Guest: Natalie Choate, Esq.
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen every other Wed. on KQV 1410 AM or at our radio show archives. Note: Some events referenced in our archives have already passed.
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- Introduction of IRA Expert and Estate Planner Natalie Choate
- Proposed Changes to Estate Tax Are ‘Truly Amazing’
- Re-Examine Your B Trust if Tax Changes Become Law
- Trusts Designed for Estate-Tax Purposes Could Hurt Surviving Spouse
- Surviving Spouse Might Outlive IRA Trust
- Trustee Can Make Disclaimer Decision if Surviving Spouse Is Unable
- Trust Can Be the Beneficiary of a Life Insurance Plan
- Wealthy Use Minimum Required Withdrawal to Pay Taxes on IRA
- Minimum Required Distribution Can Be Given to Charity
- For the Charitable, IRA Left to Charity Is Worth 100 Cents on the Dollar
- Which Investments Should You Hold in a Traditional IRA? In a Roth IRA?
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.
Nicole DeMartino: Good evening, and welcome to The Lange Money Hour, Where Smart Money Talks. Thank you for joining us. I am here with Jim Lange, CPA and attorney and nationally acclaimed Roth IRA expert. Jim has 30 years of experience, and he is also the best-selling author of Retire Secure! Pay Taxes Later, both the first and second edition, and his new book, The Roth Revolution: Pay Taxes Once and Never Again. We are live tonight in the studio. The studio line is (412) 333-9385, and this is a great night to call in because we have Natalie Choate with us on the show tonight and really back by popular demand. So, Natalie, are you with us?
Natalie Choate: I’m here.
Nicole DeMartino: Well, hello and welcome.
Natalie Choate: Thank you.
Nicole DeMartino: Alright, well, before Jim and Natalie get into it, I want to tell you a little bit about our guest tonight. Natalie is a Harvard Law grad and currently practices law in Boston, Massachusetts. She has written two books: the first one is Life and Death Planning for Retirement Benefits, and she’s also written a QPRT Manual. The first book I mentioned, in particular, Life and Death Planning for Retirement Benefits, is actually considered the bible on IRAs and retirement planning, and it’s used by estate-planning and accounting professionals around the globe. So, Natalie, thank you for joining us tonight.
Natalie Choate: It’s my pleasure.
Jim Lange: And I’ll say another word about Natalie’s book, Life and Death Planning for Retirement Benefits. I mean, it is the book, and I know that we have a lot of financial professionals listening to us from all over the country. That is the book that you should have on your shelf for the most in-depth IRA and retirement-plan questions and issues that you have. The other thing that Natalie is the author of that, I think, would be more appropriate for consumers … and actually, by the way, I think it’s a great idea for advisors also, is called The 100 Best and Worst Planning Ideas for Your Client’s Retirement Benefits —but really there’s 194 — and it has such wonderful information. The first book is more technical and more the law, and the one that I just mentioned, The 100 Best and Worst Planning Ideas for Your Client’s Retirement Benefits, that’s exactly what it is — except 194 ideas. It’s a wonderful resource. I have been through both books. I actually think I became somewhat of an IRA expert after reading Natalie’s first book cover-to-cover, and the second book I just think is fabulous. Both of those books are available at www.ataxplan.com.
Natalie has been on our show before, and we covered some of what I thought were some of her very best of the best ideas, and I’d like to cover some more today. But one of the things I was hoping that we could get an opinion from Natalie on is actually the new law that hasn’t even passed yet. Apparently, the Senate has passed the extension of the Bush income-tax cuts, and apparently, there’s also estate-tax changes, and it is expected, though we can’t be sure, that the House is also going to approve that. Natalie, could I ask you the tougher question of if you think this is going to go through, and, more importantly, perhaps, if it does go through, what are the implications for some of our listeners?
Natalie Choate: Well, Jim, it’s truly amazing the changes that this would make in the estate-tax situation, and as to whether it’s going to go through or not, I don’t know any more than anybody else who reads the newspapers. You know, one day, it looks like it’s a sure thing, and then the next day, it seems less sure. But here are some of the main points that are pretty remarkable as far as a different approach to the estate tax. First, this law would change the estate tax exemption from what’s scheduled to be $1 million on January 1, 2011, to $5 million per person, meaning that you could die, you could have as many as $5 million of assets and you have no estate tax on the money that you’re passing to your children, and a husband and wife together, that would mean a $10 million estate would be exempt from federal estate tax. Now, it’s only for two years and then we’re back to uncertainty again, and there’s still state death taxes to worry about, but this is a pretty remarkable change, and what’s even much more radical than just increasing the amount of the exemption is that this new law would have a concept of portability of the estate-tax exemption between a husband and wife, meaning that the first spouse to die can leave his or her exemption to the surviving spouse. So the first spouse could leave all their assets to the surviving spouse along with their exemption, and the surviving spouse could then have a $10 million estate with no federal estate tax. It’s something that seems like it should’ve been actually done a long time ago, but it never has been until now. And once you get over the exemption, this new law would have a 35 percent tax rate for assets in excess of the $5 or $10 million exemption amount, and it would also have a gift-tax exemption being the same as the estate-tax exemption. In other words, you could use up your $5 million by making lifetime gifts, or you can save it until you die. That’s pretty shocking.
