Posts Tagged ‘retirement accounts’

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.

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.

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 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.

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?

©2017 Fleming & Curti, PLC