PLANNING FOR DISTRIBUTIONS FROM QUALIFIED PLANS AND IRAs

By Alvin J. Golden, Esq.

Ikard & Golden, P.C.

Austin, Texas

I. COMMUNITY PROPERTY PROBLEMS

A. INTEREST OF NPS IN QUALIFIED PLANS

B. INTEREST OF NPS IN IRAs

II. THE THREE YEAR WINDOW

A. UNMARRIED PARTICIPANT

B. MARRIED PARTICIPANT

C. NO LIQUIDITY OTHER THAN PLAN

D. RULES TO LIVE BY

III. DRAFTING BENEFICIARY DESIGNATIONS

A. TRUSTS AS BENEFICIARIES - GENERALLY

B. FILLING UP THE BYPASS TRUST

C. UTILIZING THE QTIP TRUST

D. CONCLUSIONS

APPENDIX A

APPENDIX 1-A

APPENDIX B

EXHIBIT A

COMMUNITY PROPERTY PROBLEMS

INTEREST OF NPS IN QUALIFIED PLANS.

In dealing with beneficiary designations in community property states, one of the thorniest issues is the interest of the non-participant spouse ("NPS"). Given the somewhat migratory nature of our society, the rights of the NPS even in a common law jurisdiction can create a problem if a substantial part of the participant's benefits were accrued in a community property jurisdiction.⁽¹⁾ If the NPS dies first, and the benefits are still in qualified plan solution, then the law is in an absolute mess as of the date of this writing. The central issue is whether ERISA §514(a)⁽²⁾ preempts state community property law with respect to distributions from qualified plans. Two appellate courts have now written on the issue, and while there are factual distinctions between the two cases, the Ninth Circuit basically found preemption while the Fifth Circuit did not. The United States Supreme Court granted certiorari in the Fifth Circuit case of Boggs v. Boggs on November 4, 1996. A discussion of those two cases follows:

Ablamis v. Roper. The Northern District of California, in an unreported opinion in Ablamis v. Roper, held that federal law (REA and ERISA) preempted state community property laws and that the plan rights belonged only to the participant in the absence of a qualified domestic relations order ("QDRO"). It further decided that a QDRO was designed to provide for the division of qualified plan benefits on divorce, not death. The court reasoned that the estate was neither a "former spouse" nor "child or other dependent" of the participant, and therefore was not a permissible alternate payee under a QDRO.

The Ninth Circuit finally affirmed the result of the District Court in July, 1991. (The case had been argued fifteen months prior to its decision.) Ablamis v. Roper, 937 F.2d 1450 (9th Cir. 1991). The court held that a participant spouse could not be deprived of the deceased non-participant spouse's community interest in the retirement benefits "current or future." The court focused on two issues: (1) Whether the QDRO exception to the anti-alienation provisions can be applied in a probate context; and, (2) whether ERISA preempts state community property law. The court answered the first question in the negative and the second question in the affirmative.

Certain facts are key to an understanding and analysis of Ablamis. Mrs. Ablamis' will left to two testamentary trusts all property subject to her testamentary power, which included, but not by specific reference, her community property interest in Mr. Ablamis' employee benefit plans. Her children by a prior marriage were the ultimate beneficiaries of the trusts. The statute creating the QDRO requires that the domestic relations order "(i) relates to the provision of...marital property rights to a spouse, former spouse, child or other dependent of a participant, and (ii) is made pursuant to a state domestic relations law (including a community property law)." Code §414(p)(1)(B). ERISA § 206(d)(3)(B)(ii).

The court begins its analysis by assuming that California law would authorize a transfer by the non-participant spouse of his or her interest to third parties. With that assumption, the primary focus of the case shifts to the area of federal preemption and an interpretation of federal law. It then goes on to hold that ERISA did not intend state court orders to be classified as QDROs when they deal with other than inter-vivos transfers.⁽³⁾ The court further finds that ERISA's goal is to protect the immediate family of the participant, and that the QDRO exception is limited:

Orders relating to the provision of benefits to the non-employee spouse are, under certain circumstances, deemed "qualified"; orders transferring benefits from such a spouse to third parties are not. (Emphasis in opinion.)...

937 F.2d at 1457.

A second issue with which the majority deals is the estate's argument that the anti-alienation provision does not apply to spousal assignments of pension benefits.

To the extent that state community property laws permit such transfers, they are preempted by [ERISA] section 1056(d).⁽⁴⁾

Id.

The Court recognizes that this argument is absurd upon its face, and flies in the face of the entire prohibition against assignment. Surely, no one could argue that a non-participant had the right to make an assignment that a participant could not make because the anti-alienation rules were not applicable to the non-participant.

Both the majority and the dissent go astray on another issue however. The dissent argues fervently that the non-participant spouse should be allowed to dispose of her community property interest because the Retirement Equity Act of 1984 ("REA") does not prohibit the participant from disposing of all his interest. Indeed, this is true. REA permits the plan to limit the QJSA or QPSA to a certain percentage of the employee's benefit. However, most plans do not so limit the QJSA and QPSA, and extend them to 100% of the benefits. If the plan can take away the employee's right to dispose of any portion of the benefits without spousal consent, then it must inevitably follow that Congress intended to permit the preemption of community property law and to replace it with an equitable distribution approach that could be determined by the plan. In this approach, the non-participant spouse has no interest under state law.

