Advanced Underwriting Consultants

Ask the Expert – September 5, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client is retiring this year and he has a nongovernmental 457(b) plan that he would like to roll over to an IRA. Is this possible?

Answer: No, nongovernmental Section 457(b) plans (also referred to as “Top Hat” plans) are not eligible for rollover treatment to other types of retirement plans.

A Section 457(b) plan is a deferred compensation plan available for certain state and local governments and nongovernmental, tax-exempt entities. Governmental 457(b) plans are eligible for rollover into other retirement accounts like IRAs, qualified plans and 403(b) annuities. This leads many to mistakenly believe that all 457(b) plans are eligible for rollover.

When a nongovernmental 457(b) participant retires, he should consult with the plan documents to see what his options are. The participant’s options can range from cashing the account out completely, annuitizing, installment distributions, and deferring distributions until a predetermined age but not later than age 70.5.

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Ask the Experts – August 11, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client participates in a defined benefit plan that provides a joint and survivor annuity after retirement. If my client and his wife divorce, what happens to the potential spousal benefit?

Answer: If divorce occurs before the annuity payments begin, the qualified joint survivor annuity is usually cancelled, but it’s best to check with the plan administrator. That doesn’t mean the ex-wife will get nothing though. She may still be able to get a qualified domestic relations order (QDRO) that allows her to access a portion of the plan.

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Ask the Experts – July 21, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: I have a client whose son will be applying for financial aid as a college student soon. Does life insurance owned by my clients (the parents) count against him when determining his eligibility for financial aid?

Answer: No. When applying for financial aid, they will need to fill out a FAFSA. On the FAFSA, the parents and the student are required to list their investments, which will be taken into account in determining the student’s eligibility for financial aid. The instructions on the FAFSA provide the following:

Investments do not include the home you live in, the value of life insurance, retirement plans (401(k) plans, pension funds, annuities, non-educational IRAs, Keogh plans, etc.) or cash, savings and checking accounts already reported in questions 41 and 90.

Emphasis added. Therefore, purchasing life insurance, like contributing to a retirement plan, may be an effective way to minimize your client’s investments for student loan eligibility purposes.

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Ask the Experts – July 16, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client is considering purchasing a longevity annuity for his IRA. The annuity doesn’t kick in until he has reaches age 85. How does he satisfy his RMD requirements on the value of the annuity?

Answer: The IRS recently issued final regulations addressing longevity annuities.

Generally, RMDs are calculated based on the IRA account balance as of December 31 of the previous year after the account owner turns 70 ½. However, as long as an annuity is a qualifying longevity annuity contract (QLAC), it is not taken into account when determining RMDs.

To be considered a QLAC, the contract must meet several requirements:

    1. Premium limitations: The amount of premiums cannot exceed the lesser of $125,000 or 25 percent of the aggregate non-Roth IRA account balances (including the value of any QLAC in the account).
    2. Age limitation: The contract’s commencement must be no later than the start of the month after the account holder turns 85.
    3. Post-commencement: After distributions commence, the contract must meet RMD requirements.
    4. Surrender/commutation limitations: The contract cannot allow for any commutation benefit, cash surrender right, or other similar features.
    5. Death benefit limitations: The contract cannot provide a death benefit other than a return of premium feature, which would allow the beneficiary to receive up to the amount of premiums paid on the contract, less the amount the contract has already paid out prior to death.
    6. Statement of intention: The contract must state that it is intended to be a QLAC.
    7. Annuity limitations: The contract cannot be a variable, indexed, or similar type of annuity.

If your client purchases an annuity that meets these requirements, then she won’t be required to take RMDs on the value of the contract until payments begin.

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Ask the Experts – July 14, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: If my client is going through bankruptcy and receives a life insurance death benefit from on his father’s life during the proceeding, will the death benefits be protected from creditors?

Answer: It depends on the state. In bankruptcy, the debtor is able to exclude certain assets from his bankruptcy estate (referred to as exemptions). While the bankruptcy code sets forth the federal bankruptcy exemptions, Congress has given the states the choice to create their own exemptions that the state can either require residents to use, or allow residents to use (with the option to instead choose the federal exemptions).

Currently, every state has created its own set of asset protection laws, and 19 states and the District of Columbia have given their residents a choice between the state exemptions and the federal exemptions.

