Attorney Matt Schwartz explains The Seven Costly Mistakes IRA Owners Make in Their Estate Plans
|The Lange Money Hour: Where Smart Money Talks
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- Introduction of Matt Schwartz, Lead Attorney with Lange Legal Group, LLC.
- Full Disclosure: Matt and Jim Have Worked Together 14 Years
- Failure to Coordinate Estate and Retirement Plans Can Be Costly to Heirs
- Majority of Clients Are Ill-Equipped to Fill out IRA-Beneficiary Forms
- When ‘Stuff’ Happens, Improperly Prepared Beneficiary Forms Can Be Disastrous
- To Take Advantage of the ‘Stretch IRA,’ Beneficiary Designation Is Crucial
- Elimination of the Stretch IRA Would Have Serious Impact on Inherited IRAs
- It Can Make Sense for the Surviving Spouse to Disclaim a Portion of an IRA
- Clients Often Don’t Know They Can Disclaim Unless Advisor Tells Them So
- Estate Administration Is Tremendous Added Value for Client
- Knowing All the Details Can Make a Huge Difference
- The Joys - and Benefits - of Thinking Outside the Box on Estate Planning
- Revocable Trusts Can Be Designated Beneficiary, But Only if Language Is Correct
- The Right ‘Blueprint’ Can Be Invaluable in an Uncertain World
- Many Wills Don’t Address the Increase in Estate-Tax Exemption for Couples
- Today, Federal Income Taxes Pose a Larger Problem than Estate Taxes
- Don’t Ignore the Consequences of the Possible Death of the Stretch IRA
- Life Insurance Is One Option, Provided Both Spouses Are in Agreement
- Another Option Is a Charitable Trust, but It Has Some Drawbacks
- Consulting a Specialist Is the Right Course of Action
- With Regular Consultation, a Specialist Can Adjust for Investment Changes over Time
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange, and tonight, we welcome back to the program Matt Schwartz. Matt is an attorney who manages the legal department at Lange Legal Group, LLC. He uses his training and expertise to design estate-planning documents for clients, guiding them through estate and trust administration after a loved one has passed away. Matt is a graduate of Washington University of St. Louis School of Law, he’s a member of the Council of the Allegheny County Bar Association Probate and Trust Section, and a member of the Pittsburgh Foundation’s Professional Advisory Committee. Over the course of this next hour, Matt and Jim will discuss some common estate-planning mistakes that they see in their practice, including the failure of clients to coordinate estate-planning documents with the beneficiary designations on their retirement plans, estate plans that are too rigid and don’t adapt to changing circumstances, and ignoring the likely changes to the “stretch IRA” rules. Our show is live this evening, so feel free to give us a call with your specific questions. The number here in the studio is (412) 333-9385, and with that, let’s say good evening to Jim Lange and Matt Schwartz.
Jim Lange: Good evening, Matt.Matt Schwartz: Good evening, Jim.
Jim Lange: So before we get started into the program, I do want to alert our listeners that this is literally two days away from a major change in the Social Security law. We have been screaming and yelling for people to take advantage of a technique called apply and suspend, if you fall within the right age bracket, and we have written a book on Social Security where the entire book is relevant particularly for married couples between the ages of 62 and 70, and we have literally given away, I think, close to 2,000 digital copies of the book and we would be delighted to give it to all of our KQV listeners. And if you are interested, and very frankly, you should be if you’re between the ages of 62 and 70, even if you have a Social Security strategy, or you have started something, there’s a lot of opportunity here, and I’m going to urge you to go to www.paytaxeslater.com/SS. Follow the prompts to download your free book on Social Security.
Now, to the meat of the program, I do feel honor bound to alert the audience that I do have a financial interest in any business you might do with Matt Schwartz. So normally, if I have somebody like Jack Bogle on the show, or Burton Malkiel, or Ed Slott, or one of these national experts, if I think that they have written a very good book, and I usually do, I usually plug their book, but I have no financial interest if you buy the book, if you don’t buy the book, if you use their services, if you don’t use their services. On the other hand, Matt is part of our team. In fact, he actually heads the legal team at the Lange Legal Group, and if you do like what you hear and you do decide to take advantage of what’s going to be an offer for a free consultation with Matt, and you do do business with him, I will obviously make some money. So I am not 100 percent objective to our guest.
