Knowing the rules is more than a good idea--it may also be a legal requirement for advisors.
Nobody knows all the answers, but I get worried when I hear from professionals who don't know stuff they're supposed to be advising their clients on.
Here's a wake-up call: If you hold yourself out as fulfilling a certain professional niche, take some courses or consult with someone or do something to acquire the expertise your clients are entitled to expect from you.
Question: I am an administrator of our firm's profit-sharing plan. "Otto" was an employee of the firm. He died this year at age 74. He was not a partner of the firm; he was never a "5% owner." He was still working full time at the time of his death--in other words he had not "retired." His spouse, "Olivia," is sole beneficiary. Before I distribute Otto's benefits (Olivia has requested a direct rollover to her IRA), I need to determine whether to pay to her, first, a required minimum distribution for the year of death. I concluded that there is an "RMD" for this year (the year of his death) because Otto was older than age 70 1/2. Do you agree? I feel a strong sense of responsibility to Olivia because I was very fond of Otto.
Answer: I'm glad that you feel a sense of responsibility to the plan participants and beneficiaries, because as plan administrator you have the actual legal responsibility to them to administer this plan correctly. The employees don't need to rely on noblesse oblige: The IRS and DOL will hold you very accountable for your actions in this role--regardless of whether you love your employees or can't stand them! So I have two recommendations for you:
First, there is no required minimum distribution for the year of Otto's death. Normally, the "required beginning date" is April 1 following the year the employee reaches age 70 1/2, but in the case of a qualified plan (such as your firm's profit-sharing plan), the required beginning date does not occur until the later of April 1 following the year the employee reaches age 70 1/2 or April 1 following the year the employee retires. Since Otto never retired, he never reached his required beginning date. Since he died before required minimum distributions commenced, there is no required minimum distribution for the year of death. So my first recommendation is: Pay the full amount of Otto's benefits to Olivia's IRA as she has requested.
My second recommendation: Your firm should hire a professional third-party plan administrator (TPA) for the retirement plan. You owe it to your employees and yourself (and you have a legal obligation) to make sure this important work is done correctly!
Question: My client "Louise" is retiring from "Acme Co." She has several retirement plan accounts including an ESOP (employee stock ownership plan), which holds appreciated Acme stock. I know there is a favorable deal for the "net unrealized appreciation" (NUA) built into her plan-owned Acme stock; I need to advise her what to do with it. Since she wants to sell the Acme stock as soon as possible, I think the best course is to roll everything into an IRA and sell the stock in the IRA so the sale proceeds are tax-deferred. That's Plan A. But the other choice is to take distribution of the Acme stock (which has performed very well) and hold it until her death, so her kids get a stepped-up basis for the NUA (Plan B). Any comments?
Answer: Unfortunately, you are a bit wide of the mark as far as understanding the tax treatment of NUA stock. For one thing, the IRS says that an employee's heirs do not get a "stepped-up basis" for NUA. The IRS' position is that beneficiaries who inherit NUA stock get a step-up for any appreciation that occurs between the time the stock was distributed to the employee and the date of death, but no step-up for the NUA that was built-in when the employee took distribution of the stock. So scratch "Plan B."
Regarding "Plan A," the fact that Louise wants to sell the stock in the near future does not necessarily mean the best choice is to roll to an IRA and sell in there. Remember that selling outside the plan means the employee gets long-term capital gain treatment for the NUA portion--regardless of how briefly she has held the stock. And remember that a partial rollover can probably eliminate any currently taxable value for the non-NUA portion, so the only current tax would be the capital gain tax on sale of the NUA.
Rolling the stock to an IRA means giving up capital gain treatment forever, and assuring that all sales proceed will be taxed (eventually) as ordinary income. So you have to run the numbers and weigh the cost of paying immediate gains tax on the NUA versus the cost of (eventually) having to pay ordinary income tax, taking into account Louise's age, other assets and income, etc., before deciding which is best.
My recommendation is that before coming up with a plan for Louise's stock you either hire or become an expert on NUA stock to be sure Louise gets maximum value from this unique asset!
Where to read more: My book Life and Death Planning for Retirement Benefits (7th ed. 2011) covers required distributions for the year of death and NUA choices in sections ¶ 1.5.03 and ¶ 2.5 respectively. For plan administration questions, hire a TPA firm--and check their conclusions in The Pension Answer Book by Stephen Krass (Aspen Publishers, a division of Wolters Kluwers). For help on an NUA case, consider consulting with Mark Cortazzo, CFP, of Parsippany N.J., or Bob Keebler, CPA, of Green Bay, Wis. Their firms do lots of that kind of work (I don't).
Now available in electronic edition! By popular demand, Natalie Choate's book Life and Death Planning for Retirement Benefits has been published in an electronic version. The e-book edition gives you the entire book in word-searchable format, PLUS two additional chapters (on life insurance and annuities in retirement plans) that were left out of the print edition for reasons of space. Live links to cross-referenced book sections and most cited tax sources. Access anywhere you have an internet connection. Visit www.retirementbenefitsplanning.com to subscribe or learn more.