Best Use of Beneficiary Forms: Qualified Disclaimer Estate Planning
Qualified Disclaimer Estate Planning is the most flexible and tax-efficient way to pass on pre-tax retirement accounts to your family. While thinking about death and taxes is not much fun, both are going to happen at some point. Someone is going to pay the taxes after you die! Might as well make a plan!
What is Qualified Disclaimer planning and how can you use it in your estate plan? If you have a large amount in your pre-tax retirement accounts, pay attention! With just a minimum amount of planning, you can save a huge amount in taxes and give your spouse and children the flexibility to spilt your wealth after your death.
What is the Purpose of Qualified Disclaimer Planning?
Let’s start with the basics.
First, when you have pre-tax retirement accounts such as IRAs and 401k plans, the assets pass at your death via a beneficiary form. Not a will or trust, only via the beneficiary form.
It is almost never appropriate to name your estate as beneficiary of these pre-tax retirement accounts. This drags them back into probate which is inefficient and can be costly.
Next, trusts are poor beneficiaries of pre-tax accounts! Read that sentence again. If a trust is the beneficiary of your IRA and you don’t need to control the money from the grave, chances are you needlessly lose 40% of the money due to taxation. If you don’t get that, read my blog on the 10-year rule and retirement accounts.
So, the obvious question is: who should be beneficiary of your pre-tax retirement accounts? Well, it depends on the purpose of the money!
Remember the “I” in IRA stands for individual. It is yours until you die. You cannot transfer it to a charity or even to a spouse or child while you are alive (without paying the taxes first).
This money has not been taxed yet, and when you die, it is called “INCOME in Respect to the Decedent.” This IRD is treated differently than other assets in your estate. It still needs to be taxed! Remember, when you die your IRAs are not assets, they are deferred income that will be taxed.
The purpose of disclaimer planning is to allow the family member who needs the money to access it in the most tax-efficient way. Qualified disclaimer estate planning is tax-efficient, and it is flexible.
What is Qualified Disclaimer Estate Planning?
Since most of us don’t really know when we are going to die, it is really hard to plan for IRDs in an IRA. What tax bracket is your spouse in after you die due to the widow/widower tax penalty? It depends on when you die and other income sources that go with you. Or, what about the tax bracket of your children for the 10-years after you die? Who knows! But post-mortem, they might have a better sense of income needs, and future tax liabilities over the next 10 years.
Enter qualified disclaimer estate planning: the post-mortem way to maximize the utility of your retirement assets. It optimizes your pre-tax retirement accounts for your heirs.
Remember, since the SECURE Act killed the stretch IRA, you need to change the philosophy of your estate plan. This is especially true for your IRD.
An Example of Disclaimer Planning in Use
Say there is a wife with a large IRA. She lists her husband as primary beneficiary, and her two children as 50% contingent beneficiaries.
When she passes, her husband has 9 months to decide if he needs the IRA. If he needs the money, by all means take it!
If he only needs half, or any percentage of it, then pass the rest on to the kids now and get a head start on a 10-year ‘mini’ stretch. That is, instead of waiting until he dies to pass on all the IRD, pass some on now. Hopefully, it will be 10 more years before he dies, so each heir gets two mini-10-year stretches. This can prevent spiking the income into higher tax brackets for the heirs as bad as if they got all of the IRAs all at once upon the death of the second spouse.
Back to the example, say he has his own large IRA. If he takes his wife’s IRA, he might be hit with the widow/widower tax penalty, and thus it saves in taxes to disclaim his wife’s IRA now. He doesn’t need the IRD as he is in a higher tax bracket as a widow, and his kids can start the mini-stretch with part of the IRA while he is still alive.
Or, if his kids are in really high tax brackets, he should take the IRA and pull out the money at his lower tax bracket. Next, invest the money in a brokerage account to get the step up in basis when he dies.