Jim Lange: That is pretty shocking. By the way, I will remind you, though you probably remember it, but one of the most interesting ideas that you had was “pray for portability,” and apparently it worked because we’re getting it!
Natalie Choate: Well, it always did seem like they should do it, but it’s not good news necessarily for us estate-planning lawyers because a lot of what we do now is writing trusts so that each spouse can make use of their estate-tax exemption, and maybe we’re going to have to start collecting some of those extended unemployment benefits if they go to full portability! We won’t be as needed as before.
Jim Lange: Well, I have considered that possibility, so maybe, why don’t we talk about the B Trust, if you will, which was kind of a standard planning technique for a lot of estate attorneys, and what people should do if they actually have that in their documents now. That is one of my concerns. So, let’s say that you’re one of the listeners, whether it’s in western Pennsylvania or throughout the country, on the internet or even on a rebroadcast or listening to the archives —and by the way, there is a wealth of radio archives, including two excellent shows with Natalie Choate as guest. So, after hearing this, if you want more Natalie with really excellent content, if you go to www.retiresecure.com, click on “Listen Now,” and scroll down until you see Natalie’s name, there’s actually quite a few shows, including Natalie’s. So, let’s say that you are one of our listeners now, and you have this traditional AB will that so many estate planners have drafted, and let’s say your estate, maybe it was relevant for you to have AB wills. Maybe your estate is $800,000 or a million dollars or even two or three million dollars, or even five million dollars for that matter, and now you have this new law come in. Can you just do nothing, or is this something that you should be concerned about because, perhaps, you should be changing your existing documents?
Natalie Choate: Well, I think we are all going to have to look over our estate plans again once this is in place because the assumptions that people did tax planning based on, they’re just not going to be true anymore, and things may have to be changed. Now, this doesn’t necessarily mean that everyone’s going to throw all their trusts out the window, because it could be that I’m a wife and I say, “Well, I have $5 million and my husband has $5 million, and maybe I can just leave my money to my husband and leave him my exemption, too, so he’ll have all of our assets and he’ll have a $10 million exemption.” But maybe I’m going to say, “I don’t want to leave all my money outright to my husband, not because of estate taxes, but I’m worried that he might remarry and he might give it to his second wife and my kids wouldn’t get it.” So, there’s still reasons why husband and wives may want to leave some of their assets at least in a trust for the protection of the children eventually, even if it’s not an estate-tax saving necessity anymore.
Jim Lange: And one of the things I’m concerned about is that you will have more money than was intended to go into the trust, if you will, and we might end up with severe restrictions on the surviving spouse. So, for example, if one of the original ideas was to save estate tax, and now, with the exemptions up, and, frankly, at least over the last couple years, the portfolio is down, I’m worried that a surviving spouse might be limited to health maintenance and support and not have as many benefits as they might want, and have it all for naught because there’s not going to be an estate tax anyway. So, I’m actually concerned that some of the existing documents are not only going to not help the surviving spouse but will hurt them.
Natalie Choate: Jim, you’re absolutely right. I mean, I was giving an example where people might want to have a trust, even though they no longer need it for estate tax purposes. But what you’ve pointed out is the opposite problem. A lot of people now, their current documents are based on the old estate-tax law, and they tie up the assets in trust for their spouse. It may no longer be necessary. It may no longer be saving any taxes, and yet, it is restricting the surviving spouse’s access to the money, which may not be what they want now. And again, the need to review the estate plan is paramount.
Jim Lange: Yeah. What I have noticed, a little bit of a shift in recent years, is … and I don’t know if you have in your practice, but I noticed that more and more spouses are more worried about just providing for each other for the rest of their lives, and savings of estate taxes at death, and even income taxes for the heirs, are not quite as important as making sure that each of them is provided or overprovided for, and again, with these old wills, I think that sometimes we’re going to have too much money going in the trust, and instead of fulfilling the client’s goal of providing for the surviving spouse, that some of those old documents are actually going to hurt the surviving spouse.
Natalie Choate: Yep, and what you say about the concern about providing for the spouses, I love the example in your new book, The Roth Revolution, of the client who has tens of millions of dollars and is not willing to make any gifts to save estate taxes because he thinks he might need it all! And so many estate planners have the experience of, you know, you spend the morning with a person with multi-multi-multi millions, telling them you ought to make at least some gifts to reduce estate taxes, and in the afternoon, you’re probably meeting with an elderly widow who just has very little and is trying to give it away to save taxes, and you’re trying to say, “You don’t need to give it away! Don’t give it away.” So, that’s people, and that’s why our job is interesting.
