Posts Tagged ‘IRAs’

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 Since growth is not taxed until the funds are withdrawn, they will grow faster.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.

You Have a Trust — Now You Need a Beneficiary Designation

MARCH 21, 2016 VOLUME 23 NUMBER 11

You have decided to create a revocable living trust, naming your oldest daughter as successor trustee. Your trust directs that, upon your death, $10,000 is to go to each of your grandchildren, $50,000 to the Good Intentions charity, and everything else will be divided equally among your three children. So what should you put on your IRA beneficiary designation?

You might already have recognized that we just served up a trick question. There is, sadly, not an easy and obvious answer — at least not on the basis of the information spelled out so far.

It is going to be hard to tell you the correct (or even the best) answer here, but let’s look at some of the options. As you consider them, you might want to have your IRA custodian’s actual beneficiary designation form at hand. Don’t have one with you? Not a problem: you can probably download the form. Most major financial institutions offer their forms online — here are forms for Vanguard, Fidelity, TIAA-CREF. Look for your IRA custodian before we move on. We’ll wait.

Here’s something we notice about your IRA custodian’s form: it isn’t terribly flexible. Want to designate two charities? You might need to attach a separate sheet. Want to try to leave dollar amounts (“up to the first $100,000”)? You might not be able to do it at all. But let’s still look at some of the options. For the moment, we’re going to assume that you do not have a living spouse — but we’ll come back to that later.

You could just leave the IRA to the trust. This has several advantages. It’s straightforward. It lets you make any other changes you want in the trust document, and you’ll never have to fill out the beneficiary designation form again. It automatically takes care of a batch of follow-up questions unaddressed on the beneficiary designation form (like “what happens if a beneficiary is under age 18?” or “what happens if one of my beneficiaries dies before me?”).

It should be said that there are some problems with naming a trust as beneficiary. For one, the named beneficiaries might have to take all their inherited IRA money out slightly faster than if they had been named individually. For another, you might be assured — again and again — that you “can’t” name the trust as beneficiary, or that you incur extra tax liability if you do (this is incorrect, but common, advice). You’ll need to arm yourself with enough understanding that you don’t succumb and make more changes later.

So how do you actually name the trust? The online forms we looked at tell you to put down the name of the trust (“The Jones Family Trust”) and its date. Check the appropriate box (is this a current trust, or one created under your will?). Leave blank the space for a tax identification number if your trust uses your Social Security number.

You could just leave the IRA to your children. Let your trust fund the $10,000 for each grandchild, and the $50,000 to charity. The IRA could just pass to your children. The good news: it’s pretty straightforward to fill out the form (just list the three children, put 33.33% as to each and, probably, check the “per stirpes” box to make sure that any deceased child’s share goes to his or her children). The bad news: any share of the IRA designated to your child with a disability, or a spending problem, or a greedy spouse — will go outright to that child. It might cause other financial problems, but that might not be an important consideration.

You could leave the IRA to Good Intentions. It turns out that IRAs are particularly good resources for any charitable inclinations you might have. Why? Because the charity doesn’t have to pay any income tax on the IRA proceeds. But you are leaving a flat dollar amount to the charity, rather than a percentage — and most of the beneficiary designation forms assume percentages. So you have to either create a personalized beneficiary designation (and hope your custodian will accept it), or adjust the amount you leave to the charity outside the IRA, or modify your estate plan every year or two as your IRA grows and shrinks.Still, this approach might make sense. How to carry it out? Just put the charity in as beneficiary. Ask them for their tax ID number (they’ll give it to you). And watch the IRA balance every year to make sure you’re leaving the right amount (not too little, not too much) to Good Intentions.

You could leave the IRA to your grandchildren. You’re planning on leaving a small amount to each grandchild anyway, and leaving it in an IRA for most of their lives would allow it to grow, tax free, for years. But they will have to withdraw small sums every year after your death, so it can actually complicate things (especially if they are under age, or not yet ready to manage their own funds).Want to use this approach? Just list each grandchild, with date of birth. Pay attention to new additions (by birth or adoption). Make a decision about step-grandchildren, and monitor familial relationships accordingly. Review your beneficiary designation every year or two.

But what about your spouse? We promised we’d come back to this. For most people, in most circumstances, it makes sense to name your spouse as the primary beneficiary. Most of the specific items we’ve listed here will fit under the “Secondary Beneficiaries” or “Contingent Beneficiaries” section of the form.Why is this important? You probably want the account to benefit your spouse first. You might need your spouse’s approval to make any other arrangement. There are significant income tax advantages a spouse has over other beneficiaries (well, most other beneficiaries). But everyone’s situation is different, so make sure you explore this with your estate planning attorney before changing the beneficiary designation.

