CHAPTER 14 – Annuities & Employment
During the client’s
employment phase savings and compensation benefits are often accrued, for
payment at or after retirement (or at death).
This can occur with
(1) individual income deferral accumulations (e.g., an IRA), or
qualified retirement plans, etc.
In permitted situations these accumulations can be accrued on a “pre-tax
basis” (i.e., currently deducted or excluded from gross income, then with a
zero tax basis for the account assets).
Deferred/Retirement Benefits - Examples
Commercial annuities – individually
purchased (for life or term).
Qualified pension & profit-sharing
plans (& annuity distributions at retirement/death)
Nonqualified executive deferred
Stock options-ISOs & nonqualified
Individual retirement accounts (IRAs),
including “Roth” IRAs
6) Death benefit only plans from the
Retirement & Taxation of Deferred
After retirement various deferred employment related benefits may
be paid on a periodic basis.
For income tax purposes critical issues will be:
the timing of the recovery
of any cost basis, and
the amount of includible gross
In the qualified (§401)
retirement plan context (where contributions were all made on a pre-tax basis)
the entire distribution often will be includible in gross income.
Annuity Payment Options – Traditional
At the time
annuity payments commence payments can be made for:
One life annuity
Two life annuity (e.g., joint and
Note: Amounts might be withdrawn before
payments commence. What income tax
Cf., life insurance policy borrowings
Gross Income Inclusion of Annuity Income
Code §72 provides
for determining (1) the “investment in the contract” and (2) the “expected
return” to create an “exclusion ratio” for each payment received. §72(b).
Therefore, the same
portion of each future payment is included in gross income.
Is this approach
actuarially sound? What are other options for tax basis recovery in the annuity
context? Allow tax basis
See §72(d) for
qualified plan distributions & tax basis recovery. Cf., §72(b).
Additional income tax elements
1) What is a “refund
feature”? What is the tax impact of
a “refund feature”? See Code §72(c)(2) requiring an adjustment. P. 13.
2) What if the annuitant
dies prior to end of life expectancy period? See Code §72(b)(3) enabling an income
deduction (on last income tax return for individual) for the unrecovered tax
basis. P. 5.
3) What if the
annuitant outlives the life expectancy period? See Code §72(b)(2) re inclusion of the
entire amount after all tax basis has been recovered. P. 5.
Required Minimum Distribution Rules p.10
What is the
purposes of the “required minimum distribution” (RMD) rules (starting at 70_,
subject to certain exceptions)?
How determine the
What if successor
owners receive benefits – what is the required payout period?
(described in Notice 2009-9, p.12) re RMD waiver for the year 2009 (only). Why?
Estate Tax Inclusion? p.12
Code §2039 requires
inclusion in the gross estate of the value of the survivorship interest under
an annuity contract.
Client may previously
have received annuity payments and, if accumulated (after income tax) inclusion
of that net amount in gross estate under Code §2033.
Estate Tax Inclusion of the Annuity – Code §2039
1) For a one-life
annuity on the life of decedent – no residual value and no asset
transfer occurs at the time of death.
2) For a joint
& survivor annuity – what is the value of the survivor benefits in gross
estate? And, who contributed to obtaining those survivorship benefits? See Code §2039(b).
P. 16. Is a marital deduction available?
Death: §2056(b)(7)(C). Lifetime: §2523(f)(6).
Tax basis step-up
at death (under Code §1014)? No -
an IRD item. Code §691; when distribute?
Any Limit on Retirement Plan Accumulations?
Previously a dollar limit – p. 15; previously
an excise tax on distributions above $112,500 (as indexed). A “tax on success”?
Presently no limit on accumulations.
Obama proposed limit – maximum annuity
providing annual benefit of $210,000 (payable on J&S annuity, starting at
age 62); see
p. 15, fn. 24.
Should a limit
apply? Is the deferral valuable?
Qualified Retirement Plan Benefits
What are the payout
options at retirement?
What is the
relevance of the Retirement Equity Act?
See Code §401(a)(11). P.15.
Is a (gift tax)
marital deduction available, including a QTIP election? See Code §2523(f)(6).
If donee spouse dies first: See Code §2523(f)(6) (D), (p.17),
re estate tax; no
Community Property Law Applications
is a local law concept – therefore ownership is defined by applicable state
law. But, what about when the property interest (the qualified plan benefit) is
defined by federal law (ERISA)?
