10.7 Qualified Plan and Ira Retirement Benefits

• Library: Estate Planning in Virginia (Virginia CLE) (2018 Ed.)

10.7 QUALIFIED PLAN AND IRA RETIREMENT BENEFITS

10.701 Introduction. Qualified retirement plans and individual retirement accounts (IRAs) form a substantial part of an estate planning client's wealth in many cases, and the client will look to the estate planner for advice regarding beneficiary designations and distribution planning for retirement and death benefits. The following paragraphs examine the various tax and estate planning considerations involved, with an overview of the myriad rules and guidance in the difficult areas of distribution planning and beneficiary designations. The discussion considers primarily retirement plans qualified under I.R.C. § 401(a) and individual retirement accounts governed by I.R.C. §§ 408 and 408A.

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Since IRAs for the most part involve the same rules and considerations as pension and profit-sharing plans in terms of distribution and beneficiary designation planning and taxation, the term "plan" or "retirement plan" in this discussion includes pension and profit-sharing plans and IRAs unless otherwise noted. The term "qualified plan" includes I.R.C. § 401(a) (basically, pension and profit-sharing) plans, but not IRAs or SEPs (discussed below). The term "participant" or "plan participant" means an employee or a self-employed person who is a participant in a pension or a profit-sharing plan and the employee or self-employed person for whom an IRA account has been created.

A. 2001 Tax Act. The 2001 Tax Act enacted scores of provisions relating to retirement plan reform. These include increased contribution and benefit limits for qualified plans and IRAs, with catch-up contribution provisions for persons 50 years of age or older. Other provisions relate to (i) qualified after-tax Roth contributions to I.R.C. § 401(k) and 403(b) plans; (ii) changes in pension funding rules; (iii) nondiscrimination and coverage rules; and (iv) liberalization in the rollover rules to allow rollovers from IRAs (no longer just "conduit IRAs") to qualified plans. A detailed treatment of these changes is beyond the scope of this chapter, although they will be discussed where pertinent. ²⁰⁷

B. Minimum Distribution Rules. The Treasury Regulations governing required minimum distributions from retirement plans are very detailed and beyond the scope of this discussion. ²⁰⁸ The reader is encouraged to review the regulations themselves and the various articles published on the subject, ²⁰⁹ as well as those that will undoubtedly ensue.

C. Pension Protection Act of 2006. The Pension Protection Act of 2006 ²¹⁰ focuses primarily on pension funding and disclosure rules, but it

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also makes changes relating to pension plans and plan beneficiaries, including liberalized payout and rollover provisions. While a detailed discussion of the Act is outside the scope of this chapter, key provisions are noted where appropriate. The increased contribution limits under the 2001 Tax Act, which had been scheduled to expire in 2010, were made permanent in the Pension Protection Act of 2006.

D. Heroes Earnings Assistance and Relief Tax Act of 2008. The Heroes Earnings Assistance and Relief Tax Act of 2008 (Heroes Act) ²¹¹ provides various forms of relief that affect retirement plan benefits available to United States military service members, such as expanding the ability of service members to receive qualified plan distributions and requiring that qualified retirement plans provide increased survivor benefits to survivors of service members who die on active duty. In addition, the Heroes Act requires that any differential wage payment made by an employer after January 1, 2009 to an employee on active duty be treated as compensation for retirement plan purposes. ²¹² A differential wage payment is the difference between what the employee would have received from the employer but for the active military duty and the compensation the employee received for the active military duty. The Heroes Act is discussed elsewhere in this chapter where applicable.

10.702 Types of Plans.

A. Defined Benefit. Defined benefit plans, usually referred to as pension plans, provide "definitely determinable benefits" that the employee participant will receive upon retirement. The benefit is determined by a formula based on length of service and compensation, and the employer funds the retirement plan based on actuarial assumptions projected to provide the periodic retirement benefit at the employee's retirement date. The defined benefit plan (and the money purchase pension plan discussed below) are required to offer annuity payments at retirement (or at death before retirement, if there is a surviving spouse). Such a plan may or may not offer a lump sum option. No plan participant has an individual account balance set aside for him or her.

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B. Defined Contribution.

