On June 26, 2013, the U.S. Supreme Court ruled in United States v. Windsor1 that Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional. Same-sex couples married under state law are now treated the same as opposite-sex couples under federal law. According to a Williams Institute review conducted in 2011, over 9 million Americans identify themselves as lesbian, gay or bisexual.2 This decision has a significant impact on federal tax planning for such individuals who participate in retirement plans and who’ve entered or will enter into marriage. In addition, plan sponsors will need to re-examine their procedures to ensure they’re properly recognizing such marriages and complying with applicable state or federal law. Let’s examine some areas of retirement planning and administration that are affected by the marital status of an employer retirement plan participant or individual retirement account owner.
In September 1996, then-President Bill Clinton signed DOMA into law. Despite a number of jurisdictions recognizing same-sex marriages,3 DOMA defined marriage for federal law purposes as being between one man and one woman. Specifically, Section 3 of DOMA defined “marriage” to mean “only a legal union between one man and one woman as husband and wife” and “spouse” to mean “a person of the opposite sex who is a husband or a wife.” We were, therefore, left with some jurisdictions that recognized same-sex marriages and a federal government that explicitly didn’t. This conflicting treatment would eventually lead us to Windsor.
Edith Windsor and Thea Spyer were New York residents and long-time partners who wed in Canada in 2007. Because New York recognizes marriages from other jurisdictions, they were considered legally married under New York law. Thea passed away in 2009 and left her estate to Edith. Edith sought to claim the federal marital estate tax deduction, but based on Section 3 of DOMA, the Internal Revenue Service disallowed the marital deduction because Edith wasn’t a surviving spouse. Edith paid over $363,000 in estate taxes and sought a refund. After the IRS denied the refund, Edith sued for a refund, arguing that DOMA violated the principles of the Fifth Amendment’s equal protection clause. The Supreme Court held that Section 3 of DOMA is unconstitutional as a deprivation of the equal liberty of persons that’s protected by the Fifth Amendment. This sweeping change affects more than 1,000 federal statutes and programs.
Windsor exemplifies the principle that a law found to be unconstitutional is void ab initio. For federal purposes, marriages performed before the Windsor decision that were valid under state law should be recognized retroactively. In Windsor, Thea’s estate qualified for the estate tax marital deduction because she was married at the time of her death. Her marriage had to be recognized for federal tax purposes at the time of her death and couldn’t be set aside under DOMA because DOMA has been held unconstitutional.
ERISA vs. Non-ERISA
Retirement plans fall into two broad categories: those covered by the Employee Retirement Income Security Act of 1974 (ERISA) and those that aren’t.
ERISA sets uniform minimum standards for pension plans in the private sector to protect the interests of plan participants and their beneficiaries. Covered plans include: (1) profit-sharing retirement accounts, (2) stock bonus plans, (3) money purchase pension plans, (4) cash or deferred 401(k)s, (5) employee stock ownership plans, and (6) defined benefit retirement plans.
Traditional IRAs, Roth IRAs and certain Internal Revenue Code Section 403(b) tax-deferred annuity plans aren’t regulated by ERISA. In general, ERISA doesn’t cover plans established or maintained by government entities or churches for their employees or plans maintained solely to comply with workers’ compensation, unemployment or disability laws. Instead, state law and the IRC cover such plans.
Generally, any amount paid or distributed out of an IRA or a qualified plan is included in gross income by the payee or distributee. There’s an exception, however, when the transfer is made to a spouse or former spouse under a qualified domestic relations order (QDRO) incident to a divorce or separation instrument. The former spouse becomes entitled to payments as an alternate payee under the QDRO arrangement. Payments to an alternate payee are taxed to the alternate payee and not the participant.
An alternate payee who’s a former spouse of a plan participant may roll over distributions to an IRA of the alternate payee. Any other payee may not.
