Law News and Tips
A CLIENT LETTER
Fred L. Vilbig © 2018
Let me commend you on what you are doing. Having helped my wife care for her parents as their health and mental capacity declined, I know how physically, intellectually, and emotionally draining this can all be. Growing up, we never really think about the kinds of things you have to deal with now. Some people walk away. Some people delegate the duties. Some people just want to end it all. But you are caring for your mother at what is probably the most difficult time in her life, and also of your life up to now. As I said at the beginning, I commend you.
That said, I wanted to answer some of your questions. The first was whether having your mom declared incompetent created any problems for you personally. To answer that, I need to define what I mean by declaring your mom incompetent.
If she had not done any planning, that would mean getting a court involved. It’s not the end of the world, but it is sort of a pain. You’d need to get a doctor to answer a formal set of questions (“interrogatories”) to say that your mom can’t perform certain basic functions of daily living. For instance, can she remember to take her medicine at the proper time? Does she know to wear a coat when it’s cold outside?
Once you have the interrogatories, you have a hearing. Assuming all goes as planned, the judge would then put you in charge of her finances (a conservatorship) and her person (a guardianship). You would next need to get a court order authorizing you to spend money, and then you have to file an annual financial report with the court.
Fortunately, your mom did all the necessary planning. She has a general durable power of attorney, a medical directive (which includes a medical power of attorney and a living will), and a trust. Although people can put others in charge of things even while they’re competent, your mom (as most people) wanted to retain control as long as she could. So in her case, in order for you to take over, you just need a doctor to certify that she is not able to perform some of the necessary basic functions of daily living.
Just as a caution to you, although getting that kind of certification from a doctor used to be fairly easy, I have noticed in recent years that doctors have become more cautious. They are often reluctant to make that certification. However, given the right circumstances, they will.
Once you do get the certification, you can pay your mom’s bills and make decisions regarding her care. There is no need for any court proceeding. I know you were worried about having to testify, so I’m assuming that is a relief.
I now want to return to your main question about liability. The doctor’s certification does not impose any additional personal liability on you. You are basically already doing what needs to be done. With the certification, you will just have the proper authority to do it. And you can do everything with your mother’s assets, not yours. You will have no additional personal financial liability for your mom.
Once again, I want to commend you on what you are doing. Even though it can be very challenging, it is the right thing to do. Our parents took care of us when we were young, and now it’s our turn. Life is funny that way.
Let me know if you have any more questions.
Fred L Vilbig
RESOLUTIONS AND TAXES
Every year when the New Year rolls around, we all talk about making resolutions. We make resolutions to improve our appearance and physical health. We make resolutions to become better people. We make resolutions to improve our finances. I saw one study that says that people achieve less than 10% of their New Year’s resolutions. I wonder if it’s even that high.
I would like to propose a resolution for the New Year (I know this will be published in late January, but we had the new tax law to deal with). I want people to resolve to update their estate plans, and the new tax law provides an incentive. Here’s why.
The federal estate tax exemption used to be $600,000. With homes and life insurance and retirement benefits, a lot of people got caught by this tax. We wrote a lot of estate plans with tax planning included, which was the right thing to do at the time.
A typical plan for a married couple involved two separate trusts. We used two trusts to make administration simpler on the death of the first spouse to die. The trusts were generally equal in value. Every year or so we wanted to look at the assets in the separate trusts to make sure they were still generally equal, and the clients were supposed to periodically rebalance the trusts by shifting assets from one to the other where possible.
On the death of the first spouse to die, the assets in his or her trust would be distributed first to a tax-sheltered trust up to the amount of the exemption. The trustee of that trust (typically the surviving spouse) was required to distribute all of the income to the beneficiary. The surviving spouse was almost always entitled annually to demand a distribution of 5% of the trust for no reason at all. In addition, the trustee could use the principal for the health, education, maintenance, and support of the spouse in the trustee’s discretion. The amounts in the tax-sheltered trust would avoid estate taxes even on the death of the second of the spouses to die, provided that the trust was properly administered. Clients generally felt that these restrictions were reasonable enough to avoid estate taxes. Any amounts in excess of the exemption would be distributable to a marital trust that could be subject to estate taxes on the death of the second spouse to die.
