IRA Estate Planning Ideas to Discuss with Your Clients

“IRA Estate Planning Ideas to Discuss with Your Clients,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is ACTEC Fellow Travis Hayes of Naples, Florida.

Since the SECURE Act was enacted in 2019, professionals have even more considerations to review with clients who own retirement assets. Estate planning is critical in all aspects of dealing with retirement benefits, from beneficiary designations to tax consequences to RMD planning. Absent of proper planning, the beneficiaries will have to share more of what’s left of the retirement accounts with the IRS and pay more tax than may be necessary.

An expert on this topic and the author of the Life and Death Planning for Retirement Benefits treatise, ACTEC Fellow Natalie Choate of Wellesley, Massachusetts, joins us today to share some tips. Welcome, Natalie.

Overview of Individual Retirement Account – IRA

Thank you, Travis. And welcome to whoever’s listening here. The IRA that your client has — and by IRA, I will include the 401k, the 457, the 403(b) plan — all of those tax-favored retirement plans; I’ll just say IRA for shorthand- that asset is a big bag full of taxable income. That needs to be the focus for the planner as going forward as you deal with the estate plan and talk to that client.

So, the client has benefited from tax deferral and tax-deductible contributions throughout their career, and you get to your 60s, your 50s, your 70s, and all of a sudden you start realizing the downside that this money is going to come out sometime, and when it comes out, it’s taxable income.

And then, as Travis has pointed out, the stretch IRA — you used to deal with it with the stretch IRA, make it payable to your grandchild who gets a life expectancy payout for that inherited IRA, and gradually takes it out in little bits and bites over 50 years — that’s simply gone. Now, the standard is the 10-year rule. You’re looking at, normally, the maximum distribution period is going to be 10 years for your client’s retirement plan after they die, and that is not a very long period of time to absorb a million, two million, three million, or more of taxable income being dumped out.

Post SECURE Act – Beneficiaries Who Qualify for the Life Expectancy Payout

Here are some approaches that we can look at with this client to reduce that tax hit so that their chosen beneficiaries get at least as much as the IRS is going to get out of it. One point is there are still a few beneficiaries who qualify for the life expectancy payout. So we look into that possibility for this client.

Surviving Spouse

Of course, the best deal is for the surviving spouse of the client, and that surviving spouse gets a whole bunch of great deals. One is the spousal rollover; if you leave it outright to the spouse, he or she can roll it over to their own retirement plan and keep the deferral game going. It’ll still end sometime, but you can get more deferral that way in some cases.

Maybe the client doesn’t want to or can’t leave it to the spouse because the spouse is maybe perhaps not able to deal with money or is in a profession they’re subject to creditor’s claims or for estate tax reasons, you don’t want to leave it outright to the spouse. If the client can’t leave the asset outright to the spouse for whatever reason or doesn’t want to, second marriage is another reason; you can still get very beneficial life expectancy payouts for the spouse through a trust.

For example, a conduit trust for the surviving spouse gets not just a life expectancy payout. A conduit trust is one where the spouse is considered for IRS purposes to be the sole beneficiary of the entire account because all plan distributions during his or her life must be distributed out of the trust to the spouse when received by the trust. Okay, that conduit trust is going to get the spouse’s life expectancy payout deal. Okay, what’s that? Uh, guess what?

SECURE 2.0 said the surviving spouse’s beneficiary gets to use not just her single life expectancy but gets to use the   for a life expectancy payout. That’s the payout retirees use at 70+ age to take minimum distributions during life, the spouse gets that deal as beneficiary. In other words, it’s not just a life expectancy payout, it’s a life expectancy payout over the life expectancy of someone 10 years younger than the spouse. This is thanks to SECURE 2.0 that came out just a couple of years after SECURE. Look at the trust for the spouse as another way to blunt the tax impact and keep on going with deferral.

Disabled or Chronically Ill Beneficiary

Other beneficiaries that are entitled to some kind of life expectancy payout, you would be looking for if the client happens to have this type of beneficiary in their family or in their intention of benefiting, these would be still life expectancy payout available and that would be a disabled beneficiary. Outright distribution to a disabled or chronically ill beneficiary or certain trusts that are easy to prepare can get a life expectancy payout if the beneficiary is disabled.

Close in Age

And another category I’ll mention is close in age. If the client is perhaps someone who is leaving benefits to their siblings and they’re close in age, those beneficiaries can get life expectancy payouts still under SECURE.

Minor Children

Also, minor children of the client. I’m not going to emphasize that one because most people who have minor children still around are very young themselves and unlikely to die in the future. So, I don’t regard that as a major planning tool, but it’s there.

