Your Estate Plan, Your Trusts, and Your Retirement Accounts

You should read this excellent short column by financial writer Arden Dale of The Wall Street Journal, “Minding Retirement Accounts in Estate Plans,” on integrating IRAs, 401(k) plans, federal employee Thrift Savings Plan (TSP) accounts, and similar retirement savings accounts into estate and trust plans. The article deals primarily with choosing primary beneficiaries in a way that will minimize estate and income taxes. For most married retirement plan beneficiaries, that will mean choosing their spouses to receive the plan proceeds outright and free of trust, via a rollover after the first spouse’s death.Safeguard Your Retirement Plan For Children

However, trusts continue to be important contingent, or secondary, beneficiaries, especially for larger plans. The ability of your children or grandchildren (and in some cases, your spouse) to compound retirement plan investments over a long period of time makes IRAs and similar plans one of the most valuable tools for wealth succession planning for your family. Well-drafted retirement plan trusts help ensure that such plan “stretch-outs” will be administered property. I will normally recommend a separate IRA trust if you wish to

  • preserve and guard retirement plan assets from your beneficiaries’ “predators and creditors” – including remarriage spouses, your children’s and grandchildren’s creditors, and their improvidently-chosen spouses;
  • control distributions after your death (discourage or prevent a beneficiary from withdrawing all of the assets he inherits from you at once, absent a very good reason);
  • direct otherwise-reluctant retirement plan administrators to divide an account into separate accounts for your children;
  • limit payouts to any special-needs beneficiaries (including those who become disabled after your death) to protect ongoing government benefits; and
  • ensure that your retirement plan money stays in your family.

Generally speaking, if you and your spouse’s combined retirement plan assets exceed $250,000, it will be cost-effective for us create stand-alone retirement plan trusts for each spouse in addition to your Revocable Living Trust. If you’d like to arrange an appointment or a phone call, or receive more information via email, please call or email me, or use the contact tool in the sidebar.

(Updated: March 2017)

The 3.8% Net Investment Income Tax is Still Here

One little-mentioned provision of the Patient Protection and Affordable Care Act is the 3.8% net investment income tax (NIIT) that went into effect on January 1, 2013. Various commentators refer to it as the “Obamacare surtax,” the “health care surtax,” or the “Medicare tax”; but whatever one chooses to call it, it is still going to be with us unless and until the ACA is repealed.

Last-Minute Estate Planning In 2012This surtax is assessed on Form 1040 (for individuals) and Form 1041 (for trusts and estates) upon the lesser of a) net investment income or b) the excess of modified adjusted gross income (MAGI) over a threshold amount. For married taxpayers filing jointly, the threshold amount is $250,000; married filing separately, $125,000; and all other individual taxpayers, $200,000. For trusts and estates, the threshold amount is the amount where the top income tax bracket for trusts and estates begins ($12,500 in 2017).

Does the Health Care Surtax affect me?

Stated another way: 1) If your modified adjusted gross income (MAGI) for 2017 is less than or equal to the threshold amount that applies to you, you will not pay the health care surtax. 2) If your MAGI is greater than the threshold amount that applies to you, you will pay the 3.8% tax on the lesser of a) your net investment income or b) the amount of your MAGI over the threshold amount.

What’s all this about MAGI? Basically, it means that your healthcare surtax liability is determined on your income before any tax deductions are considered. That means your deductions could put you in the lowest income tax bracket, yet you could still have investment income that is subject to the surtax. Also, the capital-gains income tax rate for high-income taxpayers stands at 20% in 2017, so the total federal tax on capital gains (with the surtax) could be 23.8% in 2017 and beyond. (Don’t forget to add state capital-gains taxes to get your true marginal tax rate on investment income.)

How Can I Avoid (Or Minimize) Investment Income Surtaxes?

The good news is that there are some steps Northern Virginia families can take right now to help you avoid or reduce the amount of your Obamacare surtax. Even though the Trump Administration and Congressional majorities have stated a goal of eliminating Obamacare and the NIIT entirely, there are many slips ‘twixt cup and lip. Unless and until repeal is signed into law, there are no guarantees.