This looks pretty easy, right? What could go wrong? Well, how about this, or this. Be careful out there. Are you our client? Let us help you with the beneficiary designation form. Not our client? Talk to your estate planning lawyer.

Inherited IRA Not Protected From Creditors — How To Plan

JUNE 16, 2014 VOLUME 21 NUMBER 22

It’s not very often that the U.S. Supreme Court involves itself in legal issues related to estate planning and elder issues. Last week, though, the Court did just that — by ruling that an inherited IRA is not exempt from the beneficiary/owner’s creditors, at least in a bankruptcy proceeding. What does the decision (in Clark v. Rameker, June 12, 2014) mean for you, and is there any way for you to avoid the result suffered by Heidi Heffron-Clark?

First, let’s figure out how much of a problem the Supreme Court decision creates for you. Let’s suppose that you have diligently contributed to your own IRA, and that you have managed to accumulate a significant sum — just to give it a figure, let’s suppose that your IRA is now worth $300,000. Now suppose that you are involved in an auto accident, and you are sued for injuries caused by the accident. Of course you have auto insurance, and that should take care of most or all of the liability. If your insurance is inadequate, though, can the injured party reach your IRA? The short answer (subject to a handful of exceptions unlikely to apply to you) is an emphatic “No.”

But what if you get divorced — can your soon-to-be-ex-spouse get a share of your IRA? The answer here is generally a qualified “Yes,” but there are specific rules that have to be applied and your actual answer will be very dependent on state law and facts about your marital situation.

One more theoretical question about your theoretical IRA: if you have a series of financial reverses and have to file for bankruptcy, will your IRA be scooped up the bankruptcy court (more accurately, the bankruptcy trustee)? Generally, the answer here is “No.” Your IRA is, in most cases, protected from your creditors — even in bankruptcy.

Does it make a difference if your retirement account is not an IRA but a 401(k) account? No. IRAs, 401(k)s, 403(b)s and most other retirement accounts are similarly protected from creditors and bankruptcy trustees.

Now let’s assume that you didn’t build up that IRA at all — your wife did. She contributed all during her work life, and then she tragically died before she could benefit from the retirement account. She named you as beneficiary, and you “rolled over” her IRA (it could have been a 401(k) or 403(b) — the same rules apply) into a new IRA in your own name. You are now treated as the owner of the roll-over IRA, and it is still exempt from creditors — even though it was inherited.

You can probably see where this is going next. The situation in the Supreme Court case was the next step: Heidi Heffron-Clark’s mother Ruth Heffron was the one who actually built up the IRA. When she died, she named her daughter as beneficiary. Ms. Heffron-Clark was required to begin withdrawing the inherited IRA on a regular schedule, but she chose to leave everything she could in the IRA to continue to earn money tax-free. Then she got into financial trouble, and filed for bankruptcy. The trustee in her bankruptcy proceeding asked the bankruptcy court to order transfer of the IRA to him; he intended to liquidate the IRA and use it to pay Ms. Heffron-Clark’s creditors. She objected that IRAs are exempt from creditors’ claims and bankruptcy, but the court allowed the trustee to gain access.

Ms. Heffron-Clark asked the Federal District Court to overrule the bankruptcy court, and it did. Then the Court of Appeals reversed that finding, ruling that the bankruptcy court (and the bankruptcy trustee) had been right all along. The Supreme Court agreed to review the case, partly because another Court of Appeals from a different Circuit had ruled that an inherited IRA was safe from the bankruptcy trustee. It was important to have a single answer applicable in all U.S. bankruptcy courts.

The Supreme Court agreed that Ms. Heffron-Clark’s inherited IRA had to be paid over to the bankruptcy trustee, and used to pay off some of her debts in bankruptcy. The federal bankruptcy law’s exemption of “retirement funds” did not apply to inherited IRAs, according to the Court, because they were not anyone’s retirement savings — though they were before the original owner’s death.