The problem with this plan is that the tax-sheltered trust was an irrevocable trust. Irrevocable trusts are taxable. They have to file tax returns. Failure to file the return can result in penalties and interest. And these trusts can generate taxes on trapped capital gains. Taxes on trust income are particularly bad because although the rates are comparable to individual rates, they kick in very quickly. For instance, any trust income over $11,950 will be taxed at 39.6%.
With the new tax law, the exemption amount is around $11 million. A married couple can avoid taxes on approximately $22 million. It is estimated that only two in every 100,000 people will be subject to federal estate tax. What that means is that for most married couples, an estate plan with tax planning is not only unnecessary, but it can also end up costing money.
Another problem with these old plans is that the separate assets of spouses can be liable for the debts of the individual spouse.Jointly held marital assets are protected from the claims of the creditors of either individual spouse. In 2011, the Missouri legislature passed a law allowing joint, marital trusts to be protected from the claims of individual spouses as well. Separate trusts could be liable for the debts of an individual spouse.
I would like to propose a resolution with couples with old estate plans: update your plan. Don’t leave the surviving spouse with a headache.When one of you dies, it probably is not a good time to deal with this sort of thing.
It’s the right thing to do. I’ll wait for your call.
We finally have the much ballyhooed and vilified 2017 tax act, the “Tax Cuts and Jobs Act” (the “2017 Act”) – don’t you just love these names. The 2017 Act changes a lot of fairly obscure provisions of the tax code that will affect a relatively small number of people, but some of the changes will impact a lot of people. How they affect individual taxpayers will have to be seen. It should be noted that a number of provisions under the old law have not been repealed, but they have only been suspended through 2025. This is probably due to budgetary requirements.
For purposes of this post, I want to provide a very brief summary of some of the provisions that I think will affect the most people. I can assure you that much more will be written on it in the future.
New Income Tax Rates and Brackets: The 2017 Act reduces most of the tax rates for individuals by 2 or 3 %. The 2017 Act also creates new tax brackets for trusts and estates. Under the old law, trust and estate rates were the same as those for individuals, but they were telescoped down so that you hit the maximum tax rate at about $12,500. This will change.
Increase in the Standard Deduction: Under current law, the standard deduction for 2018 would have been $13,000 for married couples; $9,550 for heads-of-households; and $6,500 for individuals who were either single or married but filing separately. Under the 2017 Act, the standard deduction is increased to $24,000 for married couples; $18,000 for heads-of-households; and $12,000 for individuals who are single or are married but filing separately. That’s the good news.
Personal Exemptions Suspended: Now for the bad news. In exchange for the increase in the standard deduction amounts, the deduction for personal exemptions is reduced to zero until 2026. It appears that these two changes in conjunction with one another mean that prior non-itemizers may come out ahead while prior itemizers may come up short.
New Inflation Adjustment Factor: Beginning in 2018, several inflation adjusted amounts will use a “chained” consumer price index (“CPI”) formula. Reportedly the chained CPI grows faster than the unchained rate. This is an obscure point, but it might work in the favor of taxpayers.
Kiddie Tax: Since this applies to kids up to 18 (or 22 if full-time students), this is probably a bad name. Perhaps a better name would be “dependent’s tax.” However, the 2017 Act changes the tax charged on a child’s income. Earned income will be taxed at single individual rates. Net unearned income (interest, dividends, rent, and royalties) will be taxed according to the new brackets for trusts and estates.
Capital Gains: The 2017 Act retains the present provisions on capital gains, but the breakpoints will be indexed for inflation using the new chained CPI.
A number of deduction provisions are also modified under the 2017 Act.
State and Local Tax Deductions: Non-business payments for state and local property taxes and income taxes are deductible, but only up to $10,000. This will be a bitter pill to swallow for residents of high income tax states.