Jim Lange: Well, I think it is. That’s actually, to me, one of the most fun things to hear somebody’s story and to use all your creative powers and knowledge to try to help promote their goals. But I have seen a little bit of a shift in the goals towards providing for each other, and not so much for kids and grandkids.
Well, let me ask you this: Let’s assume that the new law does come through, and let’s assume that we don’t have a situation where the surviving spouse wants to make sure that some money goes to children or grandchildren. So let’s assume that the assets are well less than $10 million. Are you going to keep including the B Trust in any of your documents? I know, for example, the way I will typically draft documents is I will, with a traditional marriage — I call it the ‘Leave it to Beaver’ marriage with the original husband and the original wife and the same kids and the same grandkids — I might name the surviving spouse as the primary beneficiary, take advantage of one of your recommendations, which is to allow disclaimer provisions, and have a B Trust as a secondary beneficiary, kids equally as the third, and well-drafted trust for the grandchildren for the fourth. So the way I have traditionally drafted is the B Trust is an optional situation, and I was wondering what you have drafted in the past and what advice you would have for people that have different configurations in their wills?
Natalie Choate: It’s almost too hard to make a generalization on that.
Jim Lange: Yeah, that’s probably not a fair question, is it?
Natalie Choate: There’s so many variables and so many considerations leaving money to the surviving spouse. Are you worried about remarriage? Are you worried about the spouse’s health and nursing-home costs and creditors? It’s almost impossible to generalize there.
Jim Lange: OK, that’s fair. I guess the question wasn’t right.
Natalie Choate: Well, with my focus being primarily IRAs, the spousal rollover, the ability to defer income taxes by leaving it outright to the spouse who rolls it over to his or her own IRA and keeps the deferral going is usually the primary tax benefit that’s out there.
Jim Lange: Right, which I agree with, which, by the way, is not really what the traditional planner, who is using these AB-type wills, is doing, and I think that one of your worst ideas was leaving IRA benefits to this type of B Trust, where the spouse gets the income, the right to invade principle for health maintenance and support, and, at their death, it goes to their children.
Natalie Choate: Right. When you say it was my worst idea, you mean in my list of best and worst ideas?
Jim Lange: Yeah, that’s right. I didn’t mean that that was your worst idea that you promoted! I’m sorry if I inferred that! What I meant was that, literally, the name of the title was The Best and Worst Planning Ideas.
Natalie Choate: Right, and what’s worst about that idea is, I mean, what makes it negative is if you leave your IRA to a trust for your surviving spouse, the best deal that the trust can get is to drain down that IRA to zero over the life expectancy of your spouse, and the IRS says, “Life expectancy goes to the mid-80s.” Well, a lot of people live beyond their 80s these days, but the IRA will be gone by the time the spouse reaches their mid-80s. It will all have been distributed to the trust, and if you name the surviving spouse outright instead of naming a trust like this, the surviving spouse can roll the money into his or her own IRA, defer any distributions until age 70½, and then start gradually withdrawing the money over a much longer period not limited to his or her life expectancy. And then, later, on her subsequent death, or his, leave it to the children and get a longer stretch out over the children’s life expectancy. So the financial difference is enormous.
Jim Lange: Well, actually, to quote you, because you just quoted me before, now I’ll quote you in the Kim Coslow case, if I remember right: “The difference between using the marital trust,” if you will, again, income to spouse, and, at the second death, going to the kids or kids to the first marriage, “versus leaving a certain percentage to the spouse outright and a certain percentage to the kids outright, the difference, one, the way that you’re advocating is with using that trust, there was $9 million of benefits, and without, it was $5 million.” So you were actually, in effect, adding $4 million to the family and taking $4 million away from the IRS. So that was an example of you actually quantified the benefits of your advice, and I’ve really agreed with it. But, I guess, in general, let’s assume, for discussion’s sake, you had a client that had a traditional AB will, and whether you drafted it or whether another attorney drafted it, and let’s say that they had, let’s assume, less than $5 million. Let’s also assume that they trust each other, and that they’re not so worried about the second spouse or anything else. Do you have a general rule as to how you would draft for that client, or is that again too broad?
