King & Wood, P.A.

SECURE Act has Changed Special Needs Planning

“An applicable multi-beneficiary trust can solve some--but not all--of the challenges that the new act presents.”

The SECURE Act eliminated the life expectancy payout for inherited IRAs for most people, but it also preserved the life expectancy option for five classes of eligible beneficiaries, referred to as “EDBs” in a recent article from Morningstar.com titled “Providing for Disabled Beneficiaries After the SECURE Act.” Two categories that are considered EDBs are disabled individuals and chronically ill individuals. Estate planning needs to be structured to take advantage of this option.

The first step is to determine if the individual would be considered disabled or chronically ill within the specific definition of the SECURE Act, which uses almost the same definition as that used by the Social Security Administration to determine eligibility for SS disability benefits.

A person is deemed to be “chronically ill” if they are unable to perform at least two activities of daily living or if they require substantial supervision because of cognitive impairment. A licensed healthcare practitioner certifies this status, typically used when a person enters a nursing home and files a long-term health insurance claim.

However, if the disabled or ill person receives any kind of medical care, subsidized housing or benefits under Medicaid or any government programs that are means-tested, an inheritance will disqualify them from receiving these benefits. They will typically need to spend down the inheritance (or have a court authorized trust created to hold the inheritance), which is likely not what the IRA owner had in mind.

Typically, a family member wishing to leave an inheritance to a disabled person leaves the inheritance to a Supplemental Needs Trust or SNT. This allows the individual to continue to receive benefits but can pay for things not covered by the programs, like eyeglasses, dental care, or vacations. However, does the SNT receive the same life expectancy payout treatment as an IRA?

Thanks to a special provision in the SECURE Act that applies only to the disabled and the chronically ill, a SNT that pays nothing to anyone other than the EDB can use the life expectancy payout. The SECURE Act calls this trust an “Applicable Multi-Beneficiary Trust,” or AMBT.

For other types of EDB, like a surviving spouse, the individual must be named either as the sole beneficiary or, if a trust is used, must be the sole beneficiary of a conduit trust to qualify for the life expectancy payout. Under a conduit trust, all distributions from the inherited IRA or other retirement plan must be paid out to the individual more or less as received during their lifetime. However, the SECURE Act removes that requirement for trusts created for the disabled or chronically ill.

However, not all of the SECURE Act’s impact on special needs planning is smooth sailing. The AMBT must provide that nothing may be paid from the trust to anyone but the disabled individual while they are living. What if the required minimum distribution from the inheritance is higher than what the beneficiary needs for any given year? Let’s say the trustee must withdraw an RMD of $60,000, but the disabled person’s needs are only $20,000? The trust is left with $40,000 of gross income, and there is nowhere for the balance of the gross income to go.

In the past, SNTs included a provision that allowed the trustee to pass excess income to other family members and deduct the amount as distributable net income, shifting the tax liability to family members who might be in a lower tax bracket than the trust.

Special Needs Planning under the SECURE Act has raised this and other issues, which can be addressed by an experienced estate planning attorney.

Reference: Morningstar.com (Dec. 9, 2020) “Providing for Disabled Beneficiaries After the SECURE Act”

The Biggest Estate Planning Mistakes and How to Avoid Them

“One of the biggest wealth transfers our nation has ever seen is about to take place. Over the next 25 years, as much as $68 trillion of wealth will be passed to succeeding generations.”

Heirs who are prepared to inherit wealth, with families who talk about wealth and have an estate plan, will do better than those who do not, says the West Haven Observer’s recent article “5 Estate planning disasters you’ll want to avoid.” A constantly changing legal and tax environment presents significant challenges, but a few simple steps may save your beneficiaries from the expense and stress of these common estate planning mistakes.

1. Not designating beneficiaries properly. This is one of the most common mistakes, and one that cannot always be fixed. It’s easy to forget whose name you put on a pension or life insurance plan thirty years ago. However, failing to check those beneficiaries, especially if your life has undergone big changes, can lead to the wrong people enjoying the proceeds.

Using beneficiary designations is an excellent way to bypass the process of probate, since assets that pass this way are not subject to probate. Depending upon where you live, probate can be a long, drawn out process. A beneficiary designation is far simpler and more efficient.

Failing to name a beneficiary when setting up bank accounts, opening CDs, and savings accounts is a common error. This can be fixed by making these accounts “TOD,” or Transfer on Death, and the account goes directly to your beneficiary.