Mortgage and Home Equity Loan Interest Deductions: The deduction for interest paid on home equity loans is suspended through 2025. For mortgages created after December 15, 2017, the deduction or mortgage interest is limited to interest paid on mortgages up to $750,000 for married couples (down from $1,000,000), and $375,000 (down from $500,000) for married taxpayers filing separately. This new lower limit does not apply to pre-December 15, 2017, mortgages, but it would apply to any refinancing of old mortgages.
Charitable Contribution Rules: The limitation on the deduction for cash contributions to public charities (generally schools and universities, churches, museums, etc.) is increased from 50% of the donor’s AGI to 60% of his or her AGI. There is no increase in the deductibility of non-cash contributions to public charities or any contributions to what are called private foundations.
Miscellaneous Itemized Deductions: Under current law, a taxpayer can deduct certain expenses (such as the cost of preparing tax returns) to the extent that they exceeded 2% of the taxpayer’s AGI. This deduction has been suspended through 2025.
Individual Mandate: The individual mandate under the Affordable Care Act which imposed a penalty for not maintaining a mandated health insurance policy has been repealed.
Alternative Minimum Tax: The tax code imposes an additional tax on certain “tax preference” items and on excess children. Income is exempt up to a certain amount. For taxpayers who are hit by this tax, the 2017 Act almost doubles the exemption.
529 Accounts: Under current law, 529 plans could be used to pay for qualified higher education expenses. Under the 2017 Act, these plans can be used for tuition at elementary and secondary public, private, or religious schools, and even for certain home school expenses, up to a $10,000 annual maximum.
Estate and Gift Taxes: The 2017 Act doubles the estate tax exemption amount, indexed for inflation. It is expected that the 2018 exemption amount will be $11.2 million ($22.4 million for married couples). I’ll write more on that in the future. This increase also increases the generation skipping tax exclusion amount.
Qualified Business Deduction: The 2017 Act added a new deduction for non-corporate taxpayers engaged in a business activity other than certain service businesses, including law and accounting. The deduction is allowed for S-corporation shareholders. The math is complicated, but it’s basically connected to a business’ W-2 wages. In promoting the 2017 Act, the Republicans said that it would promote the creation of jobs. It seems that this deduction does that, but time will tell.
There has been a lot of spin put on the 2017 Act by both the left and the right. Time will tell how it plays out nationally, but to see how it will affect your taxes personally, you will probably need to see your tax advisor.
They say that making sausage isn’t pretty. I like sausage, but I’ve never made it, and I probably don’t want to know much about it. With all the government
regulation of food now, this probably isn’t as bad as it once was. However, when families used to process their own meat, they were very efficient.
Everything was used. As the saying goes, the only thing they didn’t use was the moo. And all the spare parts went into the sausage. You probably just
don’t want to know.
I look at politics much the same way. Having served on my city government, I can say it was ugly and frustrating to say the least.
To understand what’s going on, it’s probably good to keep the process in mind. Bear with me while we return to Civics 101 with an ugly dose of reality.
All revenue legislation is supposed to start in the House of Representatives. It starts in the House Budget Committee. This is where the special interest pressure starts, at least in Congress. There is public debate. Amendments are voted up or down. Then the bill is voted on according to party lines basically without regard to the merits of the bill.
If approved by the committee, the bill is then sent to the full House. Moderate horse-trading ensues, and amendments are proposed. Noble sounding speeches are made, but only for the benefit of the constituents at home. Some amendments pass while some are voted down. If the party in control likes the bill, it passes the House and is sent to the Senate.
The Senate will refer it to their Ways and Means Committee. More horse-trading ensues. Nice speeches are made. Amendments are voted up or down. Some version of the bill makes it out of that committee and goes before the Senate. Again if the party in control likes the bill, it gets approved.
The problem is the versions of the bills approved by the Senate and the House are never the same. The two versions then have to go to a Conference Committee to “reconcile” the two bills. Amendments can be inserted at that time too after all public debate is over. It’s here were some of the most controversial provisions are added, such as the HHS Mandate and the Johnson Amendments. Do you hear the meat grinder going?
