the Single Life Table (see
Appendix C). To use the table, the beneficiary will find the factor associated with his or her
age at the date of the participants death, and then simply subtract one from the factor every year
thereafter. For instance, if the beneficiary is age 55 when the participant dies, the factor for
determine the first RMD would be 29.6. The following year the beneficiary would subtract one
and the beneficiarys new factor for determining RMD for that year would be 28.6 (29.6 1).
The Inherited IRA would be fully distributed in year 30.

Distributions must begin no later than December 31 of the calendar year after the year in which
the participant died. Failure to take distributions by that would, in effect, be an election by the
beneficiary to use option 2 the five year rule.

Option 2 Five-Year Rule

Under the five-year rule there is no set schedule of distributions, but the retirement assets
must be fully distributed to the beneficiary no later than December 31 of the calendar year five
years from the death of the beneficiary. For instance, under the five-year rule the beneficiary
could withdraw 20% of the retirement assets in year one, 25% in year two, 33.3% in year three,
half the remaining balance in year four and the remainder in year five. Alternatively, the
beneficiary could decide to take no distributions for the first four years and instead withdraw the
entire balance on at the end of year five.

Inherited IRA Death After Required Beginning Date

Option 1 Distributions Over Greater of Beneficiarys or Participants Life Expectancy

When the participant dies after the RBD and the beneficiary is other than the surviving
spouse, RMDs are based on the greater of the beneficiarys or the participants life expectancy
using the Single Life Table. (See Appendix C). To use the table, the beneficiary will find the
factor associated with his or her age at the date of the participants death (or the age of the
participant, if younger), and then simply subtract one from the factor every year thereafter. For
instance, if the beneficiary is age 55 when the participant dies, the factor for determine the first
9 PLR 200528031.
10 IRC 402(c)(11); see also Notice 2007-7, 2007-5, I.R.B 395.

2007 Stephen C. Hartnett 9

 RMD would be 29.6. The following year the beneficiary would subtract one and the
beneficiarys new factor for determining RMD for that year would be 28.6 (29.6 1). The
Inherited IRA would be fully distributed in year 30.

Distributions must begin no later than December 31 of the calendar year after the year in which
the participant died. Failure to take distributions by that would, in effect, be an election by the
beneficiary to use option 2 the five-year rule.

Option 2 Five-Year Rule

No Designated Beneficiary

In some circumstances, the IRS considers that there is no designated beneficiary named for
purposes of being able to determine RMDs. The first circumstance when this occurs is when the
participant in fact fails to name a beneficiary for his or her retirement asset. Four less obvious
events where the IRS considers there to be no designated beneficiary are when the participant
names a beneficiary, but the beneficiary is one of the following:

Estate

Charity

Non-Qualified Trust

Other Entity (such as corporation or partnership)

The IRS considers there to be no designated beneficiary in these events because it is not possible
to determine the life expectancy of an estate, charity, non-qualified trust or other entity.

What are the distribution requirements when no designated beneficiary is named? Here again,
there are two scenarios.

Participant Dies Before RBD

If the participant dies before his required beginning date without having designated a
beneficiary, then the retirement asset must be withdrawn under the five-year rule.

Participant Dies After RBD

If the participant dies after having reached his RBD without having designated a
beneficiary, then the recipient of the retirement assets has two withdrawal options:

o Take RMDs over Participants Life Expectancy

The recipient of the retirement assets could take RMDs based on the remaining life
expectancy of the participant using the IRSs single life expectancy table. For example, if the

2007 Stephen C. Hartnett 10

 participant dies at age 73, his factor for that age under the Single Life Expectancy Table is 14.8.
The recipient of the retirement assets would need to take an initial RMD by December 31 of the
calendar year after the participants death equal to the value of the retirement asset divided by
14.8. The following year, the recipient would take a second RMD using a factor of 13.8 (14.8
-1), so that the retirement asset would be fully distributed over fifteen years, or

o Five-Year Rule

The recipient of the retirement assets could take distributions from the retirement
asset under the five-year rule.

