The Journal of The DuPage County Bar Association

Back Issues > Vol. 10 (1997-98)

Using a Disclaimer Strategy When Naming the Beneficiary of Retirement Plans
By Mark D. Perkins and Dean Zayed

I. Introduction

You’ve just met with a middle-aged couple that you have represented ever since passing the bar exam. The couple are friends of your family. You drafted their wills in 1987. Last month they attended one of those "Living Trust" seminars at the Marriott and called you to find out if living trusts were what they were cracked up to be.

As you are talking with them, you remember back when you drafted their wills. You had spent hours talking to more experienced attorneys; you had scoured the formbooks to find just the right language. You thought you had taken care of everything by putting in the contingent trust for their minor children. But during the meeting with your clients you find out that the wills that you had drafted were exactly what the seminar speaker had been describing in unveiling the "evils of probate."

They were astounded to discover that your carefully drafted wills did not protect them against probate or disability guardianships (the so-called "living probate"). More to the point, your clients were concerned that their kids may have to pay approximately $250,000 in estate taxes!

Taking the initiative, you quickly point out that they were younger in 1987 and the possibility of death or disability was "much" lower. Besides, you reason, that was eleven years ago and the rule of thumb is that everyone should review their estate plans every five years. Plus, the estate was less than $600,000 in 1987.

You manage to convince your clients that you can do the job for them. You will draft living trusts for them and protect their $1,250,000 from estate taxes ... and avoid probate... and avoid guardianships.

Now that they have left your office, you review the list of assets that you and your clients prepared:

Value Titled or


Cash, CDS, Bank Accts.

$ 40,000 JT

Stocks, Bonds, Mutual Funds

100,000 JT


His 21,000 JT

Hers 11,000 JT


FMV $300,000

Mortgage 80,000

220,000 JT

IRAs- Wife’s ("W")

40,000 To Spouse

IRAs- Husband’s ("H")

18,000 To Spouse

Life Insurance -Group term ("H")

100,000 To Spouse

Profit sharing Plan- H

400,000 To Spouse

401(k) Plan- H

300,000 To Spouse

Total $ 1,250,000

You have a basic knowledge of estate planning garnered from a course in estates and trusts in law school. You also know that the Taxpayer Relief Act of 1997 made specific changes that have significant estate planning implications. One of those changes was to gradually increase the effective lifetime exemption an individual has from $600,000 in 1997 to $1 million by the year 2006. For purposes of this article we will use 1998 figures, which effectively increases an individual’s exemption to $625,000. (You would also note that the new law added a new type of IRA called the Roth IRA which could be used in this estate plan as part of a rollover. Given the intricacies of such a conversion, however, this topic is well beyond the scope of this article and will not be discussed). In the end, you know that the idea is to place the maximum exemption allowed in each spouse’s estate ($625,000 in this example) so that each will "use up" his or her respective lifetime exemption and pass that wealth along federal estate tax free.

You are also enlightened enough to educate the clients about the benefits of signing revocable living trusts ("RLTs"). You know that you will most likely recommend fully funded RLTs to the client since they avoid both probate and guardianships and allow the client to take full advantage of the lifetime exemption. As a general litigator you have been involved with several contested guardianships and you know that those beasts are much more costly and messy than your basic probate estate.

You review the numbers and begin dividing assets between the husband’s ("H’s") taxable estate and the wife’s ("W’s") taxable estate. Obviously, the IRAs will be in each of the participant’s taxable estates, and the insurance and Qualified plans will be in the husbandís taxable estate. Thus, with no estate plan in place, the husband’s estate would be comprised of 1/2 of the joint property plus the life insurance, his IRA, the profit sharing plan and the 401k plan. (He would not have a probate estate.) Although the estate plan you devise will accommodate either the husband or wife dying first, for the sake of simplicity all of the analysis that follows assumes the husband will die first. Upon his death, his estate would receive a marital deduction for everything because it all passes to his surviving spouse. Thus, there would be no tax upon his death.

