Posts Tagged ‘401(k)’

Estate Planning is a Process, Not a Binder of Forms

There really is no question that it is important for almost every adult to have a will, and to consider signing both financial and health care powers of attorney. That is what we mean by “estate planning,” and it is important to go through the process of preparing those documents.

But that is not enough. There also are questions about beneficiary designations and other ownership arrangements. Some consideration should be given to whether a trust is necessary or important. And the whole process needs to be undertaken on a recurring basis. Signing your will is usually not the end of the process, and even when it is the whole thing needs to be reviewed again whenever you have major life changes.

Want a story that explains why you need to update your estate plan? Consider Robert Hendricks (not his real name) from Illinois. He was the father of two young sons. He and the mother of those two boys had recently undergone a difficult divorce. He wanted his sister to manage his estate, and to act as trustee for the benefit of his sons. He even signed a will making those changes — naming his sister as personal representative (executor), naming her as trustee for the boys’ benefit, and leaving his entire estate to the boys’ trusts.

Shortly after the divorce was finalized, Robert tragically took his own life. His sister initiated a probate proceeding, and his will was admitted to probate. But one of the Robert’s principal assets was his 401(k) plan, set up through his work. What would become of that retirement plan?

Robert’s 401(k) account simply did not name a beneficiary. In that case, would it pass to his estate, and thus to the trust for his sons? No, as it turns out.

Like many 401(k) plans, Robert’s spelled out what happens when no beneficiary is named. According to the plan’s summary documents, in that case the participant’s spouse would be the beneficiary, and if there was no spouse then the participant’s children would become beneficiaries. Since Robert’s divorce was final at the time of his death, that made his sons beneficiaries of his retirement plan.

Problem solved. That’s also what Robert’s will specified, right? Well, not quite. Robert’s will would have left all of his money in that trust, controlled by his sister. If his sons are the direct beneficiaries of his retirement plan, then their mother — Robert’s ex-wife — would have priority to manage the funds until the boys reached the age of majority.

Robert’s sister filed a petition with the probate court, asking to be named as the custodian of the retirement accounts for the benefit of the boys as specified in the will. The probate court agreed, and ordered the proceeds paid into accounts under Robert’s sister’s control. The boys’ mother objected, and appealed the decision.

The Illinois Court of Appeals disagreed, and overruled the probate court’s order. The appellate judges noted that Robert’s ex-wife, as the only parent of the two boys, had the clear priority to serve as conservator of their funds, or custodian of any money in a Uniform Transfer to Minors Act (UTMA) account, or in any other capacity.

Furthermore, the proceeds from Robert’s 401(k) were not within the control of the probate court, said the appellate judges. His will did not control where the proceeds went, since the summary plan documents themselves made clear that they went directly to the beneficiaries. The Court of Appeals directed the probate court to reverse its order and leave Robert’s sister out of the loop with regard to his retirement assets. Estate of Hintz, January 10, 2017.

Robert’s story is illustrative of a problem we see on a regular basis. If a client carefully considers his or her estate planning, and signs documents perfectly calculated to accomplish their goals, the inquiry (and, often, our task) is not completed. Beneficiary designations and titling arrangements can undo the best-laid plans. What’s worse: even if everything gets done, and done right, at the time of our office appointment, changes in documents, life arrangements or circumstances can undo the good work of careful estate planning.

All of that is why we ask a lot of questions about insurance beneficiaries, retirement arrangements, and financial account titling. That is also why we ask clients to come back and visit with us every five years or so — or, as in Robert’s case, when they get divorced, have children, get married, change employment arrangements or have other major life changes.

Estate planning is not a set of documents. It is a process, and it continues, morphs and develops over time.

Estate Planning With Individual Retirement Account Trusts

JULY 18, 2016 VOLUME 23 NUMBER 27
One of the great things about our area of law practice is that the community of practitioners is just that — a community. Take, for instance, our good friend Amos Goodall from State College, Pennsylvania: he’s one of the leading elder law attorneys in the country. Amos is not just nationally-known, either — he’s also an excellent communicator. This week he tackles a topic of considerable interest to our clients: estate planning for people who have Individual Retirement Accounts or other retirement savings. Here is his plain-language explanation:

Many folk have large retirement accounts. According to the Investment Company Institute 2016 Yearbook, in 2015, members of 60% of US households had invested $24 trillion in retirement market assets, including IRA’s, 401k’s, 403b’s, Simple IRAs, and others. This article discusses IRA’s, and someone with any of the other types of accounts should consult with knowledgeable legal and financial advisors. In fact, every single general rule stated in this article is subject to exceptions, and there may also be specific situations where these rules should be purposefully ignored. This article should be considered simply a guide for asking questions of your advisor (and better understanding the answers), rather than a roadmap for do-it-yourself action.

The typical estate plan for a married couple with IRAs is naming the surviving spouse as the first (or primary) successor owner. There are special tax benefits for a surviving spouse that do not apply to any other possible successor owners.  There are other options, but these should not be pursued without specialized advice.

Classically, they name their children as the contingent or remainder successor owners who will receive the accounts upon the second of their parents’ deaths. Single IRA owners may name their children as primary successor owners, and those without children typically name other family members to receive these accounts. Again, there are other options (including some charitable ones) that should be considered after appropriate advice.

Most IRA owners want to keep IRA assets invested as long as possible. Since growth is not taxed until the funds are withdrawn, they will grow faster. Thus, the longer they are invested, the greater they will be. This is called “stretching” the IRA.

One of the benefits to naming a surviving spouse as the first successor owner is that the spouse is permitted to “roll” the IRA into his or her own name as one of the available options.  No one else has this option, and everyone else must begin withdrawing funds (and paying taxes) as soon as the IRA becomes theirs, called the “minimum required distribution” (or MRD). For younger successors, the MRD is not great; an eight year old successor owner will need to withdraw a little over 1% (roughly one-seventy-fifth) as his or her MRD in the first year after the original owner’s death. In contrast, a sixty-five year old successor would have an MRD of almost 5%, and the MRD for a seventy-one year old spouse would be just over 6%.