Proper Titling of an Inherited Retirement Asset

Many practitioners and financial professionals erroneously believe that title to an inherited
retirement asset should be taken in the name of the beneficiary. This is not correct. Distributing
the assets from a retirement plan (or liquidating the assets and then distributing them) to the
beneficiary or an IRA in the name of the beneficiary would be considered a taxable distribution
by the IRS, requiring that income taxes be paid on the full amount in the year of distribution.
Instead, an inherited IRA should be titled in the name of the deceased participant, but for the
benefit of the beneficiary. Following are some examples:

John Doe (Deceased) IRA fbo Mary Doe

John Doe (Deceased) IRA fbo Mary Doe, Trustee under the John Doe Bypass Trust dated
January 1, 1995

John Doe (Deceased) IRA fbo Mary Doe, Trustee of the Jane Doe Trust created under the
John Doe Living Trust dated January 1, 1995.

2007 Stephen C. Hartnett 11

 3. Naming a Trust as Beneficiary of Retirement Assets

Reasons to Name a Trust as Beneficiary of Retirement Assets

Protect Retirement Assets

o Minor Beneficiaries

Retirement assets should not be paid outright to a minor beneficiary. In some states,
the payment of substantial retirement assets to a minor beneficiary would require the
establishment of a guardianship of the minors estate, whether or not the minor had a natural
guardian at that time.

o Special Needs Beneficiaries

Direct payment of retirement assets to a special needs beneficiary could disqualify the
special needs beneficiary from receiving government assistance programs such as Medicaid, In
Home Supportive Services, and SSI. In such instances, retirement assets should be made payable
to a third party Special Needs Trust.

o Spendthrift Beneficiaries

Where the participant wants to preserve the inheritance of a spendthrift beneficiary

and give control of that beneficiarys inheritance to a third party trustee, retirement assets should
not be made payable directly to the spendthrift beneficiary.

o Asset Protection for Beneficiaries

Where a beneficiary has tax problems, judgment creditors, an unstable marriage, or

engaged in a high liability profession, retirement assets can be made payable to a third party
discretionary trust to provide asset protection for the beneficiary.

Clark v. Rameker1 573 U.S. ____ (2014) (No.13-299)

Heidi Heffron-Clark inherited a $300,000 individual retirement account (IRA) from

her mothers estate. The U.S. tax code provides special rules for IRAs that are inherited by
someone other than the spouse of the deceased. These rules prohibit additional contributions to
the inherited account and require the beneficiary to withdraw, and pay taxes on, a minimum
amount from the account each year. Heidi and her husband (the Clarks), filed for bankruptcy in
2010 and claimed the inherited IRA was exempt from creditor claims. A bankruptcy judge ruled
that retirement funds must be held for the current owners retirement in order to qualify as an
exempt retirement fund under Section 522 of the U.S. Bankruptcy Code. Because the Clarks
were required to withdraw money from the inherited IRA before their retirement, the judge held
that the account was subject to creditor claims in the bankruptcy proceeding. The federal district
court reversed and held that Heidis inheritance of the IRA did not change its status as a
protected retirement fund. The U.S. Court of Appeals for the Seventh Circuit reversed.

2007 Stephen C. Hartnett 12

 The United State Supreme Court held that an inherited IRA account did not qualify as
a retirement fund for the purposes of exemption under the U.S. Bankruptcy Code. Since the
Bankruptcy Code does not explicitly define the term retirement fund, the Court held that it
should retain its ordinary meaninga fund that is set aside for an individuals retirement.
Inherited IRAs do not fit this definition because the individual cannot invest more money in the
account and is required to draw money from the account regardless of how far the individual is
from retirement. The Court held that allowing an inherited IRA to be exempt from creditor
claims would undermine the purpose of the Bankruptcy Code.

Children from a Previous Marriage

Retirement assets can be made payable to the Bypass or Marital QTIP Trust of a
revocable living trust or testamentary trust in order to provide the current spouse with income
during her life, but shelter the retirement assets for the children from a previous marriage, who
are the remainder beneficiaries under the trust.

Under-funded Credit Shelter or Bypass Trust

Naming a spouse as the beneficiary of a retirement plan may cause estate tax at the death
of the surviving spouse that could otherwise have been avoided. For example, assume H has an
IRA worth $1 million and all of the couples other assets, worth $6 million, are titled in the name
of a revocable living trust as tenants in common or community property, as applicable. W is the
beneficiary of Hs $1 Million IRA. At Hs death, the Bypass Trust is funded with $3 Million
(half the assets in the joint trust) and the Survivors Trust is funded with the other $3 Million in
trust assets. W rolls over the $1 Million IRA. W now has $4 Million in assets. Depending on the
amount of the Applicable Exclusion Amount at Ws death, Ws estate may be subject to estate
tax.

