An Anatomy of a Beneficiary Designation Form.

We all have clients who have large rollover IRAs or large interests in a qualified plan, or who are married to someone who does. It is obvious that the manner in which these benefits pass on death can dramatically affect the estate plan. Consider, as a common instance, a joint community estate consisting of a $200,000 home, $300,000 in other probate assets, and a $1 million rollover IRA.

The disposition of the $1 million IRA is not going to be affected by the participant’s will unless the beneficiary of the IRA is the participant’s probate estate. Rather, this valuable asset, representing two-thirds of the estate, is going to pass in accordance with the language found in the beneficiary designation, if any, or by the default provisions under the plan or IRA if a designation is not completed. The interest is a nonprobate asset.

The passage of the community property interest of the participant’s spouse (the nonparticipant spouse or NPS), should the spouse predecease the participant, is slightly more problematic. It will probably pass under the spouse’s will, as a probate asset,[1] or it might pass under a beneficiary designation, if the spouse has signed one and if the interest is held under an IRA. But, if the interest is in a qualified plan the interest may not pass at all, depending on whether the qualified plan is subject to ERISA,[2] and if so whether ERISA preempts state probate law.[3]

Of all of the various property interests that can pass to a beneficiary at the death of an individual, the one that is the most fraught with complex tax and uncertain property law issues is the IRA or qualified plan. There are a number of taxes that can apply to an interest in a qualified plan or IRA.

1. Income Taxes.

2. Premature Distribution Tax.[4]

3. Estate Tax.

All of these taxes are affected by the form of the beneficiary designation. In Texas, California, New Mexico, Arizona, Louisiana, Washington, Idaho, Nevada (and, to a limited extent, a few other states) all of these taxes must be applied with the community property system in mind.

Consider the following issues:

Issues Common in All States

• Does a beneficiary have the right to withdraw the entire benefit at will? If not, is the participant’s estate entitled to a marital deduction if the beneficiary is the spouse? Does the answer to this question turn on whether the participant elected installment distributions upon reaching his required beginning date. (Note now for future reference that the required beginning date, or RBD, means April 1 of the calendar year following the calendar year in which the participant turned 701/2.[5])

• How soon must a participant’s benefit be paid out following his death?

• What happens to the undistributed interest of the participant’s beneficiary after the beneficiary’s death (following the death of the participant)?

• Is a marital deduction available in the participant’s estate if the spouse is the beneficiary, if the undistributed interest can pass to a third party?

• Can a trust be named as beneficiary? If a QTIP trust is named as beneficiary, will the participant’s estate be entitled to claim a marital deduction for it? Does the fact that a trust is a beneficiary mean that the benefits must be paid out (and taxed) within five years of the participant’s death, or can we look to the life expectancy of the beneficiary of the trust?

• Can a beneficiary rollover the participant’s benefit? Can the beneficiary make a plan to plan or IRA to IRA transfer of the benefit?

• If the beneficiary is under age 591/2 at the time of the distribution, does the beneficiary have to pay the 10% early distribution penalty tax under §72(t)? Does it make any difference if the beneficiary is the participant’s spouse, and the spouse either rolled over the benefit or elected to treat it as his own, pursuant to IRC §§402(c)(9), 403(b)(8)(B) or 408(d)(3)(C)(ii)(II)?

• If the participant’s estate is the beneficiary, but the beneficiary of the participant’s estate is the participant’s spouse, can the spouse take the distribution and roll it over?

Community Property Issues

• What happens to the community property interest of the nonparticipant spouse (the NPS)— (a) on the spouse’s death, (b) on the participant’s death? Does this interest of the NPS pass by will or by beneficiary designation or neither? Does this interest qualify for the marital deduction if the participant is the beneficiary? Who is taxed for income tax purposes on the distribution of the nonparticipant spouse’s interest, and when is the tax due? If the participant is under age 591/2 at the time of the distribution, does the 10% early distribution penalty tax under §72(t) apply, and if so, who pays it?

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Most of these questions and a few more will be addressed below in the context of a clause by clause analysis of certain provisions of a model IRA/qualified plan beneficiary designation form. The author makes no warranties or representations at all regarding the effect or efficacy of these clauses, as they are set forth for discussion purposes only. This form, of which the clauses are a part, is intended to be used as an attachment to whatever form (if any) is required by the sponsor of a qualified plan or IRA. Whether it is appropriate or acceptable to the sponsor is definitely a matter to be considered, but it is the author’s experience that most sponsors have no problems with individually designed forms, in contrast to insurance companies, most of whom do not seem to care what problems their forms cause after the policy has been sold.

The beneficiary designation clauses found below are surrounded by a border. Most word processing programs allow the user to define variables the answers to which determine what will be inserted in a merged document. I have retained, a few of the variables and conditional instructions that I use (indicated within the internatio

DESIGNATION OF BENEFICIARY and ELECTION AS TO FORM OF BENEFITS UNDER IRC §401(a)(9)

This document is an attachment to any beneficiary designation form required by the terms of the IRA and is incorporated into such form. If there is no specified beneficiary designation form required by the terms of the IRA, then this document shall be the beneficiary designation form.

If possible, it is best to actually sign any form that the Plan or IRA provides or requires, with the words “see attached” filled in appropriately.

Spousal Rollover. Here, if the original owner is deceased, the owner’s spouse was the designated beneficiary, and the spouse wishes to treat the IRA as his own (pursuant to IRC §408(d)(3)(C)(ii)(II)), then this clause manifesting that intent would be appropriate. There are many important tax consequences to consider if a spouse is a beneficiary of an IRA or qualified plan. Most important is that IRC §§402(c)(9), 403(b)(8)(B) and 408(d)(3)(C)(ii)(II) allow spouses, and only spouses, to rollover from qualified plans, tax sheltered annuities and IRAs, into an IRA that will become the spouse’s own IRA (i.e., it will be treated as owned directly rather than as a beneficiary). The spousal rollover rule is clearly applicable even after the RBD has been reached.[7]

Application of Minimum Distribution Rules. The general rule is that, after death and after the RBD—the required beginning date, April 1 of the calendar year following the calendar year in which the participant reaches age 701/2—distributions must continue at least as rapidly as before death. Before death, minimum distributions will have commenced as of the RBD, usually over the joint life expectancy of the participant and the participant’s beneficiary. If death occurs before the RBD, distributions must either be made (a) over the life expectancy of the beneficiary, or (b) within five years, usually at the election of the beneficiary.

Spousal Rollover Postpones or Suspends IRC §401(a)(9). A post mortem technique that effectively suspends or postpones the application of both rules is to name the spouse as beneficiary, and then have the spouse rollover the benefit or treat the IRA as his or her own under t