Johnson County Estate Planning

Mega-IRAs Could Be a Source for New Public Policies

“Congressional Democrats are weighing a new type of required distribution from individual retirement accounts, based on the account value instead of age, according to a discussion list of policy ideas obtained by CNBC.”

There are few specifics but owners of “mega” IRA accounts worth more than $5 million might be presented with new withdrawal requirements, if legislation for a new national safety net becomes law. For a very small slice of the American population, IRAs have become million and even billion dollar tax deferred accounts, according to a recent article from CNBC titled “Democrats may change the rules for ‘mega’ IRAs over $5 million."

There are roughly two dozen tax categories being considered by Congress to help raise money for the expansion of the nation’s safety net, which for now is anticipated to have a $3.5 trillion price tag.

The policy concept was spotted on a draft of ideas lawmakers assemble before formally pitching the ideas before their colleagues. Floating game-changing ideas to gauge response is part of today’s legislative process.

The list didn’t include a specific amount but suggests a limit of $5 million. It also included information regarding the number of mega IRA accounts. Apparently, the number of IRA accounts worth more than $5 million has tripled in the past ten years.

In contrast, the average American’s IRA is valued around $39,000.

The idea is part of a broader theme of raising revenue from the wealthy to pay for social needs, like education, address climate change, assist working families with paid leave, childcare and other basic human needs.

It may have been sparked by a recent report that one of the founders of PayPal owns a Roth IRA valued at $5 billion. IRAs were created as a means of encouraging working Americans to save for retirement. However, they have become huge tax shelters for the wealthy.

More than 28,600 taxpayers owned IRAs worth more than $5 million in 2019, but they account for less than a tenth of 1% of the 70 million Americans who have a traditional or Roth IRA. The mega accounts add up to $280 billion, or about 3% of the total $8.6 trillion owed in IRAs.

Limiting the size of tax-deferred retirement accounts isn’t new. Several attempts have been made to cap the amount in IRAs or change distribution rules.

The final legislation may not be known for some time, but one response to this proposal would be to convert traditional IRAs to a Roth. Paying taxes at the time of the conversion, even if done over time, could be useful to eliminate having to pay taxes on the funds, if withdrawal rules change. In addition, there are no Required Minimum Distributions (RMDs) on Roth IRAs, so funds can grow tax free for the life of the owner.

Reference: CNBC (Sep. 8, 2021) “Democrats may change the rules for ‘mega’ IRAs over $5 million”

It Is Wise to Plan Carefully before Taking Out Retirement Funds

“If you think saving for retirement is complicated, try figuring out how to withdraw retirement funds while minimizing taxes.”

As much as 70% of your retirement funds could evaporate after income tax, estate and state taxes, says a recent article titled “9 smart ways to withdraw retirement funds,” from Bankrate.com. While this number may sound extreme, a closer look shows how easily it could happen, even to families who are well under today’s high federal estate tax exemptions. Here’s how to avoid this minefield.

Watch the rules on RMDs—Required Minimum Distributions. Once you turn 72, you’re required to start taking a minimum amount from tax-deferred retirement accounts, including traditional IRAs and 401(k)s. The penalty for failing to do so is severe: a 50% excise tax. If you get the math wrong and don’t take out enough money, the penalty is just as bad. Let’s say your RMD is $20,000 but somehow you only take $5,000. The IRS will levy a $7,500 tax bill: half the $15,000 you were supposed to pay. Ouch!

When you calculate your RMD, remember it changes from year to year. The RMD is based on your age, life-expectancy and account balance, which is the fair market value of the assets in your accounts on December 31 the year before you take a distribution.

Take withdrawals from accounts in the right order. Which retirement bucket should you tap first? A Roth IRA will be tax free but use taxable accounts first and leave the Roths for later. Here’s why.

If a 72-year-old person takes $18,000 from a traditional IRA in the 24% tax bracket, their tax bill will be $4,320. The same withdrawal from a Roth IRA won’t create any tax liability. However, if they leave the Roth alone and earn 7% annually on the $18,000 for another ten years, it could grow to $35,409, which will also be tax free when withdrawn. It’s worth the wait.

Do you know the way to take distributions? Most Americans have had several jobs and have retirement accounts in different institutions. It may be time to consolidate assets into one IRA. This can make it much easier to calculate future withdrawals, tax liabilities and asset allocation. Do this carefully—and you may need help from your estate planning attorney. You can’t take withdrawals from an IRA to meet RMD requirements for 403(b)s, 401(k)s or other plans. 401(k) plans may not be pooled to calculate a single RMD. Handle any consolidations with great care to avoid incurring tax penalties.