What emerges from the Conference Committee many times bears striking differences from what went in. And the House and Senate then have to vote the reconciled bill straight up or straight down, without any further amendments.
In my mind the problem with this process is that you and I have no real input into what comes out of the Conference Committee. Special interest groups and very powerful constituents put pressure on the committee members. Individual congressmen propose amendments that favor one of their particular constituents. If his or her vote is needed for passage, that provision passes. Sometimes you’ll see tax code provisions that referred to a business located on a lake that operates a sandwich shop between the hours of ten and five in the state of Alabama. The name of the particular beneficiary of that law is not mentioned, but it was written so narrowly that it could only apply to one organization. But nice speeches were made.
The tax bill being proposed at best has only slim margins for passage. Concessions to individual congressmen will be necessary to get the votes they need. It will be interesting to see what special interest provisions end up in it. I guess this is all part of the democratic process, but it sure seems like sausage making to me. Is that any way to run our government?
You’ve heard the expression, “It’s better to be lucky than to be good?” Well, John was lucky. He was good too, but the lucky part was the biggest thing. But being a religious guy, he knew that luck had nothing to do with it. More on that later.
John was in advertising. He’d worked hard. Over time he had moved up in his company, and they had made him a partner. Not a big partner, but still a partner. That was the hard work part.
His firm had a good reputation, and when an advertising firm from London was looking for a St. Louis partner, they found John’s firm. They made John and John’s partners an offer they really couldn’t refuse. After taxes, John netted $5 million in the company shares. That was the lucky part.
Now for the religious part: he knew this was a gift. He knew that nothing just happens by chance, so the question was, what should he do with this gift? He couldn’t just give it away since he and his wife needed the income for retirement. He also had a pretty big tax liability he was facing, so he needed to do some planning.
He was working with a financial planner at the time. After talking this through, the planner recommended that John and his wife set up a charitable remainder unitrust, a CRUT. A CRUT allows a donor to make an irrevocable gift of a remainder interest while retaining the right to receive annual payments of a percentage of the value of the CRUT principal. Since there is an irrevocable gift involved, John and his wife were entitled to a charitable contribution deduction for a portion (though not all) of the value of the assets transferred to the CRUT. In addition, since the CRUT itself is tax exempt (unfortunately not the annual payments, though), they could at least to defer tax on the sale of his stock. Pretty nifty, eh?
When John was setting up the CRUT, he really hadn’t decided on what charities he wanted to benefit and how. I had warned him about just giving money outright to charities. I have seen congregations torn apart over money fights when they received a big gift. So we set up the CRUT, I included a provision so that he could designate the charitable beneficiaries in his will.
There a little trick to doing this. If you are making a gift to a public charity, for cash gifts, you can deduct up to 50% of your adjusted gross income (your “AGI”). If you’re giving real property, stocks, or bonds, then your deduction is limited to 30% of your AGI. However, if you are contributing to what is called a private foundation, then your deduction for cash gifts is limited to 30% of your AGI, and the deduction for non-cash gifts are limited to 20% of your AGI. There is a 5-year carry-forward for the unused charitable contribution deductions, so they’re not lost, but who wants to wait for a deduction.
If you reserve the right to name a charity in the future and say no more, then your deductions will be subject to the private foundation 30/20% limits. The trick is that the CRUT needs to provide that you can only designate qualified public charities as the beneficiaries of the CRUT. Then you contribution will be eligible for the 50/30% limits.
One last thing – John did not want to give up control. He didn’t want to be locked into a bank or a charitable foundation. He wanted to be his own trustee. So we named him and his wife as the initial co-trustees.
As you can see, CRUTs can be kind of complicated, but under the right circumstances, they are a tremendous way for charitably minded people to make a gift, get a deduction, defer taxes on capital gains, and earn tax deferred income like in an IRA.
To learn more or to analyze whether this is a good option for you, feel free to call and make an appointment. I look forward to hearing from you.
