Estate Planning Blog Articles

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What to Leave In, What to Leave Out with Retirement Assets

Depending on your intentions for retirement accounts, they may need to be managed and used in distinctly different ways to reach the dual goals of enjoying retirement and leaving a legacy. It’s all explained in a helpful article from Kiplinger, “Planning for Retirement Assets in Your Estate Plan”.

Start by identifying goals and dig into the details. Do you want to leave most assets to your children or grandchildren? Has philanthropy always been important for you, and do you plan to leave large contributions to organizations or causes?

This is not a one-and-done matter. If your intentions, beneficiaries, or tax rules change, you’ll need to review everything to make sure your plan still works.

How accounts are titled and how assets will be passed can create efficient tax results or create tax liabilities. This needs to be aligned with your estate plan. Check on beneficiary designations, asset titles and other documents to make sure they all work together.

Review investments and income. If you’ve retired, pensions, annuities, Social Security and other steady sources of income may be supplemented from your taxable investments. Required minimum distributions (RMDs) from tax deferred accounts are also part of the mix. Make sure you have enough income to cover regular and unanticipated medical, long term care or other expenses.

Once your core income has been determined, it may be wise to segregate any excess capital you intend to use for wealth transfer or charitable giving. Without being set apart from other accounts, these assets may not be managed as effectively for taxes and long-term goals.

Establish a plan for taxable assets. Children or individuals can be better off inheriting highly appreciable taxable investment accounts, rather than traditional IRAs. These types of accounts currently qualify for a step-up in cost basis. This step-up allows the beneficiary to sell the appreciated assets they receive as inheritance, without incurring capital gains.

Here’s an example: an heir receives 1,000 shares of a stock with a $20 per share cost basis valued at $120 per share at the time of the owner’s death. They will pay no capital gains taxes on the gain of $100 per share. However, if the same stock was sold while the retiree owner was living, the $100,000 gain in total would have been taxed. The post-death appreciation, if any, on such inherited assets, would be subject to capital gains taxes.

Retirees often try to preserve traditional IRAs and qualified accounts, while spending taxable accounts to take advantage of lower capital gains taxes as they take distributions. However, this sets heirs up for a big tax bill. Another strategy is to convert a portion of those assets to a Roth IRA and pay taxes now, allowing the assets to grow tax free for you and your heirs.

Segregate assets earmarked for charitable donations. If a charity is named as a beneficiary for a traditional IRA, the charity receives the assets tax free and the estate may be eligible for an estate deduction for federal and state estate taxes.

Your estate planning attorney can help you understand how to structure your assets to meet goals for retirement and to create a legacy. Saving your heirs from estate tax bills that could have been avoided with prior planning will add to their memories of you as someone who took care of the family.

Reference: Kiplinger (May 21, 2021) “Planning for Retirement Assets in Your Estate Plan”

How Do I File Taxes on a CARES 401(k) Withdrawal?

Several bills were passed by Congress to ease financial challenges for Americans during the pandemic. One of the provisions of the CARES Act was to allow workers to withdraw up to $100,000 from their company sponsored 401(k) plan or IRA account in 2020. This is a big departure from the usual rules, says an article from U.S. News & World Report titled “How to Avoid Taxes on Your CARES Act Retirement Withdrawal.”

Normally, a withdrawal from either of these accounts would incur a 10% early withdrawal penalty, but the CARES Act waives the penalty for 2020. However, income tax still needs to be paid on the withdrawal. There are a few options for delaying or minimizing the resulting tax bill.

Here are three key rules you need to know:

  • The penalties on early withdrawals were waived, but not the taxes.
  • The taxes may be paid out over a period of three years.
  • If the taxes are paid and then the taxpayer is able to put the funds back into the account, they can file an amended tax return.

It’s wise to take advantage of that three-year repayment window. If you can put the money back within that three-year time period, you might be able to avoid paying taxes on it altogether. If you are in a cash crunch, you can take the full amount of time and repay the money next year, or the year after.

For instance, if you took out $30,000, you could repay $10,000 a year for 2020, 2021, and 2022. You could also repay all $30,000 by year three. Any repayment schedule can be used, as long as all of the taxes have been paid or all of the money is returned to your retirement account by the end of the third year period.

If you pay taxes on the withdrawal and return the money to your account later, there is also the option to file an amended tax return, as long as you put the money back into the same account by 2022. The best option, if you can manage it, is to put the money back into your retirement account as soon as possible, so your retirement savings has more time to grow. Eliminating the tax bill and re-building retirement savings is the best of all possible options, if your situation permits it.

If you lost your job or had a steep income reduction, it may be best to take the tax hit in the year that your income tax levels are lower. Let’s say your annual salary is $60,000, but you were furloughed in March and didn’t receive any salary for the rest of the year. It’s likely that you are in a lower income tax bracket. If you took $15,000 from your 401(k), you might need to pay a 12% tax rate, instead of the 22% you might owe in a higher income year.