Your will does not control any beneficiary designations. That’s why this step is so important.

2-Designating a minor as a beneficiary. You love your grandchildren, but unless they are adults, they cannot inherit assets until they are 18 or 21, depending on the laws of your state. If a minor does receive an asset, the court appoints a guardian to supervise and manage the assets. Your estate planning attorney will advise you on your individual situation, but one alternative is to list a guardian for the minor child inside the will, so the court appoints the person who you choose to manage the property until the child becomes of age.

Another means of providing for young children or grandchildren is to create a trust. The trust names a trustee who is usually a trusted friend or relative who is knowledgeable and responsible. They manage the assets on behalf of the child. The trust also permits assets to pass without probate.

3-Failing to fund a trust. All too often, this is the weak link that breaks the estate. Placing assets within the trust is called funding. Usually this means changing the ownership of bank accounts or real estate from being owned by an individual to being owned by the trust. If the trust is not funded and the will has instructions that seemingly contradict the trust, the asset will need to go through probate and the trust instructions will be ignored.

4-Leaving a tax nightmare for heirs. One of the many advantages of passing on real estate or other assets that appreciate that beneficiaries get a “step up” in basis. That means the heirs are not responsible for any income taxes on the appreciated assets. This can be a very big benefit. There are exceptions—inherited IRAs and 401(k)s don’t have this advantage. However, the recent passage of the SECURE Act has taken away many tax benefits for IRA heirs. Most non-spouse beneficiaries must fully withdraw the entire amount from the IRA or 401(k) within ten years, and the withdrawal is considered ordinary income. It could leave your heirs with a huge, unexpected tax bill.

There is a workaround. By converting some or perhaps all of your retirement accounts to a Roth IRA during your lifetime, you can pay the taxes when converting the IRA to a Roth IRA at your current tax rate, which may be lower than your children or grandchildren’s rate. When you die, any money in the Roth IRA goes to heirs completely tax free.

5-The biggest mistake of all is not having an estate plan. Thinking about your legacy plan, mortality and incapacity is not fun for anyone. However, by spending the time and resources in creating an estate plan, you spare your loved ones from an inordinate amount of stress and expenses, which they will appreciate. One of the best gifts you can give your loved ones is a well-thought out, properly created and executed estate plan.

Reference: West Haven Observer (Nov. 12, 2020) “5 Estate planning disasters you’ll want to avoid”

Inherited IRAs Require Careful Handling

“One wrong decision can lead to expensive consequences, and good luck trying to persuade the IRS to give you a do-over.”

For those who inherit IRAs, the intersection of taxes, estate law and financial planning can be a tricky place. There are many choices, maybe too many, and making the wrong choice can be costly, according to the recent article “6 inherited IRA rules all beneficiaries must know” from Bankrate.

There are two categories of beneficiaries. Surviving spouses, minor children, chronically ill or disabled individuals, or someone who is not less than 10 years younger than the original owner are subject to one set of rules. Everyone else has another set of rules.

You’ll need to know if the original owner had taken any RMDs—required minimum distributions—before they passed.

Did you want to minimize taxes, or is it more important for you to maximize cash distribution?

These are just a few of the issues to be addressed. Already complicated, inherited IRAs got even more complicated because of the SECURE Act, which changed some longstanding practices. Some experts tell beneficiaries not to do anything, until they meet with an estate planning attorney. The worst thing someone could do is make a wrong step and lose half of the IRA to taxes.

Here are the six rules for inherited IRAs:

1–Spouses have the most flexibility. The surviving spouse may treat the IRA as her own, naming herself as the owner. She can also roll it over into another account, such as another IRA or a qualified employer plan (including 403(b) plans). She could also treat herself as the beneficiary of the plan. However, each choice leads to further choices and decisions. She might let the IRA grow in the account until she reaches age 72, the new age for RMDs. Or she can roll the IRA into an IRA of her own, which lets her then name her own beneficiary.

2—When do you want to take the money? If you fall into the category of surviving spouses, minor children, chronically ill or disabled individuals, or someone who is not less than ten years younger than the original owner, then you can take the distributions over your own life expectancy. That’s the “stretch” option. Otherwise, you need to take distributions from the account over ten years, according to the SECURE Act. Depending on the size of the IRA, that could be a nasty tax bill. You can take as little or as much as you want, but by year ten after the owner’s death, the account must be empty.