The federal government doesn’t protect the death benefits a debtor receives as a beneficiary unless the debtor is a dependent of the insured, and then they are protected only to the extent necessary for support of the debtor.

For example, consider the recent bankruptcy case In re Sizemore (12/5/13), where a debtor going through bankruptcy received $100,000 from her ex-husband’s life insurance policy. Being a resident of Kentucky, the debtor had the choice of using either federal or state exemptions. The debtor sought to exempt the entire amount under the federal bankruptcy protections, but the bankruptcy court held that life insurance proceeds were part of the bankruptcy estate. Therefore, the life insurance proceeds could not be excluded from the debtor’s bankruptcy estate.

Also consider In re White (5/16/14), a bankruptcy case using Alabama state exemptions. Under Alabama’s bankruptcy exemption laws, death benefits of a life insurance policy are exempted from the estate if the beneficiary is the person who effected the policy in the first place.

In White, a married couple were going through divorce. The wife, who was the insured on a $50,000 life policy, died, and her husband was the beneficiary. The husband claimed that the proceeds from the policy on his wife’s life were protected from his creditors under Alabama exemption laws. He argued that he was the one who effected the policy because (1) she obtained the life insurance through his employer, and (2) he paid the premiums.

The bankruptcy court, however, ruled that because the wife was the owner of the policy, she was the one who effected the policy. Therefore, the death benefits were not protected under Alabama’s exemption laws.

A client going through bankruptcy should check with a local bankruptcy attorney to fully understand his state’s exemption laws that may apply.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Ask the Experts – July 11, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client inherited an IRA from her mother, who inherited the same IRA from her own mother. Can my client stretch RMDs throughout her own life?

Answer: No. IRA distributions can be stretched only by the account owner (after she reaches age 70 ½) and by the account owner’s beneficiary. Since your client isn’t the beneficiary of the original account owner, she cannot stretch RMDs based on her own life expectancy.

Instead she may continue the distribution schedule her mother was using. Of course, your client can take greater distributions than the RMDs if she prefers.

Here’s an example. Suppose Dorothy died in 2003 leaving her daughter, Barbara, an IRA worth $300,000. Barbara turned 57 in 2004, resulting in an RMD period of 27.9 years. Ten years later, in 2013, Barbara died, leaving the IRA, now worth $179,000 to her daughter, Jennifer. In 2014, the distribution period is now 17.9 years (i.e. 27.9 years minus 10 years). Therefore, Jennifer’s RMD for 2014 is $10,000.

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Ask the Experts – July 10, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: If my client files for early Social Security retirement benefits at age 62, will she receive a reduced survivors benefit if her husband predeceases her?

Answer: No. The fact that your client files early for her own retirement benefits does not affect her potential future survivors benefits. In other words, an individual can file for her own benefits at age 62 and switch to survivor benefits after her spouse’s death after she reaches full retirement age (FRA) without seeing a reduction in survivors benefits.

A surviving spouse generally receives the amount the deceased spouse was receiving from his own Social Security benefits at the time of his death. If the deceased spouse was receiving reduced benefits, the survivors benefit is based on that reduced amount. Conversely, any delayed retirement credits (DRCs) accumulated by the deceased spouse will increase the survivors benefits.

On the other hand, if a surviving spouse files for survivors benefits prior to FRA, her survivors benefits will be reduced; however, filing for her own retirement benefits before FRA has no effect on her survivors benefits.

Here’s an example. Wife’s FRA is 66, and she has earned a primary insurance amount (PIA) of $800 per month. She files for benefits at age 62, receiving $600 per month ($800 PIA reduced by 25% early retirement reduction). Husband’s FRA is 66, and he has earned a primary insurance amount of $2,000 per month. He files for his own benefits at age 70, receiving $2,640 per month ($2,000 PIA increased by 32% DRCs). If the husband dies and the wife has reached FRA, she will be entitled to $2,640 in survivors benefits (replacing her own benefit amount of $600 per month).

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Ask the Experts – July 9, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: Are inherited IRA funds exempt from creditors in bankruptcy?

Answer: It depends on the state. All states have their own bankruptcy exemption laws, but regardless of whether a state opts out of the federal bankruptcy protections, retirement funds held within a tax-qualified retirement account must be protected from creditors in bankruptcy.

