Originally Aired: October 22, 2015
Topic: Retire Secure! with James Lange, CPA/Attorney, Best Selling Author
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Show Introduction
- Caller One: Roth IRA Conversions and Apply and Suspend
- Caller Two: The Death of the Stretch IRA
- Trusts for Younger Generations Inheriting IRAs
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange. Regular listeners have heard us talk over the years about Jim’s book Retire Secure!, and now the third edition of Retire Secure! is on the way. It’ll be coming out in the next couple of months, and tonight, we’re going to tell you about some of the new information you’ll be able to find in this updated edition. Now, since publication of the last edition in 2009, there have been plenty of tax law changes, and they have challenged Jim and his team to revamp the advice they give to retirees on a number of different topics. Specifically, some of those changes mean that IRA and retirement plan owners need to shift their focus from worrying about estate taxes to worrying about income taxes, and that’s just one of the things we’ll be talking about on the program tonight. We’ll also touch on Jim’s updated advice on Roth IRA conversions, some new tax saving strategies and mapping out your estate plans, and we’d love to take your calls and answer your specific questions about these and other retirement and estate planning topics. So, if you’d like to join us, please give us a call at (412) 333-9385, and with that, let’s say good evening to Jim Lange.
Jim Lange: Well, thank you, Dan. So, I thought what we could do today is to talk about some of the new features, but also to maybe review a couple of the more important things that I talk about in the book. But the first point that you brought out, and perhaps for many people, it is actually a new paradigm, or a new way of looking at things. In the old days, and particularly when the exemption amount (that is the amount that you are allowed to die with without having any federal estate or federal transfer tax) was $600,000, and a lot of people had more than $600,000. So, this became a concern, and people drafted wills and trusts and strategized on how to avoid estate taxes after both the husband and the wife (if you’re married) died, and that was the emphasis for a lot of planning. I’m really more of an IRA guy: IRA, retirement plan, 401(k), 403(b). So, most of my clients probably have more money in their IRAs and retirement plans than outside their IRA and retirement plans, and that’s the group that I tend to write to, and that’s also the group that these strategies tend to be the most effective with.
So, I’ve always been interested in the income taxes, both while you are working, while you are retired and you are going into your portfolio to meet your monthly expenses, and then also even after you die. So, what is now much, much different than, say, it was when I wrote the first edition of Retire Secure! in 2006? Well now, if you are married, we have a $10.6 million federal estate exemption. This assumes a few things called portability, but to oversimplify, if the planning is done right, and even just a minimal amount of planning, a husband and wife can now shield $10.6 million from federal estate tax. So, unless you have more than $10.6 million, and I’m going to take the liberty of assuming that most of our listeners do not, and will probably never grow their estates to $10.6 million, federal estate tax is not really a worry. What’s really a worry, and I would say it’s an even bigger worry, is federal income tax. So, remember, if you have an IRA or a 401(k) or a 403(b) or some type of retirement plan, remember nobody has yet paid income tax on that money. Now, you might end up paying tax on that money, and you might do it, hopefully, after retirement, and even, hopefully, in the later part of your retirement, or it’s possible that you’ll never spend that money, and if you die with an IRA or a 401(k) or a 403(b), your heirs will have to pay income tax on that money. Now, there’s different rules, and we’ll get into when they’re going to have to pay tax, but the point is there is going to be an income tax on IRA money, and if people are interested in reducing their taxes (and who, these days, is not interested in reducing their taxes?), they should be concentrating on income taxes, not estate taxes. And that’s really one of the biggest paradigm shifts. So, we could talk more about some of the ways to avoid that. We can talk about Roth IRA conversions. We can talk about the new tax law that we fear is coming. But the big paradigm shift, and the big thing that people have to keep in mind, is we have a different game now, and the game is saving income taxes, not estate taxes. So, that’s really the first thing that we should be thinking about.
Dan Weinberg: It looks like we have a caller. It is Cindy on line one. Cindy, good evening.
Cindy: Hi. I’m calling from Malvern, PA, and I have a question about my particular situation. My husband and I are both sixty-four and we’re both retired. We have a lot of money in our IRAs, and we have plenty of after-tax money too, and I just wondered what you recommend for what we do as far as, like, Roth IRA conversions and with our Social Security?