The other thing that I will mention is while the introduction was all mechanically accurate, it didn’t say what a tremendous attorney he is. He’s smart as a whip. He has a math degree from Northwestern, which very few attorneys have, and he just has off-the-chart satisfaction ratings, and I have been very, very blessed to work with him. Is it 14 years now?
Matt Schwartz: Fourteen years.
Jim Lange: Fourteen years. OK. So what we’re going to talk about is specifically some of the very common mistakes that Matt sees, and this is going to be particularly important for people who have money in their IRAs and in their retirement plans. So Matt, one of the things that you have noted is that you claim that a lot of people fail to coordinate their estate-planning documents, which might be a will or a revocable trust, with the beneficiary designation on their IRAs and their retirement plans. Could you be a little bit more specific as to what you see and how you think some of our listeners could remedy that problem?
Matt Schwartz: Sure, Jim. Thank you for the introduction. We commonly see very sophisticated wills and trusts, and they’ll have all the best language about generations skipping transfer tax, et cetera, but then you ask the client about the IRA-beneficiary designation, and you ask them how did they name their beneficiaries? And I’m sure you’ve seen this in your practice as well, and so many times, it’s just the spouse is the primary and the children are the contingent, and no mention of trusts for the children or trusts for the grandchildren.
Jim Lange: Well, I think that that’s really critical, and you’re absolutely right. So people come in, and the majority of our clients, for better or worse, and I haven’t done a formal poll, but it seems that they have more money inside their IRAs and their retirement plans than outside their IRAs and retirement plans, and you’re quite right. They often come in with long sophisticated wills, and you ask them about the beneficiary of their IRAs and their retirement plans that often control 50 percent, sometimes 90 percent, of their wealth, and you get a blank stare. They don’t know where the papers are. Sometimes, the attorney didn’t even fill out the forms at all, and the clients filled it out themselves. Matt, in your practice, would you let a client fill out the beneficiary of their IRA?
Matt Schwartz: That’s generally not in our best practices. There’s just too many errors that can be made, and one of the challenges we face is often, financial advisers will close a sale with a client and they’ll try to get the beneficiary form signed in the last five minutes and there’s not a lot of thought that goes into it. So we generally are very hands-on in completing the beneficiary designation for the reason you mentioned, which is the retirement plan so often controlled the vast majority of the liquid wealth for so many of our clients.
Jim Lange: Well, let me ask you a question. Let’s say that somebody fills it out just like you said. So let’s say that the will is sophisticated, it leaves money to a spouse, and then kids equally, and then well-drafted trust for the beneficiary, for the grandchildren in the event that the child predeceases, and let’s say that the will is done right. It’s usually not, but let’s even say it is, and they fill out the beneficiary form that says, “Spouse first, children equally second.” Well, what’s wrong with that? Why could somebody end up with a bad result if they just do something like that?
Matt Schwartz: Well, let’s say that, unfortunately, tragedy happens in a client’s life, and let’s suppose that a child predeceases the parents, and then the beneficiary designation’s never updated and the second parent passes away, and that child who passed away had two wonderful grandchildren that the grandparents just adored. If you’re not careful with the beneficiary-designation language, which most people aren’t if it’s just a generic beneficiary designation, those grandchildren will get disinherited.
Jim Lange: All right, so what you have then is grandchildren who not only lost their parents, but then they also lost their inheritance.
Matt Schwartz: Correct.
Jim Lange: And is that the true intent of most people? Or do you think that most people would want to provide for a family who tragically loses a mother or a father?
Matt Schwartz: If I was to interview most of our grandparent clients, I think they’re more fond of their grandchildren than their children!
Jim Lange: OK! I guess they have a common enemy, right?
Matt Schwartz: That’s right.
Jim Lange: Which is the parents. Well, I think that that’s a really good point, and I know that our office is really meticulous about getting the beneficiary designation of the retirement plan right. And the other thing is, there are certain requirements that in order to get some of the tax benefits of what’s known as the stretch IRA, that that beneficiary designation has to be completed correctly, and if the end beneficiary of the IRA or retirement plan is a trust, I understand that there’s some particular trust provisions that must be in that trust in order to get the favorable tax treatment. Is that also right?