Example: Hannah and Jolene were married and resided in Massachusetts. They subsequently sought and obtained a court-ordered divorce. The order awarded Jolene 25 percent of Hannah’s 401(k) account. Jolene rolls over her 25 percent into an IRA in her name. Neither Hannah nor Jolene will be taxed on the 25 percent rolled over to Jolene’s IRA because the division was made pursuant to the divorce decree. When Jolene takes distributions from her IRA, they’ll be taxable to her.
Divorced or separated spouses who previously couldn’t establish a QDRO because of DOMA may now wish to consider doing so to match taxable income from qualified plan distributions with the recipient of that income.
A taxpayer’s first required minimum distribution (RMD) from a retirement plan need not be made until his required beginning date (RBD). For qualified plans, a taxpayer’s (other than a 5 percent owner’s) RBD generally is April 1 of the calendar year (all references to “year” will refer to calendar year) following that in which age 70½ is attained. But, if the employee retires later than the year when age 70½ is attained, the RBD is April 1 of the year after that in which the employee retires. For 5 percent owners and traditional IRA owners, the RBD is always April 1 of the calendar year following that in which the employee attains age 70½, even if the employee hasn’t retired.
Annual RMDs are generally calculated by dividing the account’s value by a life expectancy factor. During the life of an IRA owner or plan participant, the life expectancy factor must be determined under the Uniform Lifetime Table of Treasury Regulations Section 1.401(a)(9)-9, Q&A 3. The only exception to this general rule is when the owner names a spouse as “sole beneficiary,” and the spouse was born more than 10 calendar years before the owner. In that case, the RMD is lowered by using the Joint and Last Survivor Table.4
If the age difference is greater than 10 years, those who were unable to use the Joint and Last Survivor Table because of DOMA may now consider adjusting distributions for 2013 and later years to take advantage of the Joint and Last Survivor Table.
But 2013 and later years aren’t the only years affected by Windsor. Even in years before the ruling, DOMA had no effect because it was ruled unconstitutional (and so is treated as if it never took effect). That might mean, for example, the Joint and Last Survivor Table was available before 2013, notwithstanding DOMA. For those who qualified to use that table, RMDs would have been lower than under the Uniform Lifetime Table, meaning there were distributions in excess of RMDs. In each such year, the difference could have been rolled over to an IRA, but now can’t be because of the 60-day time limit for making an IRA rollover. The IRS can waive the 60-day rollover deadline whenever the failure to grant a waiver would be against equity or good conscience, including events beyond the reasonable control of the individual subject to the deadline.5 But for many, the amount involved won’t justify the cost of asking for the waiver, which is done through the private letter ruling request process.
If an IRA owner or qualified plan participant designates his spouse as the sole beneficiary, the surviving spouse may elect to treat the IRA as his own account. A common means of making that election is to roll over the plan account’s assets to the surviving spouse’s IRA. If the spouse chooses this option, he’s treated as the IRA owner for all purposes. This rollover allows the surviving spouse to defer RMDs until such spouse’s own RBD and to use the Uniform Lifetime Table (or, if remarried to a spouse who’s younger by more than 10 years, the Joint and Last Survivor Table). If the inherited account is a Roth IRA and the spouse makes a spousal rollover, he isn’t required to take any distributions during his lifetime.6
Example 1: Terry, who’s taking RMDs from his traditional IRA, dies after naming his husband, George, as beneficiary of the IRA. George won’t attain age 70½ until four years after the year when Terry died. George makes a spousal rollover of the inherited traditional IRA into a traditional IRA held in his own name. Because George is now treated as the owner of the traditional IRA for all purposes, he doesn’t have to begin taking RMDs until April 1 of the year following the year he turns age 70½.
Example 2: Lydia dies after naming her wife, Mary Jo, as beneficiary of her Roth IRA. Mary Jo makes a spousal rollover of the inherited Roth IRA into a Roth IRA in her own name. Because Mary Jo is now treated as the owner of the Roth IRA for all purposes, she doesn’t have to take RMDs during her lifetime.
Roth IRA conversions of a decedent’s retirement death benefits are now available to same-sex married couples. A surviving spouse who elects to roll over retirement benefits to a traditional IRA of the surviving spouse may make a Roth IRA conversion of the rollover IRA.