Thus, it makes sense to name as young a beneficiary as possible so as to lengthen the process and thereby to maximize the effect of compounded tax-deferred growth. For example, if a seventy year old widow leaves an IRA with $100,000 to an eight year old great-grandchild (assuming there are no generation-skipping tax considerations), and the IRA grows at 3%, then at age 65, the great-grandchild will have withdrawn over $207,000 from the account and it will still be worth over $130,000–quite a positive result for a $100,000 IRA. (At a higher rate of growth, say 6%, that same $100,000 IRA would be worth $700,000 at age 65, and MRD withdrawals would be as high as $40,000/year).

Most IRAs don’t last this long, and it would not surprise anyone that when our eight year old turns eighteen, he or she will find a reason to withdraw much of this inherited wealth. One way to be certain that MRD withdrawals are made and to limit extra withdrawals to actual needs, is naming a trust as successor owner. IRS regulations do not allow many traditional trusts to stretch. However, if the trustee is required to withdraw and pay out at least the MRD each year, the IRS will allow the trustee to use the great grandchild’s life expectancy. This is called a “conduit” trust.  Another IRA trust is called an “accumulation” trust, but this are fairly complicated to set up. Describing any IRA trust as “simple” might be stating an oxymoron, but compared to an accumulation trust, a conduit trust is straightforward for knowledgeable counsel.

The trustee of a conduit trust may make larger withdrawals if necessary (like helping with medical expenses or college) but the beneficiary will need to convince the trustee that other withdrawals are truly necessary. The trustee might say “I agree you need a new car, but look for a good used Chevrolet rather than the new Tesla you want”. Several institutions offer “Trusteed IRA”  plans for a fee, and this has the added benefit of having professionals invest the IRA funds (which may result closer to 6% than 3% growth, as in the example above); it also provides continuity in trust management. Other investors opt for family members as trustees, which may save money in fees but might impose a burden on family members.

With good planning, it is possible to provide a great gift to descendants; a trust makes it more likely they will receive it.

Even With No Estate Tax, Some Tax May Be Due on Inheritance

JUNE 9, 2014 VOLUME 21 NUMBER 21

Our clients are often confused about whether their heirs will owe any taxes on the inheritance they are set to receive. We don’t blame them — it’s confusing. Let us try to reduce the confusion.

The federal estate tax limit was raised to $5 million and indexed for inflation in 2011. That means that a decedent dying in 2014 can leave up to $5.34 million to heirs with no federal estate tax consequence at all. It is easy to double that amount for a married couple. And in 2006, Arizona eliminated its state estate tax — so there is no Arizona tax to worry about. That means that there is simply no tax concern for anyone not worth $5 million or more, right? The 99% can pass their entire wealth to their children without fear of tax consequences, right?

Of course that’s not right — it would be way too simple if that were the case. The world — at least the political world — seems to dislike simplicity as much as the physical world abhors a vacuum. Even if your estate is modest, you need to be aware of the tax consequences of leaving money to your heirs. Here are a few of the more common ways your estate might be subject to taxes on your death:

Living, and dying, somewhere other than in Arizona. About half the states, like Arizona, have no estate or inheritance tax. But that means that nearly half of the states do have a tax; some states tax the estate, and some the recipient of an inheritance. Before federal estate tax changes in 2006, it was possible to generalize about those state estate tax regimens — they tended to look alike. But no more. You need to worry about state estate taxes if you live in one of those states with a tax, if you own real estate in one of those states, or if you have heirs who live in one of those states. The details can be mind-bogglingly complex, and they are beyond our scope here. There are plenty of online resources to look up state-by-state rules — we tend to favor this 2013 article from Forbes magazine, partly because it is engagingly titled “Where Not To Die in 2013.” The information is already a year old as we write this, but not that much has changed, and it will give you a good head start.

Owning retirement accounts. You sort of knew this one already, right? You have an IRA, or a 401(k), or a 403(b) retirement plan, and you’ve named your children (or your spouse, or your helpful neighbor) as beneficiary. But keep this in mind: if you leave, say, $100,000 in an IRA to your children, they are going to receive something more like $70,000 of benefit. With careful planning, they can delay the tax liability — but they will pay ordinary income taxes on what they withdraw. Income tax will be paid by anyone receiving the retirement account (except a charity, of course — they pay no income tax), and at their ordinary tax rates. You might have arranged to minimize your own withdrawals, and pay a very low tax rate on the income you do take out — but your daughter the doctor and your son the architect might pay a much higher tax rate and have to start taking money out of the account immediately after your death.

What can you do about that issue? If you have charitable intentions, you can name a charity as beneficiary of your retirement account. You can leave it to grandchildren, who might pay a lower tax rate (and have more immediate use for the money). You can create a trust that forces your heirs to take the money out very slowly. But at the end of that process, some significant income tax is going to be paid by the recipient of your IRA or other retirement account.

Having income-producing property at your death. Arizona does not have an inheritance tax, so there is no tax cost to receiving an inheritance. Except that sometimes there is a small cost. If you leave an estate including, say, stocks and bonds, or mortgages secured by real estate, or anything else that receives income, your estate may incur a small amount of income tax liability during its administration. That can be true even if you create a revocable living trust, since it will typically take 6-12 months to settle even simple estates. But rather than your estate paying the income tax liability, it usually is passed out with distributions to your heirs. So when your daughter hears that there is no tax on her inheritance, she may be surprised when her accountant tells her she owes income tax on a few hundred — or thousands — of dollars of that inheritance.

Having property that has appreciated since you received it. Income tax is usually due on the gain in value of an asset during the time you held it. Most people realize, however, that when you die most or all of your property receives a “stepped-up” basis for calculation of capital gains. That means that your heirs usually do not pay any income tax on the increase in value during the time you owned property.

But be careful — that is not always true. If you gave the property away before your death, or you inherited it in a trust (like a spousal credit shelter trust), it might not get a stepped-up basis. That can mean that the property your heirs receive carries a significant built-in income tax liability. It might not be due immediately on your death, but it might limit their choices about when to sell or give away the property. This is much more of a problem today than it was just a few years ago — with the proliferation of A/B (credit shelter, or survivor/decedent’s) trust planning in the past three decades, a lot of property is now held in trusts and will not get a stepped-up basis on the surviving spouse’s death.

