Failing To Update A Plan Beneficiary Designation

 

Technically it is not a tax case, but it is so tax-adjacent it might as well be.

Let’s talk about beneficiaries on a retirement account – and, more specifically, an employer-sponsored retirement account.

Carl Kleinfeldt participated in the Packaging Corporation of America (PCA) Thrift Plan for Hourly Employees. In 2006 he designated his (then) wife – Dena Langdon – as his primary beneficiary.

Kleinfeldt and Langdon divorced in 2022. The divorce included a Qualified Domestic Relations Order (QDRO). A QDRO is a court order authorizing distribution to the nonparticipating (ex) spouse. The PCA Benefits Center distributed to Langdon as directed.

However, even after the QDRO there is one more step: has the ex-spouse been formally removed as beneficiary?

Kleinfeldt faxed a request to the Benefits Center to remove Langdon from both his health and life insurance as well as his retirement plan. The Benefits Center updated her status on the retirement account to “ex-spouse.” Mind you, this was not the same as removing her as a beneficiary altogether.

Why not?

There were written plan procedures to follow. Kleinfeldt’s fax was a good start but was not quite enough.

You can guess that Kleinfeldt died.

You know that Langdon wanted that retirement money.

You also know the matter went to court.

And we are in legal weeds immediately.

We are talking here about an employer-sponsored plan, which (almost always) makes the plan subject to ERISA.

ERISA in turn uses a “substantial compliance” doctrine when reviewing actions required under a plan document. It is what it sounds like: if you miss a minor clerical step, the law presumes that responsible parties know what was meant and are expected to act accordingly.

The Kleinfeldt Estate argued the substantial compliance doctrine with a white-knuckle grip.

The Court observed that substantial compliance has two steps:

1.  Was there intent to make the change?
2.  Was the attempt to make the change similar (in all material aspects) to the proper procedures required by the plan?

There was no argument about the first test: the fax was clear evidence that Kleinfeldt intended to remove Langdon as a beneficiary.

On to the second test.

The plan documents wanted Kleinfeldt to either (1) call the Benefits Center or (2) update his beneficiary designation online.

The plan documents nowhere stated that he could update beneficiaries by fax.

The Court did not consider this a minor clerical step.

Kleinfeldt did not follow the rules.

Meaning that Langdon won.

And fair had nothing to do with it.

Our case this time was Packaging Corporation of America Thrift Plan v Langdon, No 25-1859 (7^th Cir. Feb. 2, 2026)

No Tax On Social Security

 

Is not. 

For decades, social security benefits were not taxable at all. 

This changed with the Social Security Amendment of 1983, with the intent to shore up the social security trust fund. Beginning in 1984, if one’s income exceeded certain stairsteps ($25,000 for singles and $32,000 for marrieds), then benefits could be up to 50% taxable. 

Flip the calendar and The Omnibus Budget Reconciliation Act of 1993 raised the taxable portion up to 85% and added two more stairsteps ($34,000 for singles and $44,000 for marrieds). 

COMMENT: The taxation of social security is Congressional pratfall. There are two separate calculations here. The first calculation starts taxing benefits at $25,000 (for singles; $32,000 for marrieds) up to 50 percent. If your income keeps going, then you hit the second stairstep ($34,000 for singles; $44,000 for marrieds) up to 85%. Fall in between these two phaseout zones and you may want to use software to prepare your return. 

COMMENT: BTW, Congress has never inflation-adjusted those 1984 or 1993 dollars. 

No tax on social security became a political slogan during the presidential election. I have heard the phrase repeated since then, but it is not accurate. 

It would be more accurate to describe it as an age-based deduction. 

Take a look at the tax provision in its feral state:

 

SEC. 70103. TERMINATION OF DEDUCTION FOR PERSONAL EXEMPTIONS OTHER THAN TEMPORARY SENIOR DEDUCTION

 

(a)(3)(C) Deduction for seniors

 

(i)                   In general.—In the case of a taxable year beginning before January 1, 2029, there shall be allowed a deduction in an amount equal to $6,000 for each qualified individual with respect to the taxpayer.

(ii)                Qualified individual.—For purposes of clause (i), the term ‘qualified individual’ means—

(I)                  the taxpayer, if the taxpayer has attained age 65 before the close of the taxable year, and

(II)                in the case of a joint return, the taxpayer’s spouse, if such spouse has attained age 65 before the close of the taxable year.

(iii)               Limitation based on modified adjusted gross income.

(I)                  In general.—In the case of any taxpayer for any taxable year, the $6,000 amount in clause (i) shall be reduced (but not below zero) by 6 percent of so much of the taxpayer’s modified adjusted gross income as exceeds $75,000 ($150,000 in the case of a joint return).

(II)                (II) Modified adjusted gross income.—For purposes of this clause, the term ‘modified adjusted gross income’ means the adjusted gross income of the taxpayer for the taxable year increased by any amount excluded from gross income under section 911, 931, or 933.

(iv)               Social security number required.

(I)                  In general.—Clause (i) shall not apply with respect to a qualified individual unless the taxpayer includes such qualified individual’s social security number on the return of tax for the taxable year.