Jim Lange: Okay, well, can I ask you one or two questions so I can make sure that I’m giving you the right advice?
Jim Lange: All right. When you said you had ‘plenty of money’ in the after-tax, or money that you’ve already paid tax on, so we’re talking about money that is not an IRA, not a 401(k), not a 403(b). Do you have enough money, and I think it would be too confidential to ask you how much, but do you have enough money that you could picture living between now and when you are age seventy on the money that you have outside your IRAs?
Jim Lange: Okay. All right, and do either you or your husband enjoy health, or good enough health, that it is likely that one of you will live until seventy-seven or beyond?
Cindy: Hopefully, yes.
Jim Lange: Okay, hopefully yes, all right. So, there’s two real issues here, and by the way, it’s so wonderful that we’re talking when you’re sixty-four instead of age seventy. If you told me the same fact pattern, but you’re age seventy, most of the strategies that I’m going to recommend for you right now would not work, and what I would say is if you actually did a calculation depending on what assumptions you used and how much money you have, the difference between, let’s say, the status quo, is large. The status quo is both of you take your Social Security now, which would, in effect, reduce the amount that you’re going to get for the rest of your life, and you wouldn’t make any Roth IRA conversions. So, let’s call that the status quo, and I’m going to bet that the difference between the status quo, given the identical investments (so this isn’t an investment question; this is a strategy question), I actually think that you’re going to be at least a hundred thousand, maybe two or three hundred thousand dollars, better off because of this advice, and if you’re going to account the benefits to the next generation or even the next two generations, in some variations, the difference can literally be measured in at least hundreds of thousands, if not millions.
All right, so let’s take a look at the big picture. When one or both of you were working, you were, let’s say, in a higher tax bracket because you had income from your earnings, and now, other than, let’s say, Social Security, which, let’s call it optional between now and seventy, and other than IRA distributions, which also are optional between now and seventy because, remember, you don’t have to take minimum required distributions. You don’t have to take your Social Security. Now, you will have interests and dividends, etc. on the money from the after-tax portion of your portfolio, but that shouldn’t be all that substantial. So, if you don’t take Social Security and you don’t take money from your IRA or your retirement plans, then your projected income tax rate, between now and age seventy, is going to be very low, maybe even in the ten percent bracket.
All right, so what does this mean? Now, again, I’m not going to ask you how much is in each of these accounts because that’s a little personal, but let’s take a look at what’s going to happen when you’re age seventy. When you’re age seventy, what’s going to happen is you’re both going to have minimum required distributions from your IRAs, which will be roughly maybe four percent of the value of the IRA, and then it gets worse and worse, that is, the minimum required distribution becomes higher and higher as you age. In addition, you will both be taking your Social Security because there’s no benefit to waiting for Social Security after age seventy. So, there’s the point, Cindy: you’re going to be in a high tax bracket at age seventy whether you like it or not, and your tax bracket between age sixty-four and seventy is, to a large extent, optional. So, you could take IRA distributions and pay tax on it. Part of the advice that I do provide…and by the way, this is classic advice. This went in to all three editions of Retire Secure! It was always pay taxes later. So, I’m not a big fan of you taking money out of your IRA, paying tax on it and spending that money because it’s going to cost you $1.40 to spend a dollar from your IRA, and then your portfolio’s going to be depleted by forty cents, over and above the dollar that you need to spend. If you take it from money that you’ve already paid tax on (and you already said that you have plenty of money), then your portfolio’s only going to be depleted by a dollar, meaning that extra forty cents is available for investments.
So, I don’t want you to spend IRA dollars first. I want you to spend the after-tax dollars first. But, since you’re going to be in a very low tax bracket, it’s going to really be an interesting exercise to determine how much of a Roth IRA conversion you should make. Now, the right answer is you have to run numbers to determine the ideal amount, but off the top of my head, it looks like we have low tax brackets between sixty-four and seventy and a high tax bracket at seventy. What we should be thinking of is getting in most of, or maybe even all of, your Roth IRA conversions while you’re in a low tax bracket, and since we don’t want to really clobber you in any one year and get into a very high tax bracket, because you do such a big Roth IRA conversion, that a series of Roth IRA conversions might be a good strategy.