The problem, of course, is upon the death of the surviving spouse since that second taxable estate would include all of the assets of the couple ($1,250,000 — assuming income on the assets plus inflation offsets spending — this number would stay relatively constant regardless of the number of years between deaths). Thus, upon the second death, the couple will lose the benefit of one of the $625,000 lifetime exemptions. This would make the estate tax payable upon the second death (assuming 1998 tax rates and exemptions) approximately $250,000. Of course, if the wife were to die first, the result would essentially be the same. Naturally your task is to structure the planning so that both exemptions are obtained.

You get to work to divide the assets between the husband’s taxable estate and the wife’s taxable estate. A first effort produces the following:


Residence 220,000

Both automobiles 32,000

Stocks & Bonds 100,000

Cash, CDS, Banks 40,000

IRA-W’s 40,000

Totals 432,000


Profit Sharing Plan 400,000

401(K) Plan 300,000

Group Life Insurance 100,000

IRAs- H’s 18,000

Totals 818,000

Marital Deduction if

H dies first 818,000

Net Estate -0-

Add from H’s marital

deduction +818,000

Estate upon 2nd death 1,250,00

Estate Tax upon 2nd

Death 250,000

You review the computations and try to determine what is wrong. Even if you transfer all of their assets other than retirement fund and insurance into the wife’s name, the large tax upon the second death is not avoided. The problem: upon death all of the assets transfer outright to the spouse. Furthermore, a lifetime transfer of the qualified plans and the Husband’s IRA into the wife’s name would not help much since this event would immediately trigger federal income taxation of the full amount. Even though you usually write insurance defense briefs at this time of day, you realize that this is not a good result. You ponder: how do we utilize the husband’s $625,000 lifetime exemption.

For starters, you realize that one alternative might be to title everything (other than the wife’s IRA) in the husband’s name and to designate the wife as beneficiary of all of the insurance, qualified plans and IRAs. This would result in decreasing the husband’s taxable estate by the amount of the marital deduction and include those items in the wife’s taxable estate. If the husband were to die first, this would result in all of the qualified plan assets, IRAs and life insurance flowing into the wife’s taxable estate resulting in her taxable estate totaling $858,000 and a resulting federal estate tax of approximately $90,000. Not perfect but at least some assets were used to utilize the husband’s $625,000 lifetime exemption. This plan would also not shelter any assets if the wife were to die first.

You have found a way to shelter some of the husband’s assets, but you realize that there must be a way to fully fund a credit shelter trust with $625,000 of assets. At this point there are several things that you do know about this estate plan that will not change. First, you will recommend a RLT because of the superior qualities it possesses over an ordinary will. Second, a majority of the assets involved here are retirement benefits. You brilliantly deduce that if you could somehow understand the relationship between retirement plans and the RLT, your problem would just about solve itself.

II. The Twelve Critical Concepts of Beneficiary Designations

You begin reading articles with titles like "Qualified Plans and Beneficiary Designations" and "Designating a Living Trust as a Beneficiary of an IRA" and realize that the matters seem very complicated. Then you realize that the entire relationship between RLTs and retirement plans may be simplified by understanding the Twelve Critical Concepts of Beneficiary Designations. Those twelve are:

1. Required Beginning Date ("RBD"). Found in IRC ß 401(a)(9), this compels annual minimum distributions from plans beginning April 1 of the calendar year following the calendar year in which the Participant reaches age 70 1/2 (or, if not a 5% owner, the year in which the participant actually retires, if later). Failure to distribute the required minimum results in a 50% excise tax on amounts that should have been distributed but were not.

2. Minimum Required Distribution. Once the RBD is reached, this tells how much the participant must minimally distribute from the plan without being penalized. The participant may take distributions either (a) over the participant’s single life expectancy or (b) over a joint life expectancy with a "designated beneficiary" (DB). A joint life expectancy will always result in lower annual payments and increased tax deferral both during the participant’s lifetime and after the participant’s death.