RMDs are different in some situations. If one spouse is significantly younger than the other, RMDs might be lowered. RMDs are calculated using factors like life expectancy (as determined by IRS tables). If a spouse is the sole beneficiary of an IRA, and they are at least ten years younger than you, the RMD calculation is done using a joint-life expectancy table. The amount of the RMD will be reduced according to the table.

Charitable contributions count. People aged 70½ or older are permitted to make tax free donations, known as qualified charitable distributions, of up to $100,000 to a charity as part of their RMD. This distribution does not count as income, reducing income tax to the donor. If you file a joint return, a spouse may also make a contribution up to $100,000. You can’t itemize these as a charitable deduction, but it’s a good way to minimize taxes.

Withdrawals don’t have to be cash. RMDs can be stocks or bonds, which are assigned a fair-market value on the date they are moved from the IRA to a taxable account. This may be easier and less expensive than triggering fees by selling securities in an IRA and then buying them back in a brokerage account.

Can you delay RMDs if you’re still working? If you’re still working at age 72 and continuing to fund a 401(k) or 403(b), you can delay taking RMDs, as long as you don’t own more than 5% of a company and your retirement plan permits this. Check with the 401(k) custodian or human resources to be sure this is allowable to avoid expensive penalties.

Smart money management is just as important in taking money from your retirement accounts as it is in building those accounts. Make informed decision to maximize your savings and minimize taxes.

Reference: Bankrate.com (Aug. 31, 2021) “9 smart ways to withdraw retirement funds”

Don’t Shrink Your Estate with Last Minute Tax Planning

“Estate planning strategies such as family limited partnerships and gifts to charitable trusts are part of an estate planning professional’s toolbox to achieve client goals, such as minimizing taxes, effectuating philanthropic plans, teaching younger generations about a family business and passing on wealth.”

In the best-case scenario, you’d start talking with your estate planning attorney early on about your overall goals and the various tools available to minimize tax liability and transfer wealth to the next generation. Whether your estate is modest or significant, the article “A Recipe for Risk—Last-Minute Tax Planning for Estates” from The Legal Intelligencer explains how a last-minute plan failed on a grand scale. A recent memorandum opinion from the U.S. Tax Court provides a cautionary tale.

Howard Moore owned a large amount of property and ran a successful farm. He was admitted to the hospital late in 2004, was discharged to hospice and told he only had six months to live. He created an estate plan that included a family limited partnership (FLP), a living trust, a charitable lead annuity trust, a trust for the adult children, a management trust that acted as the general partner of the family limited partnership and an “Irrevocable Trust No. 1” that was created to act as a conduit for the transfer of funds from the FLP to a charitable foundation.

The primary focus of the plan was to transfer the farm to a living trust and then to transfer 80% of the farm property to the FLP. The management trust was to serve as a partner to the FLP, with the living trust owning almost all the limited partnership interests and with each of the decedent’s children owning a 1% partnership interest. The FLP was to offer protection against liabilities from the use of pesticides, potential bad marriages, creditors and the fact that the family was a bit dysfunctional and would need to work together to manage the FLP. The FLP had many transfer restrictions and the limited partners were not given any rights to participate in business management or operational decisions regarding the FLP.

The trust known as “Irrevocable Trust No. 1” was nominally funded at the time of the decedent’s death and received funding from the FLP. Those funds, in turn, were transferred to the charitable trust to gain a charitable deduction by the estate. Just before he died, Moore used FLP funds to make large transfers to his children that were designated as loans. He also made outright gifts to the children and to one grandchild.

The estate filed an estate tax return and a gift tax return after Moore’s death. The IRS issued a notice of deficiency for nearly $6.4 million and the case went to tax court. The U. S. Tax Court agreed with the IRS’ findings. The defense of the estate plan, the tax court maintained, was form over substance and the only reason for the estate plan and the numerous transactions was to save estate taxes.

There were a lot of hurdles in this case, in addition to the short time period for the estate plan to have been created. At the time of the decedent’s hospitalization, the sale of the farm to a neighbor was being negotiated. A contract to sell the farm was executed with days of transferring it to the living trust. There were numerous transfers and distributions made between trusts and the FLP, and the court concluded that all decisions about the FLP after its formation were made unilaterally by the decedent. An FLP is supposed to function as a true partnership. Many other issues and errors occurred in the rush to have this estate structured in such a short period of time.