So, again, I don’t want to commit myself to the right number without…in our firm, of course, we run the numbers. In other words, we actually model it. So, let’s say, one example where we would do no Roth IRA conversions and do projections for thirty years. Another one, we might do Roth IRA conversions of, say, ten or twenty thousand dollars, or maybe go to the top of the ten percent bracket, and then run that forward for ten or twenty years, or thirty years. Now, we might do the same thing, but we might look at going to the top of the twenty-five percent bracket, or the top of the fifteen percent bracket, which might even be better. Then, we might look at weighting some of the earlier years heavier. But anyway, without getting into all those details, one strategy that I think would be very good would be to do a series of Roth IRA conversions that would keep you in a low tax bracket. The advantage of the Roth would be it would grow income tax-free for the rest of your life, the rest of your husband’s life, and if the taxes will stay the same, the rest of your children’s and even grandchildren’s lives. So, that’s the first answer, okay?
Cindy: Would I need to have money to pay for the conversion with the after-tax money?
Jim Lange: Yes. In fact, you already said that you had plenty of after-tax dollars.
Jim Lange: So, let’s just say, for discussion’s sake, you made a thirty thousand dollar Roth IRA conversion, and let’s say the tax on that would be…let’s just even say at the fifteen percent bracket. So, what would that be? Let’s say it’d be somewhere in the ball park of $4,500. That would be the tax on a thirty thousand dollar conversion. I would want you to pay that tax from money from outside of the IRA, all right?
Jim Lange: So, you could get, in effect, thirty thousand dollars of money that is, right now, fully taxable, into a Roth IRA, and then once you have that money there, it grows income tax-free for the rest of your life. Now, if you didn’t have the money to pay the tax from outside of the IRA, then I’m not such a big fan of making a Roth IRA conversion. My normal rule of thumb is if you don’t have the money to pay the tax on the conversion from a source that is outside of your IRA, it’s probably not worth doing. We actually had a radio show on that exact topic, but let’s not get too carried away. In general, I would be interested in having you make a series of Roth IRA conversions, preferably in a low tax bracket, and paying the tax on that conversion from outside the IRA. Okay? You’re with me so far?
Jim Lange: All right. See, one of the problems is there’s no simple question, particularly if you’re going to try to explain why, and what I have found is that virtually all my clients, they don’t want just the answer, they want why, because I tend to get a lot of quantitative types and a lot of people who, frankly, it might come as a shock to our listeners, but not everybody trusts everything that a lawyer or a financial advisor says, so they want to see the proof. So, that’s why when we run numbers, we actually have the client in the room while we’re running the numbers. So, that way, the client can see what we’re doing, and they are more likely to be on board with it because they see it, and the other reason we like to have the client in the room is because we can have the client do their own ‘what ifs.’ “Well, what if I did this?” “What if I spent that?” “What if I bought a vacation home?” One client said, “What if I buy a plane?” And their wife said, “Don’t you run that number!” So, we’re a big fan of running the numbers. So, running the numbers for Roth would be one of the things.
But the other interesting potential strategy you have is, you have a number of very interesting options not only for your IRA, but also for Social Security. So, I assume that you’d rather take Social Security early, right? Because that way, you’re sure you can get it. Is that fair, or…?
Jim Lange: All right, and that’s the way most people think. You know, “Oh, the government’s going to go out of business, the Social Security’s going to go bankrupt,” blah blah blah blah blah. Here’s the problem, and I’m going to oversimplify a little bit. Technically, it’s from sixty-six on, but I’ll oversimplify. For every year that you wait, and when I say ‘you,’ I’m going to assume we’re talking about the spouse with the higher income earnings record. So, let’s use the old sexist paradigm where it’s the husband. I’m not even going to ask you because that’s not fair. So, let’s assume, for discussion’s sake, that your husband worked for more years at a higher rate, and if he takes it at sixty-four, whatever that number is, I’m going to oversimplify and say if he waited between sixty-four and seventy, what would happen is he would actually get an eight percent raise in his benefit for every year that he waits, okay? Now, this ends up being very, very substantial. It’s not quite double, but…plus the cost of living, by the way. So, you might say, “Well, gee, what if we die early and we don’t make it to age seventy-seven?” Which, in this calculation, with a husband and wife and using a strategy that I’m interested in called apply and suspend, we could consider doing this apply and suspend strategy, and if you do both die early, it is true your family will end up with less money, and Cindy, I don’t know how to say it nicely, but if you both die early, then you’re dead, and you shouldn’t be fearing an early death for financial planning purposes. What you should be fearing is living a long time and outliving your money.