3. Designated Beneficiary. Found in IRC ß 401 (a)(9), the DB is the specifically named beneficiary to a plan. The DB can be an individual, group of individuals, or a trust. A trust will only qualify as DB, however, if several requirements are met. The old proposed regulations mandated four stringent rules to be complied with in order for a trust to qualify. These requirements included: a. The trust must be valid under state law. b. The beneficiaries (all of whom must be individuals) are identifiable from the trust document; c. The trust is irrevocable; and d. A copy of the trust is provided to the plan administrator.

The amendments to the Prop.Reg. 1.401 (a)(9), published in the Federal Register on December 30, 1997, however, have eliminated the final two requirements. The trust no longer has to be irrevocable and a copy need not be provided to the plan administrator. Thus, if a trust meets the much simplified requirements, the participant is allowed to "look through" the trust to the trust’s beneficiaries to determine the designated beneficiary. The oldest beneficiary of the trust is used as the designated beneficiary for purposes of calculating the life expectancies.

4. Calculation method: "Recalculation" or "term certain." Provided that the language of the plan permits, in determining the amount and duration of annuity payments, a participant has the option to choose either the "recalculation" or "term certain" method of computing the relevant life expectancies. Recalculation means that the life expectancy of the participant and/or the participant’s spouse will be recalculated annually using the IRS’ actuarial table. Keep in mind that no other beneficiary’s life expectancy may be recalculated besides that of the spouse. Term certain means that the life expectancy period over which benefits may be paid out is established as a fixed number of years on the RBD. Then each year the minimum distribution is calculated by multiplying the current account balance by the applicable fraction. Lastly, if the plan document is silent, recalculation of the participant and the participant’s spouse’s life expectancy is required.

The advantage of recalculation is that life expectancy does not go down automatically by one full year each year thus stretching out the distribution of benefits during the participant’s lifetime. However, recalculation can reduce the distribution period after death, as the participant’s or spouse’s life expectancy is reduced to zero at his or her death.

5. Multiple Beneficiaries. If a participant has multiple designated beneficiaries, the beneficiary with the shortest life expectancy (i.e. the oldest) is the designated beneficiary used for determining the required minimum distributions.

6. Changing beneficiaries. The participant has the right to change beneficiaries at any time. Once the participant has reached the RBD, however, the minimum distribution calculation can never be improved. A change in beneficiary to a designated beneficiary with a longer life expectancy will have no effect; however, if the change is to a beneficiary with a shorter life expectancy than the shorter life expectancy must be used.

7. Minimum Distribution Incidental Rule (MDIB). If the participant names a designated beneficiary (other than a spouse) who is more than 10 years younger than the participant, the minimum distributions during the participant’s lifetime shall be calculated as if the designated beneficiary is only ten years younger than the participant. Please note that the MDIB does not apply to a spouse and only applies during the Participant’s life.

8. Withdrawal prior to Required Beginning Date. Withdrawals made prior to the beginning date (except those made in the year the participant turns 70-1/2) are not credited against the required minimum distributions.

9. Minimums are Minimums. The minimum distribution rules determine the minimum amount which must be withdrawn. The participant can always decide to withdraw more after age 59-1/2 is attained.

10. Combined Withdrawals (IRAs only). If an individual has more than one IRA, the required withdrawals may be made from any one or more of the IRAs. Prop.Reg. 1.401(a)(9)-1.

11. Always Name Contingent Beneficiaries. If there is no contingent beneficiary named, many qualified plan documents provide for a default designation to the estate. This results in loss of designated beneficiary status resulting in the assets being subjected to the Five Year Rule (if death occurs before the RBD then all benefits must be distributed from the plan within five years of the date of death) or the One Year Rule (if death occurs on or after the RBD then all benefits must be distributed from the plan within one year of the date of death).