Had Moore engaged in planning five or ten years earlier, there would have been time to create a plan in which both the substance and execution of the plan were sound and the family would have been able to save millions of dollars in taxes. By waiting until his death was imminent, the plan attempted to establish transfer requirements without the opportunity to execute them properly.

Reference: The Legal Intelligencer (May 18, 2020) “A Recipe for Risk—Last-Minute Tax Planning for Estates”

Spare Yourself These Retirement Expense Surprises

“’Stealth expenses,’ as one retiree described them to me, are waiting behind any number of corners in retirement.”

Learning about the common financial surprises that occur during retirement is an excellent way to try to protect nest eggs, says the article “The Expenses People Often Forget When They Plan for Retirement” from The Wall Street Journal.

A study by the Society of Actuaries found that one in five retirees and one in four widows experienced four or more financial shocks during retirement. That’s a lot of surprises for people living on fixed incomes. The good news is that the study also revealed that many older adults who experienced a stealth surprise appear to have bounced back.

Retirees are resilient, and most are good about making adjustments to their budgets to overcome their surprises. However, being prepared for these financial shocks is even better. Here are some of the more common hidden costs of retirement:

Replacement costs for big ticket items. A new furnace, a new car, or a new roof are all expenses that come up when you’re working. They don’t stop because of retirement. Many retirees underestimate their longevity and overestimate big ticket items that need replacement.

Relatives in need. This pinch can come from older parents or relatives and younger family members who find themselves in a financial crisis. An adult child who loses their job or goes through a divorce or a grandchild who needs help with tuition are some of the typical examples. Can your nest egg sustain their needs, or do you need to say no? Can other family members help?

Required distributions and taxes. Most people know that they will need to start taking withdrawals from tax-deferred accounts upon reaching 70½, but they don’t often understand the larger picture. The distribution may push the couple into a higher tax bracket, and increase Medicaid Part B premiums, which are tied to annual income.

It’s not possible to anticipate every single surprise cost that will come up during retirement. However, there are a few things that can be done. First, try to avoid any major expenditures during the first five years of retirement. That’s when nest eggs are most vulnerable to bear markets. Next, while you are saving for retirement or making budgets, include money for home repairs and upkeep.

Reference: The Wall Street Journal (Oct. 17, 2019) “The Expenses People Often Forget When They Plan for Retirement”

Good News About Gifts

“Granting people gifts makes you and them happy. If you can tailor your generosity so not to pay tax on your largess, you will be even happier.”

It’s worthwhile to understand the rules about taxes that might be triggered by your generosity, says Forbes in the article “How To Avoid Taxes When Giving Big-Dollar Gifts.” Did you know that you can give any one person as much as $15,000 every year, without having to pay any gift taxes? You can give any number of people up to $15,000 and they don’t even need to be relatives.

Note that if and when any gift taxes are due, it’s the giver who pays any gift taxes, and not the recipient.

Therefore, if you think the world of your next-door neighbor and give him a gift of $20,000, you only owe taxes on the $5,000 above the $15,000 limit, and that’s also if your total gift exceeds your lifetime exclusion. You don’t have to be generous with cash only. Gifts can come in the form of stock, a boat or jewelry. Just remember to keep it under $15,000, so as not to incur any gift taxes.

The $15,000 limit is per person, not per couple, so if you want to give someone $15,000 and your spouse also wants to give them a $15,000 gift, that works. You can double the gift, while still staying under the annual limit.

If your gift is going to a charitable organization—a registered 501(c)(3), you won’t owe anything in gift taxes.

In addition to this $15,000 annual cap, wealthy gift givers should just keep in mind a $11.4 million maximum that is known as the lifetime exclusion. That’s the limit in 2019, and it will rise next year. This governs all the gifting you do during your lifetime. That’s outside of the annual exclusion of $15,000.

Anything more than that in the way of gifts, and you or your estate will have to pay estate tax. The top rate for the overage is high-40%. However, you’ll have to be mighty generous to get near that limit.

Here’s what’s nice: you won’t have to pay gift taxes every single time you go over that $15,000 limit. Let’s say you give your son $50,000 in 2019. Your gift is $35,000 above the ceiling, which is taxable.  However, rather than write a check for taxes to the IRS now, you count it against the $11.4 million lifetime exclusion. You now have $11.365 remaining.

The best way to go about gifting, is to make sure that your desired gifts are working in concert with your estate plan. One reason for gifting “with warm hands” is to reduce the taxable size of the estate, but there are many other ways to do this. There are also instances when gifts need to be reported to the IRS, even if no taxes are owed on them.

Speak with an experienced estate planning attorney about your gifting strategy, how it works with your estate plan and what gift tax forms you do, or do not, need to file.