Matt Schwartz: That’s correct, and I guess what Jim’s referring to under the stretch-IRA rules is the ability for the individual beneficiary of the trust to take the money out over their life expectancy. So if you don’t have the right provisions in the trust, what will happen is the money will have to come out much quicker and the taxes will have to be paid much faster.
Jim Lange: All right. So let’s even quantify this for a minute. Let’s say, for discussion’s sake, in variation Number 1 … and by the way, you can often have a trust for an adult, whether it’s a spendthrift or a special-needs trust or the “I don’t want my no-good daughter-in-law to inherit one red cent of my money” trust, or there are other legitimate reasons to have an adult as the beneficiary of the trust. And let’s say, for discussion’s sake, that Matt, you were a little sloppy and you didn’t get the wording exactly right, and you leave, let’s say, a million dollars in an IRA, just to pick an easy number. The numbers that we have run say that there’s literally a million dollars difference, say, 20, 30 years down the road between having the ability to stretch the IRA versus what you’re talking about is the acceleration of the income tax where the poor child, or even grandchild, has to pay income tax on the full amount of the IRA within five years of (the owner’s) death, which is just an economic travesty.
Matt Schwartz: Agreed, and there is an exception that’s slightly better but not much better. If the IRA owner is over 70½, they would get to use their remaining life expectancy, but in many cases, that’s not much more than the five years. So generally, it’s not a great result.
Jim Lange: Right. So that’s a violation of one of my core principles, which is don’t pay taxes now, pay taxes later, except for the Roth, and that applies in the accumulation stage, the distribution stage, and what we are talking about now, which is the estate-planning stage.
Now, I had mentioned what I would call the “I love you” will: “I leave everything to you, my wife; I leave everything to you, my husband, and then equally to the children,” but are there situations where it doesn’t make sense for the primary beneficiary to accept the entire IRA? So let’s say that you had a wealthy family, or for some reason, it wasn’t appropriate to have the spouse as the primary beneficiary, or even the children as the secondary beneficiary. Are there situations where you like to build flexibility into your estate plan?
Matt Schwartz: Sure! I mean, that’s part of our value is building in that flexibility, and the first thing we do is we always make sure, in a married-couple situation, that the surviving spouse is adequately protected. With that principle in mind, we see many situations where if the surviving spouse accepts the entire IRA, they will have more than enough money after we’ve run all the projections to cover any unexpected contingencies. So it could often make sense for that spouse to disclaim some of that IRA to their children, when you consider the income tax benefits, with the only real cost here in Pennsylvania being the 4½ percent inheritance tax on anything disclaimed by the spouse to the children.
Jim Lange: Well, isn’t it true that, in some cases, you might want the spouse to get all the money? Let’s say that the market was bad and the assets are down, and the spouse wants to spend money, and that there might be other situations when it might make more sense to have money going to the children or grandchildren. Is there language that you specifically include that will allow the surviving spouse or the child to, the legal word is disclaim, or the simple word is “I don’t want this particular asset or a portion of this asset”? Do you actually include that kind of language in the beneficiary form itself?
Matt Schwartz: Yes. In the beneficiary form, you want to make sure you make it clear what happens in the event of disclaimer. If you’re silent on it, it will be presumed if you make a disclaimer, that the beneficiary predeceased. But the bigger issue I see is many beneficiaries don’t realize that they can disclaim unless you tell them that they can disclaim. If you don’t have the language in there, they don’t think they can do it. So it’s important to add it. And taking it one more step, Jim, if you have wealthy children, you might want to leave some money for their children. It’s really important to think about who you want the trustees of those trusts to be for the young beneficiary so that the child can be motivated towards making that disclaimer if it’s in the best interests of the family.
Jim Lange: Yeah, I suspect that over the last 14 years, you’ve probably saved families literally millions and millions of dollars by including the appropriate language, and then to get the stretch IRA right, which is tending, at least in today’s laws, to get it to younger beneficiaries, assuming the older beneficiaries are sufficiently provided for, to actually including that language, and then do clients actually need good counsel after a death in order to make the appropriate decision?