12. Disclaimer strategies. In order to preserve maximum flexibility, the planner should have in mind from the outset an appropriate disclaimer strategy. Disclaimers have been used to change beneficiary designation where the deceased participant named the "wrong" beneficiary, to redirect a benefit to the surviving spouse (so she can roll them over), and to create funding for a credit shelter trust which would otherwise have no assets. Remember that disclaimers must be exercised within nine months of the date of death and meet the requirements of IRC ß 2518 in order to be considered "qualified" and not be treated as a taxable gift to the contingent beneficiary.

III. The Solution

After studying these concepts with respect to this client’s unique situation (each and every client is unique!), you realize that the optimum solution to this quandary would accomplish all of the following:

1. Fully fund the credit shelter trust (utilizing the whole $625,000 exemption) thereby transferring the funds estate tax free without adding to the surviving spouse’s estate;

2. Allow the credit shelter trust to be available to the surviving spouse and the descendants during their lifetime for education, health, maintenance, and support (EHMS);

3. Defer income taxation for as long as possible;

4. Allow the plan to work regardless of order of deaths; and

5. Allow for the most flexibility in the estate plan so as to maximize the couple’s options in the case of any changed circumstances.

It is worth noting that there are most always multiple ways of structuring a client’s estate plan to achieve the desired result. With this in mind, keeping the plan as flexible as possible may be the decisive factor in determining which route to take.

With added vigor, you now take an even closer look at the client’s assets and think you’ve uncovered two alternative estate plans that can satisfy the enumerated objectives and leave the couple with no estate tax liability.

Alternative 1

This approach involves the husband naming his RLT as the beneficiary of the qualified plans and his IRA and transferring his other assets into the wife’s RLT? That planning alternative would yield the following:


Residence 220,000

Both automobiles 32,000

Stocks & Bonds 100,000

Cash, CDS, Banks 40,000

IRA-W’s 40,000

Totals 432,000


Profit Sharing Plan 400,000

401(K) Plan 300,000

Group Life Insurance 100,000

IRAs- H’s 18,000

Totals 818,000

Marital Deduction if

H dies first 193,000

Net Estate-1st Death 625,000

Estate Tax upon 1st

Death -0-

Add from H’s marital

deduction +193,000

Estate upon 2nd death 625,000

Estate Tax upon 2nd

Death -0-

In this case the overall estate tax burden is reduced to 0 by designating the RLT as primary beneficiary. By designating the husband’s RLT as the beneficiary of all of the husband’s insurance and qualified plans and IRAs, you can utilize the husband’s $625,000 credit shelter exemption. The RLT should be drafted in standard terms providing the marital deduction funding clause (fractional share, of course) that would place $625,000 from the qualified plans in the Family Trust and the remaining $193,000 in the Marital Trust. The Family Trust would provide that the Trustee could spend all income and invade principal (subject to ascertainable standards [EHMS]) to benefit the spouse; upon her death, the trust would benefit the couple’s children.

Naming the RLT as the beneficiary satisfies four of the criteria: it uses both $625,000 exemptions and allows the combined taxable estates to avoid estate tax; the funds are available to meet the spouses needs; the amounts in the qualified plans would remain income tax deferred while being distributed over the life expectancy of the spouse; and, under the facts of this case, assets are available to fund the credit shelter trust regardless of the order of death.

At this point you feel rewarded because you were able to meet your criteria while minimizing the overall estate tax burden. For the sake of being thorough, however, you now turn to the second alternative.

Alternative II

This analysis begins by noting that of the $818,000 value of the husband’s estate, $718,000 of that amount is qualified plans and IRAs. You know that all amounts received from a qualified plan or IRA after the death of the participant are fully taxable as income in respect of a decedent ("IRD"). Thus, if it can be avoided, qualified plan assets and IRAs should not be used to fund credit shelter trusts as they generate IRD. This is because the recipient of the distributions must pay income taxes on the distributions (i.e. on the principal) which will reduce the amount ultimately going to the beneficiaries of the Family Trust.