3—Know about year of death required distributions. If the owner of the IRA did not take his RMD in the year of his death, beneficiaries are required to do so. If a parent dies in early January, for example, it’s not likely he took his RMD. The IRS doesn’t care if you didn’t know—you’ll be liable for a penalty of 50% of the amount that wasn’t taken out. If someone dies close to the end of the year, it’s possible that heirs might not know about the accounts until after the deadline has passed. If the deceased was not yet 70½, there is no-year-of-death distribution.

4—Get all the breaks you can—tax breaks. For estates subject to the estate tax, IRA beneficiaries will get an income-tax deduction for estate taxes paid on the account. The taxable income earned but not received by the deceased is called “income in respect of a decedent.” When someone takes a distribution from an IRA, it’s treated as taxable income. However, the decedent’s estate is paying a federal estate tax, so beneficiaries get an income-tax deduction for estate taxes paid on the IRA. For a $1 million income in an inherited IRA, there could be a $350,000 deduction offset against that.

5—Beneficiary forms matter. An entire estate plan can be undone by a missing beneficiary form, or one that is not filled out correctly or is ambiguous. If there is no designated beneficiary form and the account goes to the estate, the beneficiary will need to take the distribution from the IRA in five years. Forms that aren’t updated, are missing, or don’t clearly identify the individuals create all kinds of expensive headaches.

6—Improperly drafted trusts are trouble. If they are done wrong, a trust can limit beneficiary options in a big way. If the provisions in the trust are not properly drafted, some custodians won’t be able to see through the trust to determine the qualified beneficiaries. Any ability to maximize the time to take money out of an IRA could be lost. An experienced estate planning attorney who knows the rules about IRAs and trusts is a must.

Reference: Bankrate (July 17, 2020) “6 inherited IRA rules all beneficiaries must know”

 

Update Will at These 12 Times in Your Life

“It is also important to realize that it isn’t merely ‘why’ you are updating your will, but ‘when’ you are updating that can make all the difference.”

Estate planning lawyers hear it all the time—people meaning to update their will, but somehow never getting around to actually getting it done. The only group larger than the ones who mean to “someday,” are the ones who don’t think they ever need to update their documents, says the article “12 Different Times When You Should Update Your Will” from Kiplinger. The problems become abundantly clear when people die, and survivors learn that their will is so out-of-date that it creates a world of problems for a grieving family.

There are some wills that do stand the test of time, but they are far and few between. Families undergo all kinds of changes, and those changes should be reflected in the will. Here are one dozen times in life when wills need to be reviewed:

Welcoming a child to the family. The focus is on naming a guardian and a trustee to oversee their finances. The will should be flexible to accommodate additional children in the future.

Divorce is a possibility. Don’t wait until the divorce is underway to make changes. Do it beforehand. If you die before the divorce is finalized, your spouse will have marital rights to your property. Once you file for divorce, in many states you are not permitted to change your will, until the divorce is finalized. Make no moves here, however, without the advice of your attorney.

Your divorce has been finalized. If you didn’t do it before, update your will now. Don’t neglect updating beneficiaries on life insurance and any other accounts that may have named your ex as a beneficiary.

When your child(ren) marry. You may be able to mitigate the lack of a prenuptial agreement, by creating trusts in your will, so anything you leave your child won’t be considered a marital asset, if his or her marriage goes south.

Your beneficiary has problems with drugs or money. Money left directly to a beneficiary is at risk of being attached by creditors or dissolving into a drug habit. Updating your will to includes trusts that allow a trustee to only distribute funds under optimal circumstances protects your beneficiary and their inheritance.

Named executor or beneficiary dies. Your old will may have a contingency plan for what should happen if a beneficiary or executor dies, but you should probably revisit the plan. If a named executor dies and you don’t update the will, then what happens if the second executor dies?

A young family member grows up. Most people name a parent as their executor, then a spouse or trusted sibling. Two or three decades go by. An adult child may now be ready to take on the task of handling your estate.

New laws go into effect. In recent months, there have been many big changes to the law that impact estate planning, from the SECURE Act to the CARES act. Ask your estate planning attorney every few years, if there have been new laws that are relevant to your estate plan.