Jim Lange: And when you run the numbers, to get that extra eight percent bonus is really about the cheapest type of insurance that you can get. No insurance company would give you anywhere near as favorable an implicit rate as the IRS. So, one of the things that we might consider is having the spouse with the higher earnings record wait until seventy. Now, does that mean that you’re not going to have either of you get any money until seventy? No. And does that mean that your husband, if he’s the one with the higher earnings record, should do nothing when they turn sixty-six? No. So, here’s a strategy that will most likely serve you best. I would consider having your husband do something called apply and suspend at age sixty-six, at full retirement age. What apply and suspend is, is he applies for Social Security, but he says, “Don’t pay me now.” So, what’s the difference between applying and suspending, meaning I apply for it but say “Don’t pay me now” and then just doing nothing? The difference is, if your husband applies and suspends, then what you can do is you can file for a spousal benefit, all right? So, he’s sixty-six, you’re sixty-six in this example, and what can happen is he applies for Social Security…I’ll oversimplify. I’m not going to get into the difference in months. But he applies for Social Security. He suspends, so he’s not collecting anything and he’s still keeping his eight percent raises per year. Now, you apply for a spousal benefit when you’re sixty-six. That means you would get half of what he is entitled to at sixty-six. Now, here’s the really cool thing about that: let’s just make up a number. Let’s say that his benefit would be $30,000 a year. So, now you’re collecting $15,000 a year as a spousal benefit. But here’s what’s really nice: the $15,000 a year that you’re collecting does not hurt your husband at all. In fact, he continues to get his eight percent raises every single year from sixty-six to seventy, and the fact that you’re collecting on his record doesn’t hurt him at all. Then, when you’re both seventy, we take a look to see which one is higher: half of his, which is what you’ve been collecting all along, or yours. And here’s the beauty of what has part of this strategy called apply and suspend: your Social Security goes up by eight percent for every year between sixty-six and seventy even though you’re collecting half of a benefit.
Jim Lange: So, if you combine the strategies, and then we’re getting even a little bit more complicated, we believe that it is synergistic. That is, the whole is greater than the sum of the parts. We can end up with, literally, a situation where you guys are at least a hundred thousand…and by the way, some of the numbers I’ve run, it’s literally hundreds of thousands of dollars better off. So, regardless of investment choices, although obviously, you know, we’re usually fans of low-cost index investing, there’s some very interesting strategies that are available to you and your spouse. So, does that help?
Cindy: That’s great, yeah. It sounds like free money.
Jim Lange: All right, well, free money is a good way to look at it. And one of the things that you might consider doing, if you’re interested in learning a little bit about, let’s say, our upcoming book and some of the strategies, is we can give you a website where you can get a four-page report and all kinds of videos. Maybe I’ll ask Dan to do that before break.
Dan Weinberg: That’s right, and Cindy, thanks so much for the call. By the way, anybody else who’d like to give us a call, plenty of time for your questions and comments tonight: (412) 333-9385. And as Jim mentioned, if you’d like to sign up to find out when the new edition of Retire Secure! becomes available, get a four-page summary of the best strategies in the book and some free videos as well, go to www.retiresecurebook.com.
Jim Lange: Dan, one of the things that you mentioned was (and that I think is on a lot of people’s minds) what is the best way to prepare your estate? Actually, you know something? I was about to go into that, but we have another call.
Dan Weinberg: We do.
Jim Lange: And very frankly, by the way, just like in the workshops, and I mean this sincerely, the favorite part for me of the workshops is the calls. So, I think we have Bob from Sarasota.