You return to the classic tradeoff encountered upon naming the spouse as primary beneficiary and the RLT as the contingent beneficiary. If one designates the spouse as primary beneficiary, the spouse may rollover the qualified plan or IRA to his or her own IRA and name a new designated beneficiary. The surviving spouse now becomes the "participant" with regard to those benefits under the minimum distribution rules, allowing him or her to defer distributions until his or her RBD. The "cost" of this spousal designation and income tax deferral opportunity is that the full amount of the plan assets are subject to the marital deduction and, therefore, cannot be used to satisfy the $625,000 exemption of the participant.

Looking back at the Twelve Critical Concepts, you find that last one, Disclaimer strategies, quite interesting and realize that herein lies your answer. Disclaimers can be an effective post-mortem planning device in many situations. Whether it be changed family circumstances or a different financial situation, disclaimers give the beneficiary the option to pursue whatever alternative is the most attractive to him or her at that time. These alternatives are most often used to cure overfunded or underfunded marital deductions which may result in unnecessary estate tax. If the wife would otherwise receive more than the optimum marital amount, a disclaimer can divert assets to other beneficiaries (most notably the credit shelter trust) so as to maximize the husband’s use of his lifetime exemption.

For example, naming the wife as primary beneficiary of the $718,000 worth of retirement plans would overfund the marital deduction and not fully utilize the husband’s lifetime exemption. Using a clever disclaimer strategy, however, the wife could disclaim $625,000 worth of those retirement benefits. Since the husband’s RLT is the contingent beneficiary, those benefits would now be used to fully fund the credit shelter. The remaining $93,000 would qualify for the marital deduction and become a part of the wife’s estate. This end result is identical to the result achieved in the first alternative but includes the added flexibility you sought in your fifth objective.

The difference is in the flexibility afforded the couple and potential income tax deferral. Remember your goal is to keep as much of the value of the retirement benefits outside of the credit shelter trust because the wife can defer distributions from such benefits by rolling them over to her IRA. Any part of the retirement benefits used to fund the credit shelter trust would be subject to immediate distributions (and therefore income taxation) based on the life expectancy of the beneficiary (here the spouse). If the husband dies in 10 years, for example, then the couple will surely have more assets to plan with (barring any misfortune). It is with these assets that you would then fund the credit shelter trust. Ideally, the couple will have enough non-retirement benefit assets to fully fund the credit shelter trust. Regardless, since you cannot predict when the husband and wife will die, naming the spouse the primary beneficiary and the RLT the contingent one gives the couple the most flexibility. Whenever the husband dies, the wife can choose to fund the credit shelter trust with as many non-retirement benefit assets as the couple has, an option alternative 1 does not afford. This would involve utilizing the proper combination of rolling over and disclaiming retirement benefits in order to fully fund the credit shelter trust. In the end there will be a full utilization of each spouse’s lifetime exemption as well as a minimization of the overall estate tax.


An astute estate planner must carefully analyze the mix of assets owned by the clients and logically follow the flow of funds put into action by the documents, including beneficiary designations. Many times the common response does not accomplish the objectives sought and a deeper analysis is required to ensure maximum flexibility. Although designating the RLT as primary beneficiary of the retirement assets seemingly accomplishes your stated objectives, the designation of the spouse as primary beneficiary with the disclaimer as an added weapon is the better choice.

Mark Perkins
is an Associate at Momkus, Ozog & McCluskey, L.L.C., Downers Grove. He is Chair of the DCBA’s Tax Committee. He received his Undergraduate Degree in 1987 from Elmhurst College and his Law Degree in 1990 from I.I.T.-Chicago-Kent.

Dean Zayed is an Associate at Momkus, Ozog & McCluskey, L.L.C., Downers Grove. He is a member of the DCBA’s Tax Committee. He received his Undergraduate Degree in 1994 and his Law Degree in 1997 from Northwestern University.

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