Generally, when an IRA owner or qualified plan participant dies before reaching the RBD, the account’s beneficiary must begin taking RMDs the year after the year of death to avoid distribution of the entire account by Dec. 31 of the year containing the fifth anniversary of the decedent’s passing. However, when a spouse is the sole beneficiary and doesn’t make a spousal rollover, RMDs must begin on or before the later of:
1. Dec. 31 of the year following the year in which the IRA owner died, or
2. The end of the year in which the IRA owner would have attained age 70½.
Example 1: Troy dies in 2013. His husband, Gary, is beneficiary of Troy’s IRA. Gary doesn’t make a spousal rollover and, instead, keeps the IRA as an inherited IRA. Troy was 52 at the time of his death. Gary may wait until the year when Troy would have turned 70½ to begin taking RMDs.
Example 2: Barbara dies in 2012. Her wife, Linda, is beneficiary of Barbara’s IRA. Linda doesn’t make a spousal rollover. Barbara was 72 at the time of her death. Because Barbara was already beyond age 70½, Linda must begin taking RMDs by Dec. 31, 2013.
When a non-spouse inherits a retirement account, RMDs must be calculated based on the corresponding life expectancy factor for the designated beneficiary’s age in the year of the first distribution under the Single Life Table.7 This initial factor is reduced by one for each subsequent year. For example, if the non-spouse beneficiary attains age 68 the year after the account owner’s death, the beneficiary’s factor for the first year after death is 18.6 years, the next year’s factor is 17.6 and so on. The account will be emptied out at the end of 19 years. A spousal beneficiary who doesn’t make a spousal rollover, on the other hand, is allowed to annually recalculate this life expectancy factor by referencing the Single Life Table each year, based on the spouse’s life expectancy in that particular year. For example, if the factor for the first year after death is 18.6 years, the next year’s factor is 17.8. The third year’s factor is 17.0. There are factors corresponding to each age through age 111. The account will be emptied out at the end of 43 years, instead of the 19 years allowed to a non-spouse beneficiary of the same age.
A surviving spouse who was using non-recalculated factors may now switch to using recalculated factors. Alternatively, the surviving spouse may be able to make a rollover to an IRA of the surviving spouse and use the factors in the Uniform Table beginning the year after the rollover occurs. But, a 10 percent tax on distribution before age 591/2 could apply.
Spousal IRA Contribution
In 2013, the maximum annual contribution an individual can make to an IRA is the lesser of $5,5008 or 100 percent of compensation. Therefore, to be eligible to contribute to an IRA, an individual must have compensation. A non-working, married individual can, however, make a contribution if his spouse has compensation and the couple files a joint tax return for the year of contribution.
Example: Robert and John are married in their state of residence. Robert earned $75,000 in 2013, but John doesn’t work outside of the home. John can take into account Robert’s $75,000 in income and contribute $5,500 (the lower of $5,500 and $75,000) to his IRA.
REA Consent and Waiver
Most qualified plans are subject to the Retirement Equity Act of 1984 (REA), which amended ERISA and the IRC to, in part, require plans to provide automatic survivor benefits and allow for the waiver of those benefits only with the proper consent of the participant and spouse.9 In other words, the surviving spouse is guaranteed to receive the account when the participant dies, unless the spouse properly waives his right. A participant may waive the qualified joint and survivor annuity no more than 90 days before his annuity starting date. For such a waiver to be valid, the participant’s spouse must also consent to the waiver within the waiver period.
Because IRAs aren’t governed by ERISA, they’re not subject to REA. Nevertheless, the IRA custodian often requires spousal consent if the owner wishes to name someone other than the surviving spouse as primary beneficiary. In addition, even without consent, the surviving spouse may have rights to a portion of the IRA under applicable state property law rights.
Indeed, the U.S. District Court for the Eastern District of Pennsylvania has now considered this question and held, relying on Windsor, that the same-sex spouse of a decedent was entitled to ERISA-covered retirement plan death benefits, even though not named as a beneficiary.10
DOMA’s defeat may mean that benefits that a surviving spouse should have received were, instead, paid to someone else. It remains to be seen what remedy, if any, exists or to whom the surviving spouse might look for any such remedy. The obvious candidates are those who received the distribution and/or the plan administrator who authorized the payments.