Dan Weinberg: Go ahead, Bob. You’re on.
Bob: Okay. Mr. Lange, I’ve been following your books, and I’m very interested in Roth IRAs for my grandchildren, and I’m wondering what dangers you see in the near future, or in the distant future, to the continued existence of the stretching feature of the Roth IRAs?
Jim Lange: Well, you stole some of my thunder, Bob, because I was going to talk about this. This is a very serious issue for guys like you. All right, so let’s talk about what the existing law is, and let’s talk about what the potential law is, and let’s talk about the difference between what you should be doing now and what you should be thinking of. All right, so if you mentioned Roth IRA for a grandchild, can I take it that you already have a Roth IRA and that there’s a reasonable chance that you’re not going to spend it during your lifetime?
Jim Lange: Okay, all right.
Bob: But the trust is not written yet. We’re working on that.
Jim Lange: Okay. All right. And how old are your grandchildren right now?
Bob: They range in age from two to eleven.
Jim Lange: Okay. All right, so first of all, you are absolutely right. You should have a trust, and if you’re planning to leave the Roth IRA to your grandchildren, it is critical that you have a trust drafted for their benefit because otherwise, they can have a party on your money at twenty-one, and I don’t think that that’s the intent. In fact, under the existing law, this is what I would love to see for your Roth IRA. Under the existing law, as you probably know, there’s no minimum required distribution. I’m not going to ask you how much is in the Roth IRA. That’s a little personal. Let’s just use a nice round number like $100,000. So, let’s say there is $100,000 in a Roth IRA, and let’s assume, for discussion’s sake, that you have money from outside the IRA. That is, either after-tax dollars or even traditional IRA dollars, or you might have income from Social Security or from some other source, maybe a pension, that you don’t need to spend the Roth IRA.
Bob: That’s right.
Jim Lange: Okay. So, right now, we have no minimum required distributions, and that money, under existing law, can continue to grow income tax-free from now until the day you die. Are you married, Bob?
Jim Lange: All right. Let’s assume, for discussion’s sake, since you’re the guy (we’re going to pick on guys today, and actuarially, we guys are likely to live seven years less than our same-age spouse), that you die first and you leave your IRA to your wife. And usually, people want to make sure that their spouse is okay before they leave money to a grandchild, although, interestingly enough, I’d actually like to give your wife the choice, but let’s not get into that for this question. So then, what we would do is we would name, let’s say, your wife as the primary beneficiary of the IRA, and then, assuming we’re going to skip the children (and that’s another discussion that we could have, but I want to get to the change of the law), what would happen is you would die, leave the money to your wife, your wife would eventually die, leave the money to children, let’s assume the children are young enough that it’s still in a trust, or maybe some of them are beyond the time they need a trust, and under the existing law…all right, so let’s say that by the time you and your wife are gone, that that IRA…let’s say that you two live twenty years and let’s say the money was invested at seven percent. So, that $100,000 Roth IRA will now be $400,000.
Jim Lange: All right? Now, you’re going to say, “Where’d you get seven percent?” Well, that’s another question for another day. But let’s assume that there’s $400,000, and let’s keep it simple. Let’s say you have four grandchildren and each grandchild gets $100,000. Under the existing law, what that grandchild could do is they could continue the tax-free growth on that Roth IRA. Now, they would have to take what’s called a minimum required distribution of the inherited Roth IRA. So, to simplify, let’s say that one of the grandchildren is thirty years old at the time. Let’s assume that their life expectancy, according to the tables, is roughly fifty years. Then, what they could do is they would be required to take out two percent (that is fifty divided by the balance, which is two percent) of the inherited Roth IRA. Now, that money will be income tax-free. Now, the following year, they would take forty-nine and divide that into the balance of the inherited Roth IRA. The following year, forty-eight into the balance of the inherited Roth IRA.
Bob: Where did you find those numbers? Fifty, forty-nine, forty-eight?
Jim Lange: Well, actually, I made them up, but where you can find them is in Publication 590.