Owning an annuity. You might have done some clever tax planning by buying a tax-sheltered annuity five years ago. But if you die holding that annuity, your heirs might have to pay the income tax on the income accumulated during the years you have held the annuity, and they might have to pay it immediately. Note that tax-sheltered annuities are not called tax-free annuities — they are just a mechanism to delay the income tax liability to a later date when, one presumes, your tax rate might be lower. If your currently-employed children step into your shoes, that assumption might turn out to have been incorrect.

Planning options.  What can you do if you fit into any of these categories? If we are preparing your estate plan, we will talk with you about the issues. Any capable estate planning attorney should be able to see whether you have issues to be concerned about. But that is why we always ask you for detailed information about your assets, your family and your circumstances. Yes, the estate tax regimen has gotten simpler — but that doesn’t meant that the decision-making is necessarily simple.

IRA Beneficiary Designation Raises Ambiguity About Intent


Here’s an estate planning question we get asked a lot: if you have created a revocable living trust and transferred essentially all of your assets to the trust’s name, should you also make the trust beneficiary of your IRA, 401(k) and other retirement accounts? It’s a great question, and difficult to answer without referring to your own situation. Does your trust  continue for the benefit of children or grandchildren? Are there charities named as beneficiaries in your trust? Are you single? If you are married, is the trust a joint trust between you and your spouse? Do you have an estate large enough to be taxable? Are your children about the same age, or is there a significant age span among them? Are they going to receive your estate in equal or unequal shares? All of those questions and a few more are important when deciding whether to make your trust the beneficiary of your IRA.

We were thinking about this issue while reading a recent case decided by the Arizona Court of Appeals. It involved a substantial IRA and a change in the precise language of the beneficiary designation shortly before the owner’s death. The case ultimately turned on the evidence of the owner’s actual intention, but the unintended ambiguity introduced in the beneficiary designation should give every IRA owner (and every estate planner) pause.

Frank Merriwether (not his real name) married Melissa late in life, after the death of his first wife. Melissa died, tragically, of breast cancer just five years after their marriage. Frank wanted to leave something to the Arizona Cancer Center in Tucson, hoping that research into breast cancer causes and treatment might make a difference in the future.

Frank and Melissa had established a joint trust which, upon Melissa’s death, divided into two separate trusts. One, the “Survivor’s Trust,” could be amended by Frank. If he did not amend it, the Survivor’s Trust indicated that fixed dollar amounts would be divided among several recipients, including $100,000 to the St. George Antiochian Orthodox Church. After those specific distributions, the residue of Frank’s share of the trust would be distributed to a “Charitable Trust” described in the trust document — a trust set up as charitable lead trust.

Shortly before Melissa’s death, Frank changed the beneficiary designation on his IRA account to name Melissa as first beneficiary, and the “[Merriwether] Charitable Trust as specified in [the trust document]” as contingent beneficiary. After Melissa’s death, he changed the beneficiary designation to the “[Merriwether] Charitable Trust as specified in para 8 of [the trust document].” Part of his thinking, according to the financial adviser who handled his IRA, was that he could make future changes in the beneficiary designation by amending his trust, without having to fill out the paperwork with the stock brokerage acting as IRA custodian.

A few years later Frank’s financial adviser changed firms. As part of the shift to the new brokerage company, Frank’s beneficiary designation was changed to the “charitable organizations as called out in the [Merriwether] Survivors Trust UAD 6-1-2005.” That, according to Frank’s stockbroker, was intended to refer to the charitable trust in Frank’s trust document, and to, again, allow him to make beneficiary changes without having to fill out the beneficiary designation form. Shortly after that form was completed, Frank amended his trust to make the Arizona Cancer Center the sole beneficiary of the charitable trust. Frank died just six weeks later.

As successor trustee of the trust, Frank’s nephew made a distribution of $100,000 to the St. George Antiochian Orthodox Church. The Church, however, argued that it was one of the “charitable organizations as called out in the” Survivor’s Trust, and should share in part of the rest of the distribution. The trustee disagreed, and the dispute went to court.

The trial judge ruled that the beneficiary designation was ambiguous, and that it could consider other evidence of Frank’s intention in deciding what the designation meant. With the testimony of his stockbroker, it was clear that Frank intended the money to go to the Arizona Cancer Center, and the judge ordered the trustee to follow his wishes. St. George Antiochian Orthodox Church appealed.

The Arizona Court of Appeals upheld the trial judge. The appellate judges agreed that the evidence of Frank’s intention was clear, after consideration of his stockbroker’s testimony. The only real question was whether it was permissible to consider that evidence. The general rule of law, ruled the appellate court, is that you look only to the written documents to determine intent — unless the evidence is ambiguous, in which case you can consider other evidence. In this case, the language of the beneficiary designation created an ambiguity that permitted the stockbroker to explain Frank’s wishes. The church lost, and was even ordered to pay a portion of the University of Arizona’s legal fees. In the Matter of the Estate of Maynard, November 21, 2013.

We always try to extract deeper meaning from the appellate cases we describe. Is there a broader lesson for someone in Frank’s position, or for the stockbroker, or for the lawyer (we can only assume that a lawyer was involved) who prepared Frank’s estate plan? Perhaps we can suggest a couple of points:

  1. When changing beneficiary designations — even if it is a simple change occasioned (as Frank’s was) by a change from one IRA custodian to another — it might make sense to send the new beneficiary designation to your lawyer for review and suggestions. Frank’s earlier beneficiary designations looked much better than the final one, and his lawyer might have made a simple suggestion that could have saved tens of thousands of dollars in legal fees.
  2. When naming a trust as beneficiary of an IRA, it is easier if you can name the entire trust, perhaps like this: “The Jones Family Trust Dated ______, as it may be amended from time to time.” Of course, that wouldn’t have accomplished Frank’s intention. If a sub-trust of the Jones Family Trust is being named as beneficiary, it makes sense to give it a name in the trust document and then refer to that name. That’s essentially what Frank’s first beneficiary designation did, and the second one was even better.
  3. When you are leaving a substantial IRA to a sub-trust, you might consider creating a separate, stand-alone trust. If, for example, Frank had created the Merriwether Charitable Trust Dated ____, his main trust could then have left a share to that trust — and his IRA beneficiary designation could have named that separate trust, leaving no room for ambiguity.