An alternative would be to use disclaimer planning to fully fund the Bypass Trust with
$5,250,000 in assets, the amount that can be passed free from estate tax in 2013, otherwise
known as the Applicable Exclusion Amount. Fully utilizing the Applicable Exclusion Amount
maximizes estate tax savings to the couple.11

Living Trust
Hs IRA
$6 million
$1 million

W Rollover Bypass Trust Survivors Trust

$500,000 $4.5 million + $1.5 million
Disclaims $500,000 Disclaimed =
$500,000 to RLT $5 million

11 The portability of the applicable exclusion amount between spouses made permanent
effective January 1, 2013, may impact the need to create and fund a by-pass trust.

2007 Stephen C. Hartnett 13

4. Qualified Designated Beneficiary Trust

Look-Through to Trust Beneficiaries

A Qualified Trust allows the trust to be disregarded, and allows a look-through to the
beneficiaries of the trust for purposes of determining life expectancy for RMDs. A qualified trust
must have the following four attributes:

Trust is valid under state law;

Trust is irrevocable or becomes irrevocable by the participants date of death;

There are beneficiaries that are identifiable under the terms of the trust; and
A copy of the trust document is provided to the plan administration or retirement plan
custodian by no later than October 31 of the calendar year after the death of the
participant.12

Calculating RMDs for Trust Beneficiaries.

When calculating the RMD for a retirement asset that is made payable to a trust, you would use
the life expectancy of the trusts oldest beneficiary.13 Therefore, if a retirement asset were made
payable to or disclaimed to the Bypass Trust, the age of the oldest beneficiary of the Bypass
Trust (usually the surviving spouse) would be used to determine the RMDs that need to be
distributed by the retirement asset custodian to the trustee of the Bypass Trust.

Who is the Oldest Beneficiary of a Trust?

Caution should be exercised in drafting a trust that will have retirement assets paid to it to avoid
inadvertently including a beneficiary who is older than the intended beneficiary. For instance, in
PLR 200228025, a trust was named beneficiary of an IRA. The trust provided that it was for
three beneficiaries that were then minors. The assets of the trust were to be held in trust for the
minors until each minor reached age 35, at which time the trustee was to distribute that minors
share to him or her, outright and free of trust. While the trust was in existence, the trustee was
mandated under the trust document to accumulate income and only make distributions of income
and/or principal of the trust for health, education, maintenance and support of the minors. In the
event the minors died prior to reaching age 35, the trust would be distributed to an uncle who
was age 67 at the date of the participants death. The IRS held that because it was possible that
uncle could have the trust assets distributed to him if the minor beneficiaries did not survive to
age 35, he was the oldest beneficiary under the trust and RMDs must be calculated based on his
life expectancy.

12 A copy of the trust document would need to be provided during the life of the participant
only if lifetime RMDs from the trust are being calculated using the joint life expectancy table. If
RMDs are being calculated using the Uniform Table, a copy need only be provided after death.
13 Treas. Reg. 1.401(a)(9)-4 Q & A-5(c) provides that the separate account rules of 1.401(a)
(9)-8 are not available to beneficiaries of a trust with respect to the trusts interest in the
employees benefit, but see PLR 200234074.

2007 Stephen C. Hartnett 14

The solution to this problem is to limit contingent beneficiaries of retirement assets paid to a trust
to only those beneficiaries younger than the intended beneficiary, or to use a conduit trust. A
conduit trust is a trust that simply passes through any RMDs paid to the trustee of the trust onto
the intended beneficiary under the trust and has no provision to accumulate distributions from a
retirement asset which is paid to the trustee of the trust.

In the exercise of caution, the drafting attorney should look out for the following traps:

Watch out for powers of appointment granted under the trust which could allow a trust
beneficiary to appoint trust retirement assets to an appointee older than the intended
trust beneficiary.