Reference: U.S. News & World Report (April 23, 2021) “How to Avoid Taxes on Your CARES Act Retirement Withdrawal”

Trusts can Work for ‘Regular’ People

A trust fund is an estate planning tool that can be used by anyone who wishes to pass their property to individuals, family members or nonprofits. They are used by wealthy people because they solve a number of wealth transfer problems and are equally applicable to people who aren’t mega-rich, explains this recent article from Forbes titled “Trust Funds: They’re Not Just For The Wealthy.”

A trust is a legal entity in the same way that a corporation is a legal entity. A trust is used in estate planning to own assets, as instructed by the terms of the trust. Terms commonly used in discussing trusts include:

  • Grantor—the person who creates the trust and places assets into the trust.
  • Beneficiary—the person or organization who will receive the assets, as directed by the trust documents.
  • Trustee—the person who ensures that the assets in the trust are properly managed and distributed to beneficiaries.

Trusts may contain a variety of property, from real estate to personal property, stocks, bonds and even entire businesses.

Certain assets should not be placed in a trust, and an estate planning attorney will know how and why to make these decisions. Retirement accounts and other accounts with named beneficiaries don’t need to be placed inside a trust, since the asset will go to the named beneficiaries upon death. They do not pass through probate, which is the process of the court validating the will and how assets are passed as directed by the will. However, there may be reasons to designate such accounts to pass to the trust and your attorney will advise you accordingly.

Assets are transferred into trusts in two main ways: the grantor transfers assets into the trust while living, often by retitling the asset, or by using their estate plan to stipulate that a trust will be created and retain certain assets upon their death.

Trusts are used extensively because they work. Some benefits of using a trust as part of an estate plan include:

Avoiding probate. Assets placed in a trust pass to beneficiaries outside of the probate process.

Protecting beneficiaries from themselves. Young adults may be legally able to inherit but that doesn’t mean they are capable of handling large amounts of money or property. Trusts can be structured to pass along assets at certain ages or when they reach particular milestones in life.

Protecting assets. Trusts can be created to protect inheritances for beneficiaries from creditors and divorces. A trust can be created to ensure a former spouse has no legal claim to the assets in the trust.

Tax liabilities. Transferring assets into an irrevocable trust means they are owned and controlled by the trust. For example, with a non-grantor irrevocable trust, the former owner of the assets does not pay taxes on assets in the trust during his or her life, and they are not part of the taxable estate upon death.

Caring for a Special Needs beneficiary. Disabled individuals who receive government benefits may lose those benefits, if they inherit directly. If you want to provide income to someone with special needs when you have passed, a Special Needs Trust (sometimes known as a Supplemental Needs trust) can be created. An experienced estate planning attorney will know how to do this properly.

Reference: Forbes (March 15, 2021) “Trust Funds: They’re Not Just For The Wealthy”

Can You Increase Your Social Security Benefits?

The desire to get the largest possible benefits from Social Security is a relatively new phenomenon. For decades, people received their monthly benefit check and that was it. However, in the late 1990s, a new law let seniors over age 66 work without any reduction in benefits, says the article “Social Security & You: Seniors obsess over ‘maximizing’ their Social Security” from Tuscon.com. The law led to loopholes that became known as “file and suspend” and “file and restrict.” In a nutshell, they allowed retirees to collect dependent spousal benefits on a spouse’s Social Security record, while delaying their own benefits until age 70.

Congress eventually realized that these loopholes violated the basic concept of the program. Benefits to spouses were always known as “dependent” benefits. To claim benefits as a spouse, you had to prove that you were financially dependent upon the other spouse to collect benefits on their record. However, the loophole let people who were the primary wage earner in the family claim benefits as a “dependent” of the other spouse. Five years ago, Congress closed that loophole.

More specifically, Congress closed the ability to file-and-suspend. It also put file-and-restrict on notice. If you turned 66 before January 2020, you could still wiggle through that loophole, and there are some people who are still eligible. That’s where the term “maximizing your benefits” originated.

Can you get a bigger Social Security check, if you don’t fit into the exception noted above? The only real strategy to maximizing your benefits is simply to wait. The equation is pretty simple. If you wait until your Full Retirement Age (FRA), you will receive 100% of your benefit rate. If you can wait until age 70, you’ll receive 132% of your benefit.

In some households, the higher income earner waits until age 70 to file for retirement, so that the surviving spouse will one day receive higher surviving spouse benefits.

But that’s not the best advice for everyone. If you or your spouse suffer from a chronic illness, it may not make sense to wait.

If you or your spouse have lost your jobs, as so many have because of the pandemic, then Social Security may be the safety net that you need, until you are able to return to some kind of paid employment.