Jim Lange: All right. Also, there’s lots of websites that have that, and Publication 590 has different factors. They have factors for you and your wife, they have factors if you are married to somebody who is ten years younger, and then they have factors for beneficiaries. So, this is the beneficiary factor.
Bob: I see.
Jim Lange: And I just picked simple numbers to make the math easy, okay? So, I said that, you know, he was thirty with a fifty-year life expectancy.
Jim Lange: It’s probably a little bit longer than that, but that’s the general idea. Now, if he doesn’t need the money, or he doesn’t need it soon after you and your wife die, under existing law, he can continue to defer those tax-free distributions to some extent for the rest of his life. So, literally, if you made a $100,000 Roth conversion, there are variations that he is literally millions and millions of dollars better off…or, I should say, all your grandchildren would be literally millions and millions of dollars better off because you made that conversion, and even if you adjust for inflation, they still are, depending on what assumptions you use, maybe $500,000, maybe $800,000 better off, even in today’s dollars. So, this is a great thing under existing tax law.
All right, now, let me tell you the bad news. The bad news is, I fear that they’re going to change this law, and I think I have some pretty good reasons to fear it. First, let me tell you how bad it will be, and then let me tell you why I think there’s a good chance of it being changed. If the new law that has been proposed and voted on, that narrowly we literally dodged a bullet, if that is passed, the new law will say everything’s going to be the same for you, everything’s going to be the same for your wife, but after you’re both gone, rather than the children being able to defer the Roth IRA or distributions on the Roth IRA for the rest of their lives, at least to some extent, they would have to take all the money out in five years. Now, since it’s a Roth, it won’t be taxable, but instead of getting, let’s say, an extra fifty years of tax-free growth after you and your wife die, your grandchildren might only get five years.
Jim Lange: If you leave them a traditional IRA, it’s basically the same thing except with the inherited IRA, they would still have to take a minimum required distribution of the inherited IRA. It would be taxable. Under existing law, they can stretch or defer the vast majority of the taxes for many, many years, but under the proposed law, they would have to take the entire inherited IRA and pay tax on it within five years of your and your wife’s death.
Bob: That’s for both Roth and traditional?
Jim Lange: Yeah, that’s right.
Bob: Okay, okay.
Jim Lange: All right. Now, here’s why I fear that this will likely happen. First of all, President Obama wants it, and you might say, “Well, gee, aren’t the Republicans going to save us?” And, actually, no, because in 2013, this came up for a vote. President Obama wanted it, the Republican House wanted it, and it was actually the Democratic Senate that said no. But now, we have a Republican Senate that will likely say yes, we have a Republican House that will likely say yes, we have a President that will likely say yes, and I really fear that this is going to come up in the next couple years and they’re going to change the law, and it’s going to be pretty miserable for people like you who have been prudent all your lives and saved some money and even converted to Roths with the idea that this could be a wonderful tax-free legacy to your family.
Jim Lange: All right. So now, the question might become well, how would I change my planning knowing that this potential law is on the horizon?
Jim Lange: What I would do is, I might be a little bit more conservative about how much money I would convert to a Roth. So, I’ll give you an example: let’s say if I knew that we were going to keep the existing laws, and let’s say that we figured out, we ran numbers for Roth IRA conversions and determined how much you could convert, but it turned out, the numbers that we used, you were actually a little bit worse off during your lifetime because we were so interested in what was going to happen to your children and even grandchildren that I wasn’t so…you know, let’s say you were maybe $10,000, $20,000, $50,000 worse off. If your grandchildren were going to be hundreds of thousands, or even millions of dollars, better off, you might have said, “Well, that’s okay because I can afford to be a little bit worse off if they can be much, much, much better.” Well now, if they’re going to have to pay tax on the whole thing in a traditional, or if they’re going to have to take all the money out of the Roth within five years of your and your wife’s death, then I don’t want to make a calculation where you and your wife might be worse off. So, I’m still a Roth IRA advocate for most people, but I might be more conservative as to how much money I should recommend that you could convert.
Bob: And I have a question for clarification for what you said.
Jim Lange: Okay, fair enough.