Now, more than ever, you need the assistance of experienced professionals to advise you and help you implement the best plan for you and your family. I stand ready to assist Virginia residents with the estate planning part of your project, and to work with your investment advisor and your CPA.

[Updated: March 2017]

Estate and Trust Planning in 2017: News You Can Use

PredictionsAs was the case in 2016, no major changes in federal and Virginia estate and gift tax laws arrived on January 1, 2017. However, there are big changes on the horizon. First off, President Trump promised during his campaign to work to repeal federal death taxes. In addition, repeal of the Affordable Care Act would most likely be accompanied by repeal of the Net Investment Income Tax, which affects married couples with incomes exceeding $250,000 and trusts or estates with retained income exceeding $12,400 (for tax year 2016).

At this writing, though, such changes are only proposals, so it’s wise to plan using the laws and regulations we have. And here’s what we have right now, for tax year 2017.

COLA increase in the lifetime exclusion amount for estate and gift taxes

Our current federal Internal Revenue Code”unifies” the estate tax and the gift tax, providing for a combined tax credit that allows people both to make taxable gifts during their lifetimes and to transfer estate property to heirs at their deaths free of federal taxes up to a certain total amount. That amount increases each year to adjust for inflation, and for persons dying in 2017, the new exclusion amount will be $5.49 million. (Call it a round 5-1/2 million if you like. That’s a $40,000 increase over 2016.)

You might think this amount is high enough to prevent you from having to think about federal estate taxes. However, keep in mind that this amount includes not just the value of financial assets and real estate that you own, but also the payout values of your retirement plans and any life insurance that you own at your death. When calculating how close you are to taxability, be sure to include the value of any death benefits and group life insurance that your employer might provide.

No increase in the annual exclusion amount for gifts

The Code’s gift tax provisions are written to apply to even small gifts. However, Congress in its beneficence has provide for an “annual exclusion” that exempts from gift taxation and reporting gifts up to a specified amount. That amount is also adjusted for inflation, but only when thousand-dollar increments are exceeded. For 2017, the annual exclusion remains at $14,000, the same as it has been since 2013.

A few reminders about the annual gift tax exclusion. First, you can give up to $14,000 to as many different people as you want. So if your estate is at, above, or near the lifetime exclusion amount mentioned above, making annual gifts to your children, grandchildren, nieces and nephews might be a good way to make sure they come to visit you often (as well as keeping your family’s money out of Uncle Sam’s wallet).

Also, there are several categories of gifts that can exceed this amount without incurring gift taxes or using up your lifetime exemption. Most people can make unlimited tax-free gifts to their spouses (except for noncitizen spouses – tax-free gifts to them are limited to $149,000 in 2017). Moreover, money you spend on medical care or education for someone else isn’t treated as a taxable gift so long as you pay the school, college, or medical care provider directly. (Directly means you write the check or incur the credit charge. Reimbursements of others don’t qualify.)

As always, contact me if you have any questions about maximizing or using your lifetime or annual exclusions from estate and gift taxes.

 

It’s Back! The Tax-Free IRA Charitable Rollover

Thanks to the Protecting Americans From Tax Hikes Act of 2015 (“PATH”), signed into law on December 18, 2015, Section 408(d)(8) of the Internal Revenue Code once again provides a $100,000 annual exclusion from gross income for charitable donations made directly from a traditional IRA by donors aged 70½ or older.

Donate HereFurthermore, this IRA “charitable rollover” provision has been made permanent (meaning it would take a vote of both Houses plus a presidential signature to change it), retroactive to January 1, 2015. This makes it much easier to plan for charitable rollover donations and make them without the year-end uncertainty that has plagued senior donors for the past several years.

Still IRAs Only

As in past years, distributions from 401Ks, 403Bs, TSPs of federal employees and military retirees, and other employer-sponsored retirement plans (such as SIMPLE IRAs and SEP plans) are not eligible. (However, you usually can roll assets from those plans into IRAs and then donate them if you begin the process early enough in the year.)

To qualify, the funds must be transferred directly by your IRA trustee to an eligible charity. Not all charities are eligible. For example, donor-advised funds and “supporting organizations” are not eligible recipients.

And, as in the past, distributed amounts don’t qualify for deductions (since they were never taxed in the first place). Instead, they may be excluded from your income — giving you a smaller Adjusted Gross Income on your Form 1040.

