Considering the Stretch IRA Rules After the SECURE Act.

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As a financial and estate planning technique, the “stretch” IRA allowed the beneficiary of an inherited IRA to take distributions from the IRA over her remaining life expectancy, extending the life and income tax advantages (tax-deferred or tax free growth) of the IRA. For a very young beneficiary, this could have been a virtual lifetime. That all changed with the recent passage of the SECURE (“Setting Every Community Up for Retirement Enhancement”) Act.

The SECURE Act severely curtailed the viability of the “stretch” technique for distributions from inherited IRAs, both traditional and Roth. Under the Act, most non-spouse beneficiaries will have to withdraw all of the funds from an inherited IRA within 10 years of the death of the original account owner. The new rules apply to traditional or Roth IRAs inherited after December 31, 2019.

Beginning January 1, 2020, only an “eligible designated beneficiary” may continue to use the stretch technique for distributions from an inherited IRA. Under the SECURE Act, those beneficiaries eligible to use the stretch technique are: i) surviving spouses; ii) minor children of the account owner – until age of majority (but not grandchildren); iii) disabled individuals; iv) individuals who are chronically ill; and v) beneficiaries not more than 10 years younger than the deceased account owner.

If an individual does not qualify as an eligible designated beneficiary under one of those 5 categories, she must use a new 10 year rule – the entire account balance must be withdrawn by December 31 of the 10th year following the year of the account owner’s death. Note too, that a minor child of a deceased account owner may use the old life-expectancy distributions rules until she reaches the age of majority, and then must switch to the 10 year rule thereafter.

Of course, if an IRA owner died before January 1, 2020, the old stretch IRA distribution rules still apply.

Caveat: While this post focuses on the SECURE Act’s impact on distributions from traditional and Roth IRAs, the new rules affect distributions from all inherited qualified retirement plan accounts, including SEP IRA, SIMPLE IRA, 401(k), and 403(b) accounts.

The SECURE Act adds a thick layer of complexity to an already confusing area of tax law. As with any tax law change, one should review their financial and estate plans to better understand how the SECURE Act may affect those plans.

Do you need help understanding the impact the SECURE Act has on your current planning, or need help determining how best to adapt your financial or estate plan to the new law? Give me a call, I can help.

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The SECURE Act Becomes Law – How Will it Affect Your Financial and Estate Planning?

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The SECURE Act, which passed the US House of Representatives last summer (2019), had been flying well below most people’s radar as it seemed to lose steam in the Senate, despite bipartisan support. However, quite surprisingly and with little fanfare, it was passed into law just before Christmas, and took effect January 1, 2020.

In brief, the SECURE Act changes the age when one must begin taking distributions from qualified retirement accounts, changes provisions regarding contributions to IRAs and penalty-free withdraws from retirement accounts, as well as beneficiary distribution rules for inherited retirement accounts.

For those individuals who are currently working and saving for retirement, the SECURE Act removes the age limit for contributions to traditional IRAs. Under the old rules, a taxpayer could not contribute to a traditional IRA after reaching age 70½, regardless of whether he was employed. The SECURE Act removed that age limit. Now, you may contribute to an IRA regardless of your age, as long as you are working and have earned income. This change will help boost retirement savings for older taxpayers.

In addition, the SECURE Act raises the age at which one must begin taking distributions from retirement accounts. As of January 1, 2020, the age at which require minimum distributions must begin is 72. So, if you reach age 70½ in 2020, you can relax. You may wait until April 1 following the year in which you turn 72 to begin taking distributions from your retirement accounts. If you reached age in 70½ in 2019, the rules have not changed. You must still take your initial RMD before April 1, 2020, if you did not take it before the end of 2019.

The SECURE Act also eliminates the 10% penalty for early withdrawals from a retirement account in situations involving the birth or adoption of a child. In such cases, up to $5,000 may be withdrawn from a retirement account, penalty free, within a year of a birth or adoption of a child. The withdrawn funds may be re-contributed to the account at a later date.

Likely the most significant changes brought by the SECURE Act involve distributions from retirement accounts after the death of the account owner. Under pre-2020 law, an important planning strategy for retirement accounts was to name a spouse, child, or others as account beneficiary to allow for post-death distributions to be extended, or “stretched,” over the beneficiary’s remaining life expectancy. This had the affect of prolonging the tax deferral of investment gains in a retirement account and reducing the amount a beneficiary was required to withdraw each year.