Allard v. Frech (and PLR 9018002,
p.19, pre-REA) that under Texas law the non-employee spouse has a
community property interest in the employee spouse’s qualified plan benefits.
Cf., Ablamis case (9th Cir, p.22) re federal
preemption & non-participant spouse has no interest at
Boggs v. Boggs,
U.S. Sup. Ct.
Facts: He was employee; 1st wife died; 2nd
wife survives and 2nd wife asserts right to all plan benefits (to
detriment of 1st marriage children).
Does ERISA preempt
community property rights – with result that 2nd spouse is entitled
to all plan benefits (& not part to his 1st marriage children
with 1st spouse deceased)?
Is the ERISA objective to benefit surviving spouse?
(p.32): ERISA does not
preempt (& nullify) community property law rights.
Necessity of a Proper Beneficiary Designation
Egelhoff case (p.43) – designation
of ex-spouse as beneficiary under plan – not changed after divorce, but
state law provided for revocation of designation on divorce; No, US Sup. Ct. says ERISA
Kennedy case (2009) (p. 43) – even a waiver of benefits by the ex-spouse
does not preclude payment to ex-spouse if designation document is not
changed as of death of employee.
What is the plan
administrator to do?
Unintended Beneficiary Designation
proceeding to enforce intended rights, after benefits inadvertently received by
Kensinger case, p. 45
is not involved in this proceeding.
Executive Deferred Compensation
Nonqualified deferred compensation.
lifetime is to be accomplished consistent with requirements specified in Rev.
Rul. 60-31, i.e., contractual, unsecured benefits & not funded (including
funds not in escrow).
Note, “rabbi trust”
option – no security interest; cf., “secular” trust option.
What relevance of
Code §409A (re: vesting &
Deferred Compensation and Estate Tax
in the gross estate for the amount receivable under a non-qualified deferred
compensation arrangement. Code §§2033,
proceeds? If and
Distribution is “income
in respect of a decedent” under Code §691 to the recipient.
How direct this
asset to the beneficiaries? What
tax effect to private beneficiaries?
Direct the proceeds
Types of stock
options: ISOs and NSOs.
What value is
includible in the gross estate?
Who should be the
Who should exercise
What income tax
treatment arises upon disposition of the option or option stock?
What is the
capacity to borrow to enable the exercise of the options & stock
Do not let valuable
options expire unexercised!
Incentive Stock Options
Option grant at FMV
& limit on grant amount.
No gross income
inclusion (1) at time of grant of option, or (2) upon exercise.
Capital gains event
when stock subsequently sold (but two year holding period; waiver at death).
No ISO assignment
during life, so no gifting opportunities. Inclusion of value in
Basis step-up at
death (see p.48)?
Nonqualified Stock Options
Value of option in
the gross estate at death.
Transfer option by
gift during lifetime?
Gift to the extent of the value of the option
Death of optionee before exercise, income tax liability accrues to
estate of employee.
Rev. Rul. 98-21 (p.
49) – completed gift only when the required services are performed to
enable exercise of the option.
See Rev. Proc.
98-34 (p.51) re valuation.
Individual Retirement Accounts
Sources of funds in
successor beneficiary to the IRA?
Is this a
testamentary disposition? See p. 56
& Texas Estates Code
Individual Retirement Accounts, cont.
Rev. Rul. 92-47, p.
lump sum balance is distributable to the decedent’s child.
Distribution is IRD
to the recipient.
No discount of the
IRA value for the imbedded income tax cost – Kahn case, p.59.
of account interest to charity, to achieve what objectives?
See IRA rollover to
The “Roth” IRA
No deduction at the
time of contribution but no income inclusion upon subsequent withdrawal.
IRS balances into a Roth IRA account?
Death Benefit Only Plans
Benefit provided by
employer only to survivor.
Does the employee
have sufficient benefits to be connected with this
plan? If so, apply a “retained life
interest” analysis to the survivorship interest. §2038.
But, if no pre-death
interest of the employee?
See, Levin case, p.
62. Power to alter, amend or revoke
the interest of the spouse. Cf., DiMarco case, p. 68 (re gift tax), where not the
Social Security Benefits
survivorship benefits not includible in the estate of the deceased (employee)
Security benefits do terminate at time of death.