Natalie Choate: Well, it’s not too broad. It’s just I would ask them what they want. I would say, “If you want to leave everything outright to each other, there’s no tax drawback to that. If your total estate is under $5 million, and the exemption is $5 million, I can’t tell you you should leave it in trust to save estate taxes.” Now, what are the limitations on what I just said? Well, I’m from Massachusetts. In Massachusetts, we still have an estate tax and it only has a $1 million exemption, so we’ll still be doing these trusts to make use of the Massachusetts exemption. Also, this new estate tax is only for two years. So, you know, how are we supposed to figure that in? I’m very unhappy about these temporary tax laws because, I don’t know what your experience has been, but there’s been no one coming into our office for estate planning for about a year-and-a-half because they say, “Well, we don’t know what we’re planning for.” And they don’t want to come in and have me draft a will that’s going to be good under, you know, 10 different possible scenarios. That’s too expensive. So we’ve been sitting around doing nothing for a year, and if we could get some certainty, it would be nice because then people would be willing to do some planning.
Jim Lange: Right, and what I’m doing, and Nicole’s going to have a little pitch for it later, is to do estate-planning workshops where I’m advocating the flexible system, again, where you name the surviving spouse first. I’m still planning on keeping the B Trust as an option because, like you said, it might come back.
Natalie Choate: Well, I think that’s a very good suggestion. I’m going to put that in as my 195th idea, the best planning idea from Jim Lange. You’ve got to set it up with a cascading plan that could be activated by disclaimer, so no matter what scenario prevails, you’ve got a plan.
Jim Lange: Yeah, and that’s actually what I’ve been drafting … I hate to say this, but I haven’t really progressed in my drafting, at least in the big picture, much since 1994 because I have, historically, been drafting for the surviving spouse first, the B Trust second, the kids equally third and trusts for grandchildren fourth. But one of the weaknesses of the plan that I just advocated, which I have drafted a lot of, and I don’t know if you have any special way of handling this, is if you have a client that is either where one spouse is maybe still legally competent, but may be in the early stages of a dementia or an Alzheimer’s, or maybe there is a family history of Alzheimer’s or dementia, and let’s assume … I think that these trusts are much easier and much less harmful if you’re talking about non-IRA dollars, but since we don’t want to have the negative income-tax acceleration with these trusts, and that, by the way, is the essence of the difference between the Coslows, who used the trust and got hurt and paid an extra $4 million. Ultimately, that extra $4 million was accelerated income tax. So we have, let’s call it, the tension between being a little bit afraid of leaving money to a spouse who might have dementia at the time versus not wanting to accelerate the income tax. Now, I don’t know if you have an answer to that, or if that’s a case by case basis.
Natalie Choate: Well, I have a suggestion.
Jim Lange: All right.
Natalie Choate: I have a suggestion. The way some people handle that problem is they name a trust as primary beneficiary with the trust being able to disclaim over to the spouse. That way, if you’re concerned that the surviving spouse would not have the ability to disclaim because of a possible issue of dementia or disability, the trustee is the one who pulls the trigger, and you’ve got a professional trustee who will be confident to make the decision to whether the asset should remain in the trust or should be disclaimed over to outright passed to the spouse, and they would disclaim it over to the spouse if she or he is in fact competent and/or is having assets managed through a power of attorney to be able to handle them. So that’s one way to handle that. But I do have a question for you, though, Jim.
Jim Lange: OK.
Natalie Choate: Now, you’ve been doing this since 1994, which is sixteen long years. You must’ve had some cases where the deaths have occurred …
Jim Lange: Oh, we’ve had quite a few deaths, unfortunately.
Natalie Choate: So you’re saying it’s not good to be your client because it has a high death rate?
Jim Lange: Actually, interestingly enough, we have about 1,500 wills that we’ve done, and, actuarially, we have been told that we should have roughly 3 percent, or, roughly, 45 deaths per year, and we don’t have anywhere near that. So our clients are actually doing pretty well!
Natalie Choate: Yes! Yeah, it sounds like it’s a good idea to be your client.
Jim Lange: Well, interestingly enough, we have a lot of college professors and we have a lot of engineers as clients, and they both, by the way, have similar end structures where they tend to have a lot of money in retirement plans, much more so than money outside retirement plans, but I think both of them are smart people, relatively well-educated, that might live a little bit longer. So, actually, we’ve done pretty well. By the way, I think I know what your question is, but in answer to the first question, yes, we have had quite a few deaths using this flexible-type plan.
Natalie Choate: Before I get to my question, I have to then give you a plug. If you have a lot of engineers as clients, that’s a very good recommendation for you because, unlike some other professions that I won’t name, where people perhaps have a reputation of being gullible or not careful, engineers are well-known for being very demanding of their estate planners, especially. The engineers get out their slide rules and they challenge you on all your assumptions, and if you’ve got a lot of engineers as clients, that probably speaks well of how you’re doing for them. But here’s the question I’m finally getting to: When you’ve had the death, then how has the disclaimer plan worked? Have you had people willing to make these disclaimers when it does seem appropriate to achieve the estate-planning goals?