Of course, all of this assumes that it is appropriate to name the trust as beneficiary of the IRA in the first place, and that isn’t always the case. That takes us back to our opening observation — this question is very fact-specific, and be very careful about how you handle beneficiary designations.

Planning for Retirement: Does the Three-Legged Stool Work?


For decades accountants, financial planners, lawyers and government workers have talked about Social Security and the “three-legged stool.” The metaphor had a simple attraction, especially when Social Security was a young program. The three legs? Social Security, private retirement programs and personal investments. You should have some of each, according to conventional wisdom.

The problem with the metaphor, of course, is that such a large portion of retirement-age Americans have just one leg, or maybe one strong leg and part of a second. According to the Social Security Administration, about half of retirees get more than half of their income from Social Security alone. In fact, Social Security makes up more than 90% of all income for about a quarter of elderly recipients.

Is the three-legged stool important? Maybe, but it was viewed as received wisdom as early as 1949. More modern metaphor development recognizes the predominance of Social Security in retirement planning by turning the three-legged stool into a pyramid.

According to this new view, Social Security can be seen as the broad base of the pyramid, with other sources of retirement income as higher levels. Actually, “income” may be the wrong word — better to think of retirement “resources.” The next tier of the Investment Company Institute’s pyramid, for example, is home ownership. And that analysis comes from an industry group interested primarily in encouraging individual investments in retirement accounts. The reality, though, is that ownership of the home is the second-most-common bedrock resource for retirees.

In addition, there seems to be a growing recognition on the part of near-retirees that they will need to build substantial resources for their impending retirements. Defined benefit retirement plans, once the mainstay of private pension arrangements, are shrinking as a percentage of available benefits. As a result, fewer and fewer retirees will be able to count on a pension-like retirement benefit, and more and more will come to rely on the contributions they have managed to make to their own Individual Retirement Accounts and 401(k) and 403(b) plans.

Still, the news about the private retirement plan level of the pyramid is not all bad. According to the Investment Company Institute analysis mentioned above, Americans have accumulated $20.9 trillion in assets earmarked for retirement (and that’s not counting Social Security). That investment has increased much faster than inflation or the number of potential retirees since 1975.

The private pension part of the retirement pyramid is broken out as two separate parts: employer-sponsored retirement plans (like defined-benefit plans, 401(k) and 403(b) plans) and individual plans (IRAs). The top level of the pyramid, narrow but important for those who have been able to build personal wealth, is described as “other assets.” One commentator suggests that perhaps we should include another level: part-time employment. That may sound cynical, but reflects the reality that many retirement-age adults will have to work at least part-time — a notion that was not contemplated in the original three-legged stool metaphor.

One other point about rethinking the metaphor: it inevitably leads to thinking about maximizing the Social Security level of the pyramid. And not just maximizing the individual retiree’s share, but consideration of how to maximize a married couple’s benefits when taken together. Today there is a cottage industry of websites and individual advisers reviewing retirement options and strategies for maximizing a couple’s (or an individual’s) Social Security benefits.

For the 10,000 Americans turning 62 each day, it is increasingly important to think about how to maximize Social Security (and total retirement resources), what tax consequences will flow from different strategies, and how to think about the difference between not working (“retirement”) and drawing benefits (“retirement”). It is a complicated and confusing area, but thoughtful planning (and information collection) can literally be rewarding.


This is Huge: Feds Publish New Rules on Gay Marriage


Just a few weeks ago we wrote about some of the uncertainties facing legally married same-sex couples living in states (like Arizona) that refuse to recognize the validity of their marriages. If a legally-married couple moves to Arizona, we wondered, would their ability to receive some of the tax benefits available to married couples change just because their new state did not recognize or approve of their marriage? We suggested that same-sex couples ought to be aware of the problem, but assume that they should be able to enjoy the same benefits (and burdens, for that matter) available to their married heterosexual friends.

Well, the United States government weighed in on the subject this week, and the positions taken by two different federal agencies made it clear that a valid marriage is a valid marriage — at least in the federal government’s eyes. The result? Same-sex couples still need to pay extra attention to their estate planning choices, but their choices will be much more palatable.

On August 29, 2013, the Internal Revenue Service released Revenue Ruling 2013-17. Its bottom line: if you are legally married, even though your current state of domicile does not recognize it, you will be treated as married for all tax purposes. Period. Income tax, estate tax, gift tax — it makes no difference. You are married.

In our earlier newsletter we talked about a couple, married in Massachusetts, who had moved to Arizona. Could they file their federal income taxes as “married, filing jointly”? Could they list one another as beneficiary on their IRA or 401(k) accounts, relying on the ability of a spouse to roll those benefits over into a new IRA? Would they get the benefit of a full step-up in basis for income tax purposes, just like other married couples holding community property? It was not clear a week ago. Today it is clear. The answer in each case is “yes” — though perhaps a qualified “yes” in one or two of those cases.

Why a qualified yes? Mostly because community property titling is a special case. Yes, there are federal income tax benefits for married couples titling their assets as community property — but the availability of that option is governed by state property law. Arizona is one of the handful of states recognizing community property designations at all, and it limits the option to couples it thinks are married. If a same-sex couple, legally married in another state, attempts to title, say, real estate as community property (or community property with right of survivorship), will Arizona recognize that title?

We are not sure, and so suggest that the safe approach is to create a trust (probably a joint, revocable trust), provide that all the assets in the trust are held as community property, and title most assets to that trust. That does mean that same-sex couples will end up paying somewhat more for their estate planning than their married heterosexual friends — but they will get the same result at a relatively modest cost.

The other notable change on the federal level involves long-term care arrangements for Medicare recipients. It is far less expansive than the big IRA announcement, but reflects the same general approach: married same-sex couples are to be accorded the same benefits as married heterosexual couples, at least on the federal level.