1. In General. Defined contribution plans, sometimes called "individual account plans," provide an individual account for each employee participant and benefits based solely on the employee's account balance at the date benefits are payable. The account balance includes employer contributions, employee contributions, forfeitures from other employees' accounts, and net income or gain from account assets. Thus, a defined contribution plan provides benefits based on actual contributions and any earnings or growth on them, rather than benefits formulaically projected with funding based on actuarial assumptions as provided in a defined benefit plan.

2. Profit-Sharing Plan. One type of defined contribution plan is a "profit-sharing" plan, in which the employer makes contributions based on profits or without regard to profit, either annually or otherwise. Thus, the profit-sharing plan would be more appropriately called a "discretionary contribution" plan rather than a "defined contribution" plan. In any event, employer contributions are allocated among the participants' accounts, which will be credited with plan earnings and growth.

3. Money Purchase Pension Plan. This plan appears to be misnamed, since the money purchase pension plan basically operates just like a profit-sharing plan, except that the employer's contributions are based on a predetermined formula set forth in the plan rather than allowing a discretionary or variable contribution. It is called a pension plan because, by virtue of the predetermined formula, employees' benefits are actuarially deter-minable.

4. Thrift Plan. This plan also uses individual account balances to fund benefits, its principal feature being that the employer will contribute to the participants' accounts based on the participants' contributions of their own funds to the plan.

5. Stock Bonus Plan. This plan is comparable to a profit-sharing plan, except that the accumulated benefits are distributable in the stock of the employer company, although cash can be used under certain options. An employee stock ownership plan (ESOP) is basically a stock bonus plan.

6. Target Benefit Plan. In this money purchase pension plan, employer contributions are allocated to participants on the basis of a plan formula designed to provide a target benefit for each participant. The

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participant receives the amount of his or her account balance whether or not the target benefit is actually achieved.

7. 401(k) Plan. This popular plan is a deferred compensation arrangement that allows participants to elect to receive bonus or salary or to have those amounts contributed to the plan on a pre-tax basis. Many plans operate with a salary reduction arrangement. The elective contribution limit is $18,500 for 2018 and will be inflation-adjusted in future years. A participant's plan contributions are often matched by employer contributions to some degree.

I.R.C. § 414(v) allows additional plan contributions for participants aged 50 and older, commonly referred to as "catch-up" contributions. The catch-up contribution limit is $6,000 in 2018, with adjustment for inflation in future years.

A "qualified Roth contribution program" (also known as a "Roth 401(k)") can be included in a section 401(k) plan. ²¹³ A Roth 401(k) plan allows participants to elect to have all or part of their elective deferrals to the 401(k) plan treated as contributions to a Roth IRA. ²¹⁴ Employers may make matching contributions on employee-designated Roth 401(k) contributions, but any such matching contributions must be held in a separate pre-tax account within the plan. The adjusted gross income limits that apply to contributions to Roth IRAs do not apply to contributions to Roth 401(k) plans, and, like contributions to Roth IRAs, contributions to Roth 401(k) plans are not excluded from the participants' income. A participant may roll over a Roth 401(k) account into another Roth 401(k) account or into a Roth IRA. ²¹⁵ Qualified distributions from a Roth 401(k) are not includible in gross income. ²¹⁶

8. Deemed IRA. A qualified employer plan may elect to allow participants to make voluntary employee contributions to a separate account established under the plan (the "deemed IRA"). ²¹⁷ The deemed IRA must, under the terms of the plan, meet the requirements for a regular IRA

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or Roth IRA. ²¹⁸ Contributions to the deemed IRA are treated as contributions to an IRA and not as contributions to the qualified plan, and the applicable limits on the amount of annual contributions to IRAs and any applicable income limits apply. ²¹⁹

9. SIMPLE Plan. An employer with 100 or fewer employees each of whom received at least $5,000 in pay in the preceding year may adopt a savings incentive match plan (SIMPLE plan) if the employer has no other qualified plan. Employees can contribute up to $12,500 in 2018, and contributions will be inflation-adjusted in future years. ²²⁰ The employer under a SIMPLE plan must either make matching contributions of three percent of compensation (but not to exceed the employee's deferrals) or contribute two percent of the total compensation of all...