Jim Lange: Actually, we have, and maybe I am lucky in that I have probably a lot of good marriages with trust in each other and the survivor making appropriate choices. Now, frankly, we have, even though, obviously, legally, it’s completely the surviving spouse’s decision on what to do, I kind of can’t help myself, and sometimes will take the liberty of saying, “Well, it might be a good idea to disclaim a certain amount, or a certain percentage.” In fact, actually, somebody was in my office today, and his wife died a number of years ago and he did actively disclaim, not to the trust, but he actually disclaimed IRA money directly to children. One of the things that we have that I found is interesting, is sometimes people make some disclaimers to the children on the first death, and then at the second death, we sometimes have disclaimers to grandchildren, particularly in Roth IRAs. So I would say that we’ve had a good history of people doing what I think would have been appropriate, but, and this is probably the part that you’re probably more interested in hearing, but I will tell listeners that this is really a one-time event. I did have a client that, inappropriately, refused to disclaim. So, in that case, I remember the facts very vividly. I’ll oversimplify them. There was a $3 million estate and it was all basically the husband’s IRA, and it was back when the exemption amount was a million, and I heard that the client had died, and it’s an odd thing. I sometimes see somebody on the street and I can’t remember their name, but I remember they’re the people who have $1.8 million and a no-good son-in-law, or whatever it might be. So, anyway, I remembered that this woman was going to be basically left with a $3 million IRA, and she, like many of our clients, was not a spender. She was a saver, and between her Social Security, probably a million dollars would have been more than enough for her, but since we could easily give her $2 million without any federal estate tax, my thinking is, OK, here’s what we’ll do. We’ll leave her $2 million, or, again, she had the whole option for all of it, we’ll have her accept $2 million and disclaim a million dollars to the kids and the grandkids. And I thought that, well, (A), we’ll get a million dollars out of her estate when she dies, and (B), we’ll get a much longer stretch and great income-tax benefits for kids and grandkids. And in my mind, it was done, and, you know, meeting her and talking about it and doing the paperwork was, let’s say, a formality. And she came in and I explained it, and she said, “No, I think I’ll keep it all.” I said, “Oh, no, no, Mrs. X! Blah blah blah blah blah,” and she said, “No, I think I’ll keep it all.” “Oh, no, Mrs. X! You don’t understand!” And she turned to me and she said, “No, Jim. You don’t understand. It’s my choice and I’m going to keep it all!” So I will say that at least that one time, that flexible plan backfired on me. On the other hand, and I don’t know how many we’ve done, maybe a hundred, probably more, I would say, in general, yeah, certainly more, that it has worked very well. Now, some people have done something that I might not have expected. I had one woman who was married to an engineer, and, apparently, though I didn’t know it at the time, he severely restricted her spending, and after he died, she said, “The heck with it! I’m going to keep everything and start spending!” But in a way, that was what they wanted. I don’t know if he would have accepted that, but he basically said, “Whatever she wants to do.” I don’t know if you have had similar experiences, or whether you draft more accurately and plan for events and not leave things so flexible. And again, there is the downside of that flexible plan.
Natalie Choate: Yep.
Jim Lange: I suspect that, while I don’t want to put words in your mouth, but do you do more situational drafting where you actually decide in advance, and do you include some parameters?
Natalie Choate: Well, the good news for me, Jim, is that I basically am out of the drafting business. I have not been doing active estate planning, in terms of drafting documents, for quite a number of years because I’ve been doing just the writing and speaking on IRAs and drafting beneficiary designations. But basically, somebody else is responsible for the estate plan, and I’m just engineering on the retirement benefits part of it. So I haven’t had to be counseling people on those kinds of decisions for a while.
Jim Lange: OK.
Natalie Choate: I do remember that some of my senior partners, one of them put it very succinctly. He said, “I’ve been an estate-planning lawyer for over 50 years,” and he said, “and doing trusts and estates intensively all that time, in all of those years, I have never once seen a surviving spouse disclaim a darn thing.”
Jim Lange: Oh, really? That’s interesting, because that’s much different than the experience that we’ve had.
Natalie Choate: It is a different experience, very different from yours.
Jim Lange: And I wonder why?
Natalie Choate: I think that it’s because the building in of a disclaimer plan has not been common, at least at the firm that I was working at that time.
Jim Lange: No, no. I know that I’ve been in the minority doing that, and I try to pick up on a situation where it will not be appropriate. I obviously missed it that one time. If I had a vibe, if you will, that she was going to keep everything and not disclaim a nickel, and I knew that her husband wouldn’t have wanted that, then I probably would’ve … and, of course, again, you know, it’s not like it’s my choice, but frankly, I think that the clients are influenced by what we recommend. It’s not a coincidence that the vast majority, probably 90 percent or more of the traditional families that we do estate planning for, have some variation of this very flexible plan. On the other hand, if I see a situation where it might not be appropriate, like, for example, in one that I’m working on where the spouse is not legally competent … so, when I asked you that, it wasn’t just purely for our listeners. It was partly for me.