Now suppose that Ruth Heffron had wanted to preserve her IRA for her daughter, knew that her daughter’s financial health was precarious, and knew that she would likely not live long enough to use the entire retirement account herself. Was there anything she might have done to avoid the result announced in last week’s Supreme Court decision? Yes, as it happens — Ms. Heffron could have simply named a trust for the benefit of her daughter as beneficiary of the IRA (rather than naming her daughter directly), and included appropriate limitations in the trust to protect it from her daughter’s creditors. We have often advocated for creating trusts for inheritances generally, and the Clark v. Rameker decision makes that idea much more compelling, especially for large retirement accounts.

Why would the result be different? Not because there is anything special about retirement accounts, but because it is relatively easy to protect inheritances from the recipient’s creditors by leaving the inheritance in trust — and that same principle applies to retirement accounts. The trust itself is slightly more challenging to create, but worth the effort in many, perhaps most, cases.

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

JANUARY 6, 2014 VOLUME 21 NUMBER 1

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?

DECEMBER 16, 2013 VOLUME 20 NUMBER 47

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

SEPTEMBER 2, 2013 VOLUME 20 NUMBER 33

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.

Retirement Account Is Community Property But Need Not Be Split Equally

MAY 21, 2012 VOLUME 19 NUMBER 20
Arizona is one of the nine U.S. states which recognize “community property” (a tenth, Alaska, allows couples to voluntarily create community property interests). The other eight community property states: California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Mention community property to a lawyer who has never studied or practiced in one of the community property states, and you are likely to see a twitch at the corner of his or her eyes. There is much mystique about how community property works, but it is actually pretty straightforward: all property acquired during the period of a marriage is presumed to be community property, and therefore belongs half to each spouse. In the event of divorce, the courts will probably unwind the community interest by dividing each asset in half — though it may be possible (depending on state law) to segregate assets so that roughly half the total value of community property goes to each spouse.

But of course the devil is in the details. There are lots of ways in which the simple statement of community property principles can get confusing.

The probate estate of Frank Kerns (not his real name) demonstrated one such confusion. Frank left a widow, a son from his first marriage, and an Individual Retirement Account (an IRA). He and his second wife had been married for several years, and at first he had named his wife as the sole beneficiary of his IRA. At some point, however, he changed the beneficiary designation on his IRA, naming his son as beneficiary as to 83% of the account, and his wife as beneficiary as to the other 17%. That was how the beneficiary designation read when he died.

Frank’s widow brought an action in probate court, arguing that community property rules made one-half of the IRA hers — and that Frank could not change the beneficiary designation as to “her” half. She asked the probate judge to order that she was the beneficiary of her half, and that the maximum amount Frank could leave to his son was the other 50%. The probate judge agreed.

The Arizona Court of Appeals did not agree with Frank’s widow. Or, rather, the appellate court did not agree with the conclusion of the argument. Frank’s son and widow agreed that the IRA was community property, but the Court of Appeals adopted Frank’s son’s interpretation of what that meant for the IRA.

Some community property states have adopted what is often called an “item” theory of community property. Under that analysis, one-half of each community property item belongs to each spouse, and if that theory applied to Frank his widow would be right. He would not have the power to name his son as beneficiary for anything more than what we might think of as “his” share of the IRA.

But the Court of Appeals decided that Arizona has embraced an alternate approach, generally referred to as the “aggregate” theory of community property. Under that analysis, Frank owned one-half of all the couple’s assets taken together — but so long as his widow received at least one-half of the aggregate community assets, she could not complain about what he had done with “his” half of the aggregation. Since Frank’s widow may have received some other assets (perhaps by beneficiary designation, or payable-on-death titling), the appellate court remanded the case back to the probate judge for a determination of whether “her” share of the couple’s assets had been properly protected.

Frank’s widow also argued that IRA and other retirement accounts should receive special treatment. Retirement funds, she insisted, are intended to provide for the care of the beneficiary and his or her spouse — and it should not be permissible to direct them to children or others except in unusual circumstances. The Court of Appeals was not persuaded, holding that all assets left to a spouse are intended to help provide for the spouse. In re the Estate of Kirkes, March 8, 2012.

So is community property really hard to understand, or are the principles difficult to apply? Not really. States where community property principles are not relevant also have complications and exceptions. But the basic rules are clear in both kinds of states: in community property states, property acquired during the marriage is generally presumed to be community property unless it was acquired by gift or inheritance. Property owned before the marriage generally remains separate property of the spouse who brought it into the marriage — unless he or she does something to convert it into community property. And then there are those details.

We Take a Stab at Some Of Our Common Legal Questions

FEBRUARY 21, 2011 VOLUME 18 NUMBER 6
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.

Estate Tax Reform 2010 — Is It Over Yet?