Under ERISA, an employee, active or retired, may not be deprived of any part of his pension benefits, current or prospective, as a result of a spouse's purported testamentary transfer of her asserted community property interest in such benefits.

Id., at 1460.

The dissent vigorously argues that the community property law is not preempted and that Congress' silence on probate orders as QDROs must be taken to mean that Congress never considered the issue. The thrust of the dissent's argument is that it makes no sense that REA's protection of the non-participant spouse was limited to divorce. If the goal was to create equality, that ought to extend to testamentary dispositions also.⁽⁵⁾

Meek v. Tullis. Ablamis was followed in a Louisiana case in which the court noted, "Absent any indication from the Fifth Circuit that Ablamis was incorrectly decided, this court sees no reason to disagree with the Ninth Circuit's holding." Meek v. Tullis, 791 F. Supp. 154 (W.D. La. 1992) at 156. In that case, the NPS (the wife) died intestate and the husband was entitled to one-half the community outright and a usufruct in the other one-half. The community interests in the qualified plans were not listed as assets of the succession. When the husband remarried, his usufruct in one-half terminated in favor of the children of the marriage. They sought to reopen the succession to deal with the qualified plans, and the husband filed an action for declaratory judgment in the federal court. The defendant contended that even if ERISA preempted Louisiana community property law, the heirs of the NPS should be entitled to assert a community property claim against the other assets of the succession, i.e., the assets which passed outright to the husband. The Louisiana court notes that the preemption clause of ERISA has great breadth, and that a state law may "relate to" ERISA, albeit indirectly. The court further reasoned, and I believe correctly so, that to permit the defendants to reach the plaintiff's one-half of the community property would be to, in effect, deny ERISA's preemption, because, "In either instance, Mr. Meek is deprived of one-half the value of his pension. To allow that would erode ERISA's role as a comprehensive statute designed to promote the interests of employees and their beneficiaries in employee benefit plans." Id., at 157.

Boggs v. Boggs. While the Western District of Louisiana followed Ablamis, the Eastern District went merrily along ignoring it. Boggs v. Boggs, 849 F. Supp. 462 (E.D. La. 1994).⁽⁶⁾ And, the Fifth Circuit agreed with the Eastern District! Boggs v. Boggs, 82 F.3d 90 (5th Cir. 1996). Mrs. Dorothy Boggs died and left 1/3 of her estate outright to Mr. Boggs (the participant) and 2/3 of her estate in a usufruct for Mr. Boggs. The succession in Mrs. Boggs' estate listed her community interest in employee benefits. Mr. Boggs was a participant in the company's Savings Plan (an individual account defined contribution plan), an ESOP, and a pension plan which provided only a joint and survivor benefit for the participant and the participant's spouse. Mr. Boggs remarried and his usufruct interest thereupon terminated. After his remarriage, Mr. Boggs took a lump sum distribution from the Savings Plan and rolled it into an IRA. He also took a distribution from the company's ESOP. He was paid an annuity from the company of approximately $1,800 per month, and the plan provided that Mr. Boggs' then wife was the only eligible beneficiary of the survivor's benefit. Mr. Boggs later died, with his second wife as the beneficiary of the IRA and the annuity.

Dorothy Boggs had been married to Mr. Boggs for the first 30 years of his 36 years of employment with the company. After his death (even though the usufruct had terminated on his remarriage), the children by the first marriage filed suit for an accounting of Dorothy's share of the pension payments received during the usufruct, as well as her interests in the IRA, the ESOP distributions and the annuity. The case was filed in state court, but the second Mrs. Boggs filed a declaratory judgment action in federal court concerning federal preemption of community property laws. The trial court determined that ERISA did not preempt Louisiana community property law, but the opinion is strained to say the least. The court says, "[ERISA] does not display any particular interest in preserving maximum benefits to any particular beneficiary." 849 F. Supp. at 465. This conclusion is based on the court's belief that ERISA was primarily to protect the employee from the employer. I have long believed that the whole policy behind ERISA was to safeguard the employee's retirement, otherwise why the anti-alienation provision? Also, REA makes clear the Congressional desire to protect the current spouse's rights with respect to retirement benefits.

This case was appealed to the Fifth Circuit, which heard arguments in November, 1994, and finally rendered its decision in June, 1996.⁽⁷⁾ In the opinion written by Judge Wisdom, a long time staunch defender of the community property system,⁽⁸⁾ the Court ignored the fact that the retirement pension was not something over which Mr. Boggs had any control, and over which Mrs. Boggs certainly had no right of disposition. While it is clear that an IRA is a community property asset, the relevant fact is really that the asset was not an IRA at Dorothy Boggs' death, but rather was in qualified plan solution. Judge Jacques Weiner tried to persuade the court to hear this case en banc, but was unsuccessful. Boggs v. Boggs, 89 F.3d 1169 (5th Cir. 1996). He wrote what I consider to be a well reasoned dissent to the court's refusal to hear the matter en banc, in which he discusses at some length the reasons that ERISA should preempt community property law.