Natalie Choate: Right, right.
Jim Lange: The other thing, by the way, that I thought that we’re actually running the numbers and seeing if it makes sense, and this might be more of an Ed Slott-type strategy, is buying some life insurance for him, making a trust the beneficiary of the life insurance, and then leaving IRA money to children and grandchildren on the theory that the surviving spouse won’t have the ability to do something stupid and will also get that stretch.
Natalie Choate: That sounds like a good approach.
Jim Lange: Yeah, so that’s another way to do it. So, a couple other really interesting ideas that you had in your best and worst ideas was on taking distributions from a retirement plan. I’m sure there’s quite a few listeners out there who are 70 and older, and they are taking minimum required distributions from their retirement plan, or, alternately, people who are not 70, but they still need the IRA money to meet their living expenses, and you had some advice for withholding money from an IRA to reduce estimated taxes, and what’s kind of interesting in your table of contents is, one of your ideas is “Use withholding from IRA distributions to reduce estimated taxes,” and then, right next to that, it was “Use withholding from IRA distribution followed by tax-free rollover to avoid the penalty for underpayment of estimated taxes.” The estimated-taxes issue I think is going to become even more relevant and even trickier because a lot of people are doing Roth IRA conversions these days. So I wonder if you could tell me about withholding from IRA distributions to reduce estimated taxes.
Natalie Choate: Sure. There’s two times that I strongly recommend it. One is when we have the high-income individual, a wealthy person who’s over 70½ and is being therefore required to take minimum distributions from their IRA, and this is money that the person doesn’t want to take out of the IRA. They don’t need it. They would just as soon leave it in, but they’re forced to take minimum distributions. Now, of course, a footnote here. Jim, you would recommend that they probably convert that whole thing to a Roth IRA so they don’t have to take minimum distributions anymore, and that’s probably good advice. But let’s look at somebody who’s still in a position where they’re taking forced minimum distributions, and that person also has to pay estimated taxes four times a year, and he also doesn’t like that, needless to say. Well, if you put off your minimum distribution until towards the end of the year, so maybe you take it in November or December, and then, instead of having the IRA provider send you a check for the minimum distribution, you tell the IRA provider to file form W4P — request for withholding of income taxes from a retirement plan distribution. You file that with the IRA provider and say, “My minimum distribution is $50,000. So I got to take that out now, but don’t send the check to me. Send it to the IRS as withheld income taxes.” Basically, the IRA provider withholds 100 percent of your IRA distribution and sends it to the IRS for your account. And the beauty of that is that withheld income taxes are applied presumed to have been paid equally throughout the year. So, when Uncle Sam gets that $50,000 check from your IRA, and the IRS gets it in December, but you get credit for it for estimated tax purposes as if you had paid $12,500 last April, $12,500 in September, $12,500 in June and $12,500 next January. So, you get credit for it as if you paid it throughout the year even though it wasn’t paid until the end of the year. And people have been doing that. I mean, that’s just a routine thing that wealthy people have been doing for a number of years. The advantage of it is, you get to keep the use of your money for a few more months. Of course, at today’s interest rates, on a $50,000 tax payment, you might make an extra 50 cents of interest by holding onto it for a few more months. So I guess it’s not such a dramatic benefit as it maybe used to be.
Jim Lange: Well, still, a tax-free loan of, let’s say, in increments of $50,000 is probably significant.
Nicole DeMartino: Alright, we’re over halfway through the show. We’re going to take a little break. You are listening to Jim Lange and Natalie Choate on The Lange Money Hour, Where Smart Money Talks.
Nicole DeMartino: Welcome back to The Lange Money Hour. You’re here with Jim Lange and Natalie Choate.
Jim Lange: Natalie, the other thing that I really liked about your best and worst ideas is you also included two, what I think, very good ideas regarding charitable giving, and one was, and there’s been fluctuation in this law, is to give your MRD to charity. Why don’t we take them one at a time? To the idea of somebody who is 70 or older, and they are interested in making a charitable contribution, rather than taking their minimum required distribution, including that in income, and then writing a check to the charity, then getting a deduction, that they just go directly from their IRA and give their minimum required distribution or a portion of their minimum required distribution to charity. And I was wondering if you could expand on that and tell our listeners if that is one of your standard pieces of charitable advice.
