Estate Planning Aspects of Qualified Pension & Profit Sharing Plan Distributions

I. Overview

II. Income Tax Treatment

[1] Income Tax Deferred Until Receipt by Employee or Beneficiary

[2] Income Tax on Distributions

[a] Averaging Methods No Longer Generally Available

[b] Rollovers of Lump Sum Distributions

[c] 10% Penalty on Early Withdrawals

[d] Income in Respect of a Decedent

III. Minimum Distribution Requirements

[1] Distributions to the Participant

[2] Distributions After Death of Participant

[a] Death of Participant Before Required Beginning Date

[b]Death of Participant After Required Beginning Date

[3] Minimum Distributions Excise Tax

IV. Estate Tax Treatment

V. Selecting the Beneficiary of Plan Benefits

[1] Spousal Rollover

[2] Non-Spouse Beneficiary

[3] Payable to a Trust

I. Overview

Often qualified plans (pension, profit sharing, 401(k), etc.) and IRAs are a substantial part of the estate, and understanding the rules governing income taxation, distribution requirements, death benefits and beneficiary designations is an essential part of estate planning. The rules are highly complex and have undergone frequent change, particularly with respect to distributions. What follows here is only a brief summary of some basic aspects. It is necessary to review the plan documents in each client's case, as some plans contain more restrictive provisions than what is required by law. For purposes of this discussion, "plan" or "retirement plan" is used to refer to both qualified plans under IRC § 401(a) and individual retirement accounts (IRAs) qualified under IRC § 408(a), and "participant" is used to refer to participants in pension and profit sharing plans and the owner of an IRA, except as specifically noted.

When planning with retirement benefits, it's important to remember that the first option is usually to name the surviving spouse as beneficiary, who can then roll over the proceeds to a spousal IRA. However, there are occasions in a second marriage when the testator wants to pass the IRA proceeds to the second spouse for life and then to the children of the first marriage, or the qualified plan or IRA assets must be used to fund the credit shelter family trust.

Generally, the attorney will be asked to give advice on plan distributions in three situations:

1. When an individual becomes a plan participant, he or she will be required to complete a beneficiary designation form naming someone to receive the plan benefits in the event he or she dies before all of the benefits have been distributed.

2. When the participant retires, he or she will seek advice about the choice of methods of receiving benefits. Although the participant may not need the benefits for living needs, withdrawal of benefits generally must begin by April 1 of the year following the year in which the participant reaches age 70 and one-half.

3. After a participant's death, the personal representative of his or her estate or the beneficiary of the benefits may seek advice on the various options available to reduce taxes or to defer their payment.

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COMMENTARY: PLANNING FOR QUALIFIED PLAN DISTRIBUTIONS

i. The preferable beneficiary of a client's qualified plan benefits generally will be his or her spouse. Unless there are inadequate funds to fund the credit shelter trust, the spouse should in most cases be the beneficiary for tax purposes.

ii. If the client will be making any substantial bequests to charities, they should be made with plan assets. Charitable contributions made with plan assets during life will trigger income and potentially an offsetting charitable deduction.

iii. As soon as permitted by the terms of the qualified plan, consider withdrawing the funds and placing them in an IRA.

iv. Take qualified plan assets for living expenses before selling appreciated securities held outside of the plan. The client will get a step-up in basis on the outside assets, but not from qualified plan assets.

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LEXIS users can view the complete commentary HERE (Approximately 14 pages)