The Supreme Court's interpretation of the scope of the preemptive provision of ERISA extends preemptions to a state statute or cause of action which referred to an ERISA plan, even though obliquely. Ingersoll-Rand Company v. McLendon, 498 U.S. 133, 111 S.Ct. 478, 112 L.Ed.2d 474 (1991). Mr. McLendon sued his employer in state court for wrongful discharge, alleging that he was terminated so that the company would not have to vest his pension benefits.⁽⁹⁾ The Texas Supreme Court held that plaintiff's cause of action was not preempted by ERISA because he was suing for lost future wages, mental anguish, et simili, and he was not suing for lost pension benefits. The United States Supreme Court had no difficulty in applying ERISA's preemption provision, noting that without the existence of a plan, there was no basis for creating an exception to the employment at will doctrine. The plan was the "essence" of the claim, and thus clearly the cause of action related to a pension plan.

In language which has clear relevance to the preemption of state community property law, the Court said:

Section 514(a) [of ERISA] was intended to ensure that plans and plan sponsors would be subject to a uniform body of benefit law; the goal was to minimize the administrative and financial burden of complying with conflicting directives among States or between States and the Federal Government....Particularly disruptive is the potential for conflict in substantive law. It is foreseeable that state courts, exercising their common law powers, might develop different substantive standards applicable to the same employer conduct, requiring the tailoring of plans and employer conduct to the peculiarities of the law of each jurisdiction. Such an outcome is fundamentally at odds with the goal of uniformity that Congress sought to implement.

Id. at 484.

The strong language of the Court would indicate that the Court might hold that the community property rights of a non-participant spouse created "conflicts in substantive law" that would be "fundamentally at odds with the [Congressional] goal of uniformity...."⁽¹⁰⁾

In Free v. Bland, 369 U.S. 663 (1962), husband and wife held U.S. Savings bonds in "or" designation. Under the federal regulations, such designation created a right of survivorship. At Mrs. Free's death, her son sued for the bonds, or alternatively for reimbursement from Mr. Free. The Texas courts awarded ownership of the bonds to Mr. Free, but awarded a right of reimbursement. In reversing the Texas Supreme Court and holding that no reimbursement was available, the United States Supreme Court, commenting upon the right of reimbursement, said, "Viewed realistically, the State has rendered the award of title meaningless....If the State can frustrate the parties' attempt to use the bonds' survivorship provision through the simple expedient of requiring the survivor to reimburse the estate of the deceased co-owner as a matter of law, the State has interfered directly with the legitimate exercise of the power of the Federal Government...." Id., at 669.

AUTHOR'S NOTE RE BOGGS: Even if the Supreme Court decides that there is no preemption and thus the children can maintain their suit for an accounting against their father's estate, that is only the beginning of the litigation. The state law problems may prove even thornier than the preemption issues. See Judge Weiner's dissent, supra, for a discussion of some of those problems.

. INTEREST OF NPS IN IRAs.

Federal preemption does not apply to IRAs. Therefore, the NPS is free to dispose of his or her community property interest in the participant's IRA. §408(g) of the Internal Revenue Code of 1996 (hereinafter "Code") provides that Code §408 "shall be applied without regard to any community property laws." Code §408 is a tax provision having nothing to do with ownership or disposition and therefore should not affect the property rights of the NPS. The questions are how to do this and what income tax problems does this produce if the beneficiary is other than the participant. For instance, can the NPS dispose of the IRA interest by will? How can the NPS do a beneficiary designation?⁽¹¹⁾ If the NPS can successfully designate a beneficiary without a war with the custodian or trustee, what is the effect of such designation?

A 1994 private letter ruling allowed a partition of the husband's IRA into the separate property of the wife and the husband, but the Service declined to permit the wife to treat the IRA partitioned to her as her own. PLR 9439020. Thus, the minimum distribution rules applicable to the husband also applied to the wife's IRA. Under that PLR, the plan was to make the husband the beneficiary of the wife's IRA, so how to do the beneficiary designation was solved, but all the questions concerning taxation if there were a third party beneficiary still remain unanswered.

Some of the many questions that remain unanswered are:

How is the required beginning date determined?
Are distributions before the participant's age 59-1/2 subject to the penalty tax under §72(t)? Remember that the beneficiary exception under §72(t)(2)(A)(ii) applies to distributions only "on or after the death of the employee?"
Who pays the income tax on the distributions? The regulations under §402 speak only in terms of the employee or the beneficiary of a deceased employee. There is some thought that those distributions would be taxable to the participant.
Who is the measuring life for minimum distribution purposes?
Does it make a difference whether the participant reached his RBD prior to the death of the NPS?

Prior to the participant's RBD, the better result would seem to be to treat the NPS as the participant since the NPS is the owner under state law of the interest in the IRA. This, of course, does not answer any questions as to the application of the excess distribution tax under §4980A. TAM 9441004, which found that the excess retirement accumulation tax did not apply with respect to the predeceased NPS's interest under §4980A(d)(4)(A) said:

This rule is provided so that the treatment of post-death distributions is consistent with the treatment of distributions made with respect to an individual prior to death. The legislative history also indicates that, with respect to pre-death distributions, a non-employee spouse's interest in a qualified plan distribution is disregarded in determining aggregate annual retirement distributions subject to the retirement distribution excise tax. (See Senate Finance Committee Report No. 100-445, August 3, 1988).

Does this TAM mean that distribution from the NPS's account is not counted against the distributions for purposes of the excess distribution tax? If not so counted, are the distributions from that account added to the distributions from the participant's account and does the participant pay the entire excess distribution tax?

