Retirement Assets Are Unique and Pose Unique Issues

When it comes to planning with retirement benefits, most people want to maximize federal income tax deferral (stretch out distributions as much as possible) and minimize or avoid federal estate taxes.  Retirement benefits are unique from a tax planning point of view because they are subject to BOTH the federal income tax and the federal estate tax.  Also, they are unique in the sense that beneficiary designations control who will ultimately benefit from these plans.   Any directions in a will or trust generally do not control who benefits from retirement benefits.  What controls is the designation on file.  Accordingly, close attention needs to be made designations on file.  They often need to be updated.  Communication sometimes needs to occur between your attorney and the custodian.  The custodian of these plans generally does not care about estate tax implications and other tax consequences of beneficiary designations on file with them.  Input from an attorney familiar with your planning is definitely advisable.  What follows is an example where the beneficiary designation on file can mean 1 million in savings for a family.

EXAMPLE: Husband owns an IRA worth 2 million and wife owns brokerage assets of 1 million and the home worth 1 million in her revocable trust. Husband’s estate is 2 million. Wife’s estate is 2 million.  Husband and wife have a well drafted estate plan with language that is designed to shelter the credit amount (currently 2 million, to be reduced to 1 million in 2011) of the first spouse to die.  The beneficiary designation on husband’s IRA says spouse is the primary beneficiary and the children are the contingent beneficiaries. 

 What’s wrong here?  What is wrong is that if husband passes away first, the 2 million IRA will pass to his wife and be part of her estate.  Why is this a problem?  It is a problem because if the wife rolls the IRA over into her own name, which is likely, then the wife’s estate would be 4 million.  Upon the wife’s death, her estate would owe a substantial amount of estate tax, nearly 1 million (based on current law).

What is the solution?  A flexible beneficiary designation in the IRA permitting the spouse to disclaim to a credit shelter trust could have made it so the retirement assets of the husband were available to benefit the wife during her life (all income and principal for needs) but not counted as part of her estate for purposes of the federal estate tax. 

The moral of the story is that a well drafted estate plan can fail if beneficiary designations and asset titling is not properly co-coordinated with the plan. These matters should be looked at closely in every case.

Contributed by:

Mark F. Winn

Attorney at Law, PLLC