Under the SECURE Act, the “stretch” is eliminated for most non-spouse beneficiaries. For those affected beneficiaries, all funds in a retirement account will have to be distributed within 10 years of the year of the account owner’s death. This will have the effect of increasing the amount of each year’s distribution from a retirement account and the taxes to be paid on those distributions.

Surviving spouses are excluded under the Act, and still have the option of stretching distributions over their remaining life expectancy. Minor children are also exempt from the new rules until they reach the age of majority. Finally, certain disabled and chronically ill beneficiaries and beneficiaries who are not more than 10 years younger than the account owner are also exempt.

The SECURE Act does not apply to retirement accounts owned by individuals who died before January 1, 2020. The old stretch rules will continue to apply.

Whenever significant law changes occur, it’s important to understand the real or potential impact it may have on your financial and estate planning. You should always work with a qualified, knowledgeable and trusted advisor.

If you have questions regarding the SECURE Act’s possible impact on your planning, give me a call. I can help.

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Need to take an IRA RMD before the end of the year? Why not make a tax-avoiding QCD instead?

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IRA owners must begin taking annual required minimum distributions (RMD) once they reach age 70½. An RMD is taxable as income for the year in which the RMD is taken. A lot of my clients dislike RMDs because they are a forced distribution – by law, an RMD must be taken after age 70½ whether or not the client wants the distribution. For these clients, the RMD unnecessarily pushes up their taxable income and consequently their income tax bill.

So what can a taxpayer do to eliminate, or at least reduce the income tax liability that comes with the RMD? Enter the qualified charitable distribution (QCD).

A QCD allows a taxpayer to transfer an RMD from an IRA directly to a qualifying charity without the taxpayer including the RMD amount in taxable income. The amount contributed to charity via the QCD (up to a limit of $100,000) may be excluded from adjusted gross income while satisfying that year’s RMD. The QCD exclusion is allowable regardless of whether the taxpayer takes a standard deduction or itemizes deductions. The QCD amount may not be taken as a charitable deduction if one itemizes. The benefit of the QCD is the exclusion of the QCD amount from adjusted gross income for the year in which the QCD is taken.

There are several important rules that apply to QCDs. First, the account from which the QCD is made must be an IRA, and the amount must be taxable funds (neither nondeductible contributions nor after-tax rollover funds may be used for the QCD). The IRA may be a traditional, inherited, or an inactive SEP or SIMPLE IRA. A taxpayer may not make a QCD from a 401(k) or other employer sponsored retirement account.

Second, the taxpayer must have reached the age of 70½ before the QCD is made. It isn’t enough that one turns age 70½ during the year. The QCD must be made after the date the taxpayer reaches age 70½.

Third, the charity receiving the QCD funds must be a qualifying 501(c)(3) organization. A QCD is not available for a contribution to a private foundation or a donor-advised fund.

Fourth, the amount of the QCD is capped at $100,000 per year per taxpayer. Thus, taxpayers who must take an RMD of more than $100,000 will still be required to include in adjusted gross income that portion of the RMD that exceeds the $100,000 QCD limit. However, if the taxpayer is married and files jointly, both spouses can make a $100,000 QCD from their separate IRAs.

Finally, the QCD must be made via direct transfer from the IRA to the charity. The check cannot be made out to the taxpayer. If the check is made payable to the taxpayer, he may not later give those funds to charity for the QCD, and the amount of the distribution must be included as income on the taxpayer’s return.

A QCD can be a powerful tool to help avoid income taxes when faced with mandatory RMDs. However, the rules governing RMDs and QCDs are many and complex. Make sure you are working with a qualified professional.

Have questions about QCDs, or RMDs in general? Contact me, I can help.

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Working the System – Parents Giving Up Custody of Their Kids to Get College Financial Aid

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Aunt Becky’s legal woes arose from her efforts to get her children into the University of Southern California. However, for many families, the problem isn’t getting their kids into a college of their choice, the problem is paying for it.

Some enterprising parents in Illinois reportedly have given up custody of their children to help them get college scholarships. According to a news story at Probublica online, dozens of wealthy families in Illinois have given up legal guardianship of their children so the teenagers can claim dramatically lower incomes and earn need-based financial aid.