If the participant has reached the participant's required beginning date, then does the participant's election control the timing of the distributions to the NPS's beneficiaries? It would seem that all the measurements should be controlled by the participant's elections. That still does not answer the questions concerning the §4980A and §4980A(d) tax issues.

II. THE THREE YEAR WINDOW

Code §4980A(g) added by the Small Business Job Protection Act created a three year window beginning January 1, 1997, in which withdrawals could be made from qualified plans and IRAs without regard to the excess distribution tax.

CAVEAT: The excess retirement accumulation tax continues to apply, so dying during this period will not help.

The reason behind this Trojan gift is simple -- Congress hoped to generate revenue during this three year period. (Three years is long term planning in Washington.) Therefore, one must ask, "If this provision is good for the government, can it also be good for the taxpayer?" The obvious answer is probably not, so that the correct answer in most cases is, "Defer, defer, defer." However, this decision is nowhere as simple as it seems.

UNMARRIED PARTICIPANT. Take, for example, the case of an elderly unmarried participant with no designated beneficiary and an IRA that will produce an excess retirement accumulation tax. All the proceeds must be distributed by December 31 of the year following the year of the participant's death, thereby accelerating all the income tax. If the participant takes advantage of the withdrawal, then it accelerates the income tax, but probably not by much. The income tax is then removed from the estate (albeit that it reduces the Code §691(c) deduction), the excess distribution tax is probably avoided because the minimum required distributions are reduced, and the excess retirement accumulation tax can be avoided.

If, however, in the foregoing example, the participant's child is a designated beneficiary, then the ability to "stretch out" the distributions over the child's life expectancy may be worth more than the excise tax savings. Remember that the excess distribution tax is not 15% of the entire distribution, but rather is only on the amount over $155,000 in 1996, and indexed in subsequent years, so that the effective rate on a $255,000 distribution is only 6%. Also, because the excess accumulation tax is deductible as an administration expense, and because it also does not apply to the full value of the account, the 15% rate in the law is very much an overstatement of the effective rate.

MARRIED PARTICIPANT. Take the very common case of a married participant with insufficient assets to fill up the bypass trust outside the IRA. Since IRA benefits can never really "fill up" the bypass because of the built in income tax liability, recognizing the income tax early eliminates the income tax from the estate as well as possibly allowing the bypass to be completely utilized if the IRA withdrawal is big enough. And, the spouse could still avoid or defer the excess retirement accumulation tax. But, depending upon the age of the players, it might be better to forego funding the bypass at all, and take advantage of the deferral over the life expectancy of both spouses and the stretched out benefits over the children's lives.

C. NO LIQUIDITY OTHER THAN PLAN. If there are no assets other than the plan, and if the participant is insurable, withdrawing enough to buy some life insurance to provide the ability to defer during the participant's designated beneficiary's life might be worthwhile rather than using the plan assets to pay transfer tax and accelerating income tax.

D. RULES TO LIVE BY:

You must run the numbers every time.
You should put off making the decision as long as possible in most cases.
Normally, your bias should be to defer.

Corollary: Just because you can avoid estate tax by use of the unified credit, do not assume that such a strategy produces the most benefit.

III. DRAFTING BENEFICIARY DESIGNATIONS

CAVEAT: THE FORMS ATTACHED AS EXHIBITS HERETO ARE SAMPLES ONLY AND ARE NOT TO BE RELIED UPON AS APPLICABLE TO ANY INDIVIDUAL CASE. EACH DRAFTSMAN MUST EXERCISE HIS OR HER OWN DISCRETION AS TO THE APPROPRIATENESS OF ANY LANGUAGE IN SUCH FORMS.

There is much confusion on the rules concerning designated beneficiaries and the distinctions that arise before and after the RBD. A good example of this confusion is attached hereto as Exhibit "A". The factual background is that the participant's wife rolled his IRA over. At that time, she had not attained her required beginning date. Upon attaining that date, the wife executed the "Mandatory Distribution Election" attached. Note that there is no designated beneficiary and she elected to recalculate so that her life expectancy went to zero at her death. After her mother's death, the daughter, unhappy with the legal advice she received from her attorney, contacted a major brokerage firm, and the rest, as they say, is history. Be sure to note the disclaimer at the bottom of the letter, and the care that was taken to attach, and even emphasize the irrelevant legal authority.

TRUSTS AS BENEFICIARIES - GENERALLY. The general rule is that only an individual may be a designated beneficiary. Although a trust is not an individual, if the trust meets certain requirements, the trust may still be a designated beneficiary. In order to be a designated beneficiary, the trust must meet the following requirements:

The trust is a valid trust under state law, or would be but for the fact there is no corpus.
The trust is irrevocable.
The beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the employee's benefits are identifiable from the trust instrument. This means that it must be possible at the applicable time to identify the class member with the shortest life expectancy.
A copy of the trust instrument is provided to the plan.

All of these tests must be met at the later of the date on which the trust is named as a beneficiary or the employee's required beginning date, and as of all subsequent periods during which the trust is named as a beneficiary. Prop. Reg. §1.401(a)(9)-1(Q&A D-5), hereinafter the "D-5" regulations. During the life of the participant, this kind of trust can be used as a contingent beneficiary or as a joint life for purpose of calculating a survivor annuity. A testamentary trust can be used only if the required beginning date has not been attained, since the method of distribution is fixed at the required beginning date.