An inheritance or a windfall. If you come into a significant amount of money, your tax liability changes. You’ll want to update your will, so you can do efficient tax planning as part of your estate plan.

Can’t find your will? If you can’t find the original will, then you need a new will. Your estate planning attorney will make sure that your new will has language that states revokes all prior wills.

Buying property in another country or moving to another country. Some countries have reciprocity with America. However, transferring property to an heir in one country may be delayed, if the will needs to be probated in another country. Ask your estate planning attorney, if you need wills for each country in which you own property.

Family and friends are enemies. Friends have no rights when it comes to your estate plan. Therefore, if families and friends are fighting, the family member will win. If you suspect that your family may push back to any bequests to friends, consider adding a “No Contest” clause to disinherit family members who try to elbow your friends out of the estate.

Reference: Kiplinger (May 26, 2020) “12 Different Times When You Should Update Your Will”

 

Are You Making the Most of the SECURE and CARES Acts?

“There have been several law changes that affect IRAs passed since December 2019.”

The SECURE Act made a number of changes to IRAs, effective January 1, 2020. It was followed by the CARES Act, effective March 27, 2020, which brought even more changes. A recent article from the Milwaukee Business Journal, titled “IRA planning tips for changes associated with the SECURE and CARES acts,” explains what account owners need to know.

Setting Every Community Up for Retirement (SECURE) Act

The age when you have to take your RMD increased from 70½ to 72, if you turned 70½ on or before December 31, 2019. Younger than 70½ before 2020? You still must take your RMDs. But, if you can, consider deferring any distributions from your RMD, until you must. This gives your IRA a chance to rebound, rather than locking in any losses from the current market.

Beneficiary rules changed. The “stretch” feature of the IRA was eliminated. Any non-spousal beneficiary of an IRA owner who dies after Dec. 31, 2019, must take the entire amount of the IRA within 10 years after the date of death. The exceptions are those who fall into the “Eligible Designated Beneficiary” category. That includes the surviving spouse, a child under age 18, a disabled or chronically ill beneficiary, or a beneficiary who is not more than ten years younger than the IRA owner. The Eligible Designated Beneficiary can take distributions over their life expectancy, starting in the year after the death of the IRA holder. If your estate plan intended any IRA to be paid to a trust, the trust may include a “conduit IRA” provision. This may not work under the new rules. Talk with your estate planning attorney.

IRA contributions can be made at any age, as long as there is earned income. If you have earned income and are 70 or 71, consider continuing to contribute to a Roth IRA. These assets grow tax free and qualified withdrawals are also tax free. If you plan on making Qualified Charitable Distributions (QCD), you’ll be able to use that contribution (up to $100,000 per year) from the IRA to offset any RMDs for the year and not be treated as a taxable distribution.

Coronavirus Aid, Relief and Economic Security (CARES) Act

The deadline for contributions for traditional or Roth IRAs this year is July 15, 2020. The 2019 limit is $6,000 if you are younger than 50 and $7,000 if you are 50 and older.

RMDs have been waived for 2020. This applies to life expectancy payments. It may be possible to “undo” an RMD, if it meets these qualifications:

• The RMD must have been taken between February 1—May 15 and must be recontributed or rolled over prior to July 15.
• RMDs taken in January or after May 15 are not eligible.
• Only one rollover per person is permitted within the last 12 months.
• Life expectancy payments may not be rolled over.

Individuals impacted by coronavirus may be permitted to take out $100,000 from an IRA with no penalties. They are eligible if they have:

• Been diagnosed with SARS-Cov-2 or COVID-19
• A spouse or dependent has been diagnosed
• Have experienced adverse consequences as a result of being quarantined, furloughed or laid off or having work hours reduced due to the virus, are unable to work because of a lack of child care, closed or reduced hours of a business owned or operated by the individual or due to other factors, as determined by the Secretary of the Treasury.
• Note that these distributions are still taxable, but the income taxes can be spread ratably over a three-year period and are not subject to the 10% early distribution penalty.

Keep careful records, as it is not yet known how any of these distributions/redistributions will be accounted for through tax reporting.

Reference: Milwaukee Business Journal (June 1, 2020) “IRA planning tips for changes associated with the SECURE and CARES acts”

 

Massive Changes to RMDs from Stimulus Plan

 

“Here are the highlights of the most recent tax changes found in the $2 trillion coronavirus relief bill, which the Senate has approved, and the House passed recently.”

