Multigenerational Trust Planning With Qualified Retirement Plans
The incredible growth power of the multigenerational ("Stretch QRP"), the non-spousal beneficiary's ability to choose "rollover" and the mathematics that drive the stretch revealed.
March 20, 2008
by Joseph Welch, JD
When Albert Einstein was asked to name the most powerful force in the universe, he paused thoughtfully, and then answered, "Compound interest." The "Stretch QRP" (sometimes called the "Stretch IRA" or "Multigenerational IRA") couples the power of compound interest with the additional benefit of long-term tax deferral. Result: Compound interest on steroids!
History and Basics
Roth and Traditional IRAs, 401(k)s, 403(b)s, SEPs (Simplified Employee Pension plan), SIMPLEs (Savings Incentive Match Plan for Employees) and other tax-qualified funds all share a significant benefit: income tax deferral.
Historically, qualified retirement Plans (hereinafter "QRPs") were taxed so heavily at one's death that, in an estate subject to federal estate tax, 75 percent to 96 percent of the funds were lost to a combination of federal estate taxes and federal and state income taxes. (Prior regulations required payout of the entire account balance by December 31 of the year following the Owner's year of death, triggering immediate state and federal income taxation.)
Even now, estate plans prepared by those who lack the training and information to utilize the "Stretch QRP" technique properly continue to suffer radical losses to taxation. (If the Plan Owner is survived by a beneficiary spouse, this loss may not occur upon the Owner's death, but may be deferred until the death of the surviving spouse.) However, huge tax losses are not necessary — they are avoidable by planners who are aware of the powerful techniques available for these special assets which allow continuation of the tax deferral feature past the Plan Owner's lifetime.
About the "Stretch QRP"
The "Stretch QRP" was enabled by the IRS' passage of the Temporary Regulations on December 29, 1997. Since then it has been possible, with a properly designed estate plan, to pass the entire fund on to a succeeding generation in the same type of tax-deferred form which provided accelerated growth to the account Owner during their lifetime. Income taxes on the growth continue to be deferred each year, even after the beneficiary inherits the account.
The beneficiary is obligated to withdraw Required Minimum Distributions (hereinafter "RMDs") and those withdrawals are taxed as ordinary income, but the RMDs each year generally remain smaller than the annual growth on the account until late in the beneficiary's lifetime. This causes the account to continue to grow larger, tax deferred, which generates even larger RMDs, allowing the account balance to produce very impressive lifetime benefits to the beneficiary.
The Power of Tax Deferral
In order to maximize the period of tax deferral over the largest available dollars, the beneficiary should withdraw only the RMD each year. The chart below illustrates the growth potential of one dollar kept in a tax-deferred account over a term of years:
It is obvious that a primary goal of "stretch" planning should be to keep your assets in the tax-deferred column as long as possible. Because of the potential of these investments to produce huge amounts of both asset growth and income over the life expectancy of the beneficiary generation (e.g. usually a child, grandchild or great-grandchild) it is extremely desirable to insulate those assets from creditors, predators and premature "spenddown" by using protective trust techniques.
Plan Distribution Options
A Plan Owner's ability to do the "Stretch QRP" presupposes that the retirement Plan allows for payout of Plan proceeds over the life expectancy of a non-spousal beneficiary. However, very few 401(k), 403(b) or 457 Plans allow for payout over the life expectancy of a non-spousal beneficiary. Consequently, if the Plan Owner desires the advantages of the "Stretch QRP," you should confirm with the Plan administrator that the Plan allows payout over the life expectancy of a non-spousal beneficiary.
If the Plan does not allow payout over the life expectancy of a non-spousal beneficiary, the Owner should consider rolling the account over into an IRA when the Owner retires, which typically does allow payment over the life expectancy of a non-spousal beneficiary (CAUTION: In some states, the Owner could be reducing the available asset protection by switching from a 401(k) to an IRA; check your state exemption law).
Rollover for Non-Spousal Beneficiaries
There is now a way to enable a "Stretch QRP" even if the Owner's plan does not allow distributions over the life expectancy of a non-spousal beneficiary. Since the Pension Protection Act of 2006, a non-spousal beneficiary may be able to roll the qualified Plan proceeds over from a QRP which does not allow a non-spousal beneficiary to withdraw distributions over his or her life expectancy to a QRP (usually an IRA) established by the beneficiary. However, the beneficiary should not accept a check from the Plan administrator — the only tax-deferred option for an inherited QRP for a non-spousal beneficiary is a Trustee-to-Trustee transfer into the new QRP. The new IRA should remain titled in the deceased Owner's name, for the benefit of the beneficiary (e.g. John Q. Owner f/b/o Jack, Jr.).
A non-spousal rollover is not the same as a spousal rollover. In a spousal rollover, the spouse is treated as the account Owner and may choose to defer distributions until he or she attains age 70½, at which time RMDs will be based on the Uniform Table. The non-spousal rollover beneficiary must treat the rollover as an inherited IRA and begin taking RMDs immediately (actually by December 31 of the year following the year of the Plan Owner's death) based on their own life expectancy as determined on the Single Life Table. CAUTION: "Stretch QRP" regulations are fast-changing and you should always check with competent counsel on the current state of the law regarding distribution, rollover and inheritance decisions.
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Joseph D. Welch, J.D., is the managing partner of Cary, Welch and Hickman, L.L.P. and the founder and manager of The Estate Planning Center, L.L.C. His practice is limited to estate planning, trust administration, asset protection and business succession planning. He is a frequent author and lecturer on estate planning topics. You can reach him at 866-566-0088.
IMPORTANT: This brief summary of planning ideas is for discussion purposes only. It does not contain legal, tax, investment or insurance advice and cannot be relied upon for implementation and/or protection from penalties. Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.
Unless otherwise expressly indicated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.