The Pension Rollback Strategy – Maximizing the Deferral of Qualified Plan and IRA Assets for Income and Estate Tax Purposes


Many taxpayers have the benefit of large IRA or qualified plan benefits that ultimately get rolled over into an IRA at retirement.  The reality is that many of these taxpayers rely on other sources of non-qualified assets to sustain their lifestyle income needs while deferring taxation on the qualified retirement plan assets. In many cases (particularly for professional service professionals), these qualified retirement assets represent the largest asset on the balance sheet.

Over the course of years, I have heard financial services professionals speak of IRA accounts as large as $25 million and even as large as $100 million. The reality is that many taxpayers have IRA balances of $1 million-$10 million.

The Bush tax cuts are due to expire at the end of 2012. The top marginal income tax rate is scheduled to increase to 39.6 percent. Additionally taxpayers will face an additional tax of 3.8 percent on unearned income if adjusted gross income (AGI) on a joint tax return exceeds $250,000. Considering the impact of state taxation, the average combined tax could be as high as 45-50 percent for many taxpayers.

The federal estate tax returns to taxpayers with a vengeance in 2013. The top marginal tax rate increases to 55 percent from 35 percent. The estate tax exemption equivalent drops from $5 million. The combined impact of the income and estate tax can easily exceed 80 percent.

How are taxpayers dealing with qualified plan and IRA assets now?  In many cases, a substantial amount of estate planning focus over the last twenty years has been on maximizing deferral on IRA assets beneficiaries using the “Stretch IRA” concept. The “Stretch IRA” basically involves “stretching” the required minimum distribution payments over the life expectancy of the beneficiary of the IRA.

It is a fine planning technique; however, the while the Stretch IRA provides continued income tax deferral as a result of payouts over the life expectancy of a younger beneficiary, it does not provide any estate tax deferral or  avoidance.

This blog post will provide an executive summary of a different deferral technique – The Pension Rollback. The Pension Rollback Plan can provide income and estate tax deferral on qualified retirement assets for multiple generations.

The Pension Rollback Plan

The Pension Rollback Plan involves the transfer of a large IRA balances into a defined benefit pension plan owned by the taxpayer, but sponsored by the client’s family business entity (the entity is readily formed if it does not already exist).

Current tax law provides for the ability to transfer or roll IRA assets back into a qualified retirement plan.  For example, the taxpayer can create a family limited partnership or family limited liability company. A range of valid business purposes (including centralized management of family investment assets) should satisfy both state law and federal income tax considerations. Family LLC interests are transferred to family members or a family trust at a minimal tax cost for gift tax purposes.

The structure, a family LLC or LP, converts a large retirement account balance into an income stream that ceases at the death of the account holder or at the last death of the account holder or the account holder’s spouse. The trustee of the new defined benefit plan provides a pension benefit (life only annuity) that is actuarially determined. At the death of the participant, pension benefits cease. Nothing is included in the estate of the taxpayer (the plan participant).

The excess plan benefits in the defined benefit plan revert back to the defined benefit plan. The participant’s family or trustee of the family trust controls the remaining assets under this structure without the remaining assets becoming part of the client’s estate.

The purpose of the Pension Rollback plan is to eliminate estate tax exposure that would otherwise apply to large retirement assets.  Additionally, the Pension Rollback plan creates a highly valuable multi-generational asset with minimal tax consequences to the client and to his or her family.

Creation of The Pension Rollback Plan (“The Plan”)

Step 1   In order to create The Plan, the sponsor of the qualified plan must be a bona fide business entity – Family LLC or Family LP.  This means that the sponsor must have a valid business purpose for state law and federal tax purposes.  The management of investment assets can serve this purpose.

In order to maximize income and estate tax benefits planning, the family business entity should be owned by a family dynasty trust. The client may need to form the family business entity for purposes of becoming the plan sponsor.

Step 2 – After creating the family LLC, the LLC adopts a qualified retirement plan under Section 401(a) of the Internal Revenue Code.  The Pension Rollback Plan document is a plan that the IRS has approved for all districts in the United States.  This qualified plan will be a defined benefit plan (i.e. plan that must pay a monthly benefit for the life of the retired employee).

Step 3 – In order to form The Plan, the client must have a pre-existing retirement account such as qualified plan under 401(a). In many cases, taxpayers have rolled these pension plan assets into an IRA.  Subject to the terms of the client’s pre-existing retirement account, the client may rollover all or a portion of his or her retirement benefits to the defined benefit plan sponsored by his or her family business entity.

Step 4– After the close of the first plan year, the account is converted into a life only annuity (an annuity is a fixed sum of money payable periodically).  The account may be annuitized over the life of just one participant or over the joint lives of the participant and the participant’s spouse depending on the objectives to be achieved.