FILLING UP THE BYPASS TRUST. Perhaps the most frequently encountered problem with respect to retirement benefits is the situation in which the assets outside the retirement benefits in the deceased participant's estate are not sufficient to fill up the bypass trust. While in certain situations the benefits of filling up the bypass trust may not be worth the complexities of doing so, most clients cannot tolerate the idea of giving up a "freebie," and thus most will want to carefully explore taking full advantage of the unified credit.

The "Nuclear" Family. If the situation involves a "happy family", then the preferred method, whether the benefit is in qualified plan solution or IRA, is to leave the benefits outright to the surviving spouse with a provision for disclaimer by the spouse of the amount necessary to fill up the bypass trust. The disclaimer should, of course, be a formula disclaimer.

PLR 9630034 is a road map for this type of disposition, which answers several mechanical issues concerning the actual handling of the accounts. While the ruling deals in a community property context, it has application in common law states as well. Under the facts of the ruling, the husband had attained the RBD prior to his death in late 1995. Wife was the designated beneficiary and the election had been made to recalculate both lives. Wife had not reached her RBD, but would do so in 1997. The wife's community one-half of the IRA was transferred to a new IRA in 1995 in a direct transfer without being first distributed to the wife, and the MRD was to be paid from the rolled over portion. The plan was that she would disclaim a portion of husband's community one-half by formula so that it would flow into the bypass trust, and the balance would be added to her rollover IRA. The beneficiary designation specified that if the wife disclaimed, the disclaimed portion would pass to the trustee of the bypass trust. The Service ruled as follows:

Assuming the formula disclaimer met the requirements of state law and §2518, it would be a valid disclaimer and would continue to be held in husband's IRA with the trustee of the bypass trust as the beneficiary. All the minimum required distribution in 1995 will be made to the wife from the rolled over portion, so that the wife will not be deemed to have accepted any benefits from the portion to be disclaimed.
The disclaimed portion of the husband's IRA would not be includible in wife's estate at her death.

The disclaimer will not be treated as a distribution, and thus would not be included in the income of the decedent's estate for 1995.
The transfer to the spouse's own IRA is an election to treat such portion as the wife's own, and will be treated as a trustee to trustee transfer under Code §408(d)(3)(A) and not as a rollover under Code §408(d)(3)(B). The relevance of that is that there may be only one rollover in a given year, while there may be multiple trustee to trustee transfers. Thus, the transfer after the disclaimer can also be rolled over without waiting a year.
The wife could designate beneficiaries of the rolled over portion, and could use those beneficiaries as joint measuring lives with the initial distribution year being 1996, the year in which wife attained age 70-1/2. Since those beneficiaries are wife's children, the benefits could be stretched out.
Most importantly, the minimum distribution required from the disclaimed portion will be based upon the wife's recalculated life expectancy. The trust does not qualify as a designated beneficiary under the D-5 regulations because it was a testamentary trust and therefore was not irrevocable at the participant's RBD. However, the wife is the designated beneficiary, and thus the disclaimed portion will continue to paid out over her life expectancy under the at least as rapidly rule.

The ruling also goes into some detail as to how to calculate the MRD in the rollover IRA in the years in which the exact amount of the disclaimer is unknown. It also treats what is clearly a fractional share disclaimer formula as a pecuniary disclaimer, but finds that the income is not accelerated.

Although there is no direct authority in a common law jurisdiction, the spousal beneficiary should be able to make a trustee to trustee transfer immediately at a portion of the IRA that the spouse knows will not be disclaimed, thereby approximating the rollover of the spouse's community one-half in the ruling.

If the participant has reached his required beginning date ("RBD"), and if the NPS is the beneficiary, then the NPS will be a designated beneficiary for purposes of determining the payout of the benefits into the bypass trust. This is true even if the spouse were not the beneficiary thereof (assuming that no beneficiary was older). I recognize that getting the NPS to disclaim would not be easy if the NPS were not the primary beneficiary.

If the participant has not yet reached his RBD, then when the spouse disclaims, the designated beneficiary will be determined under the minimum distribution rules. You must make sure that the trust qualifies as a designated beneficiary under the D-5 regulations. Remember that a testamentary trust can be a designated beneficiary under this circumstance since the trust must be irrevocable only after the participant reached his RBD.

In executing the disclaimer, the following should be considered:

The disclaimer language should be in the beneficiary designation and should be a fractional share formula. This is true even though PLR 9630034 indicates that a pecuniary amount disclaimer will not accelerate IRD. I happen to believe that the position of the PLR is correct, but there is some authority that a pecuniary gift does accelerate IRD.
The will (or revocable management trust if that is the primary dispositive vehicle) should direct that any amount disclaimed be added first to the bypass trust (which presumably would be the residuary trust in this case), after all other dispositions to the bypass trust have been funded.
The will and the beneficiary designation should specify how income is to be determined. In this regard, note that several states have statutes concerning how much of the payment from a retirement plan is income to the trust and how much is principal.⁽¹²⁾

Make it clear that the NPS is not to be treated as predeceased (as is the presumption under the disclaimer statute). This provision is only necessary if the deceased spouse has reached the RBD and the surviving spouse's life expectancy has been recalculated to prevent the argument that the surviving spouse is treated as having predeceased and therefore has a zero life expectancy.