When the guardianship proceeding is completed — usually during junior or senior years of high school — students are able to declare themselves financially independent on college applications. In one instance detailed by the Wall Street Journal, a student whose parents owned a $1.2 million home only had to declare $4,200 in income from a summer job. That student was able to obtain about $47,000 in scholarships and federal Pell grants to attend a private university that costs $65,000 per year.

The practice is legal, but the United States Department of Education is looking into the matter. And some universities are pushing back against the practice, reducing university-based financial aid awards to some students.

The article notes that laws in Illinois governing the transfer of legal guardianship are broadly written and that as long as the parents, children and the court agree, a judge can approve the transfer even if parents are able to financially support their kids. It’s not clear if the tactic has been tried in other states.

You can read the entire Propublica article here.

How Will the SECURE Act Affect Your Retirement Savings?

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Having passed the US House of Representatives and now moving quickly through the US Senate, the SECURE (Setting Every Community Up for Retirement Enhancement) Act appears to be on its way to soon becoming law. The SECURE Act will make numerous changes to how money is contributed to, and withdrawn from retirement accounts. While many of the Act’s provisions are administrative in nature, that is, they deal with the way retirement plans are administered, several provisions will directly affect retirement savings and withdrawals. Here are some of the more important ways the SECURE Act could affect your retirement savings:

First, the Act pushes back the time when retirement savers must begin taking distributions from their IRAs and other retirement accounts. Under current law, a person is required to begin taking retirement account distributions at age 70½, whether or not he or she wants to. The SECURE Act will push the age when required distributions must begin to age 72. This means that retirement savings may continue to grow untouched and untaxed for another year and a half before distributions must begin.

Next, the SECURE Act eliminates the age restrictions on IRA contributions. Americans are living and working longer. However, under current law a person may not contribute to an IRA after age 70½, even if still working. Under the SECURE Act, a person may continue to contribute to an IRA after age of 70½ if still working.

Finally, the SECURE Act changes the required minimum distribution rules with respect to IRA and other retirement account balances upon the death of the account owner. Under the Act, distributions to individuals other than the surviving spouse of the account owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the account owner, or child of the account owner who has not reached the age of majority, are generally required to be distributed by the end of the tenth calendar year following the year of the account owner’s death.

Under current law, a non-spouse beneficiary of an IRA or defined contribution-type retirement account [such as a 401(k) or 403(b) account] may elect to “stretch” distributions from an inherited retirement account over his or her remaining life expectancy. For younger beneficiaries, this means that the remaining account balance has a longer time to grow tax deferred before being withdrawn, and the amounts withdrawn may be taxed at lower rates. The SECURE Act will accelerate distributions from inherited retirement accounts, reducing the time horizon for tax deferred growth and increasing the taxes that must be paid on the larger withdrawals.

This change will have an impact on beneficiary designations and estate plans, especially those situations in which a trust is named as a beneficiary of a retirement account.

Insofar as the SECURE Act will affect retirement saving and distributions in these and other ways, readers should plan to meet with a qualified legal or financial professional to determine the best way forward under the Act should it become law.

If you don’t have an attorney or financial planner, but would like to work with one, please give me a call. I can help.

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DIY Estate Planning – Another Cautionary Tale

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“I don’t need a lawyer. I don’t have an estate, just have a house and some bank accounts. My family can help me out, and look, here’s a form I found on the internet I can use. What can go wrong?”

Yet time and again, what appears to be a simple and effective way to avoid some legal fees ends up creating a legal quagmire costing tens of thousand of dollars to remedy. Do-it-yourselfers mostly turn to family members or the internet for help. A recent case out of Macomb County Probate Court gives us another example of just how “well” that can turn out:

In mid-2016, Martin met with several members of his family for the purpose of preparing his last will and testament. The meeting was attended by Martin’s brother, John, John’s son Paul, John’s daughter Elise, and Martin’s niece, Theresa.

John downloaded and printed a will form off the internet, and Elise completed the fill-in-the-blank form according to Martin’s instructions. The form provided that all of Martin’s assets were to be distributed equally among Martin’s 3 siblings. The family members also discussed the status of Martin’s bank accounts. After completing the form, the group went to Comerica Bank so Martin could sign the will before a notary. While there, Martin and Theresa also signed new signature cards for each of Martin’s 6 accounts at the bank to give Theresa access to the accounts as the family explained to Martin. Unfortunately, Martin died about 4 months later.

