CHAPTER 14 – Annuities & Employment Retirement

During the client’s employment phase savings and compensation benefits are often accrued, for payment at or after retirement. 

This can occur with (1) individual income deferral accumulations (e.g., an IRA), or

(2) an employer qualified retirement plan.

In permitted situations these accumulations can be accrued on a “pre-tax basis” (i.e., currently deducted or excluded from gross income, with zero-basis for account assets).

 

Deferred/Retirement Benefits - Examples

·         Commercial annuities – individually purchased

·         Qualified pension & profit-sharing plans (& distributions at retirement/death)

·         Nonqualified executive deferred compensation arrangements

·         Stock options-ISOs & nonqualified

·         Individual retirement accounts (IRAs), including “Roth IRAs

·         Death benefit only plans from the employer

Retirement & Taxation of Deferred Payments       p.2

After retirement various deferred benefits may be paid on a periodic basis.

For income tax purposes the issues will be:

·         the timing of the recovery of any cost basis, and

·         the amount of includible gross income.

In the qualified retirement plan context (where contributions were on a pre-tax basis) the entire distribution often will be includible in gross income.

Annuity Payment Options
p.2

At the time annuity payments commence payments can be made for:

·         Term certain

·         One life annuity

·         Two life annuity (e.g., joint and survivorship)

Note:  Amounts might be withdrawn before annuity payments commence.

                     What income tax treatment?  Cf., life insurance policy borrowings.

Gross Income Inclusion of Annuity Income        p.4-5

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 recovery first?

See §72(d) for qualified plan recovery & tax basis recovery.  Cf., §72(b).

Additional income tax elements

What is a “refund feature”?  What is the tax impact of a “refund feature”? See Code §72(c)(2) requiring an adjustment.

What if the annuitant dies prior to end of life expectancy period?  See Code §72(b)(3) enabling an income deduction (on last tax return for individual) for the unrecovered tax basis.

What if the annuitant outlives the life expectancy period?  See Code §72(b)(2) re inclusion of the entire amount after all tax basis recovered.

Required Minimum Distribution Rules    p.10

What is the purposes of the “required minimum distribution” (RMD) rules (starting at 70½, subject to certain exceptions)?   P.11

How determine the required distribution?

What if successor owners receive benefits – what is the required payout period?

Note exception (described in Notice 2009-9, p.12) re RMD waiver for 2009 (only).  Why?

Estate Tax Inclusion of Annuity – Code §2039

For a one-life annuity on the life of decedent – no residual value and no asset transfer occurs at the time of death.

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).

Marital deduction available? §2056(b)(7)(C).

Tax basis step-up at death (under Code §1014)?  No, an IRD item. Code §691.

Qualified Retirement Plan Benefits                 p.14

What are the payout options at retirement?

What is the relevance of the Retirement Equity Act?  See Code §401(a)(11).

What value is includible in the deceased employee’s gross estate?

Is a (gift tax) marital deduction available, including a QTIP election?  See Code §2523(f)(6), including subsection (D), (p.18), re estate tax, a pre-deceased donee spouse, & no §2044 inclusion.

Community Property Law Applications              p.18

Community property is a local law concept – therefore ownership is defined by applicable state law. But, what about when the property interest (qualified plan benefits) is defined by federal law (ERISA)?

Allard v. Frech (and PLR 9018002) 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.23) re federal preemption & surviving spouse has no interest at death.

Boggs v. Boggs,
U.S. Sup. Ct.             P.23

Facts:  He was employee;  1st wife died; 2nd wife survives and she asserts right to 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 his children)?  Is the ERISA objective to benefit surviving spouse?

Dissent:  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 preemption here.

Kennedy case (2009) (p. 44) – 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?

Executive Deferred Compensation          p.45

Nonqualified deferred compensation.

Deferral during lifetime is to be accomplished consistent with requirements specified in Rev. Rul. 60-31, i.e., contractual, unsecured benefits & not funded (including in escrow).

Note, “rabbi trust” option (cf., “secular” trust).

Relevance of Code §409A?

Deferred Compensation and Estate Tax           p.47

Inclusion required in the gross estate for the amount receivable under a non-qualified deferred compensation arrangement.  Code §§2033, 2039.

Distribution is income in respect of a decedent under Code §691 to recipient.

How direct this asset to the beneficiaries?  To tax effect to private beneficiaries?  Direct proceeds to charity?

Stock Options   
p.48

Types of stock options:  ISOs and NSOs.

What value is includible in the gross estate?

Who should be the beneficiary?

Who should exercise the option?

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 purchase?

Incentive Stock Options
p.48

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. 

Basis step-up at death (p.48)?

Nonqualified Stock Options                    p.49

Value of option in gross estate at death.

Transfer option by gift during lifetime?  Gift as value of the option right.

Death of optionee before exercise, income tax liability to estate of employee.

Rev. Rul. 98-21 (p. 50) – completed gift only when the required services are performed.  See Rev. Proc. 98-34 (p.52) re valuation.

Individual Retirement Accounts                    p.55

Rev. Rul. 92-47, p. 56;  Entire balance isdistributable to child.

Distribution is IRD to receipient.

Possible transfer of account interest to charity,  to achieve what objectives?  P.59.

The “Roth” IRA
p.60

No deduction at the time of contribution but no inclusion upon subsequent withdrawal.

Death Benefit Only Plans
p.61

Does employee have benefits to be connected with this plan?  Therefore, apply a retained life interest analysis to the survivorship interest.

But, if no pre-death interest of the employee?

See, Levin case, p. 61.

Social Security Benefits
p.69

Social security survivorship benefits not includible in the estate of the deceased (employee) spouse.