DISTURBING THE DEAD
Fred L. Vilbig © 2017
As I mentioned in my last column, a good estate plan is where the kids are still celebrating the holidays five years after mom and
dad have died. A bad plan is where they’re not even talking to one another soon after the funeral. Sometimes the fights are enough to wake the dead.What
a good topic for Halloween!
I run into that family every once in a while where the parents haven’t planned their estate carefully or implemented the plan correctly. Many times when mom and dad are getting older, they become more and more dependent on one child as opposed to the others. Sometimes it’s to the complete exclusion of the others. And sometimes it’s that child who is isolating the parents.
We have a case like that now. There are four children in the family. When mom and dad were younger, three of the kids clearly remember both mom and dad saying everything would be split into four equal shares when they died. The mom and dad also set up a trust. The trust said that when mom and dad became incompetent, one of the sons could step in to pay the bills. On their death, the trust provided that everything was supposed to be split four ways just like the three kids remembered.
But for whatever reason, mom left her bank accounts out of the trust. She even had a power of attorney authorizing one of the kids to take care of the non-trust accounts. But that was not the daughter who moved in with her. After dad died and mom was growing more feeble, that daughter convinced mom that since she was living with her, mom should just “put her name on the accounts.” That way she could pay her mother’s bills and make her life easier.
There are a couple of ways you can “add someone’s name to an account,” but the daughter marched mom down to the bank and had mom add her name as a joint owner.
One of the characteristics of a joint bank account is that when a joint owner dies, the entire account passes over to the surviving joint owner(s). In the case of a husband and wife, that is usually a good thing. In our case, it wasn’t.When someone is added to a bank account as a joint owner, all other planning becomes meaningless. On the death of one joint owner, the entire amount in the account belongs entirely to the surviving joint owner(s), no matter what a will or trust might say.Once its theirs, they can do whatever they want with it.
Soon after the funeral, the funeral home wanted to be paid. The son who was the successor trustee under the trust went to check how much money was in the trust to pay these bills. He found mom’s checkbook. According to the ledger, there was plenty of money in it. However, he thought it was curious that the checks had his sister’s name on them but said nothing about the trust. He called the bank only to be told that they couldn’t talk to them. They couldn’t even tell him who owned the account now. His blood pressure began to rise.
It occurred to him that since his sister’s name was on the account, he should ask her, so he did. When he asked what happened to their mom’s checking account, he was told it was none of his business. His blood pressure rose a little more.
When he pressed the question, his sister told him that mom wanted her to have that money, and she deserved it. She had been the one taking care of mom all these years (a slight exaggeration), and this was mom’s way of paying her back. The son asked when mom had said this, and the sister told him. The son knew mom had been pretty ill at about that time. His blood pressure was getting sky high.
When the brother told the other siblings about this, they were furious. They called a family meeting, and the one sister came. The three other kids told her that mom and dad had wanted them to split those accounts equally, but the sister stuck to her position. Tempers flared, voices got harsh, the meeting ended in chaos, and litigation will follow.
It’s such a sad ending to what had been a very happy family life. It’s not at all what mom or dad would’ve wanted. I’m sure it’s enough to make them turn over in their graves.
There are alternatives.Feel free to contact us to discuss further. Call today: 314-241-3963
Fred L. Vilbig © 2017
I often say that a good estate plan is where five years after mom and dad are gone, the kids still celebrate holidays together. When it does happen, it’s a joy to see, but I’m afraid it’s pretty rare.
Some of the time the divisions are not immediately apparent. I remember one family early in my career. There were four kids, and only one of them was married. Two of the sisters lived together, and a brother lived nearby. The married sister lived in the area as well. They came in together to plan their estates, and all seemed fairly happy.
Then one of the sisters died. She had named a niece as the personal representative. They all came in to talk about probating the estate. The senior partner of our firm started the meeting with a pretty stern warning that if any disputes came up, everyone except the niece would have to leave the conference room. I guess he had a sense that something was up.