Several of the provisions that were signed into law in the relief bill can taken advantage of immediately, reports Financial Planning in the article “Major changes in RMDs and retirement contributions in $2T stimulus plan.” Here are some highlights.

Extended deadline for 2019 IRA contributions. With the tax return filing date extended to July 15, 2020 from April 16, the date for making 2019 contributions to IRA and Roth IRA contributions has also been extended to the same date. Those contributions normally must be made by April 15 of the following year, but this is no normal year. There have never been extensions to the April 15 deadline, even when taxpayers filed for extensions.

When this tax return deadline was extended, most financial professionals doubted the extension would only apply to IRA contributions, but the IRS responded in a timely manner, issuing guidance titled “Filing and Payment Deadlines Questions and Answers.” These changes give taxpayers more time to decide if they still want to contribute, and how much. Job losses and market downturns that accompanied the COVID-19 outbreak have changed the retirement savings priorities for many Americans. Just be sure when you do make a contribution to your account, note that it is for 2019 because financial custodians may just automatically consider it for 2020. A phone call to confirm will likely be in order.

RMDs are waived for 2020. As a result of the Coronavirus Aid, Relief and Economic Security Act (CARE Act), Required Minimum Distributions from IRAs are waived. Prior to the law’s passage, 2020 RMDs would be very high, as they would be based on the substantially higher account values of December 31, 2019. If not for this relief, IRA owners would have to withdraw and pay tax on a much larger percentage of their IRA balances. By eliminating the RMD for 2020, tax bills will be lower for those who don’t need to take the money from their accounts. For 2019 RMDs not yet taken, the waiver still applies. It also applies to IRA owners who turned 70 ½ in 2019. This was a surprise, as the SECURE Act just increased the RMD age to 72 for those who turn 70 ½ in 2020 or later.

IRA beneficiaries subject to the five- year rule. Another group benefitting from these the rules are beneficiaries who inherited in 2015 or later and are subject to the 5-year payout rule. Those beneficiaries may have inherited through a will or were beneficiaries of a trust that didn’t qualify as a designated beneficiary. They now have one more year—until December 31, 2021—to withdraw the entire amount in the account. Beneficiaries who inherited from 2015-2020 now have six years, instead of five.

Additional relief for retirement accounts. The new act also waives the early 10% early distribution penalty on up to $100,000 of 2020 distributions from IRAs and company plans for ‘affected individuals.’ The tax will still be due, but it can be spread over three years and the funds may be repaid over the three-year period.

Many changes have been implemented from the new legislation. Speak with your estate planning attorney to be sure that you are taking full advantage of the changes and not running afoul of any new or old laws regarding retirement accounts.

Reference: Financial Planning (March 27, 2020) “Major changes in RMDs and retirement contributions in $2T stimulus plan”

 

Loss of Stretch IRA is Not Such a Big Deal

“The stretch IRA is dead and everyone (including me) is writing about how this is the apocalypse for IRA planning. Well, it isn’t. Let’s all take a deep breath.”

Yes, the SECURE Act has eliminated the use of the stretch IRA, which is the ability to pass an IRA down to a child or grandchild and have them take out withdrawals over their lifetime. No big deal, says the article “No stretch IRA? No problem” from Investment News. Here’s why.

Only the biggest IRAs are affected. How many IRAs actually make it to the beneficiary that are large enough to justify stretched payouts? According to the Treasury Department, only about 20% of all individuals who were required to take the Required Minimum Distribution (RMD) actually stick to the schedule and take that amount out. Four out of five people who own IRAs take much more money than the minimum. This reduces the amount in the account that is left for their beneficiaries and reducing and even eliminating the possibility of heirs using the stretch option.

There’s no change to spousal beneficiaries. Most married people leave their IRAs to their spouses, and surviving spouses are exempt from the new stretch restrictions. Spouses who inherit IRAs and other assets still have the same options they had before the SECURE Act was passed. Financially savvy spouses (or those with good advisors) will do a spousal rollover and further delay the “no stretch problem” for another generation. By doing this, they postpone the start of the ten-year payout rule. If they use more of the IRA during their own lifetime, again, there’s not that much to worry about.