You can see how flexible this plan is! Once you are dead, your spouse and kids have a sense of their income needs and tax brackets. Keep some, and pass as much as you can on now. Or, if there is no need, pass all of it on now and start the 10-year clock early.
How to Set Up Qualified Disclaimer Planning
Spouse is the primary beneficiary. They can disclaim part or all of the IRA to the contingent beneficiaries.
Make the kids contingent beneficiaries. It is that simple to set up!
Next, tell your spouse that he or she has 9 months upon your death to disclaim whatever percent he or she thinks is appropriate to pass on the most to the kids over the longest period of time.
Is a Disclaimer a Gift?
Next, let’s clarify some other issues in disclaimer planning.
First off, even though your pre-tax retirement accounts pass via a beneficiary form, they are still included in your estate for the purposes of estate taxes. Since the estate tax exclusion is currently greater than $11M per person, this isn’t a huge issue for most folks.
Even if you give your IRA away to charity when you die, it is included in your estate (though your estate gets a deduction for the charitable gift so it comes out in the wash). This is again a reminder that someone will always pay taxes on this deferred income.
Next, when you leave your pre-tax retirement accounts to someone else at death, it may be considered a gift for estate planning purposes. If you leave it to your spouse, it doesn’t count as a gift due to the unlimited marital deduction. If you leave it to your kids, it is a gift, but is not double taxed against your estate tax exclusion. But if you leave your IRA to grandkids you need to think about GSTT (generation skipping transfer tax) but only if you are near the estate tax limit. Yes, that gets super confusing so don’t worry about it unless you might have a taxable estate.
But a qualified disclaimer is not a gift from the primary beneficiary to the contingent beneficiary. Qualified when talking about retirement accounts means that it is subject to ERISA. Qualified when talking about disclaimers means that it is specifically allowed by tax code not to count as a gift.
What Is a Qualified Disclaimer?
A qualified disclaimer is specifically one allowed in the tax code.
Anyone who inherits property can disclaim it, which serves the purpose of allowing the asset to go to the contingent beneficiaries.
In order for a disclaimer to be qualified it must hit the following criteria:
- Writing: the refusal must be in writing.
- Timing: the disclaimer must be made within nine months after the date of death unless the disclaiming beneficiary is under age 21.
- No Acceptance: the disclaiming beneficiary must not have accepted any interest in the benefits. This does not include a final yearly RMD.
- No Control: the disclaiming beneficiary cannot control to whom the property passes.
Make sure you follow the rules for this, which should be pretty straight forward in most cases for assets. Assets can be qualified or non-qualified.
If you have a qualified disclaimer, it is as if the primary beneficiary never inherited the property. With a non-qualified disclaimer, on the other hand, the primary beneficiary is treated as if they got the property and then passed it on. This sucks, because there are taxes and gift tax implications. If the disclaimer is non-qualified, then the disclaimant, rather than the decedent, is treated as having transferred the asset to the contingent beneficiary.
The Disclaimer Need Not be for the Entire Amount
There are actually three ways to disclaim an asset:
- Full Disclaimer. This is pretty self-evident.
- Pecuniary (or dollar figure) Disclaimer. You can specify how much is disclaimed in dollars.
- Fractional Disclaimer. Here you can disclaim just a proportion of the account. Say 10%. Or 50 or 90%. Keep what you need, pass on the rest.
Summary: Qualified Disclaimer Estate Planning for a Flexible and Tax-Efficient Legacy
A “qualified” disclaimer is an irrevocable refusal by a primary beneficiary to accept benefits or transfer of property. When done appropriately, the property passes to the contingent beneficiaries as if the primary beneficiary is dead.
The disclaimer can be a complete or a partial. In essence, disclaimer estate planning allows your family to decide after you die what the best way is to split up your pre-tax retirement accounts. Flexibility and the ability to control the taxes is key. Remember, there is an optimal way to leave money to charity, and there is an optimal way to leave money to your heirs.
There is little reason that most folks shouldn’t take part in disclaimer planning for their assets that pass via beneficiary form.