Limit the ultimate remainder beneficiaries to those heirs at law who are younger
than the intended beneficiary.14

Be especially cautious where a charity is intended as the ultimate remainder

beneficiary.15

Do not name as charity as one of several primary beneficiaries under a trust, if it is

intended that RMDs from retirement assets allocated to other non-charity beneficiaries
are to be taken over the life expectancy of such beneficiaries.16

Do not allow the use of trust retirement assets to pay for the debts and expenses of the
decedent, except to extend the payment of the debts and expenses can be made prior to
September 30 of the calendar year after the participants death.17

Do not allow the use of trust retirement assets to pay the estate taxes of the participant,
except of the payment can be made prior to September 30 of the calendar year after the
participants death.18

14 As with PLR 200228025, if the trust was not a conduit trust and a potential heir at law was
older than the intended beneficiary, it is possible the IRS could take the position that the RMDs
must be based on the age of the oldest heir at law as of the date of death of the participant.
15 Because a charity has no life expectancy, it would be considered the oldest beneficiary under
the trust and distributions from a retirement asset to the trust would be limited to the five-year
rule.
16 Because the trust must use the life expectancy of the oldest beneficiary to determine RMDs
for all its trust beneficiaries and the charity has no life expectancy, distributions from the
retirement asset would be limited to using the five-year rule.
17 The IRS considers the payment of the participants debts and expenses by the trust to be the
same as naming the participants estate as a beneficiary of the trust. Therefore RMDs would
have to be calculated using the five-year rule.
18 The IRS considers the payment of the participants estate taxes by the trust to be the same as
naming the participants estate as a beneficiary of the trust, therefore RMDs would have to be
calculated using the five year rule.

2007 Stephen C. Hartnett 15

Other Precautions for the Drafting Attorney

Funding Formula

The IRS treats a pecuniary gift19 that is satisfied with an asset as though the trustee had sold the
asset and given cash to the beneficiary. Therefore, caution should be used in allocating retirement
assets within a trust that uses a pecuniary marital formula 20 or pecuniary exemption formula21. A
provision should be added to the retirement provisions of the trust that all retirement assets
should be allocated using a fractional formula.22

19 A pecuniary gift is a gift of a designated amount such as I give $100,000 to my son at my

death. A pecuniary formula gift defines an amount rather than expressing it is dollar terms such
as allocating the amount that can pass free of estate taxes at death to the Bypass Trust.
20 An example of a pecuniary marital formula is allocate to the Marital Trust (or QTIP Trust)
the minimum amount of the trust estate that qualifies for the marital deduction necessary to
reduce estate taxes to zero.
21 An example of a pecuniary marital formula is allocate to the Bypass Trust the maximum
amount of the trust estate that can pass free of federal estate tax.
22 An example might be Upon the death of a Participant who is the Deceased Trustor,
notwithstanding any other provision in this trust, the Trustee shall first allocate to the Bypass
Trust all of the Trust Estate that is not properly characterized as Retirement Assets, until such
trust is fully funded. To the extent the Bypass Trust is not fully funded using only assets that are
not characterized as Retirement Assets, the Trustee shall next allocate to the Bypass Trust the
smallest fractional share of any Retirement Assets which are under the control of the Trustee
necessary to fully fund the Bypass Trust (which fraction, depending on the circumstances, may
result in some, all or no Retirement Assets being allocated to the Bypass Trust). To the extent
any Retirement Assets are not needed to fully fund the Bypass Trust, and subject to the
exceptions designated in the paragraph immediately below, the Trustee shall distribute such
Retirement Assets to the Surviving Trustor, outright and free of trust. If the Surviving Trustor
disclaims this outright distribution, any Retirement Assets so disclaimed shall be allocated to the
Marital Trusts.

2007 Stephen C. Hartnett 16

Uniform Principal and Income Act

The Uniform Principal and Income Act (UPAIA) treats distributions from a retirement plan as
coming ten percent from income and ninety percent from principal. 23 This is intended to preserve
trust assets to the greatest extent possible. However, this allocation may not be congruent with
the wishes of the participant (especially with regard to distributions to the surviving spouse).
Depending on how the trust is drafted, it may prevent the trust from qualifying as a conduit trust,
if that is what is intended. If the default definition of income from a retirement plan under the
UPAIA is not in accord with the intent of the participant, a special definition of income should be
added to the trust provisions.24