Most beneficiaries don’t stretch. Not at all. Windfalls usually don’t last very long. How many beneficiaries wait patiently for 30, 40 or 50 years to deplete an inherited IRA? Not many. For many beneficiaries, the new ten-year rule might actually be more realistic. For the smaller IRAs, it may be more logical to empty the account with a lump-sum distribution, especially if it is distributed among several beneficiaries in low tax brackets. However, if the IRA is a Roth, hang on to it and let it grow, tax-free, for as long as possible.

Most beneficiaries are in lower tax brackets. People like to leave their IRAs to their grandchildren, but most grandchildren, under the SECURE Act, will not be able to stretch IRA payouts over their lifetime. If the grandchild is a minor, then the kiddie tax emerges, and the child might have to pay taxes on any withdrawals at their parent’s tax rates. Do your homework with your estate planning attorney.

While the inherited payout is ten years, the tax hit to younger, usually lower income earners, won’t be as bad. However, the kiddie tax could lead to a huge tax hit for your adult children and grandchildren. Another option is naming multiple grandchildren. More beneficiaries will at least stretch out the tax hit over multiple tax returns.

Speak with your estate planning attorney about what needs to change on your estate plan, in light of the new restrictions created by the SECURE Act. There are strategies that they can discuss with you to minimize the tax liability.

Reference: Investment News (March 2, 2020) “No stretch IRA? No problem”

 

Estate Planning Checklist, Especially for Procrastinators

“Nobody likes to think about dying. However, it happens whether we prepare for it or not.  If you don’t do some advance planning, it can cause even more longer lasting pain and grief, not to mention money and strained relations for your loved ones.”

Many people don’t think of themselves as having an “estate.” However, a house, car, savings account, life insurance, and all the possessions you own are an estate. If, after years of procrastinating, you finally did the right thing and had an estate plan created with an experienced estate planning attorney, is there anything else you need to do? Yes, says Federal News Network in the article “Good at putting things off? Here’s the last checklist you’ll ever need!”

Where should you keep your estate planning documents? These documents need to be kept in a secure location that is known to the people who will need access to them. A will might be kept at home in a fire and waterproof safe, or at your attorney’s office. Each estate planning attorney has his or her own process and can make recommendations. A will placed in a safe deposit box may create huge headaches, if the box is sealed upon death. Remember that people will need easy access to some documents, like a Do Not Resuscitate, or Medical Health Care Proxy, so they could be stored somewhere in the home where they can be grabbed in an emergency.

Who should have a copy of my estate plan? This is a personal preference. Some people give a copy to all heirs and their executor. Others prefer to keep it private. It is essential that the person who will be your executor knows where your will is and can get access to it quickly.

Update beneficiary designations. Many assets are governed not by the will, but by the beneficiary designations on the accounts. That may include retirement accounts, annuities, IRAs, life insurance, and possibly bank accounts and investment accounts. Check them every few years, especially if there have been divorces, marriages and new members added to the family.

Review how your assets are titled. If there are assets owned as “joint with right of survivorship,” they will not pass through probate and will become owned by the joint owner upon death. Sometimes this works well for large accounts, but sometimes it backfires. Talk with your estate planning lawyer.

How long does my estate plan last? An estate plan does not have an expiration date.

When should I amend my estate plan? Anytime there is a large change in the law, as has recently occurred with the passage of the SECURE Act, the estate plan should be reviewed. The SECURE Act has changed the rules about IRA distributions for heirs. Anyone with a sizable IRA should review their plan.

Any time there is a large event in your life, is another time when your estate plan should be reviewed. Those events include a death, birth, marriage, or divorce. If the person you had named as your executor or who had been given Power of Attorney or Health Care Proxy is no longer in your life or is no longer trusted, you also want to review and change these documents.

Reference: Federal News Network (Feb. 5, 2020) “Good at putting things off? Here’s the last checklist you’ll ever need!”

 

Alternatives for Stretch IRA Strategies

“The elimination of the Stretch IRA is a game changer, especially for parents who were considering bequeathing savings in IRAs to their children.”

The majority of many people’s wealth is in their IRAs, that is saved from a lifetime of work. Their goal is to leave their IRAs to their children, says a recent article from Think Advisor titled “Three Replacements for Stretch IRAs.” The ability to distribute IRA wealth over years, and even decades, was eliminated with the passage of the SECURE Act.

The purpose of the law was to add an estimated $428 million to the federal budget over the next 10 years. Of the $16.2 billion in revenue provisions, some $15.7 billion is accounted for by eliminating the stretch IRA.