(II)                Social security number.—For purposes of subclause (I), the term ‘social security number’ has the meaning given such term in section 24(h)(7).

(v)                 Married individuals.—If the taxpayer is a married individual (within the meaning of section 139, this subparagraph shall apply only if the taxpayer and the taxpayer’s spouse file a joint return for the taxable year.”

What do I see? 

•  There is no mention of social security benefits.
•  There is no mention, in fact, of retirement income at all.
•  You do have to be at least age 65 to qualify.
•  The deduction is (up to) $6,000 per qualifying individual.
•   Make too much money ($75,000 for singles and $150,000 for marrieds) and you start losing the deduction. The deduction phases-out completely at $150,000 (singles) and $250,000 (marrieds).
•  If you are married, you must file jointly. Married filing separately will not work here.
• The only mention of social security is that one must include one’s social security number on the tax return, otherwise the IRS will consider it a math error and send you a bill for taxes due.

What do I not see?

• No tax on social security.

I get it: for many if not most people, social security benefits would not have been taxable anyway because of the stairsteps, the increased standard deduction and the additional standard deduction for taxpayers age 65 and over. I would prefer that we use the English language with more precision, but such is not our fate. 

We didn’t even mention the insolvency of the social security system itself. 

Take advantage if you can, as the deduction has a shelf life of only four years. Granted, a future Congress can extend (and re-extend) this deduction ad infinitum, but I suspect that will not happen here.

 

Repaying a COVID-Related Distribution

Do you remember a tax break in 2020 that allowed you to take (up to) $100,000 from your IRA or your employer retirement plan? These were called “coronavirus-related distributions,” or CRDs in the lingo. In and of itself, the provision was not remarkable. What was remarkable is that one was allowed three years to return some, all, or none of the money to the IRA or employer plan, as one wished.

I was thinking recently that I do not remember seeing 2021 individual returns where someone returned the money.

Granted, we have a flotilla of returns on extension here at Galactic Command. I may yet see this beast in its natural state.

Let’s go over how this provision works.

To make it easy, let’s say that you took $100,000 from your 401(k) in 2020 for qualifying COVID-related reasons.

You had an immediate binary decision:

·      Report the entire $100,000 as income in 2020 and pay the taxes immediately.

·      Spread the reporting of the $100 grand over three years – 2020, 2021 and 2022 - and pay taxes over three years.

There was no early-distribution penalty on this distribution, which was good.

You might wonder how paying the tax immediately could be preferable to paying over three years. It could happen. How? Say that you had a business and it got decimated by COVID lockdowns. Your 2020 income might be very low – heck, you might even have an overall tax loss. If that were the case, reporting the income and paying the tax in 2020 might make sense, especially if you expected your subsequent years’ income to return to normal levels.

What was a COVID-related reason for a distribution?

The easy ones are:

·      You, a spouse or dependent were diagnosed (and possibly quarantined) with COVID;

·      You had childcare issues because of COVID;

·      You were furloughed, laid-off or had work hours reduced because of COVID.

Makes sense. There is one more:

·      You experienced other “adverse financial consequences” because of COVID.

That last one has an open-gate feel to me. I’ll give you an example:

·      You own rental cabins in Aspen. No one was renting your cabins in 2020. Did you experience “adverse financial consequences” triggering this tax provision?

You have – should you choose to do so – three years to put the money back. The three-year period starts with the date of distribution, so it does not automatically mean (in fact, it is unlikely to be) December 31^st three years later.

The money doesn’t have to return to the same IRA or employer plan. Any qualifying IRA or employer plan will work. Makes sense, as there is a more-than-incidental chance that someone no longer works for the same employer.

 Let’s say that you decide to return $50 grand of the $100 grand.

The tax reporting depends on how you reported the $100 grand in 2020.

Remember that there were two ways to go:

·      Report all of it in 2020

This is easy.

You reported $100 grand in 2020.

When you return $50 grand you … amend 2020 and reduce income by $50 grand.

What if you return $50 grand over two payments – one in 2021 and again in 2022?

Easy: you amend 2020 for the 2021 and amend 2020 again for the 2022.

Question: can you keep amending like that – that is, amending an amended?

Answer: you bet.

·       Report the $100 grand over three years.

This is not so easy.

The reporting depends on how much of the $100 grand you have left to report.

Let’s say that you are in the second year of the three-year spread and repay $30,000 to your IRA or employer plan.

The test here is: did you repay the includable amount (or less) for that year?

If yes, just subtract the repayment from the includable amount and report the difference on that year’s return.

In our example, the math would be $33,333 - 30,000 = $3,333. You would report $3,333 for the second year of the spread.

If no, then it gets ugly.

Let’s revise our example to say that you repaid $40,000 rather than $30,000.

First step: You would offset the current-year includable amount entirely. There is nothing to report the second year, and you still have $6,667 ($40,000 – 33,333) remaining.

You have a decision.

You have a year left on the three-year spread. You could elect to carryforward the $6,667 to that year. You would report $26,666 ($33,333 – 6,667) in income for that third and final year.