Stop Funding the Retirement Plan and ROTH Conversions

Okay, moving away from the beneficiaries who still get life expectancy payout. Another thing to discuss with the client is taking steps during life to stop that retirement plan from growing and maybe shrink it. That would be to stop funding if it’s already too big to handle in the estate plan. And do ROTH conversions when you can. If the client is in a low bracket year temporarily, moving money out of the traditional plan into a ROTH IRA; yes, you pay tax now, but hopefully in a lower bracket than your beneficiaries will face. And the money in the Roth account, of course, is forever tax-free.

Other Tips

Don’t Forget the Basics

Next item, don’t forget the basics. This is where I get calls. These things are messed up because the basics weren’t done. You have to look at the beneficiary designation forms; it’s part of the estate planning job to make sure the beneficiary designation form says what you told the client you wanted to have it say.

You can’t leave that up to the client. If the lawyer’s not going to do it, the financial planner or accountant or somebody should be checking these beneficiary designations annually to make sure they’re going to leave things the right way. Otherwise, you can have a disaster, such as you could have the client in a company plan — retirement plan, big plan, you’re planning to leave it to a trust. You have great planning ideas, but the beneficiary designation is never done — that plan could require a lump sum distribution to the client’s estate on their death if they have no beneficiary designation. So, let’s not get glamorous with ideas. Let’s look at the basics and make sure those are taken care of first.

Teapot Trust

Here’s some more planning ideas. One is, what if you’re a client who has a big family? They have children, they have grandchildren, there are lots of people around. Well, instead of concentrating on the spread and the payout period, how about concentrating on the tax rate? And the fact that you’ve got multiple potential recipients means multiple potential income tax brackets.

And a lawyer in Florida named Alan Gassman and his law firm in Clearwater invented something called the Teapot Trust, where you have two trusts. One has the retirement plan and one has the other assets. The retirement plan takes out distributions, the trust — that trust that holds the retirement plan — takes distributions as required and then sprays them around to whoever in the family that year is going to be in the lowest bracket. Now, I don’t know how you figure that out, you’ll have to read his book, but that’s the idea. Meanwhile, your other trust has non-IRA assets and that’s used to equalize total distributions to the various family members.

Leave it to Charity

Now, the best tax planning idea if you totally want to eliminate taxes on the IRA after death is to leave it to charity. If the client has any charitable intent as part of their estate plan, this is obvious, you’d be amazed how often it gets skipped. Leave the IRA to the charity. They won’t pay income tax on it. Everybody else in the family, they will pay income tax if you leave it to them. It’s not hard, just make sure that charitable intent is funded with the retirement plan.

Charitable Remainder Trust

And finally, the best tax idea for IRAs that I have ever seen and I believe in is best for last: the charitable remainder trust, used much less than it should be. A charitable remainder trust, you leave your IRA to it, the IRA goes in totally tax-free. So, the whole account goes into the trust. It pays a fixed income to your family member during life, 5% or more it has to pay.

So, let’s say it pays, you put a million dollar IRA in, it’s going to pay 5% payout to your niece or whoever for life. And that’ll be 5% of whatever the value is each year. Hopefully, it increases with investments, but either way, it’s a steady, assured income of some kind. Of course, those payouts to the beneficiary are taxable income. And when the beneficiary dies, whatever’s left in the charitable remainder trust goes to the charity.

This is for a client who wants to provide income, life income, for someone who is mature or older, doesn’t work so well with young beneficiaries for various reasons. The setup doesn’t work for them, but it also wants to benefit charity. The beauty of it is the whole IRA goes into the charitable remainder trust income tax-free. The trust pays no income tax, beneficiary pays income tax on those 5% distributions.

And that’s only part of what’s good about the charitable remainder trust. The other part is this isn’t some crazy idea I saved up. You have to go to my other seminars to get those. This is in the Internal Revenue Code, and the IRS has even issued sample forms for it. It’s not some crazy, far-out idea. They want you to do this. So that’s it, that’s my package of ideas for dealing with your clients’ retirement benefits as part of their estate plan. Thanks for listening.

Thank you, Natalie, for sharing your expertise regarding estate planning with retirement benefits and providing us with tips and ideas that we can discuss with our clients who own IRAs and other retirement account assets.

You may also be interested in:

• SECURE Act 2.0 and Charitable Remainder Trusts (July 2023)
• Trusts for Disabled and Chronically Ill Beneficiaries under the SECURE Act (Sep 2020)

A video to share with your clients:

• IRAs and IRA Beneficiaries
• How the SECURE Act May Impact Your Retirement Plan

 

 

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