As you may have guessed, a dispute arose after Martin’s death over ownership of the Comerica bank accounts, a dispute which ended up in the Macomb County Probate Court.

At trial, Theresa asserted the funds belonged to her as the surviving joint owner. According to Comerica, signing the new cards by Martin and Theresa established them as joint owners of all 6 accounts (containing about $680,000). Martin’s niece, Elise, now personal representative of Martin’s estate, countered that the funds belonged to the estate for distribution to his siblings per the terms of Martin’s will. Martin had discussed this with the family and that certainly was his understanding and intention when he added Theresa onto the accounts. Following a bench trial, the probate judge sided with Elise that the money belonged to Martin’s estate.

Not satisfied with the probate court loss Theresa appealed to the Michigan Court of Appeals, which again sided with Elise and Martin’s estate. The court opined that although creation of the accounts in Martin and Theresa’s names was prima facia evidence of Martin’s intention to vest title of the accounts in Theresa’s name upon his death, Elise was able to overcome Theresa’s prima facia case that Theresa was entitled to survivor rights to Martin’s accounts. The court noted that Martin did not seek independent counsel and was advised only by his family. Further, the evidence at the trial showed Martin discussed creating “convenience accounts” with his family members and may have mistakenly believed that by adding Theresa as a co-owner, she was only going to be a signer on the accounts, which was consistent with what Martin and his family discussed.

Nothing is simple and straightforward when it comes to estate planning or any other legal matter. You may think you are doing one thing, but the result is something completely unexpected, which can lead to disastrous, and costly, results. (Imagine what it cost in legal fees to settle Martin’s mess.) You should look to family members for a referral, not legal advice. Yes, attorneys cost money, but you are paying for their expertise and advice, which can save you or your family much more in the long run.

Engage knowledgeable legal counsel whatever your problem. Work with an attorney you trust. Don’t be afraid to spend some money up front for good legal advice to save a lot more money later on.

The case is In re Estate of Martin Langer. You can read the full opinion of the Michigan Court of Appeals here.

UTMA Account Seized in Bankruptcy – What Can We Learn?

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Uniform Transfers to Minors Act (UTMA) accounts are a popular tool for gifting assets to minors. They can easily be set up without the services of an attorney or accountant. A contribution to an UTMA account is considered a completed gift for tax purposes, but the minor beneficiary is prohibited from accessing the funds in the account until their 18th (or even 21st) birthday.

The account is managed and controlled by a custodian, who can be the minor beneficiary’s parent, guardian, or some other responsible adult. Once an UTMA account is created, any funds or other property transferred to the account cannot be returned to the person making the gift. When the minor reaches age 18 or 21, depending upon the state in which the account was created, he is entitled to access the funds in the account.

However, UTMA accounts are not without their drawbacks. Like other planning tools, unforseen circumstances can arise that defeat the good intentions of the gift maker.

One such example is illustrated in a recent bankruptcy case out of Rhode Island, In re Marcus Soori-Arachi. In 1998, when Marcus was 15, his father purchased an UTMA annuity for him with Fidelity in Nebraska. Under Nebraska law, the UTMA annuity should have terminated when Marcus turned 19 and the proceeds distributed to him. However, Marcus’s 19th birthday came and went and the account went undisturbed for another 10 years.

In 2017 Marcus, then married and living in Rhode Island, filed a petition for bankruptcy under Chapter 7 of the bankruptcy code. As required by bankruptcy law, the trustee appointed to administer Marcus’s case began the process of gathering and liquidating all of Marcus’s non-exempt assets.

The case trustee notified Fidelity that the UTMA annuity (now worth $105,000) should be turned over to the trustee. Marcus objected in the bankruptcy court, arguing that the UTMA annuity was not part of his bankruptcy estate and could not be liquidated by the trustee. (Marcus did claim a basic exemption protecting about $6,500 from the trustee.)