Existing beneficiaries of stretch IRAs will not be affected by the change in the law. But going forward, most IRA heirs—with a few exceptions, including spousal heirs—will have to take their withdrawals within a ten year period of time.

The estate planning legal and financial community is currently scrutinizing the law and looking for strategies will protect these large accounts from taxes. Here are three estate planning approaches that are emerging as front runners.

Roth conversions. Traditional IRA owners who wished to leave their retirement assets to children may be passing on big tax burdens now that the stretch is gone, especially if beneficiaries themselves are high earners. An alternative is to convert regular IRAs to Roth IRAs and take the tax hit at the time of the conversion.

There is no guarantee that the Roth IRA will never be taxed, but tax rates right now are relatively low. If tax rates go up, it might make converting the Roth IRAs too expensive.

This needs to be balanced with state inheritance taxes. Converting to a Roth could reduce the size of the estate and thereby reduce tax exposure for the state as well.

Life insurance. This is being widely touted as the answer to the loss of the stretch, but like all other methods, it needs to be viewed as part of the entire estate plan. Using distributions from an IRA to pay for a life insurance policy is not a new strategy.

Charitable Remainder Trusts (CRT). The IRA could be used to fund a charitable remainder trust. This allows the benefactor to establish an income stream for heirs with part of the IRA assets, with the remainder going to a named charity. The trust can grow assets tax free. There are two different ways to do this: a charitable remainder annuity trust, which distributes a fixed annual annuity and does not allow continued contributions, or a charitable remainder unitrust, which distributes a fixed percentage of the initial assets and does allow continued contributions.

Speak with your estate planning lawyer about what options may work best in your unique situation.

Reference: Think Advisor (Jan. 24, 2020) “Three Replacements for Stretch IRAs”

 

Unintended Kiddie Tax Change Fixed in the SECURE Act

“The kiddie tax was created long ago to prevent wealthy parents from cutting their taxes by transferring a large amount of investments to their dependent children, who would be taxed at a lower rate.”

Families were hurt by a change in the kiddie tax that took effect after 2017, but they’ll be able to undo the damage from 2018 and 2019 now that a fix has become law. The SECURE Act contains a provision that fixed this unintended change, as reported in the San Francisco Chronicle’s recent article, “Congress reversed kiddie-tax change that accidentally hurt some families.”

The kiddie tax was created many years ago to prevent wealthy families from transferring large amounts of investments to dependent children, who would then be taxed at a much lower rate than their parents. It taxed a child’s unearned income above a certain amount at the parent’s rate, instead of at the lower child’s rate. Unearned income includes investments, Social Security benefits, pensions, annuities, taxable scholarships and fellowships. Earned income, which is money earned from working, is always taxed at the lower rate.

The Tax Cuts and Jobs Act of 2017 changed the kiddie tax in a way that had severe consequences for military families receiving survivor benefits. Instead of taxing unearned income above a certain level—$2,100 in 2018 and $2,200 in 2019—at the parent’s tax rate, it taxed it at the federal rate for trusts and estates starting in 2018.

Hitting military families with a 37% tax rate that starts at $12,750 in taxable income is unthinkable, but that’s what happened. Low and middle-income families whose dependent children were receiving unearned income, including retirement benefits received by dependent children of service members who died on active duty and scholarships used for expenses other than tuition and books, were effectively penalized by the change.

Under pressure from groups representing military families and scholarship providers, Congress finally added a measure repealing the kiddie tax change to the SECURE Act, which seemed as if it was going to be passed quickly in May. The bill was stalled until it was attached to the appropriations bill and was not passed until December 20, 2019.

There is a specific provision in the bill: “Tax Relief for Certain Children” that completely reverses the change starting in 2020. It also says that subject to the Treasury Department issuing guidance, taxpayers may be able to apply the repeal to their 2018 and 2019 tax years, or both.

The IRS has not yet issued guidance, but the expectation is that amended returns will be required, if a taxpayer elects to use the parents’ tax rate for that year.

Some parents whose children have investment income may be better off using the estate-tax rate for the two years that it is in place. In 2019, those trust brackets may actually allow more capital gains and dividends be taxed at the 0% and 15% rates than by using the parents’ rates.

Reference: San Francisco Chronicle (Jan. 20, 2020) “Congress reversed kiddie-tax change that accidentally hurt some families”