Matt Schwartz: I think it’s one of the most essential values we provide, which is not just doing the planning but being there to help with the administration, and it’s just like if you have a repair in your car and you didn’t know how to do it, if you do it yourself, it’s generally not going to be a good job, and it’s pretty similar with estate administration after death. People will say, “Oh, I don’t want to pay the attorney!” And it’s generally much better to sit down with an attorney who’s done it hundreds and hundreds of times and can walk you through all the tricks and save you a lot of aggravation during a time where you’re grieving the loss of your loved one.
Jim Lange: Well, I think you’re actually being a little bit too modest because the truth is, there’s a significant difference between a strategic thinker like you who has a quantitative background, has a very good sense of people and what their situation is, and of course it’s always the client’s option, but if you have the built-in options when you prepared the documents, and then you are working with a surviving spouse, or even the surviving children, after the first or even the second death, that is when you can truly provide value that would literally save the family hundreds of thousands of dollars in taxes. Is that a fair characterization?
Matt Schwartz: I would say I tend to be more modest, so that’s probably a fair characterization! But sometimes, even small things, Jim, there might be a reasonable life-insurance policy that the husband left that the wife doesn’t really need the money. Insurance is one of those few assets that passes inheritance tax-free in Pennsylvania, and just thinking about the disclaimer there, I know that’s slightly off the IRA topic, but it’s just more broad in our thinking as to how can we provide the most value for the family.
Jim Lange: Well, it actually does tie in because I would think that you don’t go to a doctor and say, “Look at my right arm and ignore everything else.” Presumably, you’re going in and you’re saying, “OK, well, here’s my situation. I have, you know, this problem with my leg and this problem with my liver, et cetera, et cetera, et cetera,” and you are hoping and relying on the appropriate professional to get you to the best health, and I would say that, to a large extent, you do that with our existing clients and their retirement and estate planning, and that you’re doing a combination of providing all the options when people are actually drafting the documents, and then giving appropriate advice afterwards. So despite your natural modesty, I actually believe that you’re performing an enormously valuable service, and the fact that we don’t even charge a percentage, we just charge a standard hourly rate, I think provides a tremendous value for clients.
Matt Schwartz: And I appreciate you saying that, and I think too often you will see attorneys who are very rigid in their thinking and they’re only thinking about the specific mechanical legal requirements without that wisdom to give the practical advice based on experience as to what you feel is going to be best for that family, based on getting to know them and knowing their goals.
Jim Lange: And what I have found, and both of us worked for larger firms before I broke off and started my own and then you broke off and started working with me, is that we were working for big firms that charged, frankly, considerably more per hour than we did, and we didn’t see this kind of wisdom and judgement going on. I remember when you came in, you were saying, “Boy, this is so cool to actually think and use strategies and to do these things that are saving people a lot of money.” And I suspect that that’s one of the ways that you get satisfaction.
Matt Schwartz: Absolutely. I mean, there’s nothing like a family telling you that they’re so grateful for your help when you’ve helped them on such a serious matter, and they don’t feel like they just paid your bill, and to get that extra recognition is really important.
Jim Lange: I think So and sometimes, a lot of things that nobody even notices. So for example, I’ve noticed that if somebody has a charitable desire, that you fulfill that through the IRA or the retirement plan instead of the will, and that alone saves income tax on the amount of the money going to charity.
Matt Schwartz: Sure. I mean, the charity is going to receive … let’s say the bequest is a hundred thousand dollars. The charity’s going to receive a hundred thousand dollars one way or another. But if you give that to an individual, that has a tax burden associated with it, and the purchasing power on that might be $75,000.
Jim Lange: I do feel honor bound to mention that I do have a financial interest in the event that you hear some of the things we are saying, realize that we would be an excellent choice to prepare your own estate plan, and then call our office at (412) 521-2732, or go to the website at www.paytaxeslater.com to set up an appointment with Matt, and that is because Matt and I work together, and if you choose to work with Matt on your estate plan, I will make some money on that. That is, as opposed to the vast majority of our guests, where I have no financial interest either way. And by the way, the commercial that plugged the Social Security book, really, particularly right now, married couples between 62 and 70, it’s free, it has great information, it was a best-seller, it’s still Number 7 in its category at Amazon the last I checked, and it’s free to KQV listeners. I would highly recommend that you do that at www.paytaxeslater.com/SS.