Bob: It’s been my impression that Republicans tend to be do whatever they can to lower taxes, and yet these moves that you’re expecting by the Republican Senate and House seem to me to be just the opposite, not lowering taxes. Why is it that Republicans are opposed to this system? I can understand why Democrats might be, but not Republicans.
Jim Lange: Well, I had that exact same question, and here’s the answer that I was given: that the Republicans want to lower taxes in general, and in order to pay for that reduction in taxes, they are trying to take away the tax ‘goodies,’ if you will.
Bob: Oh, I get it.
Jim Lange: And this stretch IRA, or this stretch Roth IRA, is considered, say, a tax goodie. So, this might be a method of simplifying and reducing taxes for everybody, but frankly, it comes at the expense of long-time savers. The other thing is, from a personal standpoint, I’ve done about 2,000 estate plans where the stretch IRA and the stretch Roth IRA have been major planning components, and very frankly, were going to probably be my most significant legacy, and now that legacy is seriously threatened.
Jim Lange: But I did want to talk about actually two other things before we call it a day because this is very important. Let’s assume…and let’s not get into why we want to leave it to grandchildren instead of children, although that’s another interesting discussion. All right, so right now, these grandchildren are young, and unfortunately, when you do estate planning, you have to take into account the possibility that something could happen to you and your wife, and then boom! These Roth IRAs would go to your grandchildren.
Jim Lange: If you don’t have a trust, what would happen, under Florida law, which, by the way, would be pretty much the same as any state law, except there might be a different ‘age of majority’ that might be eighteen or twenty-one. But what would happen is there would be somebody appointed to watch over that money and dole it out to the grandchildren, presumably as needed, until they are either eighteen or twenty-one, depending on the law of the state, and then there would be no restriction, meaning that your grandkids could, you know, go out, find out about the money, withdraw all the money, go out, buy a Maserati, go out on a drinking binge, go out and, you know, have some drugs and sex and rock and roll and everything else on your dollar, which somehow, I suspect, is not really the purpose that you saved that money for them. Is that fair?
Bob: That’s correct.
Jim Lange: All right. And the other thing is, right now, they’re too young for you to know if they’re going to be responsible kids or not, and even if they are, you know, twenty-one is pretty young these days.
Jim Lange: So, I would recommend that rather than just leaving it outright to them, that there be what’s called a testamentary trust. Now, a testamentary trust means that it is a trust that doesn’t take effect. It has no power. There’s no money in it until you and your wife die. So, during your lifetime, it’s 100% your money. You could do whatever you want. You could spend it. You could burn it. You could invest it. Whatever you want. Then, if you die and you name your wife your primary beneficiary, she would have the same power. Again, whatever she wants. But after both of you are gone, and let’s assume that your grandchildren are still young enough that they would fall under the terms of the trust, you might have a trust that says something like…now, you might vary it for individual purposes and your own preferences, but I’ll give you a starting point. “The trust is to be invested, and the income from the trust, or the minimum required distribution of the inherited IRA or the inherited Roth IRA, will be distributed to the beneficiary, and the beneficiary the trustee has empowered to go into the trust for principle for health, maintenance, support and education.” So now, we have a trustee who, without knowing better, I would want it to be one of your children. I don’t want it to be an attorney. I don’t want it to be a bank. I’d like it to be a family member that you trust that would invest the money for the benefit of your grandchildren, and then dole it out as appropriate. It’s really important that, if you do this, you go to an attorney that knows what they’re doing because there’s six specific conditions that that a trust must meet in order (I’m getting a little technical now) to qualify as a designated beneficiary.
Jim Lange: So, you don’t want to just go to any attorney. You want to go to an attorney who is very used to drafting trusts as beneficiaries of IRAs, and if you were to do that, then if they don’t change the law, you’re very likely to get the result that you want, which is long-term tax-free growth for your Roth, and maybe even long-term tax-deferred growth for your traditional IRA. Now, most attorneys don’t do a good job of drafting trusts for the benefit of grandchildren when the underlying asset is an IRA, and actually the Wall Street Journal came out with an article that said don’t draft a trust, and by the way, Bruce Steiner, who’s an estate attorney from New York, we both, the same day, wrote letters to the Wall Street Journal saying, “No, you gave the wrong advice. The advice should not be ‘don’t draft a trust.’ It should just be ‘find an attorney that knows what they’re doing, that knows how to draft that trust.’”