For example, if the participant’s surviving spouse has significant assets, the participant may want to annuitize for his or her life only so that the account balance goes directly to the participant’s family upon death.  .

Step 5 – Upon the death of the last annuitant, the assets remaining in The Plan are removed from the estate of either the participant or the participant’s spouse.  However, this event does not cause the assets to be removed from family control.

Any remaining assets at the death of the last surviving spouse constitute an “actuarial gain” in favor of The Plan, which is sponsored by the family LLC that is owned by the family dynasty trust.  This allows the structure to be continued such that future generations are not burdened with transfer tax exposure.

The Dynasty Trust

Dynasty Trusts are long-term trusts created for the Grantor’s descendants in order to maximize trust assets for estate and generation skipping transfer tax (GST) purposes.  Long after the death of the Grantor, a Dynasty trust can distribute income and principal the way the Settlor intended when he or she was alive.  Even if the trust’s assets accumulate for years, they remain free from federal gift and estate taxes for the life of the trust.

The Dynasty trust structure serves two purposes for The Plan.  The first purpose is to counter any argument that establishing The Plan caused a taxable gift.  The second is to maintain the transfer tax and asset protection benefits for generations if desired.

The trust will own the sponsor of The Plan from inception.  At inception, the family LLC will have minimal value.  Thus, if an asset transfer occurred at the time, it would be irrelevant.  The rollover of the retirement assets changes nothing.  Lastly, the annuitization should not be treated as any kind of “transfer” between the older generation and the next generation.  No gift is made.  The account balance immediately before the conversion and the income stream immediately after the conversion should have the same “value.”

Lifetime Advantages of the Pension Rollback Plan

The Plan offers substantial income tax and financial planning benefits for both the participant and/or the participant’s spouse.  From an income tax planning perspective, the conversion of the account balance to a fixed annuity payment sets the distribution from the plan at a fixed amount.  The fixed amount does not increase or decrease with fluctuations in the value of the retirement assets or the participants age as with other pension plans.  This fixed amount satisfies the minimum distribution requirements under the law.

Satisfaction of the required minimum distribution rules with The Plan approach is highly advantageous compared to the typical distribution rules with other retirement plans.  Under the typical distribution rules, the older the participant gets, the greater the percentage of account balance that must be distributed.  Further, if the investment of the account has produced positive results, a higher percentage for required distributions will be applied to a larger account balance resulting in an even larger distribution that will be included in taxable income.

Many retirees have structured their financial affairs such that they really don’t need access to their retirement accounts and would prefer to keep their distributions as small as possible in order to avoid the loss of tax deferral on the distributed amounts.

Exit Strategies

The Plan generally has a few exit strategies.  First, the easiest strategy is to continue the PR plan as a “Perpetual Family Pension Plan”.  Under this approach, each generation will participate in the plan and earn a maximum retirement benefit under the plan.  At retirement age, the Perpetual Family Pension Plan strategy will provide a substantial retirement benefit to supplement the participant/heir’s retirement income.

Under the Perpetual Family Pension Plan scenario, succeeding generations obtain only an income interest that will terminate at the death of each respective heir (or the death of the heir’s spouse).  Thus, all undistributed retirement assets remain outside of the federal transfer tax environment.

A second exit strategy for terminating The Plan (particularly larger plans) is to sell the family LLC to a large company that can convert the excess retirement assets to cash.  An appropriate Purchaser could make such a conversion because such a Purchaser would have many employees for whom the company is required to make retirement plan contributions during the current year.  The sale would occur at a discount of the assets remaining in the plan to be desirable to the purchaser.  The Purchaser benefits from the sale because it was able to buy discounted dollars.

The Seller benefits from the sale because the after- tax proceeds received as a part of this sale are treated as long term capital gain income.  Long term capital gain even after the expiration of the Bush tax cuts will continue at a much lower rate than ordinary income. The Seller can afford to sell at a discount and still possess a more valuable asset.

Alternatively, the sale may occur as a tax-free merger transaction where the owner of the entity sponsoring the plan would receive stock in the purchase.The transfer tax benefit associated with this exit strategy is that it retains the sales proceeds inside the Dynasty trust that owns the Family LLC that sponsors The Plan.  Therefore, the sale proceeds remain outside of the transfer tax environment for as long as the assets remain in the trust.


The Pension Rollback Plan is a unique strategy that can provide income and estate tax deferral for qualified retirement plan assets for multiple generations. These assets are the most tax sensitive in that the combination of income and estate taxes can easily erode eighty percent of assets that were accumulated over multiple decades. The strategy provides a better income and estate tax result than the commonly used Stretch IRA as well as providing greater asset protection for the qualified plan assets.

Feel free to contact me if you have any client situations that can utilize the Pension Rollback Plan.

About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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