Again, note that it is not necessary that the trust into which the disclaimer is made be irrevocable. A revocable management trust or testamentary trust will qualify if the participant has already reached his RBD because the spouse is the designated beneficiary. If the participant has not reached his RBD, then the D-5 regulations do not require the trust which is to be a designated beneficiary to be irrevocable at the death of the participant prior to the RBD. See Appendix B for beneficiary designation.

The Not So Nuclear Family. In the increasingly frequent instance in which the surviving NPS is not the mother of the children of the participant, disclaimer planning may not be advisable. In that case, if the desire is to fill up the bypass so that the surviving spouse will have the benefit of the plan assets, then the formula must be in the beneficiary designation. In this situation, under the existing D-5 regulations, it does make a difference whether the participant has reached his RBD. Prior to the RBD, a testamentary trust can qualify as a designated beneficiary (assuming that it meets the other tests) but at the RBD, the trust must be irrevocable to qualify. The trustee under the relevant document must have clear instructions which mandate the allocation of the benefits.

Of course, another method of dealing with these benefits is to name the adult children as beneficiaries of the bypass share. To do this, if the benefits are in an IRA, one might wish to consider establishing separate IRA for the children (or maybe a separate IRA for each of them). In a community property state, a marital property agreement that such IRA and the earnings thereon are separate property would be advisable. The participant can maintain a proper level in that IRA through judicious use of withdrawals and trustee to trustee transfers. This technique clearly requires some continuing care and feeding and a knowledgeable trustee or custodian.

C. UTILIZING THE QTIP TRUST. Many clients, particularly in second marriage situations, may desire that the employee benefits be devised to a QTIP trust, and the considerations as to designated beneficiaries and formulas which appertain are the same as those with respect to a bypass gift.

CAVEAT: If the benefits are in qualified plan solution rather than an IRA, and if REA applies to the plan, the NPS's consent to the waiver of the QPSA or QJSA must be obtained in accordance with the provisions of IRC §417.

If the gift is to a QTIP trust rather than to a bypass trust, there are certain other complications with which you must deal. While the seminal authority is Rev. Rul 89-89, 1989-2 C.B. 231, the kind of disposition specified therein is very difficult and somewhat unrealistic. This ruling would require that all the income of the IRA be distributed annually and that the principal of the IRA must be distributed in equal installments over the life of the surviving spouse. This would unnecessarily accelerate the minimum required distributions (and perhaps fall short of the MRD in later years). The Ruling also requires that all expenses be charged to principal and that the QTIP election be made for both the IRA and the trust. Subsequent private letter rulings have softened the formula somewhat, so that the IRA custodian/trustee will be required to pay out the greater of the MRD or all the income of the IRA, which may still accelerate distributions, but not so badly. See, e.g., PLR 9420034.⁽¹³⁾

Under the QTIP regulations, it is not necessary that the trust itself require that all the income be distributed annually so long as the surviving spouse has the power to compel such distribution. Use of this technique might allow for a greater deferral, since the income does not need to be withdrawn unless the spouse so requests. But doesn't this create a general power of appointment in the spouse which would cause all the income to be taxed to her on an annual basis anyway? This is similar to a defective grantor trust.

Additionally, the QTIP statutes and regulations speak in terms of the powers of the spouse to require that property be made productive. Where the IRA itself is not a trust with dispositive provisions, powers to the trustee to do those things will meet the QTIP requirements.

One underlying issue that no one seems to want to address is the problem in determining what the fiduciary income is. IRA custodians do not keep fiduciary accounting records with allocations to principal and income because such records are, for the most part, irrelevant.

To deal with these issues, you must, therefore, provide the following with respect to the gift to a QTIP trust, and these should be included in the beneficiary designation as well as the trust:⁽¹⁴⁾

To meet the all-income test, if the power of appointment problem in the spouse is to be avoided, the trustee of the QTIP trust must be required to compel the IRA custodian or trustee to distribute the greater of all the income of the IRA or the minimum distribution amount. How does this tie in with state statutes which dictate what portion of a distribution from an IRA is income? To be safe, the instrument should specify that income from the IRA is income to the QTIP.
The trustee of the QTIP trust must be able to require the trustee of the IRA to make the IRA property productive. This should be done in the beneficiary designation, which will operate as an amendment to the IRA. Likewise, the spouse should be given the power to compel the IRA custodian to do so if the trustee fails to do so.
The QTIP election must be made both as to the QTIP trust and the IRA according to Rev. Rul. 89-89.

See Appendices A and A-1 for forms for this type of disposition.

As can be seen, the use of QTIPs as a beneficiary of an IRA are very complex, lack flexibility, and provide a lot of traps for the unwary. Given the fact that the amount which can be passed to the younger generation is between 25¢ and 35¢ on the dollar, there is a real question as to whether the game is worth the candle. Even if there are no other assets to pass to the children, if either spouse is insurable, a life insurance policy which reflects the real, albeit diminished value of the interest in the IRA to the next generation is much more efficient, and the IRA benefit can be left to the surviving spouse outright, thereby leaving in tact all the elections as to excise tax, etc.

. CONCLUSIONS. From the above, certain principles can be derived:

It is always simpler to use individual beneficiaries than trusts.

Taking advantage of the credit shelter may or may not prove advantageous to the family unit when balanced against deferral.

If you are bound and determined to use a credit shelter trust as a beneficiary of the IRA, structure the beneficiary designation with the surviving spouse as the designated beneficiary with disclaimer provisions so that the decision as to whether to take advantage of the unified credit is delayed until it must be made.

