The new Pension Protection Act of 2006, which was signed into law on August 17, 2006, creates new opportunities for retirement planning. Two outstanding features are: (1) non-spousal rollovers from a qualified plan to an Inherited IRA, and (2) charitable contributions of IRAs during lifetime.
Up until the enactment of the new Pension Protection Act of 2006, only a surviving spouse could rollover a qualified plan to an IRA after the participant’s death. Once the rollover occurred, it was as though the surviving spouse had created their own IRA for which they could then defer the required minimum distributions until their reaching age 70½. At that point, they would then need to withdraw the required minimum distributions over their lifetime.
The new law does not impact spousal rollovers. A rollover can still be made by the spouse to their own IRA after the death of the owner.
However, a beneficiary other than a surviving spouse, i.e. a child or unmarried partner, had been in the past forced to withdraw the qualified plan in full and pay income tax on the amount over the period set forth in the plan agreement. This period was typically one to five years after the plan owner’s death. A non-spouse beneficiary could not defer income tax by stretching out the distributions over their life expectancy.
Now, beginning January 1, 2007, a non-spouse beneficiary will be able to rollover a qualified plan into an Inherited IRA after the plan owner’s death. This rollover can even be done if the owner names a trust as the beneficiary of the qualified plan. In this case, the trustee of the trust must rollover the qualified plan to an Inherited IRA on behalf and for the benefit of the trust beneficiary.
There are several advantages to a client naming a trust as a designated beneficiary. The first is protecting the assets from creditors, including any former spouses of the beneficiary. In addition to creditors, spendthrift beneficiaries, who often withdraw far more than the required minimum distributions, can now be protected as well. Lastly, the naming of a trust will allow the owner’s financial advisor to continue to manage the assets as the owner had desired.
A non-spouse beneficiary naming an Inherited IRA can now use their own life expectancy in determining the required minimum distributions. This will significantly reduce the amount the beneficiary must withdraw each year, allowing for further deferrals of income tax and providing the ability for the account balance to continue to grow income tax-free. However, a non-spouse beneficiary must begin taking the required minimum distributions from the Inherited IRA by December 31 of the year following the year of the owner’s death. This is different from a spousal rollover, where the surviving spouse is able to defer the required minimum distribution until the attainment of age 70½.
A key ingredient necessary for the rollover to work is the non-spouse beneficiary must direct the trustee of the qualified plan to rollover the assets directly into an Inherited IRA. In other words, a trustee to trustee transfer. In addition to this requirement, and unlike the spousal rollover, the IRA must remain in the name of the deceased owner.
It is critical to avoid re-titling the qualified plan in the name of the non-spouse beneficiary. Also, one must avoid transferring the qualified plan to an existing IRA in the non-spouse beneficiary’s name. Both of these actions will constitute a taxable distribution of the entire amount. In other words, the Inherited IRA should be titled as follows: Joe Participant, Deceased, IRA f/b/o Alice Participant (Beneficiary). Remember, any distribution to a non-spouse beneficiary is a taxable event and subject to income tax. Therefore, all distributions should be made payable directly to the Inherited IRA.
If you currently have a qualified retirement plan, this is the time to check with your plan administrator to determine whether your beneficiary designation is set up to take full advantage of the stretch out now allowed in an effort to defer income taxes.
For taxpayers who are philanthropically motivated, the new act provides that in 2007 a taxpayer who is at least 70½ years old can contribute to a charity an amount up to $100,000 from one or more individual retirement accounts (IRA).
It is important to realize that distributions from a SEP IRA, Simple IRA, or a qualified plan are not eligible because they are not distributions from an IRA. If the desire is to contribute to a charity, then consider rolling your qualified plan assets into an IRA in order to take advantage of this new opportunity.
An advantage in making contributions to a charity is to allow the IRA custodian to make a direct transfer to a public charity. This will allow the taxpayer to avoid having to report the distribution as taxable income. Unlike a typical IRA distribution, the direct distribution to the charity will not appear as taxable income on the taxpayer’s tax return. However, because the distribution does not appear as income, the taxpayer will not get an offsetting charitable income tax deduction to reduce the income created by the IRA distribution. It is important to remember the check must be made payable directly to the charity. If the check is made payable to the IRA owner then endorsed over to the charity, the owner will have to report the distribution as taxable income.
Public charities include religious organizations, schools, etc. Unfortunately, the act does not provide for donor-advised funds, supporting organizations, and charitable remainder trusts. A significant benefit to this provision of the act is that charitable contributions that meet the above requirements will satisfy the taxpayer’s required minimum distribution for the year of distribution. Individuals who may want to consider the advantages of contributing directing from their IRA to a charity would include:
Individuals who currently claim the standard federal income tax deduction: These individuals, who do not itemize, will get the equivalent of an unlimited federal charitable income tax deduction up to $100,000.Individuals who would lose phased-out deductions with increased income: These individuals should consider this approach because under the new law, a direct contribution of an IRA up to the $100,000 limit does not increase the taxpayer’s adjustable gross income, nor does it impact any other deductions.Any individual who is subject to the 50% limitation on Adjusted Gross Income (AGI): A direct contribution to a charity of up to $100,000 will not be subject to the typical 50% of AGI cap for cash contributions to a public charity.
For the above reasons, including the desire to benefit your favorite charity, one should consider making the direct contribution from their IRA in the year 2007.
As always, it is important for you to consult with your tax advisor when considering any of the above provisions,