Within 10 minutes (maybe even five), they were at each other’s throats. I don’t even remember what the issue was. I was stunned. The partner was yelling for everyone but the niece to leave. That was a rude introduction to what money can do to the family dynamic.
Other times the conflict is well-known. I recently met with a woman whose sister was refusing to cooperate and was using trust assets for her own benefit. The mother had named both daughters as co-trustees, so the use of trust assets for personal benefit was clearly a breach of fiduciary duty. My client was not happy and wanted to get her sister out. The trust was basically paralyzed.
There was another problem. Although mom had created a trust, for some reason she did not transfer her bank accounts into the trust. She added pay-on-death (“POD”) clauses on all of them naming both of the daughters as the beneficiaries of the accounts. My client had gone to the bank to cash out her share of the accounts, but the bank refused. It turns out that if there are multiple beneficiaries on a POD account, no one can get anything out of the accounts unless all the POD beneficiaries are there. The banks don’t want to get in the middle of any conflicts.
Normally it’s easy to get people together when they’re getting money. In the case of the sisters, the one sister refused to show up. Apparently she would rather not have the money if it meant that her sister would get some money. Things don’t always have to make sense. Litigation may follow.
So what are parents supposed to do? I typically discourage multiple trustees. I like one person to be in charge. If there are multiple trustees, I like having an odd number so that a tie vote is unlikely. If the sibling conflict is obvious to the parents, then a relative, friend, or corporate trustee may be in order. It just depends.
In any event, parents need to honestly assess their children’s relations. Otherwise, the kids might end up with a paralyzed estate.
ELDER LAW PLANNING:
PROCEED WITH CAUTION
Fred L. Vilbig © 2017
“Elder Law” keeps popping up, and not in a particularly good way.
I’ve recently met with a couple of clients who as part of an elder law plan put together an irrevocable trust and transferred most of their assets into it. The problem with this plan is that it is basically irrevocable. Although the makers of the trust typically retain the right to the trust income, they are irrevocably giving away the principal, the underlying assets. One of the clients had their air-conditioner go out after they gave everything away, and they didn’t have enough money to pay to fix it. Things got hot. Another client didn’t do the math right and ran out of money.
For anyone in this predicament, there may be a way out, but it does cost money. It also requires the cooperation of everyone involved. The trust makers and all the beneficiaries (this even includes the kids who now have a right to the principal) may be able to enter into what is called a “nonjudicial settlement agreement” (an “NJSA”), but depending on the situation, an NJSA may not work. The other alternative is to go to court. Never a good thing.
Elder Law planning requires some careful, conservative calculations. Clients need to make sure that if they irrevocably put their savings into a trust, they will still have enough money to live on and to meet any reasonably foreseeable emergencies. It may be that they can only put part of their savings into such a trust and keep part of it out as a rainy day fund. Of course, assets that are left out could be lost to pay for medical costs, but I’d rather have clients run that risk than to just run out of money.
Another issue clients need to consider is what of their assets can be transferred into an irrevocable trust. For instance, if you transfer an IRA (many times a client’s largest asset besides their house) into an irrevocable trust, that constitutes a taxable event which accelerates all the unpaid taxes on the entire amount. That’s probably a bad plan. It’s questionable (and probably ill-advised) whether clients can transfer their homes into an irrevocable trust while they are still living there. You probably can transfer life insurance in, but then you have to figure out how premiums will be paid. It gets complicated.
In any event, irrevocable income trusts can be useful planning tools, but they are not for everyone. Clients need to plan very carefully before creating one. After all, they are irrevocable.
Contact Fred now about your situation. The first consultation meeting is free.
HURRICANE RELIEF FROM THE IRS
Fred L. Vilbig © 2017
Retirement plans are designed for… well, retirement. You put tax-deferred income into the plan to grow tax deferred. Beginning at age 59 ½, you can start withdrawing plan assets and just pay the income tax on what you take out. The assets that remain in the plan continue to grow tax free. Beginning at age 70 ½, a plan beneficiary must begin taking out a minimum amount (the “required minimum distribution” or “RMD”) which is a pro rata amount based on the participants life expectancy.