Reference: Forbes (October 14, 2019) “How To Avoid Taxes When Giving Big-Dollar Gifts”

Tax Changes will have Impact on Divorces

Assets will have to be divided, as well as dealing with paperwork, courts and tax law changes.

Dividing up assets is difficult in a divorce and the new tax law changes that went into effect in January are not going to make it any easier, according to Next Avenue in “How the Tax Laws for Divorce Will Turn Upside Down in 2019.”

Here are the four key changes:

Alimony paid will no longer be tax-deductible, and alimony received will no longer be treated as taxable income. For decades, alimony has been tax deductible for the person paying it and taxable as income for the person receiving it. Expectations are that the federal government will benefit by as much as $6.9 billion over the next 10 years. Other expectations are that high-income divorcing spouses will fight more aggressively to pay less in alimony, since it is no longer a deduction. Smaller alimony payments may be a result. In addition, legal fees paid to secure alimony will no longer be deductible.

If your divorce is modified in 2019, you might be subject to this new rule. If you are already divorced, you’ll be governed by the old rules. However, be careful of any divorce modifications in 2019.

Pre- and post-nuptials may change also. Certain agreements may be nullified under the new law.

Children won’t be a tax deduction. The 2017 tax law eliminated the $4,050 exemption for each dependent until 2025. On the other hand, the child tax credit has doubled from $1,000 to $2,000.

For those who are facing divorce in the year to come, be aware that your attorney, your spouse and you need to work together if possible, to minimize the tax liabilities that may be created in the divorce.

If you are the spouse with the higher income, consider trading an IRA account to your lower earning spouse, because that shifts the tax burden to the IRA owner, when they start taking distributions. If you are the lower-earning spouse, understand that unless it’s a Roth IRA, you will have to pay taxes on distributions.

If possible, delay the divorce until others have navigated the new rules. It takes time for attorneys and financial advisors to get up to speed, when there are large changes in the law. By mid-year or later, the professionals who guide you along this journey may have strategies they did not have in the early part of the year.

An estate planning attorney can advise you in creating an estate plan that fits your unique circumstances.

Reference: Next Avenue (Dec. 4, 2018) “How the Tax Laws for Divorce Will Turn Upside Down in 2019”

There are Many Reasons and Uses for an Estate Plan

It’s easy to put off starting an estate plan.  However, you really do want to take care of your family.

Why should you have an estate plan? There are many reasons and many goals, including providing for your spouse and children, as well as dealing with a family business, minimizing tax liabilities and naming the people you want to act on your behalf when you’re gone, according to the Brainerd Dispatch in “Wealth Column: Estate Planning Basics,”

So, what do you need? First, you’ll need a will, which is the basic tool for estate planning. It prevents two very expensive and stressful issues: managing your wishes for your estate and possibly losing hefty sums through unnecessary taxes.  However, that’s just the start.

You may also need trusts, depending on your family’s situation. You’ll want to have life insurance policies with beneficiaries. Life insurance proceeds are not governed by the will, so your heirs will receive any funds directly. Benefits from retirement funds fall into this same category. That’s why making sure that your beneficiary designations are up-to-date, is so important.

Working with a team of trusted advisors, is productive for most people. Remember that your estate plan touches on taxes and investments as well as your will, power of attorney and medical directive. Consider these steps to get your entire estate plan in order:

• Gather personal data about yourself and your family,
• Create a balance sheet of your assets and liabilities,
• Review your will and any existing trusts,
• Evaluate all estate tax options, such as the best method of disposing of your share of community property—considering the unlimited marital deduction and the use of tax-sheltered trusts,
• Consider the optimal way to distribute your retirement plan benefits,
• Calculate potential estate, gift and income tax liabilities,
• Determine the availability of liquid assets to meet potential estate expenses and taxes.

An estate planning attorney can work with the information you have gathered to create an estate plan that fits your unique circumstances.

Resource: Brainerd Dispatch (Aug. 3, 2018) “Wealth Column: Estate Planning Basics”

What about Assets If There are No Kids or Spouse?

If you do not have children or a spouse to include in an estate plan, the first thought may be family and friends. That is probably a good place to start.

If you do not have any children or a spouse, there are many options available for creating an estate plan that benefits others, according to nj.com in “Single without kids? Who should be your heir?” This is not an unusual situation and an estate planning attorney will be able to help you examine your options. You have many choices, although it may not seem that way at first glance.

Yes, start with considering family members. If you leave money to older siblings who are dependent upon programs like Medicaid, you might put their financial situation at risk. If the older sibling dies shortly after receiving the inheritance, then the money will be part of their estate.