Natalie Choate: Well, actually, that’s a very timely point because there was this law in the years 2006 through 2009 that said if you are older than age 70½, you can transfer money directly from your IRA to a charity, up to $100,000 per year, and that money goes directly to the charity. It doesn’t go onto your tax return, so you don’t get a deduction for it, but you also don’t have any income, and that’s a little bit more advantageous, usually, than taking money out of the IRA and then making a deductible gift to charity. But that law expired at the end of 2009, and part of the new tax law that you and I were just discussing, that looks like it might pass in the next day or two, would say “We are reviving that for 2010.” So, again, people who are over 70½ can make gifts directly from their IRA to a charity in the year 2010. Now, there’s only what? Ten days left in 2010, or two weeks or something? It’s crazy to pass this kind of law two weeks before the end of the year, but that’s what they’re looking at doing, and I would say someone who is interested in making gifts to charity from their IRA, you know, if you want to make a gift to charity, go ahead and do it from your IRA. The worst that happens is it’s treated as a distribution to you, followed by a deductible gift to the charity, and the best that happens is they pass this law and your gift is retroactively blessed as being just a straight gift to charity. It doesn’t go onto your return, and you don’t get a deduction. It’s so complicated, it’s ridiculous!
Jim Lange: Well, it is complicated. On the other hand, there’s real tax savings associated with it. So, for example, sometimes, that is the difference between being able to deduct certain medical expenses and other areas of itemized deductions.
Natalie Choate: If they do pass it, it is, certainly for some people more than others, but it’s a more advantageous way to give your minimum distribution to charity.
Jim Lange: Yeah. And I do know that there is limited time left, and I’m trying very hard not to talk about Roth IRA conversions, but we actually still have some people coming in for Roth IRA analysis, so it’s still not too late, and interestingly enough, one of the ideas that I kind of plugged in the book, the idea of giving back your Social Security, getting a tax deduction for the return of your Social Security, doing a Roth IRA conversion that same year, which basically allowed you to do a Roth IRA conversion for little or for not a lot of tax, and then getting higher Social Security benefits in the future. That was just changed, so that idea is no longer available to us. So I feel that way a little bit with some of these rules, and, particularly, things with Roth IRAs that might have a limited life. But anyway, back to charity, the other idea that you had, which I think is a great idea and I have incorporated it into my own practice, is under choice of beneficiary, you list the charity as the best choice of beneficiary if you have charitable intent, as opposed to leaving money in your will to charity, you would actually leave a portion of the IRA, and if you could expand on that idea, I think that that’s a real winner, and I’m sure that particularly our charitable listeners would love to know how they can get more of a bang for their charitable buck.
Natalie Choate: Yes, that idea would be based on if, let’s say, we have a parent who, he’s leaving part of his estate to his children and his children are in their 50s, and part of his estate to charity. Which assets would you leave to the children? Which assets would you leave to charity? Well, the IRA is worth 100 cents on the dollar to the charity because they don’t have to pay income tax when they take money out of your IRA. You leave your IRA to your children, they do get to stretch it out over their life expectancy, but particularly, if you’re talking about older adult children like in their 50s or 60s, their life expectancy, under the IRS tables, is 20 or 30 years, pretty good payout. But they do eventually have to pay income taxes when they take the money out of the IRA. So it’s not worth 100 cents on the dollar to them, and other assets might be worth more to them. So, definitely, for a charitably inclined client, we would look at using the IRA to make that asset payable to the charity and other assets to the family members, and that’s, like I say, it’s something to look at. It’s not always best because if you’re leaving the IRA to very young beneficiaries like grandchildren or something, they might be able to stretch out the distributions from the IRA over such a long period of time that the income tax becomes negligible. So it’s a factor that’s in there, but definitely, if you’re charitably inclined, think about leaving your IRA to your favorite charity as a very good choice of beneficiary for that IRA.
Jim Lange: Yeah, I love that idea, or even a certain amount or a certain percentage. Most people don’t tend to leave a ton of money to their grandchildren, but smaller amounts, and what I tend to like to do, if possible, is to leave Roth IRAs, particularly after the first death, to well-drafted trusts for the benefits of grandchildren.
Natalie Choate: That’s a great planning technique. It’s spectacular, and I very much appreciate the fact you put in there “a well-drafted trust,” because, clearly, if you leave a significant asset to young grandchildren, it’s going to be at risk due to their immature years as to whether they’re going to spend it wisely, whether they’re going to lose it to creditors or sports cars or divorce or any of life’s vicissitudes, but by protecting it in a trust, you’re going to get the stretch payout over that long life expectancy tax-free from a Roth IRA. The numerical projections of the benefits of that plan are very impressive.
Jim Lange: Yeah, I don’t think too many of our engineering clients would be happy to know that their grandchildren were going to have a big party with sex, drugs and rock and roll when they were 21 because they failed to put some of that money in trust when it should’ve been, when it could’ve literally grown income-tax-free for the entire life of the grandchild, and as you pointed out earlier when we were talking about titling a decedent’s IRA or Roth IRA, that you get a little bit of, what I would call, cheap immortality of having your name associated with that inherited IRA or inherited Roth IRA maybe 40, 50, 60 years after you’re gone, if you’re leaving that money to a grandchild.