An August 29, 2013, announcement from the Department of Health and Human Services affects Medicare Advantage beneficiaries. It is not very far-reaching, but it is nonetheless important. In cases where one spouse is already admitted to a skilled nursing facility (what most of us call a “nursing home”), when the second spouse requires placement he or she must be permitted to choose the same facility. In other words, Medicare Advantage plans must have rules supporting spouses’ ability to stay together. And those policies must apply to same-sex married couples, too — even if their marriages are not recognized in the state where they live.

Why is this modest change important? Because, like the IRS declaration, it indicates that the federal government will be extending protections to validly married same-sex couples regardless of their state of residence.

Legal rights and responsibilities are evolving quickly for same-sex marriage. The first few states permitting same-sex marriages debated whether to even permit out-0f-state couples to marry. In the next wave of legal developments, it seemed clear that couples living in Arizona probably would not benefit from traveling to, say, Canada or Iowa to get married, only to return to Arizona and have their marriages all but invalidated. This week’s announcements make it clear that a committed same-sex couple should seriously consider whether they want to get married in a friendlier jurisdiction, even if they intend to return to Arizona to live.

The federal pronouncements also make it that much more difficult for states like Arizona to continue to resist the pressure to change. If a legally married same-sex couple, living in Arizona, wants to get divorced, do they have access to the Arizona court system? The current legal thinking in Arizona is that they might be able to seek annulment of their marriage (which, in Arizona’s legal view, never validly existed), but not a divorce (or dissolution).

Consider, for instance, the dilemma facing Phoenix-area resident Anne Armstrong (not her real name) earlier this year. She and her partner Roberta Reynolds had been married in California, but Anne wished to end the marriage. She filed a petition for annulment of the marriage in the Arizona Superior Court in Phoenix. Roberta did not respond, but the Judge Eartha K. Washington nonetheless refused to annul the marriage. Because same-sex marriages are invalid in Arizona, ruled the judge, there was nothing she could do to help Anne end her California marriage.

The Arizona Court of Appeals reversed that decision and sent the case back to the judge for further proceedings to annul the marriage and divide the couple’s property. Atwood v. Riviotta, May 16, 2013. While Anne’s legal problems were addressed, the decision left two huge issues unresolved: (1) what about same-sex married couples who don’t want to end their marriages, and (2) why should the legal process for ending same-sex marriages be different in the first place? Furthermore, the Court of Appeals resolution was by an unpublished decision, meaning it could not even be cited as precedent for other, similar cases as they arise.

What about resolution of child custody issues, or property divisions? What about bigamy laws, or other societal norms affecting married couples? If a couple is permitted to file income tax returns as married under federal law, why should it be different for state income tax returns? The pressure on Arizona (and other resistant states) is intense: it is time for our legal system to deal with changes sweeping across the country, and the federal government’s pronouncements this week will add to that pressure.

We Invite Your Questions, and Answer a Few

MAY 30, 2011 VOLUME 18 NUMBER 19
Periodically we try to answer some of our readers’ frequent questions, which we enjoy receiving. Some more recent questions and our quick attempts at simple answers follow. Remember, please, that slight variations in fact patterns can lead to different answers; these are intended as illustrations and guidance, not as iron-clad answers to your legal concerns. Please consult your lawyer (and we’d be interested in taking on that role, if you live in Arizona and would like to call and make an appointment) before relying on this information.

Can I leave my IRA account to a third-party special needs trust for my daughter?

Yes, you can. It may not be the best answer, and it may raise a number of other issues and concerns, so please talk to your lawyer about your specific situation. But one of your choices is indeed to leave the IRA (or a retirement plan of any kind) to your daughter’s special needs trust.

If a significant portion of your wealth is tied up in an IRA, 401(k), 403(b) or other tax-deferred retirement plan, there is plenty of information out there about how important it is to name individual beneficiaries, how the plan ought to be divided upon your death into shares for each beneficiary, and how your beneficiaries should be encouraged to “stretch out” their withdrawals as long as possible. We agree with all of that — but if one of your beneficiaries has a disability, and particularly if she is receiving Supplemental Security Income, Medicaid or other means-based public benefits, it is also important to create a special needs trust for that beneficiary. There is no reason her share of your IRA can not be made payable to that special needs trust.

The notion of naming a trust as beneficiary of a retirement account is fairly novel. Not too many years ago it was absolutely to be avoided, and many investment advisers, accountants, lawyers and financial companies retain that anti-trust bias deeply embedded in their collective and corporate psyches. But the rules are different now, and it is much easier to name a trust as beneficiary. You just need good advice from someone who is familiar with those rules and can explain how they affect your retirement account in your family situation.

In general terms, the primary effect of naming a trust as beneficiary will usually be that the age of the oldest person who might ever receive benefits from the trust will be used to calculate the withdrawal rate. But let’s see if we can make the explanation clearer. Let’s assume that your daughter, Diana, is 47. You also have two sons, Steven (age 54) and Scott (age 43). You have named Diana’s special needs trust as beneficiary of 1/3 of your IRA. Sadly, you die this year (we don’t mean anything personal — we have to let you die some time in order to ever figure out the effect of your beneficiary designations).

Next year Steven will have to withdraw at least 1/29.6 of his share of your IRA (we figure that as about 3.38%). Scott has to withdraw at least 1/39.8 of his share (that looks like about 2.51%). Diana would have to withdraw at least 1/36 (2.78%) if she had been named as beneficiary outright, but she wasn’t. So how much will her special needs trust have to withdraw?

It depends on who is named as remainder beneficiary. If upon Diana’s death the remaining money in the special needs trust goes to Scott and Steven, then we use Steven’s age for the calculation and the trust will have to withdraw the same 3.38% that he had to withdraw from his share. If Diana’s trust goes instead to her two sons (ages 15 and 17) then Diana herself is the oldest beneficiary and we can use her age — and the withdrawal will be 2.78%.

Clear as mud? Yes, but you should have seen the rules before they were simplified in 2002. While the numbers are daunting, the current rules are actually pretty easy to figure out,  and the ability to stretch out distributions from your IRA for another 36 years (or so) allows Diana’s share to continue to grow tax-deferred, despite the need to put her share in trust.