You could alternatively choose to amend a prior year for the $6,667. For example, you already reported $33,333 in 2020, so you could amend 2020, reduce income by $6,666 and get an immediate tax refund.

Which is better? Neither is inherently better, at least to my thinking. It depends on your situation.

There is a specific tax form to use with spreads and repayments of CRDs. I will spare us the details for this discussion.

There you have it: the ropes to repaying a coronavirus-related distribution (CRD).

If you reflect, do you see the complexity Congress added to the tax Code? Multiply this provision by however many times Congress alters the Code every year, and you can see how we have gotten to the point where an average person is probably unable to prepare his/her own tax return.

 

No Required Minimum Distributions For 2020

There is a tax deadline coming up. It may matter to those who are taking required minimum distributions (MRDs) from your IRAs and certain employer-based plans.

You may recall that there is a trigger concerning retirement plans when one reaches age 72.

COMMENT: The trigger used to be age 70 ½ for tax years before 2020.

The trigger is – with some exception for employer-based plans – that one has to start withdrawing from his/her retirement account. There are even IRS-provided tables, into which one can insert one’s age and obtain a factor to calculate a required minimum distribution.

COMMENT: There are severe penalties for not withdrawing a minimum distribution. Fortunately, the IRS is fairly lenient in allowing one to “catch-up” and avoid those penalties. At 50% of the required distribution, the MRD penalty rate is one of the most severe in the tax Code.

Let’s say that you are in the age range for MRDs. You have, in fact, been taking monthly MRDs this far into 2020.

There has been a law change: you can take 2020 distributions if you wish, but distributions are not mandatory or otherwise required. That is, there are no MRDs for 2020. This means that you can take less than the otherwise-table-calculated amount (including none, if you wish) and not taunt that 50% penalty.

Why the change in tax law?

The change is related to the severe economic contractions emanating from COVID and its associated lockdowns and stay-at-home restrictions. Congress realized that there was little financial sense in forcing one to sell stocks and securities into a bear market to raise the cash necessary to pay oneself MRDs.

Hot on the heels of the change is the fact that different people take MRDs at different times. Some people take the distribution early in the year, others late, and yet others take distributions monthly or quarterly. There is no wrong answer; it just depends on one’s cash flow needs.

Let’s take the example we started with: monthly distributions.

Well, it’s fine and dandy that I do not have to take any more distributions, but what about the amount I took in January -before the law change? And February – before …., well, you get the point.

You can put the money back into the IRA or retirement account.

Think of it as a mulligan.

But you have to do this by a certain date: August 31, 2020.

You have approximately another month to get it done.

Here are some questions you may have:

(1)  Does this change apply to 401(k)s, 403(b)s, 457(b)s?

Answer: Yes.

(2)  How about inherited accounts?

Answer: Yes. You have to put it back in the same (that is, the inherited) account, of course.

(3)  What if I was having taxes withheld?

Answer: You are going to have reach into your pocketbook temporarily. Say that you took a $25,000 distribution with 20% federal withholding. You never spent any of it, so you have $20,000 sitting in your bank account. If you want to unwind the entire transaction, you are going to have to take $5,000 from somewhere, add it to the $20,000 you already have and put $25,000 back into your IRA or retirement account.

You may wonder what happened to the $5 grand that was withheld. It will be refunded to you – when you file your 2020 tax return.

(4)  Continuing with Example (3): what if I don’t have the $5 grand?

Answer: Then put back the $20,000 you do have. It’s not 100%, but you put back most of it. You will have that gigantic withholding when you finally file your 2020 taxes.

(5)  What if I turned 70 ½ last year (2019) and HAVE TO take a MRD in 2020?

Answer: The answer may surprise you. The downside to waiting is that you would (normally) have to take a distribution for 2019 (you turned 70 ½, after all) and another for 2020 itself. This means that you are taking two MRDs in one tax year. Under the new 2020 tax law, you do not have to take EITHER (2019 or 2020) distribution. Your first distribution would be in 2021, and you would have had no distributions for 2019 or 2020.

(6)  Does this change apply to pensions?

Answer: No. Pensions are “defined benefit” plans, whereas IRAs, 401(k)s and so on are “defined contribution” plans. The change is only for defined contribution plans.

(7)  Does this change apply to Roths?

Answer: Roths do not have minimum required distributions, so this law change means bupkis to them.

(8)  What if I went the other way: I withdrew from my traditional IRA and would like to put it back as a Roth?

Answer: Normally one cannot do this, as MRDs do not qualify for a Roth conversion. With no MRDs for 2020, however, you have a one-time opportunity to flip some of your traditional IRA into a Roth. Remember that you will have to pay tax on this, though.  

(9)  How does this law change interact with the qualified charitable distribution rules?

Answer: A qualified charitable distribution (QCD) is when you have your IRA custodian issue a check directly to a charity. You do not get a deduction for the contribution, but the upside is that you do not have to report the distribution as income. If you do not itemize deductions, this technique is – by far – the most tax-efficient way to go. The QCD rules are independent of the MRD 2020 rule change. If you want to donate via charitable distributions in 2020, then go for it!

If you are already into your MRD for 2020 and do not need the money – some or all of it – remember that you have approximately another month to put it back.