Natalie Choate: True. And speaking of cheap immortality, Jim, today, you’ve got me on a red-letter day because my book, the new seventh edition of Life and Death Planning for Retirement Benefits, it shipped from the printer yesterday and I’m going to see my first copy tomorrow in my office.
Jim Lange: Oh, by the way, that is big news, and frankly, that’s something I’m going to do tomorrow is to hop on your website and get that. By the way everybody, we have been … I mean, this book … really is the bible. Everybody should have this, and I have multiple editions, and it has been a little while since there’s been a new edition, and Natalie’s had a number of updates that she has graciously even made available to some of the people who have bought her book before, but that is a big day. I actually didn’t know that you were working on that, and this is just like a monumental book. So, this isn’t the kind of book that is updated every year or two. This is the kind of book that can be updated, I don’t know, every five years, and even then, that has to be a monumental piece of work.
Natalie Choate: It was a lot of work. It’s about a year-and-a-half overdue, I would say, so I’m glad it’s finally finished and I can’t wait to see what it looks like.
Jim Lange: Well, congratulations. You know, I have sometimes wondered what is going to happen when Natalie retires and doesn’t want to write this book anymore because, really, it’s the book. I mean, I’m sure the IRS agents use it. There’s nothing better, and actually, one of my ideas for you, Natalie, is at some point for you to sell the rights, if you will, to revise that after you no longer are up for it.
Natalie Choate: I am in the market. I will tell you, after this revision, I said I am never doing this again! Of course, I said that every other revision, too, but it’s time to get a life and find somebody else to take this over.
Jim Lange: Well, for whatever it’s worth, even forgetting any money that you might get for it, I mean, realistically, I don’t know how much money you make from your books, but realistically, this is a great service to planners and estate planners and financial advisors and the IRS. So, just like a good estate planner will always make sure they have a good law firm to do estate administration after somebody dies, after you no longer are up for it, the idea that somebody is taking it over, and for whatever it’s worth, at the risk of an unadulterated plug, I think Bob Keebler might be about as good a choice as I can think of off the top of my head.
Natalie Choate: I’ll put him on my list.
Jim Lange: OK. Now, I know he’s not an attorney, but I think that he has a certain attention to detail that not a lot of people would have.
Speaking of attention to detail, one of your ideas for investing retirement-plan money, in a way, it might be a classic, but I don’t see it happen a lot, so I’ll just tell you that the title of the idea, and then maybe you could expand on it a little bit. And by the way, Natalie, for people and for the advisors, and we have quite a few advisors listening from all over the country, is there an order form at www.ataxplan.com that they could actually order that?
Jim Lange: Right, and by the way, I will also tell you that having purchased it myself through that website, there are some advantages of purchasing it through there because Natalie has a newsletter that I occasionally get that, I suspect, if I got it through Amazon, I would not get.
Natalie Choate: That is correct.
Jim Lange: But the fact that I got it directly through her, and she had my hardcopy address, and, interestingly enough, the newsletter does not tend to be a sales letter. It tends to be “Here’s some current stuff and here’s what’s going on.”
But anyway, back to another one of, I thought, very good ideas, was holding non-municipal bonds, in other words, taxable bonds, in the IRAs or retirement plans and holding stocks outside the retirement plans. In a way, it’s a classic, but I think a lot of people aren’t doing it, and if you could expand on that, I’m sure our listeners would appreciate that.
Natalie Choate: Well, this is a good question for a debate and to hear every investment advisor’s approach to it, but the question is, you have different types of investments. Which one should you hold in your Roth IRA? Which one should you hold in your traditional IRA? Which one should you hold in your outside account? And in recent years, it’s made sense to hold the stock-type assets — equities, real estate and things like that — outside the IRA because you could benefit from the low tax rate on capital gains of just 15 percent, and I guess maybe we’re going to have that with us for a few more years. Whereas distributions from a traditional IRA are going to be taxed as ordinary income when they eventually come out. Even if it really represented a capital gain inside the IRA, it’s all ordinary income when you take it out of the IRA. Therefore, it seemed like bonds and things that generate ordinary income should be inside a traditional IRA to shelter the ordinary income because it’s going to be ordinary income when it comes out. You’re not losing the capital gain rate by having those assets in the IRA.
Nicole DeMartino: You know what, Natalie? I’m sorry to interrupt you. We have about 30 seconds and we have to say goodbye. So, thank you for being on the show tonight. Congratulations on your book. For the advisors out there, if you want to get the book, www.ataxplan.com. Happy holidays, Natalie.
Natalie Choate: Thank you.
Nicole DeMartino: Thank you for joining us. You’ve been listening to The Lange Money Hour, Where Smart Money Talks.