Want more information, or the numbers for your own children’s ages? Look at the IRS’s Publication 590. Appendix C is Table I, the Single Life Expectancy table to be used by IRA (and 401(k), 403(b) and other) beneficiaries.

Do alimony payments continue when someone goes on Medicaid long-term care assistance?

Short answer: yes. Now let’s parse the question a little bit more.

Assume husband and wife, married many years, were divorced five years ago. He was ordered to pay alimony of $1,000/month to her for the rest of her life. She has now gone into the nursing home, and has spent all of her own funds for her care. She has qualified for Arizona’s Long Term Care System (ALTCS — it’s Arizona’s version of the long-term care Medicaid program) payments toward her nursing home bills; she turns over her alimony payment and all but about $100/month of her Social Security, and ALTCS pays the balance of her nursing home bill.

If her ex-husband could legally stop paying the alimony payments, ALTCS would simply increase the payment to the nursing home by $1,000. She would be no worse off and he wouldn’t be subsidizing her nursing home care any more.

Because he is legally obligated to continue the alimony payments, however, ALTCS will continue to count them in its calculation of how much to pay to the nursing home. And if he went to court to argue “changed circumstances” and no continuing need to pay alimony, he might find that her attorney argues that the changed circumstances justify increasing the alimony payments so that she is not on ALTCS at all. Even if that didn’t happen, ALTCS might be inclined to view the proceeding as a sham just to get him out of paying the support payments. So it is far from certain that he would be better off by going back to the courts.

What about the reverse situation? Let’s imagine for a moment that it is the ex-husband who has gone into the nursing home. He has spent down all of his assets and applied for ALTCS. He receives $2,800/month in Social Security another $1,500 in private retirement; ALTCS says that he must turn over all but about $100/month of that income to the nursing home, and it will pick up the (small) difference.

Can he stop paying alimony? Well, no. The divorce court has ordered him to pay, and he needs to go back to argue “changed circumstances” as a way of getting out of having to make the payments. Will ALTCS, then, reduce his contribution requirement, recognizing that he is under a legal obligation to pay the alimony? Well, no. They say that his care comes first, and the entire income (minus his small personal needs allowance) has to go toward his care — and their payment to the nursing home will reflect that calculation.

What should he do? He needs to get legal help and get his support order modified. He should not simply ignore the outstanding alimony award.

Please note that “alimony” is not called that any more, and “divorce” is also an old-fashioned word. They are common in the vernacular, but the legal terms — at least in Arizona — are now “spousal maintenance” and “dissolution,” respectively. We know that, but we fear that it makes the explanation so much harder to read.

We Take a Stab at Some Of Our Common Legal Questions

We get asked plenty of general legal questions. We try to give helpful answers, recognizing that we can not give specific legal advice to non-clients (and particularly to questioners from outside Arizona, where we are licensed to practice law). Often our best answer is “check with a local lawyer familiar with the appropriate area of law.” Unsatisfying, but it really is the right answer in many cases.

Still, we want to get general legal concepts out to the public. Why? Because we think it makes non-lawyers recognize when the legal problem they face is too complex for self-help, and it even helps make the questioner a better client when they do get to the lawyer’s office.

What kind of legal questions can we answer? very general ones. Like these, which are some of our most common questions:

Does my living trust need a new tax ID number? The best way to answer this is probably to explain when a trust doesn’t need its own “Employer Identification Number” (EIN — even if the trust isn’t an “employer,” that’s the kind of tax ID number it will get).

General rule: every separate entity requires its own TIN, whether that is a Social Security number (for you) or an EIN (for your corporation, trust, LLC, or whatever). First major exception to the general rule: if your trust is revocable, and you are the trustee, for tax purposes it is not a separate entity at all — you don’t need an EIN and, in fact, you shouldn’t get one.

Now let’s make it a little more complicated. If your trust is irrevocable, or you are not the trustee, the rules are a little harder to parse. The key question is whether your trust is a “grantor” trust. If it is, and if there is only one grantor (or one married couple), then it does not need an EIN. If it is not, or if there are multiple grantors, it must have its own EIN.

Note that whether or not the trust needs (or is even permitted to get) an EIN is not the same question as whether it has to file a separate tax return. That one is more complicated, and we’ll save it for another day.

Can a revocable trust be named as beneficiary of an IRA? Yes, but be careful. This is something you should discuss with your attorney or your accountant (or both).

Before we talk about naming your trust as the beneficiary, we have a question for you: what are you trying to accomplish by naming the trust as beneficiary? If your trust divides equally and distributes outright among a fairly small number of beneficiaries upon your death, why not just name those beneficiaries on the IRA as well as in the trust? Then you don’t have to figure out the rules on naming a trust as beneficiary, and you don’t have to keep wondering if you’ve done it right.

Maybe you have a child who is ill, or a spendthrift, or needs to have his inheritance placed in trust. In that case — and in a few other cases — it can make sense to name your trust as beneficiary of your IRA. Now you need to become familiar with the difference between what lawyers usually call “conduit” trusts and “accumulation” trusts. The former require distribution of any money received from the IRA’s minimum distribution requirements each year, and the latter allow (but do not require) the IRA distributions to accumulate. The distinction is important; the accumulation trust will require distributions on the basis of the oldest possible beneficiary of the trust. That is the result in most cases where a trust is named as beneficiary.

These same rules apply, by the way, for other tax-qualified accounts, like 401(k) and 403(b) plans. Some advisers will tell you it is not even permitted to name a trust as beneficiary of an IRA or qualified plan. They are wrong, but the rules are a little difficult to figure out in individual cases. Also, some account custodians (that is, the bank or financial institution where the money is held) may limit or even prohibit trusts as beneficiaries.

How does community property work in Arizona? Nine U.S. states are usually listed as the “community property” states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. In addition, Puerto Rico recognizes community property, and Alaska allows couples to choose community property treatment of their joint assets.

But what does it mean to have property held as community property? In Arizona, it means that the property is jointly owned, that each spouse has an equal interest, and that either spouse has the right to manage the property on behalf of the community.