Plan participants who have newly recognized spouses and who have named beneficiaries other than said spouses should consider submitting new beneficiary forms and a spousal waiver that will be effective under REA and the terms of the plan governing the participant’s retirement account. IRA beneficiary forms should also be checked and re-submitted for spousal consents where needed.
Naming beneficiaries isn’t the only time a spouse’s consent is needed. Consent may also be required for plan loans, hardship distributions and retirement annuity options other than a qualifying joint and survivor annuity. A review of plan documents and meetings with plan administrators would be wise.
Generally, distributions from 401(k), 403(b) or 457(b) plans while the participant is still employed and before the participant reaches age 59½ aren’t permitted. Hardship distributions, however, are allowed if authorized under the plan document. A distribution is made on account of hardship only if the distribution is: (1) made on account of an immediate and heavy financial need of the employee; and (2) necessary to satisfy the financial need.11
The hardship event is limited to one that affects the participant, but can also include a spouse, beneficiary12 or a dependent, if the plan so permits. This new recognition of same-sex marriages on a federal level will provide a participant with an important financial resource if his spouse has a financial hardship, even if his spouse isn’t named as beneficiary.
Sponsors and Administrators
Many plan and IRA documents define “spouse” and “marriage” using generic language, if they’re specifically defined at all. Plan sponsors should review their documents to decide if a more thorough definition of these terms is appropriate to reflect the equal treatment of opposite-sex and same-sex couples. Plan sponsors should also inspect their current documents and waivers on file to determine if they need to be updated for same-sex married participants.
Many questions remain following the Windsor decision, including:
1. How are already-filed federal returns affected? Can they be amended because DOMA’s unconstitutionality means DOMA was never effective?
2. Will the IRS grant waivers of the 60-day rollover period?
3. What happens when a legally married same-sex couple moves to a jurisdiction that doesn’t recognize their marriage?
4. What options might now be available if a qualified plan was previously paid to a deceased participant’s spouse when the marriage was recognized under state law, but wasn’t recognized under DOMA?
5. What options might now be available if spousal consent was required, but none was given because DOMA was thought to have applied?
6. What’s the plan sponsor’s or plan administrator’s duty to determine marital status of a plan participant under state law, retroactively or going forward?
7. Will civil unions and domestic partnerships be treated differently?
8. What are the rights of a same-sex spouse to ERISA plan benefits of a spouse who died prior to the Windsor ruling, which aren’t yet distributed?
9. For those living in community property states, what’s the status of community property rights that had been recognized by state law, but not federal law?
It‘s likely that further litigation will follow to answer these and other questions. In the meantime, it will be important for same-sex married couples to understand their rights and for plan sponsors to re-evaluate the framework of their plans to comply with these new federally recognized definitions of “spouse” and “marriage.”
1. United States v. Windsor, 570 U.S. __, 2013 U.S. LEXIS 4935 (2013).
3. The following jurisdictions currently recognize same-sex marriages: California, Connecticut, Delaware, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Rhode Island, Vermont, Washington and Washington, D.C.
4. Treasury Regulations Section 1.401(a)(9)-9, Q&A 3.
5. Internal Revenue Code Sections 402(c)(3)(B) and 408(d)(3)(I).
6. IRC Section 408A(c)(5).
7. Treas. Regs. Section 1.401(a)(9)-9, Q&A 1.
8. Or $6,500 for taxpayers age 50 or over. See IRC Section 219.
9. Sample waivers can be found in Notice 97-10, 1997-1 CB 370.
10. Cozen O’Connor, P.C. v. Tobits, et al., No. 2:11-cv-00045 (Dist. Ct. E. Penn. July 29, 2013).
11. Treas. Regs. Section 1.401(k)-1(d)(3)(i).
12. As amended by the Pension Protection Act of 2006.