Life Expectancy Death payments under a Keogh

[mwyatt]

It has been clarified that non-spouse beneficiaries have the same right to get minimum distributions over their lifetime from the account of a deceased participant in a qualified pension plan as they would as if the money was in an IRA. However:

This is all well and good if the participant was in a large plan expected to continue in the future. What about the non-spouse beneficiaries of a one-man plan? Obviously, for the benefits to be paid well into the future, the plan itself must continue. However, the plan sponsor (as well as the sole participant) is no longer with us. How to handle this?

A situation that has been posed to us is a self-employed Keogh PS plan where the 2 adult children are the named beneficiaries (no spouse involved). The 2 kids are both self-employed, therefore there is a basis for establishing a new qualified plan and/or taking over from the prior sponsor (namely their mother).

Any thoughts out there? The brokerage firm who handled the plan has been giving some obtuse advise (first response was to establish trusts under the plan's name for each kid - didn't think you could continue plans too long without a sponsor).

[chris]

Had a similar situation where the brokerage firm suggested that the Plan buy an annuity for each of the children. They had come up with some reason such that doing so wouldn't require a 5500 each year. Also, since the annuity met certain requirements, the beneficiaries were not taxed on the entire $$$$ amount used to fund their annuities but were taxed on payments as each one was received. Don't know that that helps you in any regard, but.....

[Guest P A Weick]

IRS had a similar situation where they approved of an annuity purchase for beneficiaries in PLR 200244023. Not exactly your situation but perhaps it can help.

[mbozek]

Since the plan will be terminated when the Sole propreitor dies there are four possible options:

1. Buy immediate annuity for each beneficiary to make payments

2. pay a lump sum to each beneficiary.

3. If decedent established an IRA naming one or both children as beneficaries maybe there could be a trusteee to trustee transfer from the Keogh to the IRA. Dont know of any ruling involving non spouses but there is a ruling allowing a tax free transfer from a qualified plan to an IRA in which the spouse was the beneficary. PLR 9418034. This may not work for non spouses because there can be no tax free rollover.

4. I dont know if the plan can be kept in existance for 5 years after death of the owner and make 5 annual installments. The IRS used to believe that a plan could not continue if the sponsor died or was liquidated.

[mwyatt]

Thanks Mbozek for your comments. The issue of course is some sort of deferral of taxes to the beneficiaries. If this account was part of ACME Co., wouldn't be quite the problem, especially after clarification of rules that non-spouse beneficiaries can receive minimum distributions (hence sidestepping the 5-year rule). However, this all falls apart in the case of a small plan that has its life expectancy tied to the plan sponsor. Rule of thumb is to never die before rolling your balance to an IRA, I guess...

[Mary Kay Foss]

I'm surprised about your initial premise that nonspouse beneficiaries can receive RMDs from a qualified plan. The 401(a)(9) regulations allow it but I've yet to see a qualified plan that will allow a nonspouse beneficiary any deferral at all. The plan document always trumps the law.

Actually the larger companies seem more interested in paying off nonspouse beneficiaries rapidly than the small ones. I guess they have enough trouble dealing with their ex-employees and don't need to deal with ex-employee's heirs.

I recommend that all my single clients roll qualified plan benefits to an IRA whenever they have a distributable event. I've also recommended that Keogh and closely-held small employers allow in-service distributions before retirement. Periodically they can roll most benefits to an IRA aand reduce the risk of having a nonspouse beneficiary having to take payments out of the qualified plan over a short time period.

My understanding is the same as a previous poster that the IRS doesn't like qualified plans without an employer. To avoid trouble I think they should be shut down as soon as possible - 5 years sounds too long.

[Appleby]

mbozek,

In your post, # 3 would not be an option for a non-spouse beneficiary, as non-spouse beneficiaries are not allowed to rollover death distributions from qualified plans. IRC § 402©(9); Treas Reg § 1.402©-2,

I agree with Mary Kay about five years being too long. IMO, the plan should be terminated by the end of the year following the year of death ( if not sooner)

When you have a situation such as that posted by mwyatt, you now have an orphan plan or wasting trust. There are several issues here that would suggest that an orphan plan must be terminated promptly in order to prevent the plan from losing its qualified status.

An orphan plan cannot be continued for an extended period, as a qualified plan must be maintained by an employer IRC 401(a). If the sole proprietor dies, then there is no employer to maintain the plan. Therefore the successor trustee (assuming there is one- if there is not, we have a different issue/challenge) must terminate the plan as soon as administratively feasible

There is the issue of updating the qualified plan for tax law changes. If there is no employer, it is likely that the plan would not be amended for tax law changes...Beneficiaries may not be aware of this requirements

Important reminder…the plan must be amended for GUST prior to termination.

[mwyatt]

OK, a couple of points. Plans can now pay out RMDs to non-spouse beneficiaries; see the updates to the Relius checklists if you disagree. If your high-end clients haven't expressed interest in this type of tax minimization technique, they will. Of course as you say it'd be best to have this happen in an IRA; however one can't typically foresee the time of one's demise.

We aren't talking about $2,500 death benefit distributions here, we're talking about one-man plans with 6 or 7 figure balances (and this is also that same deceased person who has been paying your invoice over time). So you may want to just pay out the plan and be done with it, but the beneficiaries may have different ideas other than paying taxes immediately on the distribution, especially if there are methods available to lessen the tax bite.

[mbozek]

The IRS has not formally articulated a policy toward orphan plans and I have seen many qualified plans in which the owner died years ago continue on with assets for the benefit of the spouse or the children and the plans are amended for changes in the tax law. These plans are under the IRS radar screen because the service has no way of identifying them other than by an individual audit. The beneficaries may elect to take a business risk and have the payouts made under the MRD rules and out run the 3/6 year s/l if the plan is audited.