If you decide to leave assets to your siblings and have a will properly prepared by an estate planning attorney, then the assets will be distributed according to the terms of the will, regardless of how the siblings feel about it. Is it likely that there will be a will contest? If no, then make an informed decision based on how you want your assets distributed.

There are other things that you can do with your assets. Consider making a charitable donation to an organization you have been involved with during your lifetime or one that shares your values and goals. A scholarship to your college or to a local community group would be greatly appreciated and may create a lasting legacy to your memory. You can also give with “warm hands,” which is making charitable donations while you are alive, to nonprofit organizations. That way you can enjoy seeing the impact of your gift, while you are alive.

Make sure to consider the tax ramifications of any estate plan. There may be an inheritance tax in your state that will have a significant impact on the inheritance. Will your heirs be able to afford that?

Sit down with an estate planning attorney and talk about what it is you’d like your estate to achieve after you’ve passed.

Resource:nj.com (July 20, 2018) “Single without kids? Who should be your heir?”

Estate Planning? You Face Some 401(k) Questions

Companies offer retirement savings plans.  However, the challenge can be in both saving and withdrawing.

Most employers offer 401(k) plans to employees, as a means of encouraging savings for retirement. Some are generous enough to offer matches, although there are fewer of those today than in the past. Even after decades of the existence of the 401(k), you most likely have questions, according to USA Today’s article  “401(k) limits: 7 answers to your top retirement plan questions.”

When can I start building my 401(k)? Some employers let you start with your first paycheck. Others have a waiting period. Enroll as soon as possible to get your money growing.

How much should I save? Remember to adjust your savings rate as time goes on. If you get a raise and you are able to do so, increase your savings. If you start by saving 5% of your salary, move up to 10% when you’re more established in your career, then closer to 15% when retirement is on the horizon.

What about taxes? Most 401(k)s are “tax deferred,” meaning that your contributions are made with pre-tax dollars. If you contribute $250, your take-home pay is reduced and so is your tax burden. Note that you don’t pay taxes on capital gains, interest or dividends.  However, the IRS does take its share, when you withdraw funds during retirement.

When do I withdraw my retirement money? You can start taking withdrawals from your 401(k) any time after age 59½.  However, you’ll have to pay income taxes. If you are younger than that, You must pay income taxes PLUS a 10% early withdrawal penalty. That’s a retirement no-no. You can take a loan from your 401(k)—$50,000 or half your total savings, whichever is lower.  However, you must pay yourself back with interest. Penalties can add up quickly, so only do this in an emergency.

How much can I sock away? If you’re under 50, you are limited to a $18,500 contribution in 2018. If you are over 50, an additional $6,000 is allowed to help you catch up.

Can I save more? You might be able to use a traditional IRA or a Roth IRA. It depends upon your age and your income level. Talk with an estate planning attorney about how to best structure your savings to max out retirement savings and tax benefits.

What if I get a new job? If you have saved more than $5,000, you can leave the money in the account.  However, don’t forget about your 401(k). If it’s less than that, your old employer will want you to roll the money into a different retirement account. If you don’t respond to their request, it’s possible that they will send you a check, minus taxes and early-withdrawal penalties. Don’t lose money because you forgot to transfer your money!

Reference: USA Today (July 1, 2018) “401(k) limits: 7 answers to your top retirement plan questions”

Minnesota’s Tax on Trusts Unconstitutional

The state was attempting to collect tax without consideration for residency.

A tax court has decided that Minnesota’s trust taxation is unconstitutional, according to the Wills, Trusts & Estates Prof Blog in "Tax Refunds for Trusts With Minnesota Grantors? Minnesota Income Tax Statute Ruled Unconstitutional."

Minnesota’s income tax statute makes 100% of a trust's assets taxable in that state, if the trust became irrevocable when the settlor was a resident of Minnesota.

This rule applies regardless of where the trust beneficiaries reside or where any trustees reside.

The court looked at trusts that had an out-of-state trustee, beneficiaries who lived in Minnesota and beneficiaries who lived in other states.

It determined that these trusts could not be considered resident trusts of Minnesota and, therefore, the state could not tax intangible assets. Presumably, the same logic could be applied to some other trust situations.

This ruling could lead to refunds for some trusts.

However, it appears likely that Minnesota will appeal to the Supreme Court.

Reference: Wills, Trusts & Estates Prof Blog (June 7, 2017) "Tax Refunds for Trusts With Minnesota Grantors? Minnesota Income Tax Statute Ruled Unconstitutional."