So Matt, we were talking about some of the more sophisticated types of beneficiary designations, and you had mentioned the example of a trust for a grandchild. Can you tell us a few more of the sophisticated beneficiary designations that you think might be appropriate?
Matt Schwartz: Sure. Commonly, we’ll also see a revocable trust as a beneficiary option, but whenever you use a trust, I cannot state this enough, you really need to have the right language in that trust, because if you don’t, it’ll be the scenario that Jim was talking about before where the beneficiary can’t take the money out over their lifetime and may have to take all the money out in five years. And what we commonly see when we see wills come into our office, I’d say, Jim, it’s probably at least two out of three if maybe not more, tend to not have the right language to receive IRA assets.
Jim Lange: By the way, what you’re saying is astounding, because if you think about it, all right, I’m going to take your number on faith, or even if it’s half, that means half of the - and these are people who have gone to attorneys and have drafted revocable trusts - half of these trusts don’t have the right language, which means that the kids are going to have to pay income tax on the entire IRA within five years, or maybe a little break if they were older than 70, as opposed to if the language is correct, in which case they could stretch or defer income taxes. And again, some of the numbers that we have read are that, let’s say you’re leaving money to a 45- or a 50-year old. Over time, the difference between having that big income-tax hit upfront versus being able to take it out slowly can literally be almost as much as the amount that you’re leaving. So the fact that you recognize this, that you do this correctly, is I just think a great thing for people.
Matt Schwartz: And I think also what we commonly see, particularly I’ve seen it in the last six or seven years, that a lot of the custodians of the IRA assets, the people like Vanguard, Fidelity, Morgan Stanley, Merrill Lynch, etc., TD Ameritrade, they tend to be more strict on what they will accept as a beneficiary designation. And particularly, we see this in 401(k) plans and 403(b) plans. So having a revocable trust as part of the estate plan to at least be able to use the life expectancy of the oldest beneficiary of the trust, if the kids are only a couple of years apart, that’s not a bad outcome as far as stretching out the IRA. So we’ve seen the need to use revocable trusts more in estate planning for people who have large IRA and 401(k) balances, simply because some of their custodians are not accepting a more sophisticated beneficiary-designation attachment.
Jim Lange: Well, I remember that in a situation that you have recommended avoiding probate, going the revocable-trust route, not just to avoid probate, but in order to protect the tax status of the beneficiaries, whether it be children or … I mean, it would be horrible to leave money to grandchildren and have that income accelerated, because that could literally be hundreds of thousands of dollars.
Matt Schwartz: And I think the other thing that families get scared about, I was talking with a client about this the other day, and it took him a while to understand the point, but you can say, “I want to leave my Roth IRA to my grandchildren,” but if you do that directly … now, my daughters are 15 and 13. They’re not quite at that super-influential age yet, but if you leave a Roth IRA to a 21-year-old, and you expect them to take it out over 60 years, good luck without any restrictions.
Jim Lange: Yeah, I think not very many grandparents would be happy to know that their legacy was used to purchase a Ferrari rather than education, and actually what works very well for an inherited Roth would be some money for the grandchild’s retirement, all those years of tax-free growth.
Matt, one of the issues that I think our listeners face, and they might not even realize it, is one of the problems in today’s world is we just don’t know what’s going to happen. Out of all the thousands of projections that I’ve done through many, many years, I hate to admit it, but over 35 years, I’d say that I never got it right. I always did something wrong. You know, we thought the market was going to go up; it went down. We thought the husband was going to die first; the wife died first. Something that we didn’t expect to happen actually did happen. So when you draft these wills and beneficiary designations, do you like to build in some flexibility so in the event of a major change in circumstances, whether it’s a financial circumstance, whether it’s a death, whether it’s a disability, whatever it might be. And of course, people don’t like to come in for reviews and have it redone every couple of years. Are there some things that you could do to build in flexibility into these estate plans that, in the event there is a change in circumstances, people don’t have to necessarily come in to get a review, or, in the event they fail to, that there are appropriate things that can be done after the first or second death?