At first this might seem like a pretty simple rule—for example, 401(k) accounts, governmental 457(b) plans, 403(b) tax-sheltered annuities, and IRAs (up to $1,245,475) are all excludable from the bankruptcy estate. Does this mean inherited IRAs are protected as well? After all, an inherited IRA is still an “individual retirement account.”

On June 6, the Supreme Court addressed the issue of whether funds held inside an inherited IRA qualify as “retirement funds” within the meaning of the bankruptcy code. The Court held that they are not.

In Clark v. Rameker, Heidi Heffron-Clark, a Wisconsin resident, inherited an IRA from her mother. Ms. Heffron-Clark thereafter filed for bankruptcy and sought to exempt her $300,000 inherited IRA from the bankruptcy estate under the federal bankruptcy exemption laws. She argued that the IRA exemption applies, so she should be able to exclude the IRA from her bankruptcy estate.

The Supreme Court disagreed. It held that funds held inside an inherited IRA are not retirement funds. But how are funds held inside of a “retirement account” not retirement funds?

To fully understand the decision of the Court and its reasoning, it’s important to understand the difference between a traditional IRA and an inherited IRA.

With a traditional IRA the owner may make contributions until he turns age 70 ½, at which point he is required to start taking distributions (RMDs). Additionally, until he turns 59 ½, if he withdraws any money from his IRA, he faces a 10 percent penalty unless an exception applies.

On the other hand, inherited IRAs cannot receive contributions, so the owner may never invest additional money into the account. Additionally, regardless of the new owner’s age, he must take periodic distributions from the account or fully distribute it within five years. Finally, there are no penalties for taking distributions prior to age 59 ½.

After taking into account the differences between traditional IRAs and inherited IRAs, the Court looked at what it means for funds to be defined as “retirement funds.” It held that the term means “money set aside for the day an individual stops working.” It reasoned that funds inside an inherited IRA, which must be distributed either within five years from the original owner’s death or stretched throughout the life of the beneficiary, couldn’t possibly be set aside for a later date.

The Court also looked at the characteristics of an inherited IRA to determine whether funds held inside such an account could be viewed as money set aside for retirement. The Court pointed to three aspects of inherited IRAs to show that such IRAs are not retirement funds.

      • The holder of the inherited IRA may never invest additional money in the account.
      • The holder of the inherited IRA must take RMDs.
      • The holder of the inherited IRA may take distributions at any time without penalty.

Because inherited IRAs are much more restricted than traditional or Roth IRAs, the Court found that an inherited IRA should not be considered a retirement vehicle. Therefore, the funds inside an inherited IRA are not retirement funds for federal bankruptcy purposes and are not protected from creditors.

What is the lesson of the Clark case? Inherited IRAs are not protected under federal law during bankruptcy. States may still carve out their own exemptions for inherited IRAs, though.

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Ask the Experts – July 7, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: If my client has a simplified employee pension (SEP) plan and works after he turns age 70 ½, can he wait until he retires to start taking RMDs?

Answer: Unfortunately, the IRS says that even though SEP and SIMPLE IRAs are employer-sponsored retirement plans, they are still IRAs, and therefore the IRA rules for RMDs apply. An owner of an IRA must start taking RMDs in the year the taxpayer turns 70 ½, so even if your client keeps working, he will nevertheless be required to take distributions from his SEP plan.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Ask the Experts – June 23, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client owns an IRA and will turn 70 ½ next year. Since she still works and plans on working indefinitely, can she roll over the IRA to her 401(k) and thereby avoid having to take RMDs until she retires?

Answer: Yes. RMDs are not required to be taken from 401(k) plans until the latter of (1) the year the employee turns 70 ½, or (2) the year the employee retires. For your client, the latter will be the year she retires. On the other hand, IRAs are required to start RMDs in the year the account holder turns 70 ½.

However, when an account holder rolls over money from an IRA to a 401(k), the funds become part of the 401(k) and therefore are governed under the 401(k) rules—which means the account holder may defer RMDs until retirement.

Keep in mind that not all employer-sponsored plans allow rollovers, so check with the plan administrator first. Also beware of the restrictions attached to some employer-sponsored plans. For example, your client’s plan might not allow withdrawals from the 401(k) plan until she retires.

Finally, since your client turns 70 ½ next year, she will need to complete the roll over this year to avoid next year’s RMD.

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