Tax-Qualified Retirement Plans Tax-qualified retirement plans, such as IRAs, are one of the most common forms of retirement savings in the United States.92 Under the Pension Protection Act of 2006 and the Worker, Retiree and Employer Recovery Act of 2008,93 “non-spouse” recipients can now inherit tax-qualified retirement plans without paying taxes on the entire lump sum amount during the year they receive the funds. They can instead withdraw the funds and pay taxes on them over the recipient’s lifetime, dramatically reducing their overall tax liability.94 Thus any “single” person (including a member of a state-sanctioned same-sex marriage, e.g., in Massachusetts) may designate a partner, relative, close friend or other loved one as beneficiary.
Figure 14: Difference in Annual Retirement Income from Inherited IRA
Annual Income from Inheritance Drawn Down from Age 65-80 $17,696 $14,491 $10,864
While the new law is certainly an improvement for LGBT and single elders, it still leaves some gaps. Surviving heterosexual spouses can leave inherited retirement accounts to grow tax-free until they reach age 70½, but “non-spouse”95 beneficiaries cannot. Nor can “non-spouse” beneficiaries simply roll plan assets over into their own IRAs. Rather, they must start drawing down a minimum amount of funds each year beginning the year after the original accountholder dies.96 Over time, this different treatment can have a significant impact on retirement savings and income, especially for those who inherit an account earlier in life. Take the example of a widow who inherits a $50,000 IRA at age 49½ and invests this amount for a 5% return. A heterosexual widow could use this account to draw $10,864 per year in after-tax income for 15 years starting at age 70½, while a lesbian widow could draw only $9,582 in aftertax income for the same period—a difference of $1,282 per year.97 Using the same assumptions except changing the age of the widow to 39½, a heterosexual widow could draw down $17,696 per year in after-tax income, compared to $14,491 for a lesbian widow, a difference of $3,205 per year.98 See Figure 14.
Employee Pensions/Defined-Benefit Plans Pensions provide an important source of retirement income, with over 40% of older households receiving income from pension plans99 and 53% of workers age 50-64 having pension benefits in their current jobs.100 Under federal law, the pension of a married earner automatically defaults to the Qualified Joint and Survivor and Annuity (QJSA) option, which makes the pension payable (albeit with a smaller monthly payment) over the lifetimes of both the earner and his or her spouse.101 A second option, the Qualified Pre-retirement Survivor Annuity (QPSA), allows the worker’s surviving spouse to receive the pension if the worker spouse dies before retiring.102 Employers may offer either or both options to coupled LGB employees, but most do not. Of employers surveyed
$9,582
Age 49 1/2
Age 39 1/2
Age When Surviving Spouse Inherits IRA Heterosexual Widow
Lesbian Widow
Tax-qualified retirement plans include 401(K)s, 403(B)s, 457s and IRAs. These plans are eligible for favorable tax treatment. Contributions and earnings on those contributions are tax-deferred until withdrawn for each participant. 93 The PPA allowed companies to optionally offer these “inherited IRA” plans, while WRERA made it mandatory to offer these plans. 94 The beneficiary withdraws funds regularly in amounts based on the beneficiary’s life expectancy as dictated by the IRS life expectancy table—so a 50-year old beneficiary must withdraw 1/34th of the funds at age 50, 1/33rd of the funds at age 51, etc. See http://www. irs.gov/pub/irs-pdf/p590.pdf for more information. 95 Note that married LGBT spouses are still considered unmarried under the current federal law. 96 Withdrawals must start the year after the death of the original account holder and the beneficiary must take a minimum distribution every year based on his or her life expectancy, whereas a heterosexual spouse could let the account grow tax free until age 70½. 97 MAP analysis. Assumes that the heterosexual widow invests the full amount at a 5% compounded return. At age 70½, she then decides to draw down the account in equal amounts over 15 years, at a retirement marginal tax rate of 15%. By contrast, the same-sex widow must start withdrawing from the account at age 50½ in accordance with the IRS life expectancy table. She pays 25% tax on these withdrawals until she retires at age 65, at which point her marginal tax rate drops to 15%. She puts the withdrawals in a savings account, where interest earnings are also taxed at 25% until age 65, then at 15%. Like the heterosexual widow, she earns a 5% gross compounding rate of return on any principal. Also like the heterosexual, widow at age 70½, she then decides to draw down the remaining IRA in equal amounts over 15 years (at a retirement marginal tax rate of 15%) in addition to her retirement savings, which are not taxed beyond tax on interest earned (since she has already paid tax on these funds when initially withdrawn from the IRA). In this scenario, the heterosexual widow can take home $11,392 per year in after-tax income (combining withdrawals from the inherited IRA and her savings account), versus $10,061 for the same-sex partner. Scenario uses IRS life expectancy table found at http://www.irs.gov/pub/irs-pdf/p590.pdf. 98 Same analysis as above, except the lesbian widow must start withdrawing funds at a 25% tax rate at age 40½. 99 Figures are for 2006. From “Fast Facts and Figures,” Social Security Administration, 2008. In 2006, 29% of older households received income from private pension plans and 14% received income from government pensions. 100 The State of 50+ America, AARP, 2007. 101 Single heterosexual elders may also receive pension or survivor income from an ex-spouse, e.g., as part of a divorce settlement or because the pension holder did not change the joint survivor option despite a break in the relationship. 102 If the worker spouse dies before retiring, the other spouse gets the pension in the year in which the deceased spouse would have started receiving the pension. 92
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