Stay out of this area of planning and live a happier (and probably longer) life.

APPENDIX A

IRA BENEFICIARY DESIGNATION

(QTIP TRUST)

I, [Participant], am the owner of Individual Retirement Account #________ (the "IRA"), of which ______________________. is the [Trustee/Custodian] (the "IRA Trustee/Custodian"). Such account is entirely the community property of my spouse and me. I have not yet attained age seventy and one-half (70-1/2).

DESIGNATION OF BENEFICIARIES

I hereby designate the following beneficiaries:

1. If my spouse, ________________, survives me, then my account shall be divided into separate shares as follows:

a. One share shall be my spouse's community property one-half interest in the IRA, and shall be distributed to my spouse.

b. One share shall be a fractional share the numerator of which shall be a sum equal to the largest amount, if any, that can pass free of federal estate tax by virtue of the unified credit allowable to my estate by Section 2010 of the Internal Revenue Code and the state death tax credit allowed by Section 2011 of the Internal Revenue Code (but only to the extent that the consideration of such state death tax credit will not result in an increase in any state death taxes which would otherwise be payable to any state by reason of my death), but no other credit, and after taking into account property which passes or has passed under my will and outside of my will (other than by this IRA Beneficiary Designation) and is included in my gross estate for federal estate tax purposes but does not qualify for the marital or charitable deduction and after taking into account charges to principal that are not allowed as a deduction in computing my federal estate tax and of which the denominator shall be the value of the IRA included in my gross estate for federal estate tax purposes. For the purpose of establishing such fraction, the values finally fixed in the federal estate tax proceeding relating to my estate shall be used. I direct that this share shall continue to be held by my IRA Custodian/Trustee and shall be paid and distributed in installments, not less often than annually, to the Trustee of the __________________ Trust. My custodian/trustee shall distribute the greater of the minimum required distribution as required under §401(a)(9) or the actual income generated or deemed to be generated by such plan or individual retirement account. For purposes of determining income in the _______________ Trust all of the income from the IRA shall be treated as income of the Trust. In determining the amount of income to be distributed to my spouse with respect to the qualified plan or IRA benefit, my custodian/trustee shall determine such income so that in all events my spouse shall have a "qualifying income interest for life" as that term is used in Code §2056(b)(7). The trustee shall not charge to income any expense properly chargeable to the principal portion of any distribution. If the Trustee of the __________________ Trust shall so request, my IRA Custodian/Trustee shall distribute amounts over and above the minimum distribution amount in the amount requested by the Trustee of the _________________ Trust.

2. If my spouse does not survive me, then my IRA Custodian/Trustee shall divide my IRA into as many equal shares as there are then living children of mine and deceased children of mine leaving lineal descendants surviving. The IRA Trustee shall distribute one such share to each living child of mine, and one share to the lineal descendants of each deceased child of mine, per stirpes. My IRA Custodian/Trustee shall distribute the principal and income of such share in installments, not less often than annually, as directed by the beneficiary of each share. Any distribution hereunder shall be made at such time and in such manner so as to comply with the Minimum Distribution Rules.

3. If any portion of the installment payments hereunder shall be payable to a minor or minors, then my IRA Trustee shall pay such installments to any trustee of a trust established for such minor under the _________________Trust, and such payment shall be in complete acquittance of the IRA Custodian/Trustee, and it shall not be required to see to the application of any of the amounts so paid.

II.

ADMINISTRATIVE PROVISIONS

1. "Internal Revenue Code" means the Internal Revenue Code of 1986, as amended and as in effect at the date of my death. Any reference by section number shall refer to the section of the Internal Revenue Code as in effect on the date of my death (even if such section has been renumbered). Any reference to a section of the Internal Revenue Code that has been repealed shall be disregarded.

2. "Minimum Distribution Rules" shall mean the rules set out under Section 401(a)(9) of the Internal Revenue Code, and the regulations thereunder.

3. If my spouse and I die under such circumstances that it cannot be reasonably determined which one of us survived, my spouse shall be deemed to have survived me.

4. Any Excess Retirement Accumulation Tax as defined in Section 4980A(d) of the Internal Revenue Code shall be paid from the proceeds of the IRA hereunder by my IRA Custodian/Trustee if the Personal Representative of my estate should so request.

IN WITNESS WHEREOF, I have hereunto affixed my signature this ____ day of ________, 1996.

___________________________________

[NOTE: THIS FORM SHOULD BE USED IN CONJUNCTION WITH APPENDIX A-1]

APPENDIX 1-A

WILL PROVISION FOR IRA BENEFICIARY DESIGNATION:

Special Provisions Regarding IRA and Qualified Plan Benefits. If the Residuary Trust shall be the beneficiary of any benefits from a qualified plan as defined in Code §401(a) or an individual retirement account ("IRA") as defined in Code §408(a), then I direct my trustee to treat distributions from any qualified retirement plan or IRA as income from the trust to the extent of the greater of income generated or deemed to be generated by such plan or individual retirement account or the amount determined to be income under §113.109 of the Texas Trust Code. For purposes of determining income, fiduciary accounting principles shall be applied. In determining the amount of income to be distributed to my spouse with respect to the qualified plan or IRA benefit, my trustee shall determine such income so that in all events my spouse shall have a "qualifying income interest for life" as that term is used in Code §2056(b)(7). The trustee shall not charge to income any expense properly chargeable to the principal portion of any distribution. In addition, the trustee shall have the right in its discretion to withdraw any part or all of the remaining qualified plan benefit or IRA. If the trustee shall fail to demand the distribution of income as required herein, my spouse may demand such distribution directly from the trustee or custodian of the qualified plan or IRA.