Matt Schwartz: Yes. That’s definitely very important to have all the options laid out. I like to describe it as the blueprint. You don’t necessarily have to activate the blueprint until after death. So you don’t have to make any choices right now, but the choice you need to make is just laying out the blueprint, and I can’t stress the importance of that, because if you don’t lay out the blueprint right, then your options are limited and they may not be what you want at the time you need to execute the estate plan.
Jim Lange: And I will say that we have been using the Cascading Beneficiary Plan, actually even more than 14 years ago, but you are frankly the master at drafting it and understanding all the nuances and actually making it happen, and perhaps, most importantly in the context of this conversation, tying in not just the will and what I would call the after-tax assets, but also providing that flexibility with the IRAs, the Roth IRAs, life insurance, et cetera. So the way I might like to think about it is, using your language of the blueprint, is you’re creating all these options for each set of assets while the client is alive, and then after death, you have, with the built-in flexibility of these documents, you can kind of pick and choose based on circumstances that we can’t reliably predict now which course of action to take, and that is one of the ways you save people a lot of money. Is that correct?
Matt Schwartz: Correct, and I think, in the interest of fairness, we emphasize to all our clients with the Cascading Beneficiary Plan the importance of trusting your spouse, because if you don’t trust your spouse, that money may not end up going where you want it to go after the first death. And often, we see in estate planning still, Jim, after all these years, after the increase in the federal estate-tax exemption, we still come across a fair amount of the federal estate-tax-formula wills for the marital deduction, which really doesn’t make sense based on the large exemption today.
Jim Lange: Yeah. What you’re referring to is a trust that basically says rather than leaving money to a spouse, it leaves the first unified credit-shelter amount to the spouse, which, right now, is over about $5.4 million. So rather than leaving money to the spouse, you are leaving money to a trust for the spouse where the spouse gets the income, which I consider just an income-tax nightmare, and there are a lot of people out there that still have these documents.
Matt Schwartz: Agreed, and to add misery to the situation, we come across cases where the money is retirement money that’s being left to that type of trust, and the spouse can’t do a rollover IRA and use the same great table that the IRA owner gets to use during their lifetime. Instead, they have to take it out over what’s called the single-life table, which is significantly faster than they’d be able to take it out if they were treated as the owner.
Jim Lange: Yeah, this is really an income-tax disaster. The other thing that I think a lot of people don’t realize is that the game has changed. The old game, maybe when I started practicing law in the mid-’80s, was, at least to a large extent, centered around saving estate or transfer taxes. Now, with a $10.9 million combined exemption for husband and wife, not that many of our clients have a federal estate-tax problem, but with IRAs of a quarter million dollars, $500,000, $1 million, $2 million, they almost all have a federal income-tax problem, and is it fair to say that that is really your specialty? Not that you ignore federal estate taxes, or Pennsylvania inheritance taxes, but it’s really in the area of federal income taxes and what to do with IRAs and retirement plans after a death that is the area that you really save people the most money. Is that a fair characterization?
Matt Schwartz: I would agree with that. Our true value is in the federal income-tax savings, and as Jim has talked about in the past, there are whisperings in Congress about the possibility that all IRA beneficiaries who are not spouses, in the future may have to take out their IRAs over five years.
Jim Lange: All right, so now we’re on to a new disaster, and this isn’t the law today, but, very frankly, with your help, we have published two peer-review articles in Trusts & Estates magazine on this. As a result of these articles, I have been invited to speak at a very prestigious estate-planning group, and they actually are giving me two hours to talk about this, so I’m going to try to condense maybe a two-hour talk with articles into about a two-minute discussion, because we want to get to a few other points, too, but can you tell us what you mean by the death of the stretch IRA, and why ignoring that could be such a critical mistake for our listeners?
Matt Schwartz: So let’s say that your child’s 40 years old and the second spouse passes away. Under current law, that second child would have a little bit over 45 years to take out the balance of that IRA, and if they cause the stretch IRA to die, that same child would have to take out the IRA in five years, and going back to the example Jim gave of the million-dollar IRA, suppose there’s one beneficiary. That’s $200,000 a year of reportable income on top of the other income that that beneficiary may be earning.