If a participant begins withdrawing money too soon, there is a 10% early withdrawal penalty. Some (but not all) plans allow participants to borrow funds, but there are restrictions. If the plan includes the required language, you can borrow up to the lesser of $50,000 or one half of the amount in the plan. You have to pay the loan back in five years in at least quarterly equal payments of principal and interest. Finally, the loan must be evidenced by a legally enforceable agreement.
In two recent Announcements (Announcement 2017-11 and 2017-13), the IRS has loosened these requirements for victims of Hurricane Harvey in Hurricane Erma. People who live or work in one of the Texas or Florida counties identified by FEMA for individual assistance are eligible. The IRS wants employers to try to comply with the requirements, but they sympathize (a word rarely used in the context of the IRS) with the victims of the storms. Therefore, eligible individuals can access their retirement assets to make it through the storms and to rebuild.
I recognize that St. Louis was not affected by the storms. However some readers may have family in these areas. If so, they may want to get in touch with them to let them know that they can contact their employers about accessing these retirement funds. Yes they will have to pay it back, but it is a source of funds during very difficult times.
Fred L. Vilbig ©2017
Whenever clients with trust-based estate plans sign their documents, we handle their real estate with a deed of some sort and their stuff (i.e., their tangible personal property) with an assignment.
With regard to their other assets, we typically don’t get actively involved. As Abraham Lincoln once said (and you should always quote Honest Abe to make a point), “A lawyer’s time is his stock in trade.” That is, all a lawyer has to sell is his or her time, so if they do work for someone, they are going to charge them.
To keep costs down, we give clients a detailed letter about funding their trusts. We tell them to go to their bank, their investment advisor, their broker, and their insurance agent. Clients just need to show them the letter and say “Do what he says.”
That almost always works… except with retirement accounts. Retirement accounts include IRAs, 401(k)s, and 403(b) accounts to name the most common ones. As you probably know, these are accounts in which you can deposit pre-tax money, let it grow tax deferred, and take it out after you reach 60. You only owe tax on what you take out, when you take it out. Of course, once you reach 70 ½ you have to take out your “required minimum distribution” (your “RMD”), but anything left in the account grows tax-deferred. It’s a good retirement plan many people take advantage of.
I’m going to focus on IRAs here because that is where most of the money ends up. If you are participating in a 401(k) plan, when you retire, they’ll probably make you roll it over into an IRA. You’ll have to be careful doing that too since there are time limits.
When someone has a trust-based estate plan, if they’re married, we always tell them to name his or her spouse as the initial IRA beneficiary. That allows for the maximum planning opportunities on the death of the first spouse to die. The surviving spouse can do a tax-free rollover, and there may be some tax benefits available. You want to leave your options open.
But on the death of an IRA owner where there isn’t a surviving spouse, I tell clients to name the trust as the beneficiary. In 2015, the US Supreme Court ruled that an inherited IRA is liable for bankruptcy claims. I haven’t seen the cases, but I’d have to think that regular lawsuits won’t be far behind. Running an IRA through a trust can give a beneficiary some asset protection.
Here’s where we get the questions. Some financial planners worry that if you name a trust is the beneficiary of an IRA, on the death of the employee/owner, all of the assets in the IRA will become immediately taxable. That is not true.
In 1999 the IRS promulgated some regulations to cover this very point. They said that if your trust contained their magic language, it would not cause the immediate taxation of 100% of the IRA. But what the IRS said was that the trust could not hold on to the IRA distributions. If the trustee received the RMD, it had to pass it through the trust and pay it to the named beneficiary. If there are multiple beneficiaries, then the IRA administrator can break the IRA into equal subaccounts for each beneficiary, but each payment still had to pass through the trust to the appropriate beneficiary.
That has been the law since 1999. I can point to the section in the trust agreement with the magic language, but we still get pushback. Maybe it just seems like it’s too good to be real, but here it’s real.