Tax Planning for Retirees

Estate Tax on Retirement Benefits

Increased Gift and Estate Tax Rate. – For gifts and deaths in years after 2012, the gift and estate tax rate is increased to 40 percent. The rate was 35 percent for years 2011 and 2012. The gift and estate tax exclusion continues at $5,000,000, adjusted for inflation. Any unused exclusion amount also continues to be portable between the estates of spouses, provided a valid election is made. (American Taxpayer Relief Act of 2012, HR 8, 112th Congress, § 101(e).) See Chapter 20 of the treatise for a discussion of the estate tax treatment of retirement benefits.

Combining Income Tax Deferral with QTIP Treatment. – If a retirement plan or IRA distributes a lump sum to a QTIP trust upon a retiree’s death, the excess of the lump sum over the retiree’s investment will immediately become subject to income tax. However, it may be possible to enjoy income tax deferral, while retaining QTIP treatment, by paying the benefits as an annuity or in installments. Note also that, with proper structuring, both income tax deferral and QTIP treatment may be available for installment payments to a trust from a nonqualified plan. (Rev. Rul. 2006-26, 2006-1 C.B. 939, Ltr. Rul. 9040029.) See Chapter 20 of the treatise for a discussion of the estate tax treatment of retirement benefits.

Beneficiary Income from Retirement Benefits Unaffected by 2010 Estate Tax Election. – The estate of a retiree dying in 2010 may elect not to pay estate tax. The downside of the election is that property passing from the retiree at death will generally not receive a step-up in basis to fair market value. Instead, the decedent’s basis in the property will generally  carry over to the recipients of the property for income tax purposes.

However, retirement benefits do not receive a basis step-up for income tax purposes whether or not the election is made. Thus, the election not to pay estate tax for a decedent dying in 2010 generally has no effect on the amount of taxable income derived by beneficiaries from receipt of the decedent’s retirement benefits. (Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, HR 4853, 111th Congress, § 301(c); I.R.C. §§ 691, 1014(f), 1022(f).) See Chapter 20 of the treatise for a more complete discussion of estate taxes and their implications.