[NOTE: THIS CLAUSE MAY BE USED FOR INTER-VIVOS TRUSTS ALSO WITH MINOR MODIFICATIONS.]

APPENDIX B

IRA BENEFICIARY DESIGNATION

(DISCLAIMER TRUST)

DESIGNATION OF BENEFICIARIES

I hereby designate the following beneficiaries:

1. If my spouse, ________________, survives me, then I designate my spouse as the designated beneficiary of my account. My spouse's date of birth is _________.

2. If my spouse should disclaim any interest in my account, such amount disclaimed shall pass to the trustee of the ___________________ Trust. My spouse shall not be treated as having predeceased me.

3. If my spouse does not survive me, then my IRA Custodian/Trustee shall divide my IRA into as many equal shares as there are then living children of mine and deceased children of mine leaving lineal descendants surviving. The IRA Trustee shall distribute one such share to each living child of mine, and one share to the lineal descendants of each deceased child of mine, per stirpes. My IRA Custodian/Trustee shall distribute the principal and income of such share in installments, not less often than annually, as directed by the beneficiary of each share. Any distribution hereunder shall be made at such time and in such manner so as to comply with the Minimum Distribution Rules.

4. If any portion of the installment payments hereunder shall be payable to a minor or minors, then my IRA Trustee shall pay such installments to any trustee of a trust established for such minor under the _________________TRUST, and such payment shall be in complete acquittance of the IRA Custodian/Trustee, and it shall not be required to see to the application of any of the amounts so paid.

II.

ADMINISTRATIVE PROVISIONS

2. "Minimum Distribution Rules" shall mean the rules set out under Section 401(a)(9) of the Internal Revenue Code, and the regulations thereunder.

3. If my spouse and I die under such circumstances that it cannot be reasonably determined which one of us survived, my spouse shall be deemed to have survived me.

IN WITNESS WHEREOF, I have hereunto affixed my signature this ____ day of ________, 1996.

__________________________

ENDNOTES

1. In most community property jurisdictions, the participant has the right to dispose of the entire interest in a qualified plan benefit (subject to REA) or an IRA, being limited only by the fraud on the spouse doctrine. Discussion of that issue is left for another time and place.

2. ERISA §514(a) provides, in pertinent part, "...[T]he provisions of this subchapter and subchapter III of this chapter shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan." (Emphasis added.)

3. ³ Finding that the estate of the spouse is not a "former spouse" is relatively simple. In this case, also, the bequest was to a trust, which clearly does not fit the definition of an alternate payee. Even had the bequest been outright, Mrs. Ablamis' children were not qualified alternate payees. One questionable aspect of the reasoning is the court's assumption that the alternate payee is the estate. Would it not be more logical to hold that the beneficiary was the alternate payee?

4. This section is the U.S.C. cite and the usual reference is to ERISA §206(d), which is the anti-alienation provision of ERISA. The Internal Revenue Code counterpart is §401(a)(13).

5. ⁵But REA gives a benefit to the NPS during the NPS's life, which differs markedly from a right of disposition which does not benefit the NPS personally at all.

6. In fact, the only reference to Ablamis is a cite to a 1992 Washington & Lee Law Review article. Curiously, however, the court cites a 1979 California case as to which the Supreme Court of the United States denied certioraribecause of lack of a substantial federal question as standing for the proposition that California community property law is not preempted.

7. It is interesting to note that it took the Fifth Circuit in Boggs longer than the 15 months it took the Ninth Circuit in Ablamis.

8. Judge Duhe, also a Louisiana lawyer, joined Judge Wisdom. The dissent was by Judge King, a non-community property lawyer.

9. ⁹The Court noted that Mr. McLendon had enough hours of employment in the year of his discharge to have ten years of service, and thus be entitled to vesting. Further, the Court also noted that ERISA §502 provides a federal cause of action for acts by an employer which deprive a participant of his benefits under a pension plan.

10. See the dissent in Mackey v. Lanier Collections Agency and Service, Inc., 485 U.S. 825, 108 S. Ct. 2182 (1988), in which four justices felt that the general garnishment statute of Georgia "related to" an ERISA plan and was therefore preempted. The majority felt that the garnishment statute was one of general application and that it was saved from preemption because its connection with ERISA was too "remote, tenuous and peripheral." Shaw v. Delta Airlines, Inc., 463 U.S. 85, 103 S.Ct. 2890 (1983), n.21.

11. NationsBank's form permits the NPS to designate a beneficiary, but that is the only form with which I am familiar that does so.

12. See, e.g., Texas Trust Code §113.059 which sets the standard at 5% of the inventory value and changes the long standing Texas rule that all distributions from qualified plans are income.

13. For the rules concerning IRAs involving a nonresident alien spouse in a community property state, with application to common law states also, see PLR 9623063.

14. If the benefits are in qualified plan solution rather than an IRA, this could become even more difficult. The plan administrator may well refuse to accept the beneficiary designation containing all the rights of the trustee and the plan will probably not be flexible enough to accommodate the requirements.