Give Your Heirs as Much Flexibility as Possible
I gave serious thought to changing the title of Chapter 15, which discusses the ideal beneficiary for your retirement plan, to “My Pet Peeve”. This is because of how annoying I find it to see people spend thousands of dollars to create elaborate wills and trusts, only to render them useless because they carelessly listed the wrong beneficiary on their retirement plan. Unfortunately, it’s an all too common mistake.
What follows here is one of the most, if not THE most, important concepts in the book. Your will and trust documents do not control the distribution of your IRA or retirement plans. Any account that has a specific beneficiary designation will be distributed to the individuals listed on that beneficiary form, regardless of what your will or trust says. Why is this important? Well, I’ll tell you about a situation I became aware of recently. A gentleman who had been married and divorced twice prepared a will that left all of his assets to his children from his first marriage. Most of his wealth was in his retirement plan, though. He died unexpectedly, before he could get around to changing the beneficiary designation of that plan from his second ex-wife to his children. After his death, the second ex-wife (who had since remarried) received the very large retirement plan, and his children received the non-retirement assets, which were worth far less than the retirement plan. To add insult to injury, the second ex-wife made sure that his children knew that she had used her inheritance to buy herself and her new spouse very expensive cars – even going so far as to post photos on social media websites as proof! So your beneficiary designations are very, very important – so important that, in fact, if you’re my client I won’t even let you fill them out by yourself!
I like to give my clients as many options as I can. The beneficiary designation that I usually recommend gives your heirs as much flexibility as possible. It allows both your surviving spouse and your adult child, assuming that the child is the contingent beneficiary, to disclaim or refuse the inheritance to his or her own children (your children and/or grandchildren). Under current laws, this allows the children and grandchildren to take minimum distributions based on their own life expectancy. Will I still do this if the law changes? More than likely, yes, but the financial benefits will not be as significant as they were in previous years. If this topic interests you, then you’ll probably want to read Chapter 15 to learn about all the changes.
My next post will continue on the topic of beneficiary designations, and why they are important if your estate plan includes trusts. Stop back soon!
Jim
A nationally recognized IRA, Roth IRA conversion, and 401(k) expert, he is a regular speaker to both consumers and professional organizations. Jim is the creator of the Lange Cascading Beneficiary Plan™, a benchmark in retirement planning with the flexibility and control it offers the surviving spouse, and the founder of The Roth IRA Institute, created to train and educate financial advisors.
Jim’s strategies have been endorsed by The Wall Street Journal (33 times), Newsweek, Money Magazine, Smart Money, Reader’s Digest, Bottom Line, and Kiplinger’s. His articles have appeared in Bottom Line, Trusts and Estates Magazine, Financial Planning, The Tax Adviser, Journal of Retirement Planning, and The Pennsylvania Lawyer magazine.
Jim is the best-selling author of Retire Secure! (Wiley, 2006 and 2009), endorsed by Charles Schwab, Larry King, Ed Slott, Jane Bryant Quinn, Roger Ibbotson and The Roth Revolution, Pay Taxes Once and Never Again endorsed by Ed Slott, Natalie Choate and Bob Keebler.
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Those of you who have been following me for a while know that that one of my most cherished mantras is “Pay Taxes Later!” An extension of that mantra was my recommendation that, upon your death, your beneficiaries continue to take advantage of the minimum distribution rules to “stretch” your IRA for as long as possible so that they could achieve the maximum tax-deferred growth possible. This used to be a fairly straightforward concept but, with the increase in second and third marriages, as well as non-traditional marriages, it has become much more complicated.
A nationally recognized IRA, Roth IRA conversion, and 401(k) expert, he is a regular speaker to both consumers and professional organizations. Jim is the creator of the Lange Cascading Beneficiary Plan™, a benchmark in retirement planning with the flexibility and control it offers the surviving spouse, and the founder of The Roth IRA Institute, created to train and educate financial advisors.
In January of 2015, President Obama proposed eliminating the tax-free benefits of Section 529 college savings plans. Under his proposal, savings would grow tax-deferred, but withdrawals would be taxed as income to the beneficiary (usually the student). His belief was that taxpayers who save in 529 plans are families who can better afford the cost of college than everyone else. In reality, it is estimated that close to ten percent of 529 accounts are owned by households having income below $50,000, and over 70 percent are owned by households with income below $150,000. What isn’t surprising, though, is that the tax revenue realized by this action would have been significant, because as of the end of the 4th quarter of 2014, the assets held in 529 and other college savings plans reached almost a quarter of a trillion dollars. How many students would have been forced to apply for loans if they had been required to pay tax on withdrawals from their college savings plans? Fortunately, the House of Representatives thought differently than the President and, in February of 2015, they passed HR 529. This bill not only maintains the tax-free status of 529 plans, but also makes them more flexible and easier to use. Hopefully the Senate will follow the House’s lead and pass a companion bill with similar provisions.
Some employees have Stock Options, or the option to buy the stock of the company that they work for within their retirement plans. A unanimous Supreme Court decision in 2014 might discourage employers from offering their employees a stake in the business in future years, because they can now be held liable if the value of the stock drops. Employers can now also be held liable under insider trading laws for certain actions they make within the retirement plan, with respects to company stock.
The Center for Disease Control annually publishes a document called the National Vital Statistics Report. This report estimates the life expectancy of men and women in the United States. At birth, the life expectancy for a male is 76.7 years and, for a female, 81.4 years. What is interesting about the report, however, is that it shows that, the longer you do live, the more your life expectancy increases. If you’ve already made it to age 65 and are male, you are likely to continue to live until age 83. If you’re a 65-year old female, you can be expected to live until age 85.5. If you’re a male and you’ve already made it to age 80, you can expect to live until age 88.3; an 80-year old female can expect to live until age 89.7. When your life expectancy continues to increase, how can you possibly make sure that the money you’ve saved for retirement lasts for your entire life?
Earlier this year, President Obama announced that he wants to create new rules that give financial advisors a “fiduciary” status under the law. I welcome this wholeheartedly because a fiduciary is required to always put his clients’ interests ahead of his own. This means that a financial advisor cannot make investment recommendations based on the commission they would receive from the investment, and that they must first consider the benefits that would be received by their client. As a fee-based advisor I have always served as a fiduciary to my clients and believe that it is an immensely important role.
Those of you who have attended my workshops or read the previous editions of my book may remember a rule of thumb I used to use that said, “Spend your after-tax dollars first, tax-deferred dollars second, and then your Roth IRA”. Well, guess what? The changes in the tax laws now mean that there are no more rules of thumb! My new advice is, “Spend your after-tax dollars first, and then withdraw traditional IRA and Roth IRA dollars strategically to optimize tax results.”
Over the years, I’ve met with many clients who have managed to accumulate small fortunes over the course of their working careers – even though their incomes were never even high enough to put them in the top two or three tax brackets. I call these clients my “savers.” These individuals seem to share one trait – mainly that they simply don’t feel the need to spend money if they don’t have to. Instead, they set the money aside for the times when they absolutely must spend and, more often than not, they spend far less than what they could.