There may be other reasons why you might need to take your benefits earlier, even earlier than your FRA. Some households start taking their Social Security benefits at age 62, as a way to augment other income.

If you don’t already have a “My Social Security” account set up on the Social Security Administration’s portal, now is the time to do so. The Social Security Administration stopped sending annual statements years ago, but you can go into your account and download the statements yourself and start planning for your future.

Reference: Tuscon.com (Feb. 10, 2021) “Social Security & You: Seniors obsess over ‘maximizing’ their Social Security”

taxes during retirement

Do I Have to Pay Taxes during Retirement?

Paying taxes when you aren’t working but are instead receiving income from a lifetime of working and Social Security is a harsh reality of retirement for many people. Figuring out how much of your income will be consumed by taxes is a tricky task, according to the article “What You Need to Know About Taxes and Your Retirement” from Next Avenue. Ignore it, and your finances will suffer.

Most households will pay about six percent of their retirement income in federal income tax, but that number varies greatly, depending upon the size of their retirement income. The lowest income groups may pay next to nothing, but as income rises, so do the taxes. Married couples with an average combined Social Security benefit of about $33,000, 401(k)/IRA balances of $180,790, and personal financial wealth of $87,000 could find themselves paying 10.5% to 20.9%.

Income taxes and health costs are most people’s biggest expenses in retirement. Income taxes are due on pensions and withdrawals from tax-deferred accounts, including traditional IRAs, 401(k)s, 403(b)s, and similar retirement accounts. The same goes for tax-deferred annuities. Required minimum distributions must be taken starting at age 72.

Roth IRA and 401(k) distributions are tax free, since taxes are paid when the funds go into the accounts, not when they are withdrawn.

If you have investments in addition to your tax-deferred funds, like stocks or bond funds, you also pay taxes on the dividends and interest paid to you. If you sell them, you’ll likely need to pay any capital gains taxes.

Learning that a portion of your Social Security benefits are subject to federal income tax is a shocker to many retirees, but about 40% of recipients do pay taxes on their benefits. The higher your income, the more taxes you’ll need to pay.

There may also be state taxes on your Social Security benefits, depending on where you live.

However, here’s the biggest shocker–if you work part time, you may forfeit benefits, temporarily, if you claim before your Full Retirement Age, while you are working. Claiming before FRA means that your benefits are subject to earnings limits—the most you can make from work before triggering a benefit reduction.

Social Security withholds $1 in benefits for every $2 earned above the annual earnings limitation cap. If you reach your FRA after 2020, that’s $18,240. If you reach your FRA in 2020, the annual exemption amount is $48,600.

Pension, investment income and any government benefits, like unemployment compensation, don’t count towards earned income.

Benefits that are withheld will be returned to you once you hit FRA when Social Security bumps up your monthly benefit to make up for the withholding, but this takes place over time.

Reference: Next Avenue (Sep. 17, 2020) “What You Need to Know About Taxes and Your Retirement”

financial windfall

How to Be Smart about a Financial Windfall

Few would complain about a financial windfall, but many people report feeling feelings of anxiety, guilt and stress about what to do with new-found wealth, and even more importantly, how to not blow it. Making a plan, says the article “Handling a financial windfall” from MSN Money.com, is the best way to start.

Treat yourself. Finding a balance between being cautious about the money and enjoying it is not easy, especially if you’ve never handled large sums of money before. One way to do this, is to set aside a certain percentage of the money for fun. Depending on your situation, that might be 5% or less.

What is the tax liability? Some windfalls come with taxes, and some don’t. Life insurance proceeds are not taxable, but an inherited IRA is. Gambling winnings are definitely taxable, as is income realized from the sale of a home or stocks. If you don’t know what the taxes on your windfall will be, find out before you spend anything.

Time for a team approach. If you don’t already have an estate planning attorney, a CPA or financial advisor, now is the time. Ask well-off friends, whose business acumen you respect, who they recommend. Speak with these professionals to learn about what they do, and don’t be shy about asking what they charge for their services.

Create financial and life goals. You may have choices now that you’ve never had. Knowing what matters to you, can help determine how you use the money. It’s very personal. Some of your choices:

  • Buying or upgrading a home
  • Investing in financial markets
  • Buying life insurance
  • Creating an emergency fund
  • Paying for education
  • Saving for retirement
  • Paying off credit card debt

These are just a few—the choices are limitless. Think about this from a long and short-term perspective. What matters today—buying a luxury car, for example—may become an expensive loss in ten years.

This is also the time to have an estate plan created, or if you have an estate plan, this is the time to update your plan. A big change in your financial situation may require changes to protect your assets, which can be done through your estate plan.

Enjoy the windfall but also be smart about protecting it.

Reference: MSN.Money.com (July 31, 2020) “Handling a financial windfall”

 

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