Advanced Underwriting Consultants

Ask the Experts – April 1

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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 who’s receiving series of substantially equal periodic distributions for life (SEPL) under Section 72(t) from her IRA to avoid the 10% early distribution penalty. After starting the SEPL plan, she made a direct trustee-to-trustee transfer of the entire IRA balance to a new carrier, but the new carrier is reporting that no exception applies when it sends my client a 1099-R. What should she do?

Answer: Fortunately, Congress and the IRS make the rules—not your client’s new carrier—so as long as she follows the SEPL rules under Section 72(t), and if the direct trustee-to-trustee transfer doesn’t disqualify the SEPL, she will not owe a penalty on the distributions.

Ordinarily, the carrier files Form 1099-R when it makes a SEPL distribution and shows in Box 7 that an exception to the 10% early distribution penalty applies. If this is the case, the taxpayer is not required to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.

However, the carrier isn’t required to verify that an exception applies when it makes a distribution and sends out the 1099-R. In such cases, the carrier will generally claim in Box 7 that “no known exception” applies to the 10% penalty.

If this happens, the taxpayer will have to file Form 5329, assuming an exception actually applies. She will only be required to fill out Part I of Form 5329 with respect to this distribution, and it should show that no additional tax is required.

On a side-note, if the carrier reports on the 1099-R that no known exception to the penalty applies, and if the taxpayer agrees that the 10% penalty should apply, she can skip Form 5329 and directly report the penalty on her Form 1040, line 58.

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 – March 6

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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 deceased former client named her living trust the beneficiary of an IRA.  There are two primary non-spouse successor beneficiaries of the living trust.  Can the trustee of the trust arrange for the IRA account to be split into two parts—one for each beneficiary—and can each beneficiary stretch her own part based on her life expectancy?

Answer: No.

The general rule is that if an inherited IRA with multiple beneficiaries is divided into separate accounts, each beneficiary can stretch RMDs based on his or her own life expectancy.

Additionally, the beneficiaries of a trust (which itself is the named beneficiary of the IRA) may be treated as the designated beneficiaries—and qualify for stretch treatment—if four requirements are met:

1. The trust is valid under state law,

2. The trust is irrevocable or becomes irrevocable upon the death of the grantor,

3. The beneficiaries of the trust are readily identifiable from the trust itself, and

4. A list of beneficiaries or a copy of the trust is provided to the IRA by October 31 of the year following the date of the grantor’s death.

These types of trusts are referred to as look-through trusts.  The oldest beneficiary of a look-through trust is considered to be the designated beneficiary for stretch purposes.

It would appear that the combination of these two rules (separating an IRA and the look-through trust rule) would allow each beneficiary to stretch based on his or her own life. However, the IRS held in Regulation Section 1.401(a)(9)-4, Q&A-5(c), that if the IRA beneficiary is a trust, the IRA cannot be separated and stretched based on the lives of each individual trust beneficiary.

With proper planning, this problem could be avoided. For example, if the beneficiaries are widely separated in age, it may make sense to plan on the front end to divide the IRA into multiple accounts, and direct each of the accounts into separate look-through trusts for each one of the beneficiaries. This way, the IRA owner maximizes the control and tax aspects of the IRA planning.

However, in today’s question, there is only one living trust with two beneficiaries, and so separating the IRA into multiple accounts would not allow each of the beneficiaries to stretch based on each of their respective lives.

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 – February 25

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

Question: Does a direct trustee-to-trustee transfer of an IRA count as a rollover contribution for purposes of the one-rollover-per-year rule? Does a rollover from a qualified plan to an IRA count against the one-year rule?

Answer: No and no.

In Revenue Ruling 78-406, the IRS ruled that the one-year waiting period between rollovers applies only for 60-day rollovers—not for direct rollovers. For example, if an account holder has one IRA that he wants to split into three or more IRAs, he could do a 60-day rollover for one, and direct trustee-to-trustee transfers for the other IRAs.

The one-year waiting period also doesn’t apply for rollovers from a qualified plan to an IRA. The waiting period only applies to rollovers where the funds were received from an IRA—not a qualified 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 – January 20

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

Question: A client’s husband passed away naming an irrevocable trust as the beneficiary to his IRA. His surviving spouse is the sole beneficiary of the trust. Can she roll over her deceased husband’s IRA into her own IRA?

Answer: Possibly, but it will depend on how the trust is set up.

A surviving spouse who directly acquires a decedent’s IRA will be able to roll over the decedent’s IRA into the surviving spouse’s own account—even if the spouse is not the sole beneficiary of the IRA.

If the IRA beneficiary is a trust or estate, the answer becomes less definitive since the IRS has not yet addressed this specific issue outside of numerous Private Letter Rulings (PLRs). While PLRs cannot be relied upon for precedence, they can provide insight on how the IRS might view the issue in the future.

In PLR 201125047, the IRS stated the general rule that if the proceeds of a decedent’s IRA are paid to a trustee who then pays the proceeds to the surviving spouse as beneficiary of the trust, the surviving spouse will be treated as having received the proceeds from the trust—not the IRA itself. Therefore, under the general rule, the surviving spouse could not rollover the proceeds.

However, the IRS noted an exception. If the surviving spouse has the sole authority and discretion under the trust language to pay the IRA proceeds to herself, she may roll over such proceeds from the trust into her own IRA. But if someone other than the surviving spouse—e.g., a trustee—decides who receives the IRA funds, according to PLR 201125047, the surviving spouse would not be able to roll over the funds as they are distributed.

What happens if the trust document itself dictates that all or a certain ascertainable portion of the IRA goes to the surviving spouse? Does she have the “sole authority and discretion” under the trust language to distribute the proceeds to herself? If she has the complete right of withdrawal of the assets, then she should be allowed rollover treatment. PLR 201225020.  However, if there are substantial limitations on when the proceeds may be distributed, she might not meet the threshold of authority.