Under a special and favorable IRS rule under the charitable rollover provisions, distributions from an IRA to charity are deemed to come first from the taxable portion of the IRA account, and then from any non-taxable portion. This is a distinct benefit to taxpayers who made non-deductible IRA contributions during their working years.

The Donor May Not Receive Anything Of Value

This rule can be harsh, so be careful. Any quid pro quo benefit or thing of value received by the donor in return for the charitable rollover distribution, such as the value of a dinner or other non-trivial benefit, may disqualifies the entire distribution, not just a portion equal to the benefit received, from IRA charitable rollover treatment.

Therefore, a careful donor will first advise the charity well in advance that: (1) a distribution will be made from an IRA account to the charity and that it is intended to constitute a “qualified charitable distribution” under IRC § 408(d); and (2) that no goods, services, or benefits of any kind are to be provided by the charity to the donor or any other person in consideration for the distribution. (Charities usually know this well, but it never huts to remind them.) In addition, a wise donor will request in advance that the charity provide a letter to the donor acknowledging the amount of the distribution that it received and confirming that no goods, services, or benefits of any kind were or will be provided to the donor or any other party in exchange for the distribution.

Your New Estate Planning Checklist

Fortunately (or unfortunately, if you’re not all that happy with our current estate and gift tax laws), the start of 2015 brings no significant changes to the federal or Virginia tax laws or to Virginia laws affecting estate and trust planning and administration.

So instead of an update on new laws and tax rates, here’s a practical checklist you can use to evaluate your estate plan and, perhaps, make some financial and planning resolutions for the upcoming year. Because an out-of-date estate plan might be missing useful features that I’ve added in recent years in response to those years’ changes in tax and nontax estate planning laws and court decisions.

Action This DayDo you have an estate plan in place? (That question is for you, non-clients.) Whether you do or not, please go through the rest of this checklist. If you answer “no” or “I don’t know” to any of the following questions, please contact me so that we can get things set right.

Do you have a revocable living trust and pour-over Will in place? If so, have you and I sat down and reviewed them within the last three or four years?

Does your Health Care Power of Attorney permit a person (such as your spouse or a family member) or committee of your choosing (such as a family member in concert with your doctor) to make emergency health care decisions for you in the event you are ever unable to do so?

Are you pretty sure that your estate plan will minimize death taxes and income taxes for your beneficiaries (including taxes on your real estate, investments, life insurance proceeds, and IRA or TSP assets)?

Do you need to take any steps to avoid to avoid possible will contests or similar disputes among the beneficiaries (and non-beneficiaries) of your estate?

Are the people you have named in your Wills as Guardians of your minor children’s persons, and named in your trusts as Trustees of the assets you might leave them, still the best people (or financial institutions) for the job? I often counsel my clients to pick co-Trustees – banks or trust companies to do the heavy lifting, and trusted individuals (who might be the beneficiaries themselves) to keep an eye on them.

Does your estate plan provide protection from creditors and lawsuits for assets you leave to your surviving spouse, children, and grandchildren? (If it was drafted before 2012, it almost certainly doesn’t protect them to the maximum extent now possible.)

If you have a revocable living trust in place as part of your estate plan (and you should), have you transferred all of your assets to yourself as Trustee so that your family can avoid the expenses, annoyances, and stress of probate? If not, we should get started this day.

Does your estate plan protect your children’s inheritances in the event your surviving spouse chooses to remarry? (And your surviving spouse’s inheritance, in case he or she chooses unwisely?)

Does your estate plan include provisions to allow the assets you leave to your surviving spouse and your children to get a step-up in basis at their deaths, to minimize future capital-gains taxes?

If this checklist leads you to believe there might be ways your current estate plan could be improved, I invite you to contact me so that we can make it better.

Congress Procrastinates Again on Tax-Free Charitable IRA Rollovers

Once again, a special provision of the Tax Code offering older owners of individual retirement arrangements (IRAs) an advantageous way to make charitable donations, is scheduled to expire on December 31. For the remainder of 2013, a traditional IRA owner, age 70½ or over, may transfer directly, tax-free, up to $100,000 per year to an eligible charity, regardless of whether he or she itemizes income-tax deductions.