Jim Lange: So that’s probably going to be taxed, if not at the very highest rate, at least at a very high rate. And again, the numbers we’ve run are that with a million dollars, the difference might be that the child ends up with either nothing after a certain period, even during that child’s life, or still has a million dollars. So this is not law yet, but what are some of the things that people should perhaps think about in terms of strategy, and particularly for those clients who have a substantial IRA? So this would not be for everybody, and I know one of the things that you are very sensitive about is you don’t need a jackhammer when a flyswatter would do. But what are some of the techniques that people should at least be considering that might not even be on their radar right now?
Matt Schwartz: Well, Jim, I would say this is the most significant issue for people who primarily own a house and a little bit of money in a bank account, and the vast majority of their wealth is tied up in these retirement plans, because what ends up happening if you don’t think of some alternatives to increase the after-tax wealth is that the children are digging into their IRA distribution to have to pay the income tax, that they don’t have their own money to help cover the income tax, which is even adding to the income-tax misery.
Jim Lange: So they have a big tax bill, and the only place they have to pay the money is from the IRA, or the inherited IRA, so then they take money out of the inherited IRA to pay the tax on the inherited IRA, and then they have to pay more tax, and it’s one of those circular calculations that has driven us nuts in practice.
Matt Schwartz: Correct!
Jim Lange: All right. So this is a miserable situation. But it’s not law yet.
Matt Schwartz: Right.
Jim Lange: What are some of the things that perhaps somebody should be thinking about, either in terms of documents like a charitable trust, or other strategies like Roth IRA conversions or more money in the tax-free world?
Matt Schwartz: So one option, if a couple is insurable, is to visit life insurance just because of the ability to create an after-tax estate with what we call “leverage,” that generally you are going to get a better payout than what you’re going to pay into the life insurance.
Jim Lange: Well, we have run lots of numbers on that, and the thing that I like about that strategy … and by the way, this is only if you can afford the money for the premium, and even if you can afford the money for the premium, I personally like three forms of gifts. I like just, here’s some money to the kids. Go do whatever you want. Here’s some money for the grandchildren’s education, typically with a 529 Plan, and then the third type that you’re alluding to, which is a second-to-die life-insurance policy. And one of the reasons I really like that strategy is even if this law (eliminating the stretch IRA) doesn’t take effect, or you die before this law takes effect, it will still be a favorable strategy, but if you get the insurance now and then the law changes and then you die, which is probably the most likely scenario, it can literally be the difference of millions of dollars to the children.
Matt Schwartz: And what we always say with couples who feel comfortable with buying the second-to-die life insurance is you have to make sure that both spouses are on board with the plan, because it does no good for only one spouse to advocate the plan, have that spouse pass away, and then have the survivor not pay the premium.
Jim Lange: Yeah, that’s right. So that’s one strategy. What about a charitable remainder trust? And I know that you’re very active with the Pittsburgh Foundation. What about a charitable trust? And let’s even say that somebody isn’t all that charitable. Are there situations, perhaps not now, but situations in the future that you can anticipate using a charitable trust, and that the end beneficiaries actually get more financial wealth than if you left it to them outright?
Matt Schwartz: Sure. Without getting too technical, a charitable trust is a vehicle that could create similarities to the stretch IRA we have now. The major downside to a charitable trust is if you wanted all the money to stay with the family, you’re going to have some money to go charity. But we’ve run some numbers and seen scenarios where the family could end up better and charity gets something as well, which makes many of our clients happy.
Jim Lange: Yeah. The way the math works, if you just think about it simplistically, let’s say you leave a million dollars to a child and he has to cough up the income tax on the whole thing within five years of the parents’ death, and let’s say that that money’s going to be taxed at 35 or 40 percent. So now, instead of having a million dollars, a child has, say, $600,000, or maybe $650,000. Of course, the income tax will have been paid on that. Or is it better for the child to be receiving the income on a million? So which one would you rather have: the income for your whole life on a million or $650,000 outright? And the answer, by the way, because we’ve worked out the numbers, is it depends on how long the child lives. If the child dies shortly, then the charity’s going to do very well and the family isn’t. If the child lives well into his 70s and beyond, the child’s actually going to get more money than if they had just taken the $650,000. And then, as you had mentioned, then it’s a bonus to the charity. Something that we are not doing now, as I understand it, but something that you have in your quiver. Is that fair enough?
