This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

RETIREMENT PLANS/IRAs AT DEATH

For a more detailed version of this article see 1997 Changes Regarding Living Trusts as Retirement Plan Beneficiaries.

Retirement plans are some of the most difficult assets for which to optimize death planning. Often they are extremely valuable but have unexpected tax consequences.

Typically, retirement plans hold pre-income tax funds. If you are the "participant" in a plan and make withdrawals while you are alive, they are subject to income tax (and perhaps penalty). Although it seems unfair to many people, at your death they are subject to both estate tax and income tax.

Proper planning for many people is dictated by simple economics: I need it, I spend it, I pay tax.

On the other hand, some people have enough other funds that they can plan for future generations and maximize their gifts to their families. It is clear that for the maximum long-term benefit, delay of income taxation by postponing withdrawals as long as possible achieves the greatest growth, through tax deferred compounding.

While you are alive, you are not required to begin withdrawals until the "Required Beginning Date": April after you reach age 70½. Once you reach 70½, the minimum distribution rules apply and you must make irrevocable elections regarding your method of withdrawal: either the fixed or recalculation method, with either a single life or a joint life expectancy, using either your spouse or any other person who is treated as being a maximum of 10 years younger than you.

Death of Participant
If the participant dies before reaching the Required Beginning Date, unless a spouse is the named beneficiary, someone must pay income tax. Only a properly designated spouse can roll over a retirement plan into a new plan, continuing the tax deferral. All other beneficiaries must begin to make taxable withdrawals, using either of the 2 basic methods:

1. Take withdrawals (and pay income tax) at any time within the next 5 and a fraction years after the plan participant's death, ending on December 31. This allows 6 income tax years in which to drain the plan and pay the tax.

   OR

2. Annuitize the plan, taking the payments over the properly designated beneficiary's life expectancy. This is a rigid method, which cannot be changed after the election is made.

If the participant dies after reaching the Required Beginning Date, there is less flexibility:

1. It must be withdrawn over the remaining life expectancy table for the deceased participant. (Assume Dad died at 72, but according to IRS tables, a 72 year old person has a 10 year remaining life expectancy; Dad's heirs must use that 10 year period.)

   OR

2. Annuitize the plan, taking the payments over a properly designated beneficiary's remaining life expectancy.

In computing the life expectancy of an individual, there are 2 methods:

1. "Recalculation" requires an annual review of the person's life expectancy each year. A 50 year old person has a 28 year life expectancy and takes out 1/28 this year; next year (at 51 years old) he has a 27.1 year expectancy and takes out 1/27.1. Using the recalculation method you never run out of life expectancy, until actual death.

   OR

2. "Fixed" requires use of the person's initial expectancy, reduced by 1 each year. This year the 50 year old takes 1/28 out of the plan; next year he takes out 1/27;... at age 78 he takes any remaining amount. Even though he would have a 9 year expectancy left at age 78. A drawback is that half of the people outlive their life expectancy.

With this confusing background, how does naming a Living Trust as beneficiary impact the heirs' option? Now, thanks to a recent change in the law, a Trust may be named beneficiary and allow the same choices as if a person were named individually, rather than through a Trust, if the Administrator of the plan is given the basic terms of the Trust.

Why should the Trust be named instead of the individuals? Often, individuals are too young; also Trusts may provide asset protection for heirs.

It might be wise to check the named beneficiary of your retirement plans and ensure that they are held as expected, and if you want a Trust to be a beneficiary, rather than your heirs directly, the Administrator should be given a summary of the terms of the Trust.

For a more detailed version of this article see 1997 Changes Regarding Living Trusts as Retirement Plan Beneficiaries.

CHILD SUPPORT AND DEATH

Recent cases have decided that child support is payable even after death.

Further, it may be payable to the custodial parent under very surprising circumstances.

Bob and Mary had a 1 year old baby when they divorced and Bob married Bimbo. Mary had custody. Several years later, Bob died while owning $300,000, leaving 50% to his child and 50% to Bimbo.

Assume that the child support would have been $100,000 from the date of Bob's death until the child reached age 18. California Courts may hold that Mary (Bob's ex-wife) gets $100,000 as child support; child and Bimbo split the $200,000 remaining after payment of the child support debt to Mary.

Bob had intended that the $150,000 he thought he was leaving to child was to replace child support. But under California law, child support is payable to the custodial parent and gifts to a child do not supplant or reduce child support owed to an ex-spouse.

Now let's assume that Bob had lived and Mary died. Perhaps Bob gets custody. Mary left half of what she owned to her child, the other half went to her new husband. What do the statutory guidelines say about child support?

Mary has no earnings (she is dead), so if child support owed to the custodial parent (Bob) is based on earnings, Mary's estate has no problem, right? Wrong!

The Courts have held that Mary's saved living expenses (she has no further need for rent for her home, car, insurance, clothing, food, haircuts, etc.) now that she is dead count as earnings. The custodial parent (Bob) is entitled to child support out of Mary's estate. In effect, Mary's new husband has to pay child support to Bob.

Could this have been avoided? Probably. In their Wills or Trusts, they could have used language which could have helped: "I leave this gift for the benefit of my child instead of child support I would have had to pay during my life."

If you are subject to a child support order (either for a minor or even an adult disabled child), please call that information to your estate planner's attention.