Another problem a surviving spouse might encounter is that the IRA custodian might not allow a direct trustee-to-trustee transfer to the surviving spouse’s own IRA. Under such situations, she would only be able to do a 60-day rollover.

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.

Question of the Day – July 17

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Here’s the question of the day.

Question: My client asked me about implementing a VEBA.  How does that work?

Answer: A VEBA is not a separate benefit plan, but is a way for an employer to set aside money for benefits.  The acronym VEBA stands for Voluntary Employee Benefit Association.  The VEBA itself is a kind of fund—usually in a trust—that is the conduit for funding employee benefits.

The main reason that life insurance professionals have advocated VEBAs is because, they argue, VEBAs coupled with certain IRS Code provisions allow permanent life insurance to be purchased by a business on a tax deductible basis without the premium being included in the participants’ taxable income.

VEBA plans are highly technical, complex and, from our perspective, tax risky.  In many cases, VEBAs have been paired with Section 419 planning to achieve the desired income tax results.  The IRS has effectively outlawed Section 419 plans funded with permanent life insurance.

In addition to the tax risk, an employer implementing a VEBA must be willing to pay the administrative costs associated with setting up and maintaining a VEBA trust.

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.

Question of the Day – Mach 27

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Here’s the question of the day.

Question: What is a special needs trust?

Answer: Those who want to make assets available to special needs beneficiaries should generally consider drafting a special needs trust.  A special needs trust or supplemental needs trust (SNT) is a specialized legal document designed to provide benefits to the beneficiary without adding to their countable net worth or countable income.

 

An SNT can be created to come into existence immediately, or it can spring into existence in the future.  For example, a special needs person’s parents might create an SNT inside of the last will or revocable trust.

An SNT enables a person with a physical or mental disability to have, held in trust, an unlimited amount of assets.  If the SNT is drafted and administered properly, those assets do not count against SSI or Medicaid eligibility.

An SNT gives the trustee the ability to provide for supplemental and extra care over and above that which the government provides. The SNT must not require, the trustee to make distributions for the special needs beneficiary, as such a requirement would cause the trust assets to count as available resources.

To be effective, SNTs must be irrevocable once they are created and funded. An attorney drafting the trust will coach the family about how the trust should be administered, and will include directions in the trust for its termination and ultimate distribution to family members or other beneficiaries.

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.

 

Question of the Day – March 5

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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 who participates in a nonqualified deferred compensation plan at his current for-profit employer.  The funds for paying the benefit are inside a Rabbi trust.  The client is entitled to a lump sum payment from the plan in six months.  Is there any option for deferring the client’s income tax result?

Answer: No.

Amounts paid under a nonqualified deferred compensation plan at a for-profit company are not eligible for tax-free rollover to any type of qualified plan—or any other investment.  The amount due under the plan is generally income taxable when paid.

In the past, some employers gave participants the option to choose to take an income stream rather than a lump sum at retirement.  Under the tax rules in effect at the time, the participant arguably didn’t realize an income tax result until the payments were actually received.

Under the Section 409A rules that have been in effect for the last few years, it no longer makes tax sense to draft deferred compensation agreements giving a participant the choice between a lump sum or income stream at retirement.

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.

Question of the Day – February 17

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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 married wealthy client who is purchasing permanent insurance on his life.  He wants the insurance to be excluded from his taxable estate, but also wants access to the policy’s cash values during lifetime.  Is it possible to do both?

Answer: Normally, if the insured wants to exclude the death benefit of an insurance policy on his life from his taxable estate, the insured must give up ownership rights in the policy in favor of a third party.  Commonly used third parties are adult children or irrevocable life insurance trusts (ILITs).

If the insured creates an ILIT to own life insurance for the purpose of estate tax avoidance, the trust must not give the insured any right to reach in and enjoy the assets during the insured’s lifetime.  Since that’s the case, the insured normally can’t achieve both estate tax exclusion and lifetime access to a policy’s cash value.

However, if the insured is in a stable marriage, access may be achieved indirectly through the insured’s spouse.  So, for example, if the insured creates an ILIT to own a permanent life policy, the ILIT may allow the insured’s spouse to have some access to the policy’s cash value during the lifetimes of the insured and the insured’s spouse.  This kind of ILIT is sometimes referred to as a spousal lifetime access trusts (SLAT).

The technique has some drawbacks.  The trust needs to be carefully drafted and funded to avoid inadvertent inclusion of the life proceeds in the estate of the insured.  Also, if the couple gets divorced or if the spouse dies before the insured, access to the policy’s cash values may be lost.

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.

Question of the Day – November 15

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

Question: My client wants to take care of young beneficiaries with her life insurance policy.  What’s the best way for her to do that?

Answer: In a perfect world, our clients would always create trusts to manage and distribute money for the benefit of young beneficiaries.  However, trusts cost money and substantial effort to create.  They are also costly and time-consuming to administer.

For many, trusts can be created inside of last wills to take care of children.  Such trusts are called testamentary trusts.  Some of our clients still are not candidates to create those because of the effort and cost involved.

To help create practical choices for taking care of money for young family members, the state governments came together to essentially create simplified trusts.  The first set of these rules were the Uniform Gifts to Minors Act (UGMA).  Since UGMA and its variations were enacted, the state governments came up with a new, improved version of the rules called the Uniform Transfers to Minors Act (UTMA).

Together, UGMA and UTMA accounts are referred to as custodial accounts.  Custodial accounts name a minor beneficiary and a custodian, who is likely to be a responsible adult.

Naming a custodial account the beneficiary of a life insurance policy might be the best practical choice when a client cannot or will not create a trust for the beneficiary of a minor.

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.