Jim Lange: So, that would be my indicated course for you. You said you’re in the process of getting that done, and I think that’s great, and hopefully, the attorney that you’ve chosen is experienced and diligent and will properly draft that trust. I do like the idea of naming your spouse first because I never, ever want to not completely protect the spouse. Now normally, what we tend to do, under the classic Lange’s Cascading Beneficiary Plan, is rather than naming your grandchildren after your wife, we would typically name your children, and then give your children the choice of whether they want to keep the inherited IRA or the inherited Roth IRA for themselves, or whether they want to (the legal word is) disclaim the IRA. But if they disclaim it, instead of just disclaiming it to nowhere, they literally have a well-drafted trust to disclaim into where they can be the beneficiary. Now, you might prefer just skipping that generation, or you might prefer leaving some each, or you might prefer giving that generation the option to disclaim, and if you have more than one child, you might have different children making different choices. So, one child might say, “Yes, I’d like to keep it all. I need it.” And the other child might say, “Well, no. I don’t need it. It’s worth more to the grandchild, so I’ll disclaim it.” And then, another child might say, “Well, I’ll keep half and disclaim half.”
Bob: Does your new book tell how to make one of these trusts?
Jim Lange: Well, it sure does.
Bob: Oh, good.
Jim Lange: Now, it’s not going to have the detail that you could just do this yourself, but it does have a discussion of our classic estate plan, which is called Lange’s Cascading Beneficiary Plan, and if you like that flexible approach that I just mentioned, that would be a good source for you. Also, the four-page summary has that also.
Bob: Well, as I see it, the difference between what we have now and what we would have (if Congress does what you’re expecting it to do) is that all the RMDs would have to be collected within five years, but they would still stay in the trust under control of the trustee.
Jim Lange: That’s right. Very good. Very good.
Bob: Ah, okay.
Jim Lange: So, you can see why obviously it would be better if we could use the existing law. Unfortunately, some people say, “Well, am I grandfathered by the fact that I have it set up before they change the law?” And unfortunately, the answer is no, and the price for getting it grandfathered might be a little bit too high. Do you want to know what the price is though?
Jim Lange: You have to die.
Jim Lange: I am getting the look from Dan Weinberg, so I assume that we are done?
Dan Weinberg: Well, we got about a minute left if you have any closing thoughts. Bob, thank you so much for the call.
Bob: Well, thank you very much for the information. I want you to know I’ll get a copy of your new book.
Jim Lange: We do appreciate it. All right, great. Thank you, Bob.
Bob: I’m not trying to be somebody promoting your book on the side. I really am interested in what you said and I think it was very helpful.
Jim Lange: Well, Bob, I never mind when a caller promotes my book! Bob from Sarasota…by the way, Sarasota’s a beautiful town in Florida with lots of artistic things. They have concerts and art galleries and all kinds of things. I have a cousin that lives in Sarasota. I just saw him last winter.
And by the way, the book is really national in scope. I’m obviously a Pennsylvania practitioner with a law firm, a CPA firm and an investment advisory firm located in Pittsburgh, and what we tend to do for our local clients is give them the options of tax preparation and will preparation. Our office actually does all the strategies, the Roth, Social Security, that stuff, then we work with P.J. DiNuzzo, who uses low-cost index funds to invest the money, and then, together, rather than each of us charging a fee, we charge one percent or less, depending on how much money is invested.
Dan Weinberg: All right, great information tonight, and we’ve been talking about the new edition of Retire Secure!, the third edition of Jim’s book. Now, if you would like to learn more about this, go to www.retiresecurebook.com, and there, you can sign up to be notified when the book is available, which hopefully will be in the next month or two, right?
Jim Lange: Probably two.
Dan Weinberg: Okay, two months. You can also get a four-page summary of the best strategies contained in the book, as well as from free videos. Again, that is www.retiresecurebook.com. I’m Dan Weinberg, and for Jim Lange, thanks so much for listening. We’ll see you again for another edition of The Lange Money Hour.