When one spouse dies, his (or her) half int0erest in the community property normally passes according to his will or, if he did not sign a will, to his children (including those who are also children of the surviving spouse). To avoid that result couples are permitted to specifically designate their property as “community property with right of survivorship.” If that title has been used, the surviving spouse receives the entire community asset on the first spouse’s death. Note that the different community property states treat the right of survivorship differently, and we are only describing Arizona’s approach here.

It is also possible for a portion of an asset to be subject to community rights. This might happen, for example, if one spouse brought the property into the marriage but mortgage payments were made during the period of marriage from community income or assets. This kind of calculation is usually much more important in divorce proceedings than upon the death of one spouse.

Property received by inheritance or gift, and property owned before the marriage, are not community property — they are the separate property of the recipient or owner. Couples can choose to convert their community property into separate property, and can even agree that property acquired in the future will be treated as separate property.

Thanks. But I have a different question to ask. Go ahead — pose your question as a comment here, and we’ll try to answer it. Don’t be too surprised if we tell you that it is too specific, or requires knowledge of another state’s laws, or we can’t answer it for some other reason. But we’ll try to be helpful.

One word of caution: do not give us a detailed fact pattern and ask us for advice. We simply can not provide individual legal advice — free or even for a fee — based on unsolicited e-mails or comments. You will not have any lawyer/client privilege for your recitation of the facts, and we will not be able to help with that kind of inquiry. We do welcome your general questions that give us a chance to explain legal principles, though.

Trust Named as IRA Beneficiary? Here’s How it Works

Three weeks ago we wrote about how to leave an IRA (or other qualified retirement plan) to a special needs trust for your child who has a disability. Two weeks ago we wrote about whether you should (and how you would) name any trust as beneficiary of an IRA. At the risk of getting too technical for most readers, this week we are going to tread lightly where few have gone before: let us explain what happens after you have named a trust as beneficiary of your IRA, and what choices the trustee of your trust might face.

First we have to clarify a couple of often-misunderstood concepts. We will write here about IRAs, but the same rules will apply to pretty much any “qualified” retirement plan. That means 401(k), 403(b), Keogh, SIMPLE, SEP-IRA and other plans will follow the same rules. Different tax rules apply to Roth accounts, but some of the same distribution principles will apply. For convenience, though, we will keep talking about IRAs.

There are actually several stages of IRA we might discuss. Let’s distinguish among them:

  • A regular IRA is “owned” by the contributor. There may be some community property rules in the state in which the contributor resides, or some marital rights attaching to the IRA in non-community property states, but for tax purposes the contributor “owns” the IRA.
  • One choice your beneficiary may have after your death is to “roll over” your IRA. If your beneficiary is your spouse, he or she can roll the IRA over into a new IRA in their name. This, incidentally, is where the IRA/401(k) (and etc.) distinction gets muddy; your spouse can roll your 401(k) account over into a new IRA. Those IRAs, whatever their source, are usually referred to as “roll-over” IRAs.
  • Spouses are not the only ones who can roll IRAs into a new account. Non-spouse beneficiaries can also do something similar, and the resulting accounts are often called “roll-over” IRAs, too. But they are different. They are also “inherited” IRAs (see below), and the beneficiary must begin withdrawing money from an inherited IRA immediately.
  • If a non-spouse beneficiary leaves your IRA right where it is, they become the owner but the IRA is now an “inherited” IRA. They can designate a beneficiary in case they die before withdrawing all the IRA funds, but any beneficiary will have to make withdrawals at your beneficiary’s rate. So, in other words, you name your 45-year-old daughter as beneficiary, you die, she names her 22-year-old son as her beneficiary, and upon her death he has to withdraw based on her actuarial life expectancy, not his own. She might have decided to move your IRA to another custodian; in that case she has an IRA that is both a “roll-over” and an “inherited” IRA.

With that background, the Internal Revenue Service has recently clarified how this all can work if you name a trust as beneficiary of your IRA. In Private Letter Ruling 201038019, issued on September 24, 2010, the IRA gave guidance to an individual taxpayer who requested approval for a proposed way of handling just this problem.

Private Letter Rulings, by way of background, are not intended to be official regulations or rules. They are individual guidance offered (for a substantial fee) to individual taxpayers who want to be sure they are not going to get in trouble. Although “private” in the sense that they apply only to that taxpayer, they are public in the sense that the IRS discloses them to everyone, and they do give some indication of how the IRS thinks about the issues addressed. You are probably safe proceeding on the basis of an Private Letter Ruling.

Here’s what the taxpayer proposed to do, and what the IRS approved, in the recent Private Letter Ruling:

  1. The decedent had named his revocable living trust as beneficiary of two IRAs. He had three children, each of whom was to receive an equal share of the trust after his death.
  2. The trustees of his trust proposed to divide each of the IRAs into three separate IRAs. In other words, there would be a total of six IRAs, still (for the moment) in the name of the decedent. Then each child would be named as beneficiary of two of the IRAs — one from each of the original IRAs.
  3. Once that was accomplished, each of the six “transitional” (their term) IRAs would be rolled over into a new IRA. Each of those new IRAs would name one of the children as the inherited owner, and each child could then name his or her own IRA beneficiaries.
  4. The custodians of those “final” six IRAs were each given a copy of the decedent’s revocable living trust, which was valid under state law and became irrevocable upon the decedent’s death. Those elements of the plan critical because they are required by federal tax law.
  5. Each of the three children would be required to begin withdrawing their IRAs immediately, and at the rate calculated for the oldest of the three children.

The taxpayer’s proposed approach was fine with the IRS, but it would not necessarily be the only way to proceed. The trustee of the trust might be permitted, for instance, to leave the IRAs right where they were, to withdraw the funds over the period of the oldest child’s life expectancy, and to distribute those withdrawn amounts to the three children. But the IRS guidance makes it clear that this approach works, too.