IRAs Only

Donation can and heartDistributions from 401Ks, the TSPs of federal employees and military retirees, and other employer-sponsored retirement plans (such as SIMPLE IRAs and SEP plans) are not eligible. However, if you hurry, you may be able to roll assets from those plans into IRAs and donate them before the giving deadline expires.

To qualify, the funds must be transferred directly by your IRA trustee to an eligible charity. Not all charities are eligible. For example, donor-advised funds and “supporting organizations” are not eligible recipients.

The distributed amounts don’t qualify for deductions (since they were never taxed in the first place). Instead, they may be excluded from your income — giving you a smaller Adjusted Gross Income on your Form 1040.

Charitable Rollovers Are MRDs

Amounts transferred to a charity from an IRA are counted in determining whether you have met the IRA’s required minimum distribution (MRD) requirement. And if you have made both deductible and nondeductible contributions to your traditional IRAs, a special rule treats amounts distributed to charities as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions made to you.

Tax-Free IRA Charitable Rollovers Reinstated by American Taxpayer Relief Act (“ATRA”)

Donation can and heartFrom 2006 through 2011, individuals age 70-1/2 or older were eligible to make donations of up to $100,000 directly from their individual retirement accounts (IRAs) to benefit public charities.

Although they received no charitable deduction for such transfers, they didn’t have to report the distribution as taxable income, either. Result: zero tax. And, such a distribution counted toward fulfilling their required minimum distributions (MRDs) for those years.

But Congress didn’t act during 2011 to extend them, so they disappeared during 2012. However, Congress, in its wisdom (and perhaps because nonprofit institutions deluged Congress with lobbyists) reinstated IRA charitable rollovers in the American Taxpayer Relief Act of 2012 (signed into law on January 2, 2013), both for tax year 2013 and retroactively for tax year 2012. And since most taxpayers eligible to make IRA charitable rollovers didn’t make them in 2012 (since there was no guarantee they would get zero-tax treatment), Congress extended the period to make 2012 contributions through January 31, 2013.

If you decide to make an IRA charitable rollover during January, be sure to discuss with your tax advisor whether you should characterize it as a 2012 rollover or a 2013 rollover.

Consider “Front-Loading” Your Life Insurance Trust Contributions

A proposal that first appeared in the Obama administration’s failed 2012 budget proposal seeks to override existing state laws and limit the terms of cascading or “dynasty” trusts to 90 years. This proposal didn’t make it into the “Fiscal Cliff” legislation, but might resurface again in 2013.

Frontload your irrecovable life insurance trustAlthough there can be no guarantees, any new federal law along those lines probably would treat existing dynasty trusts as grandfathered, and so exempt from this term limitation. However, if gifts were made to such trusts after the effective date of a trust term limitation law, a result might be that the trust would lose its grandfathered status. This already happens with certain grandfathered trusts (those settled before September 25, 1985) with respect to the generation-skipping transfer (GST) tax.

Or, a contribution after the effective date might cause the trust to be divided into a “dynasty share” and a “limited-term share.”

Many of my clients (and many, many people who aren’t my clients yet) have already-existing life insurance trusts (ILITs) to which they contribute annually. Many of these trusts are 100% exempt from the generation-skipping transfer tax. Those folks, to the extent possible and practicable, should consider using some of their lifetime exemption to “front-loading” their gifts to such GST exempt ILITs. Just in case.

Virginia Trust & Estate Law Recodification Charts (For Attorneys and Advisors)

Trusts & Estates DetectiveEffective October 1,  2012, Virginia has reorganized and renumbered its statutes relating to wills, estates, trusts, fiduciary powers, fiduciary responsibilities, and related topics in an attempt to put everything (more or less) in one Article of the Code, so that attorneys and advisors will not need to skip so often between different Articles, Chapters, and Sections when drafting or interpreting documents.

Virginia estate planning listservs and forums have been flooded with questions about which “old” sections have been replaced by which “new” sections, and vice versa. The tables that show the renumberings are buried deep in the Virginia Code Commission website and are kind of hard to find, so I’ve put them here:

(Note: Clients and casual browsers might find these a bit dry.)