(Image: Shutterstock)

It is not unusual in a blended family situation for a client to completely divide his or her estate so that the two sides, i.e., the partner step-parent and the client’s children, would possess independent shares of the estate and not share temporal interests in any part of the estate.

Such a dispositive plan can extend to non-probate property in general and qualified retirement plans and IRAs in particular. If the account holder desires to make a trust the beneficiary of plan benefits and to incorporate estate tax planning, the only safe way to do maximum estate and income tax planning for plan benefits is to use a fractional formula division between the credit shelter trust and a marital deduction trust.

Where there is a blended family situation, it is not unusual to see the plan benefits first allocated to the marital trust. It is very important for an account holder to immediately change a beneficiary designation upon divorce, or they will have to depend upon the ex-spouse beneficiary to disclaim the interest unless a state statute divests the ex-spouse of any interest in the plan.

Given the advantage of naming a spouse as beneficiary, it may be better to name the spouse as beneficiary and compensate the children with other assets. Quite often, the most simple and certain solution is to make gifts of cash to adult children who use that money to purchase life insurance on their parents’ lives or to create a trust for children to own the policy and receive the life insurance proceeds.

‘Short’ List of Factors to Consider

Below are some questions to consider when planning for IRAs and qualified plans for a client with a blended family.

1. Plan Documents:

  • Obtain a copy of the qualified plan/IRA document.  A Summary Plan Description is insufficient.   What does the qualified plan/IRA document permit or restrict?  IRAs can be made very flexible by additions to the document.  Will the distribution options within the qualified plan/IRA document qualify for the marital deduction (greater of minimum required distribution or the trust’s income for the year)?
  • Will the document require or permit recalculation of the participant’s life expectancy? What about recalculation of the non-participant spouse’s life expectancy?
  • Does the document permit the beneficiary to take all of the money out of the qualified plan/IRA? If not, what are the distribution options?

2. Beneficiary Designations:

  • What is on file? Get confirmation letter from custodian or administrator.
  • Who are the contingent beneficiaries?  If the participant does not name any beneficiaries, what does the plan document provide?   Can disclaimers be used?  Should they be used?

3. Client’s Goals and Objectives:

  • These may be limited by the client’s income needs. With respect to qualified plans but not IRAs, these usually are limited where the participant is married by REA. Under REA, a non-participant spouse is entitled to a joint and survivor annuity in a qualified plan if the participant dies after retirement as well as a preretirement survivor annuity if the participant dies prior to retirement, or a spousal benefit in most defined contribution plans. (Code Sections 401(a)(11), and 417.) These rights may be waived only in very restricted circumstances and under strict rules. (Treas. Reg. Sec. 1.401(a)-20, Q&A 31.)

4. Client’s Income/Cash Flow Needs:

  • Should examine potential income sources and cash needs of the client, spouse and beneficiaries both before and after age eighty-five.

5. Client’s Family Situation:

  • Children of prior relationships will require more careful planning. 
  • Relationships between spouse and children and children between themselves?
  • Status/strength of marriage? 
  • Ability of spouse and other beneficiaries to manage money?

6. Ages of Participant, Spouse and other Beneficiaries:

  • Minimum Distribution Incidental Benefit Rule (“MDIB”), which limits, for purposes of calculating the minimum distribution, the age of any person other than the participant’s spouse is limited at most to a ten (10) years less than the participant. Code Section 401(a)(9)(G).
  • Required  Beginning Date (“RBD”)—with one limited exception for participants in qualified plans who own less than 5 percent of their employer, April 1 of the year following the year that the participant or beneficiary (depending upon the circumstances) attains the age of 70½. Code Sections 401(a)(9) (as to qualified plans) and 408(a)(6) (as to IRAs).
  • 10 percent penalty for premature distributions. (Code Sections 72(t) and 4974(c).)
  • 50 percent penalty for failure to make minimum required distribution.  (Code Section 4974(a).)
  • Recalculation of life expectancy of the participant and/or the participant’s spouse (but no one else).  (Code Section 401(a)(9)(D).)

7. Estate Tax Considerations:

  • Estate tax apportionment—Who will be responsible for the federal estate tax on the benefits still in the qualified plan/IRA?  Where will those taxes come from?

8. Access to Capital Needs:

  • Even though income needs may be satisfied in projected fashion, what is the chance for needed access to the plan balance?  Do the plan documents and any trust set up to receive that balance permit access for such need?

9. Estate Tax Liquidity:

  • Is any liquidity set aside from which to pay estate tax on the qualified plan/IRA balance?
  • If so, who controls it?  (Hopefully, it will be controlled by the person who ultimately will owe the estate tax.)

10. Ethical Considerations:

  • No ERISA or REA rights in IRA’s for non-participant spouses where the participant retires and rolls over qualified plan balances into an IRA.  (DOL Sec. 2510.3-2(d); IRC Secs. 401(a)(11) and 417.)
  • Reliance on disclaimers or on the non-participant-spouse to “do the right thing.”  (See, e.g., Bank One Milwaukee, N.A. v. Fueger, 201 Wis. 2d 216, 549 N.W. 2d 742 (Ct. App. 1986).)

11. Client’s Age and Health: 

  • Are there health disparities between the participant and the participant’s spouse?
  • What is the family history of illness and life span?

12. When Expert Assistance Is Needed:

  • Who will compute the required minimum distributions? The penalty is 50 percent of what should have been distributed but was not.
  • The client should come visit you at the following times:

A.  Upon becoming a participant in a qualified plan.

B.   Prior to marriage while a participant in a qualified plan.

C.   Upon separation from service, e.g., retirement, layoff or changing jobs.

D.  Upon attaining age 59½.

E.   Upon the death of a named beneficiary.

F.   At age seventy (gives you some time before the required beginning date).