The bankruptcy court disagreed, finding that the UTMA annuity belonged to Marcus when he turned 19. The court ruled that it did not matter that the annuity was still in the account as of the date Marcus filed bankruptcy. Under Nebraska’s UTMA law, the custodial nature of the account terminated on his 19th birthday. Marcus gained an immediate right of ownership, possession, and control of the annuity, regardless of whether he actually exercised that right. The UTMA annuity could not be sheltered from his creditors in bankruptcy.

While this case interpreted Nebraska law, a bankruptcy court interpreting Michigan law would reach the same conclusion. While Michigan law protects the proceeds of an annuity from the claims of the creditors of a beneficiary, it does not protect the annuity proceeds from the claims of the creditors of the annuity owner, which Marcus became at age 19.

The facts of this case are unusual in that the annuity remained untouched in the UTMA for so long after Marcus reached age 19. When Marcus turned 19, he more than likely didn’t have any debts. But as time went on, he acquired a debt burden that grew to the point that he had to seek bankruptcy court protection, losing about $99,000 in the process.

Still, the case serves as an important reminder for those of you planning your estates. How well do you really know your children or other beneficiaries? Do they have excessive debt? Have they filed bankruptcy in the past? Are they being sued, or is a lawsuit threatened? What about a divorce – is a child’s marriage on the rocks? Knowing the answers to questions like these can help you structure or revise your estate plan, including beneficiary designations, to protect an inheritance from being lost to a beneficiary’s creditors.

The bankruptcy court’s opinion can be accessed here.

Middle Aged Man Dies Leaving Substantial IRA With No Beneficiary – What Happens Next?

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A client, “Susan,” contacted me recently to help settle the affairs of her recently deceased son, “Frank.” Frank owned a traditional IRA that has a fairly substantial balance. Unfortunately, Frank did not list a beneficiary for the account. Shelly is Frank’s only living heir. Frank was 57 when he died in 2018. What are Susan’s options with regard to Frank’s IRA?

Because Frank’s IRA had no identifiable beneficiary, by default the IRA is payable to his estate. And since Frank died before age 70½, a special 5-year rule applies to the distribution of his IRA. In general, the entire balance of Frank’s IRA must be distributed by December 31 of the year containing the fifth anniversary of Frank’s death. In this case, the entire balance of Frank’s IRA must be distributed by December 31, 2023.

An estate does not have a life expectancy, so distributions cannot be “stretched” beyond the 5 years. However, the entire account balance does not have to be taken in one distribution, it can be broken up over multiple years to reduce the taxes payable as long as the entire account balance is distributed before the end of the fifth year following the year of the account owner’s death.

(Now, had Frank died after April 1 following the year he attained the age of 70½, Susan would have been able to stretch distributions from Frank’s IRA to the estate over his remaining life expectancy, avoiding the special 5-year distribution rule.)

If the entire account balance is not withdrawn by the end of the fifth year following Frank’s death, then the IRS could impose a penalty equal to 50% of the balance remaining. The penalty could be waived by the IRS if it finds there was a reasonable basis for the error.

Failing to designate a beneficiary of an IRA (or other retirement account for that matter) is one of the costliest mistakes you can make. Two problems are created: First, because distributions cannot be “stretched” beyond 5 years, there is little tax-deferred growth that can be achieved in such a short period of time. Second, since distributions from the account must be accelerated, the larger distributions create larger income tax bills.

It always pays to double check beneficiary designations on your retirement accounts (and life insurance, too). I recommend at least annually. Make sure you have beneficiaries named on all of your accounts, and to make sure those beneficiary designations are up to date. Has a beneficiary died, or is there some other reason to replace a beneficiary? If so, update your beneficiary designations immediately.

Do you have an issue concerning distributions from a retirement account, or planning for distributions from a retirement account? If so, call me, I can help.

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April 1 Deadline to Receive first RMD Looms.

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For all of you out there who turned age 70½ in 2018, you must start receiving required minimum distributions (RMDs) from your traditional IRAs and employer sponsored plans [401(k), 403(b), etc.,] by April 1, 2019.

The April 1 deadline applies to all employer sponsored plans and traditional IRAs and IRA-type plans, such as SEPs, SIMPLEs, etc. The deadline does not apply to Roth IRAs.