DECEMBER 20, 2010 VOLUME 17 NUMBER 39
The ink is not yet dry on Congress’s tax and unemployment insurance compromise. Signed just last week by President Obama, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 has now become law. It continues previous income tax breaks for everyone, regardless of wealth. It extends unemployment insurance coverage for an additional 13 months. It also rewrites the estate tax — it does not simply carry forward the estate tax rules adopted a decade ago.

Under the new law no estate tax will be due on estates of less than $5 million. Since there is no Arizona state estate tax, that means that only the wealthiest Arizonans (or those with significant assets in other states which do impose an estate tax) need to be concerned about estate tax rules at all. It should mean that estate planning just got easier, more predictable and lower-risk for nearly all of our clients.

It should mean that, but it may not. There are a number of details to watch out for, including:

  • If you are married and your estate plan was initially prepared a decade or more ago, you might well have a two-trust arrangement. Sometimes described by the shorthand “A/B trust” designation, such an arrangement can actually now increase the total tax paid by your heirs. How could that happen? If a separate trust is created and funded at the first spouse’s death, assets assigned to that trust will not get a stepped-up basis on the death of the second spouse. Under the new law you can get an equivalent estate tax result and still preserve the 100% step-up in income tax basis at the second spouse’s death.
  • If a loved one died during 2010, the heirs get to choose which tax regimen to adopt — either the no-tax choice originally in place for 2010 or the $5 million exemption now adopted. Since the $5 million option includes full stepped-up basis (the original 2010 structure limited the step-up to $1.3 million for unmarried decedents), it may actually be beneficial to opt for the new taxable-estate option. Hard to figure out? Yes. The good news: you have until September, 2011, to decide which option is better.
  • The $5 million exemption is now “portable.” That means that if your spouse dies without having planned to use the exemption, it is still available to you. In other words, a couple effectively gets $10 million in estate tax exemption without having to prepare any planning documents. One small caveat: if the surviving spouse remarries and their new spouse predeceases, they lose the original unused exemption amount (but still get to use any unused exemption from the second spouse). It looks like Congress has (perhaps unwittingly) created a new marriage-discouraging provision for seniors — or at least for wealthy seniors.
  • For a decade we have been saying that the most important estate tax principle would be certainty. If you are pretty sure you know what the estate tax will look like for the next five years or so, you can plan accordingly. Unfortunately, Congress and the Administration have given us only two years of certainty — and much of the certainty we have is that the issue will be politically charged and intensely debated for much of that two-year period. In fact, Vice President Biden told a national television audience Sunday morning (on NBC’s Meet the Press) that “scaling back … the estate tax for the very wealthy” would be a top priority for the Administration over the next two years.
  • The new law also increases the level at which both gift taxes and “generation-skipping” taxes are an issue. Both of those also set at the $5 million level for the next two years. If either or both returns to lower levels after 2012, that could mean an important planning issue for very wealthy individuals in the meantime. Should gifts be made now, just in case? Should gifts be made to grandchildren and later generations, just in case? Expect to see more about those issues in coming months.
  • Paradoxically, the new rules could mean that more people (at least more wealthy decedents) should be filing estate tax returns — even though no estate taxes are due. Penalties for failure to file are higher, the importance to surviving spouses has increased and the stakes involved have generally gone up.

Does all of that sound like the issues are resolved? No — but the plain fact remains that a tiny minority of Americans are wealthy enough to be worried about any of these issues. How do you know if you need to worry? Take this quick four-question quiz:

  1. Is your entire estate (including life insurance, IRAs and retirement accounts) worth less than about $2 million? Whatever happens in the next two years, it is pretty unlikely that the estate tax level is going to return to a number below about $3.5 million (the favorite number kicked around by Democrats during debates over the past year).
  2. Are you married? If so, you can double the estate value in the previous question.
  3. Do you live in Arizona (or another state with no estate tax)? There are only about a dozen states where state estate tax is important — Arizona is not one of them.
  4. Are you middle-aged or older? If so, are you comfortable assuming that your net worth will not dramatically increase in the next few years?

Depending on your answers, your estate planning choices are likely to be simplified. You should check to see whether you now have estate planning provisions that are no longer needed. You should also check whether your non-tax planning issues have been addressed. Do your documents name the right person to act as trustee, health care agent, personal representative and financial agent? Do they leave your assets to the people (and organizations) and in the proportions that you want? Do they refer to events, locations or items that are no longer relevant?

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