The Private Letter Ruling doesn’t address one question. Why would the original IRA owner have named his trust as beneficiary if the IRAs were going to be distributed outright to the three children anyway? In such a case, we usually recommend that the owner name his children as beneficiaries directly — thereby avoiding the shortened payout period based on the oldest child’s life expectancy, as well as the need to go through the intermediate steps described in the Private Letter Ruling.

There are a number of reasons the IRA owner might have chosen to leave his IRAs to his trust. Usually those reasons include a disabled spouse, a child receiving public benefits, an unequal distribution of proceeds or some other complication. The Private Letter Ruling in this case does not give us enough information to determine which, if any, of those conditions applied. Still, it does give us valuable guidance for those cases in which a trust is named as beneficiary of an IRA.

How to Leave Your IRA to a Trust — And Why You Might

Last week we wrote about how you can go about leaving your IRA (or 401(k), 403(b), etc.) to a child with a disability. In passing we mentioned that the discussion about how to leave your IRA to any trust could wait for another day. Today is that day. Let’s tackle this as a Q&A session (or, if you prefer, we can call it a FAQ list).

Can I name a trust as beneficiary of my IRA?
Yes. That was easy.

Are the rules the same for 401(k), 403(b) and other retirement accounts?
Generally, yes. If you have more esoteric retirement accounts, talk to someone to make sure you are doing the right thing. What the heck — talk to an expert in any case. Our purpose here is just to give you some background and introduce the language and issues, not to give you direct legal advice.

Before you tell me how to do it, why would I want to name a trust as beneficiary of my IRA?
There are several reasons you might:

  • If you have a child who is a spendthrift, or married to a spendthrift, or who is involved in tax issues or legal proceedings, you might want the retirement account to be protected against creditors.
  • If you worry that your child might get divorced and want to keep your retirement account out of the divorce calculations and proceedings, a trust might help protect the account (and, for that matter, other assets you are considering leaving to that child).
  • You might just want to delay the withdrawal of your retirement account as long as possible. Of course, you could name your child as beneficiary and trust him or her to withdraw the money as slowly as is permissible. With a trust you can help assure that “stretch-out” of the IRA.

Why is my banker/broker/accountant telling me I can’t name a trust as beneficiary?
That used to be the rule, and lots of professionals are not yet caught up. There are also a couple of special rules that apply when you name a trust as beneficiary — though they are not at all hard to comply with, so it’s not clear why advisers get hung up on those rules. Finally, even though the rules permit naming a trust as beneficiary they do not require all account custodians to go along — so your broker might be telling you that, while the rules permit naming a trust, your account can not take advantage of those rules.

If I want to name a trust as beneficiary, what must I do?
There are a handful of requirements. The important ones: give the IRA custodian a copy of the trust (that, by the way, can be taken care of later — but you can do it now if you want), name only one income beneficiary for the trust, and make sure your beneficiary designation comports with the trust set-up and your larger plans. That probably means you should get competent professional assistance, but that’s usually a good idea for your estate planning anyway.

Are there bad things that happen if I name a trust as beneficiary?
Yes, but not very bad. Depending on the ages of all the beneficiaries and potential beneficiaries, you might have shortened the stretch-out time to a period less than the life expectancy of the primary beneficiary.

Uh, could you please repeat that — in English?
Of course. Let’s use an illustration.

Suppose you have three children: Abigail, Ben and Candy. You are OK with Abbie and Ben getting their shares of your IRA in their names — you trust them to make sound judgments about how quickly to withdraw the money, and you don’t want to bother with a trust for them. Candy is a different story. The details of that story don’t matter: you just want to put Abigail in charge of deciding whether to withdraw more than the minimum amount each year from Candy’s share of the IRA.

You can name a trust for the benefit of Candy as beneficiary of 1/3 of your IRA (naming Abbey and Ben as the other two beneficiaries outright). But what will happen if Candy dies before the IRA is closed out?

As it happens, Candy does not have children. You decide to have the trust say that upon Candy’s death the remaining trust interest in “her” share of your IRA will go to Abigail and Ben. Abigail is ten years older than Candy. That all means that Candy will have to make her IRA withdrawals using Abigail’s age and life expectancy.

But wait. Candy does have children?
Well, why didn’t you say so? That makes it even easier. You can have the trust provide that if Candy dies before the last IRA withdrawal her children become the beneficiaries of the trust (and, indirectly, the IRA). As before, we use the oldest potential beneficiary as the determining age — and we are going to assume for the sake of this piece that Candy is older than all of her children. No effect on Candy’s withdrawal rate. But note that if Candy does die, her children will still have to withdraw from the IRA at Candy’s rate, not their own.

What about estate taxes?
Now you’re talking about a whole different kettle of fish (or something). As you know, the estate tax situation is in flux right now, and some states have their own estate tax rules. That makes it very hard to generalize, and unnecessarily complicates this discussion. Suffice it to say that your IRA will be part of your estate for estate tax purposes, and just because there is income tax due on it does not mean that there won’t also be an estate tax liability attached to it. But if your entire estate is worth less than $1 million, you probably are not going to care very much. Stay tuned for a new number to be inserted in that sentence sometime before the end of 2010.

That sounds pretty simple. Could you please make it more complicated?
We’d be happy to, but it’s not required. We could give you information about what lawyers call “conduit” trusts and “accumulation” trusts. We could explain why you can’t have the money go to a charity upon Candy’s death. We could even try to give you some better names for your imaginary children (while still adhering to the A, B and C convention). But for most of our clients, those complications are unnecessary.

The bottom line: it is not that hard to name a trust as beneficiary of your IRA, 401(k) or other qualified retirement plan. You just need to review the rules, and understand why you might want to do such a thing.

It is also permissible to consider all that, try to get the rules straight, and then decide not to bother. One thing that we don’t want to allow you to do, though: ignore the issue, prepare a will that seems to handle all of your assets, and then have an IRA beneficiary designation that doesn’t agree with the rest of your estate plan, imposes an undue burden on your children and beneficiaries, or fails to address your child’s disability, money problems or legal or financial situation.

We hope this has helped demystify a subject that lawyers and accountants often seem to enjoy complicating. Your life, however, tends to be complicated. Please get good legal, financial and investment advice before you decide what you should do.

©2017 Fleming & Curti, PLC