Matt Schwartz: Correct. I think over the years we’ve had one or two people who have one planned.
Jim Lange: All right. But again, keeping that in mind as a possibility. If you had a very specific medical problem, perhaps a brain tumor, would you want to see a specialist, or would you want to see a general surgeon? Unfortunately, it’s getting tougher and tougher for lawyers, particularly general-practice lawyers, to make a good living, and what they end up doing is … many attorneys, by the way, many fine attorneys in certain areas, but they sometimes go and attempt to do things that are not within their area of specialty. We have a fairly strict policy in our office not to take on any work unless we’ve either done quite a bit of it or, frankly, we just refer it out to somebody who we think can do a better job and do it more efficiently and more cost effectively than us. Matt, have you seen situations where people have … that is people, clients, who are looking to get their wills done. Instead of going to a specialist like you, and I would think of you as kind of a specialist with people that have significant or often the majority of their assets in IRAs and retirement plans, and if they go to a general attorney, or even an estate attorney that isn’t used to working with people with significant IRAs, is that a real problem and is that advisable, or does it make more sense to really see a specialist who does this literally day in, day out?
Matt Schwartz: Well, I mean, my answer’s going to be a little biased here, but I think seeing a specialist makes all the difference. If you are getting your car repaired, do you go to the place that is the cheapest, or do you go to the place that’s going to repair the car, who is always working on your type of car repair, so that that car’s going to run well for a long time?
Jim Lange: Well, I think that’s right, and it’s just some of the nuances that we’ve mentioned today, which is just a few of many, that you routinely do, and one of the things that I really like about your practice is you’re a pretty modest guy, and a lot of times, you just include all this extra value that people don’t even realize that they are getting, and to me, let’s say our “form,” everybody really is a snowflake, and I know that you think out things, but there are certain similarities and we have forms, but even our forms have been very well thought out to provide additional value to IRA and retirement plan owners.
Finally, let’s go to another big mistake that I think we see, which is, let’s assume perhaps incorrectly that the estate plan was done correctly the first time. So let’s assume that you have gone to a specialist, they have not only done the appropriate wills or revocable trusts, but that the revocable trust, the trust within the trust, specifically have those five conditions in order to qualify for a stretch IRA, let’s assume that they have the right language on the IRA-beneficiary form, let’s assume that the attorney actually filled out the forms correctly, and everything was done correctly, and then, as time goes on, people change investments, they switch financial advisers, they might even change an investment within the same financial house. What are some of the problems that we see in that situation?
Matt Schwartz: Sometimes, if they’ve changed that investment, all that work we put into that beneficiary designation sometimes gets blown out the window, and we also see when people don’t consult us right after a death that their adviser will just go ahead and move the IRA into the spouse’s name when maybe what the spouse really wanted to do, Jim, was to consider a disclaimer of a portion of the IRA to their children.
Jim Lange: So what you’re really saying is if you’re not thinking this out, and you don’t go to a specialist, it can cost you a lot of money, and that money that you’re losing isn’t going to your family, and it’s not even going to the charity of your choice or your children or your grandchildren, it’s going to the IRS if this isn’t done correctly. Is that fair?
Matt Schwartz: Absolutely. I mean, there’s cases where if the beneficiary designation is done by another firm and we don’t get an opportunity to see it, sometimes people forget to name a backup beneficiary, and you end up leaving the estate as the beneficiary, which, for the most part, will stick you with the five-year period. Sometimes, you can get that little extra period we mentioned, but then there’s extra complications with trying to get it out of the estate to the beneficiary, and it just adds a lot of cost and headache and frustration for the client who says, “Well, why didn’t my adviser tell me about that?”
Jim Lange: Well, Matt, I think you’ve given a wealth of information for our listeners, and again, I will repeat that offer that if somebody is interested in meeting with Matt, and if you’re married, we ask that you bring husband and wife to the meeting, as well as a filled-out form, to please go to www.paytaxeslater.com and fill out the form, or to call Alice at (412) 521-2732.
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James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.
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