The April 1 deadline only applies if you did not receive your initial RMD in 2018. In addition, the April 1 deadline only applies to the RMD for the first year (2018). For all subsequent years, beginning with 2019, RMDs must be received by December 31. If you turned 70½ in 2018, but did not receive the first RMD from your IRA or other employer sponsored plan accounts by December 31, 2018, then you must take the RMD for 2018 before April 1, 2019. You still must receive the RMD for 2019 by December 31, 2019. So you will have to take two distributions in 2019, one for 2018 by April 1, and the second for 2019 before December 31.

Even though the April 1 deadline is mandatory for all owners of traditional IRAs and most participants in workplace retirement plans, those who are still employed may (if the plan allows) delay taking RMD distributions from their workplace plans until April 1 of the year after the year they retire. Still-working employees cannot, however, delay taking RMD from traditional IRAs beyond April 1 after the year they turn age 70½ . This “still-working” exception only applies to workplace plans that permit a delay.

There is less than 1 month to the April 1 deadline. It is important to remember that the distribution must be received by April 1. It isn’t good enough to request the distribution from your IRA custodian. If it isn’t received by April 1, you will still be taxed on the amount of the first year RMD that should have been received, and the IRS will impose a penalty equal to 50% of that RMD. Ouch!

If you are faced with the April 1, deadline to receive your first RMD, and are not sure how much you are required to take or how to do it, give me a call, I can help.

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Frozen Pension Benefit – Do You Take the Lump Sum?

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It’s a difficult question without an easy answer. For many, income security in retirement depends upon getting the answer right.

Employers have been fazing out pension programs for many years now, replacing them with 401(k) and similar employee-contribution type plans. Many of these fazed out pensions were frozen, leaving participant employees eligible to receive at least some benefit from the pension plan. For those who are entitled to a benefit from a frozen pension plan, many have the option to receive an up-front lump sum payment of their accrued pension benefit in lieu of a lifetime monthly annuity payment.

Faced with that option, do you take the money, or settle for the lifetime annuity? The knee-jerk reaction of many is to take the lump sum. I’ve seen lump sum offerings in the six-figures, a pretty significant chunk of change. But even then it’s not an easy question to answer, especially for those who have limited savings or other income resources beyond Social Security. Will that lump sum be enough to see you through for the rest of your life?

When you retire, a primary goal is to have sufficient income to cover living expenses for the rest of your life, regardless of how long you live, factoring in economic conditions such as inflation, and fluctuations in the financial markets. For married couples, that income must last for two lifetimes. To complicate things further, if you are like most people that I’ve work with, you will underestimate how long you will live in retirement. (Everyone faced with the lump sum payment question thinks they’re going to die in a car accident tomorrow so they want the money today.) But for a married couple in their middle sixties, it is reasonable to expect at least one spouse will live into their 90s. Living 3 decades in retirement is becoming commonplace.

If you elect the annuity, you (and even your spouse with certain elections) will get a check every month for the rest of your life, no matter how long you live. You bear no risk.

Suppose you decide to take the lump sum. You’ll receive a single payment from the pension plan regardless of how long you end up living. Now you have to invest that money to generate an income stream that will last the rest of your lifetime. How long will that be; and how confident are you the money will last that long? It depends upon many factors, but that risk is on you. And you don’t want to run out of money during retirement.

So what’s the answer – do you take the lump sum or settle for the annuity? Let’s look at some of the factors that can play into that decision:

If you (and your spouse if married) are in good health, and the security of a lifetime income stream is important to you, the annuity makes sense. If you are not comfortable handling your own investments, the annuity lets you leave investment decisions to the pension plan. If you are pessimistic about the economy, inflation, or other risk factors in the future, you can leave that risk with the pension plan choosing the annuity option.

The lump sum option may make sense if you (and your spouse if married) are older and in poor health. If you have sufficient savings and investments that the annuity would not be a needed source of lifetime income to make ends meet, then the lump sum may be the better choice. Also, if you are confident in your abilities to manage your investments to generate a good rate of return, and can prudently manage withdrawals from savings and investment over your retirement years, the lump sum may be appropriate.

In any event, if you are offered a lump sum payment as an option from a frozen pension plan, it is crucial to work with a competent advisor who can help you make a proper decision that meets your goals and objectives in light of your financial situation. Avoid an advisor who has a vested interest in your opting for the lump sum – like they want to manage and invest the money (for a fee).

If you are struggling with the lump sum vs. annuity question, give me a call, I can help.

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