23 See for example, California Probate Code 16361(e).

24 One alternative is to define income as the actual amount of income earned by the retirement
plan. Take, for example, a RMD received by the trustee in the amount of $75,000. If the
retirement plan had a value of $1 million and earned 5%, then $50,000 of that $75,000 RMD
would be characterized as income and $25,000 would be characterized as principal. A sample of
such allocation language is: The Trustee shall allocate to income that portion of Retirement
Assets that equals (a) the amount of Inside Income that my Trustee reasonably determines has
occurred since the Trustee has acquired a right to receive the Retirement Assets; reduced by (b)
the amount of prior Retirement Assets from the same contractual, custodial, or trust arrangement
that was allocated to trust income. The Trustee shall allocate the balance of the Retirement
Assets, if any, to principal. The term Inside Income with respect to each contractual, custodial,
or trust arrangement, refers to that portion of the Retirement Assets that are characterized by the
payor as interest, dividends, or a dividend equivalent. To the extent any portion of Retirement
Assets are not so characterized by the payor, Inside Income shall consist of any amounts that
would be allocable to income under applicable state law governing the allocation of principal and
income for trusts, if said statutes were applied to a trust holding the assets that fund all
Retirement Assets to which this Trust is entitled under such arrangements. If the Trustee cannot
identify the character, amount, or nature of said assets, the Trustee may reasonably estimate the
character, amount and nature of such assets.

2007 Stephen C. Hartnett 17

 Appendix A

IRS Uniform Table for Calculating RMDs

Age RMD Age RMD Age RMD Age RMD Age RMD
70 27.4 79 19.5 88 12.7 97 7.6 106 4.2
71 26.5 80 18.7 89 12.0 98 7.1 107 3.9
72 25.6 81 17.9 90 11.4 99 6.7 108 3.7
73 24.7 82 17.1 91 10.8 100 6.3 109 3.4
74 23.8 83 16.3 92 10.2 101 5.9 110 3.1
75 22.9 84 15.5 93 9.6 102 5.5 111 2.9
76 22.0 85 14.8 94 9.1 103 5.2 112 2.6
77 21.2 86 14.1 95 8.6 104 4.9 113 2.4
78 20.3 87 13.4 96 8.1 105 4.5 114 2.1
115+ 1.90

Appendix B

Selected Excerpt from IRS Joint Table

Ages 50 51 52 53 54 55 56 57 58
70 35.1 34.3 33.4 32.6 31.8 31.1 30.3 29.5 28.8
71 35.0 34.2 33.3 32.5 31.7 30.9 30.1 29.4 28.6
72 34.9 34.1 33.2 32.4 31.6 30.8 30.0 29.2 28.4
73 34.8 34.0 33.1 32.3 31.5 30.6 29.8 29.1 28.3
74 34.8 33.9 33.0 32.2 31.4 30.5 29.7 28.9 28.1
75 34.7 33.8 33.0 32.1 31.3 30.4 29.6 28.8 28.0
76 34.6 33.8 32.9 32.0 31.2 30.3 29.5 28.7 27.9
77 34.6 33.7 32.8 32.0 31.1 30.3 29.4 28.6 27.8
78 34.5 33.6 32.8 31.9 31.0 30.2 29.3 28.5 27.7
79 34.5 33.6 32.7 31.8 31.0 30.1 29.3 28.4 27.6

2007 Stephen C. Hartnett 18

 Appendix C

Single Life Expectancy Table for Inherited IRAs

Age RMD Age RMD Age RMD Age RMD Age RMD
20 63.0 38 45.6 56 28.7 74 14.1 92 4.9
21 62.1 39 44.6 57 27.9 75 13.4 93 4.6
22 61.1 40 43.6 58 27.0 76 12.7 94 4.3
23 60.1 41 42.7 59 26.1 77 12.1 95 4.1
24 59.1 42 41.7 60 25.2 78 11.4 96 3.8
25 58.2 43 40.7 61 24.4 79 10.8 97 3.6
26 57.2 44 39.8 62 23.5 80 10.2 98 3.4
27 56.2 45 38.8 63 22.7 81 9.7 99 3.1
28 56.2 46 37.9 64 21.8 82 9.1 100 2.9
29 55.3 47 37.0 65 21.0 83 8.6 101 2.7
30 54.3 48 36.0 66 20.2 84 8.1 102 2.5
31 53.3 49 35.1 67 19.4 85 7.6 103 2.3
32 52.4 50 34.2 68 18.6 86 7.1 104 2.1
33 51.4 51 33.3 69 17.8 87 6.7 105 1.9
34 50.4 52 32.3 70 17.0 88 6.3 106 1.7
35 49.4 53 31.4 71 16.3 89 5.9 107 1.5
36 48.5 54 30.5 72 15.5 90 5.5 108 1.4
37 47.5 55 29.6 73 14.8 91 5.2 109 1.2
110 1.1
111 1.0

2007 Stephen C. Hartnett 19