Originally Aired: June 9, 2016
Topic: New Rules Could Massively Increase Tax Burden on Inherited IRAs with James Lange
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- The Beneficiary Determines the Outcome of an IRA
- What if the Spouse is Not the Beneficiary?
- Stretch IRAs give Greater Benefit to Younger Beneficiaries
- ‘Leave It to Beaver’: Three Classes of Potential Beneficiaries
- Disclaiming Inherited IRA can Benefit Children/Grandchildren
- Stretch IRA could Come to an End in 2017 ? or Not
- Death of Stretch IRA could Mean Huge Tax Liability
- Charitable Remainder Trust is a Good Way to Avoid Tax Hit
- Downsides of Charitable Remainder Trusts
- Another Strategy: Spend More to Leave a Smaller IRA
- What To Do Now, Whether the Stretch IRA Dies or Not
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.
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and attorney Jim Lange. This week, our focus is on the death of the stretch IRA: what it will mean, and what some of the alternatives are for investors when the stretch IRA laws are eventually changed. Now, this is an issue that regular listeners have heard Jim and his guests talk about, but today, we’re really going to tackle the subject in depth, including some potential alternatives to the stretch IRA, specifically charitable trusts. So, let’s not waste time. Let’s get right into our discussion.
And Jim, let’s start at the beginning, and I guess the first question would be: What happens to an IRA when an IRA owner dies?
Jim Lange: What happens to an IRA at death will depend on who the beneficiary is. And let’s take two broad classes of beneficiaries and distinguish the different rules between them. The first is the spousal beneficiary. That is, the husband names his wife or the wife names her husband. And what happens then is the IRA continues (subject to several exceptions that are probably not too important for most people) as if it was the IRA of the spouse directly. So, let’s say, for discussion’s sake, that at your death, your spouse is 65 years old, and your spouse elects to roll over, or do a trustee-to-trustee transfer, into their own IRA. At that point, since they are not yet 70, if they want, they can continue to let that IRA grow and to earn dividends, appreciate capital gains, et cetera, without having to take any money out until they are 70½, at which time, they are basically required to use the same rules that you are when you turn 70½. To be more specific, if you are not yet 70½ and you have money in your IRA, you can continue to let it grow and to accumulate, but then, when you turn 70½ ? technically, April 1st of the year following the year you turned 70½ ? you must take what’s called a minimum required distribution of the IRA. So, let’s say, for discussion’s sake, to use a nice even number, that the IRA is valued at $1 million, and that the factor is somewhere around 25. So, to oversimplify, you would be required to take out four percent of that IRA … actually, it’s a little bit less, but at four percent of the IRA. So, you’re taking out $40,000. You must pay income tax on that money whether you like it or not. After you pay income tax on that money, you can do anything you want with it. You can spend it. You could give it away. You can continue to invest it. But that money will no longer be an IRA. Some people say, ‘Well, gee, since I have to pay tax on the money anyway, can’t I just convert that to a Roth?’ And the answer is no, you can’t. If you want to do a Roth IRA and you are over 70½, not only do you have to take your minimum required distribution and pay tax on it, but you also must take an additional chunk of money, convert that to a Roth and pay income tax on that additional chunk. But forgetting the Roth for the moment, the idea is, after you are 70, you must take money out of your retirement plan and pay taxes on it. If you can afford to, I would prefer that you take out only the minimum, and in other workshops and radio shows, I’ve talked about the idea of don’t pay taxes now, pay taxes later, with the exception of the Roth, which would apply in the accumulation stage when you are earning money for your retirement, the distribution stage when you are taking money from your IRAs and retirement plans to meet your expenses, and even, in what we’re going to be talking about mostly today, in the estate-planning stage, which is what happens to an IRA after you’re gone. So, in answer to … and this is just part one of your question ‘What happens to an IRA?’is if you leave it to your spouse, subject to exception, it more or less continues as if it was the spouse’s IRA.
All right, now, the more important issue for our purposes today is what if the beneficiary is not a spouse? And by the way, it could be anybody. It could be a friend, a niece, a nephew, a lover, whatever it might be, but I’m going to assume for the moment that it’s your children or child. So, what happens if you die with an IRA and you leave it to your child, or perhaps you die with an IRA, you leave it to your spouse, and then at the second death, the IRA goes to your child? At that point, the child has a unique asset, and it’s not like any other asset in the Internal Revenue Code. It isn’t an IRA because it has its own special characteristics, and in addition, nobody has yet paid income tax on that money, and unless you end up leaving it to charity or your child leaves it to charity, someday, somebody will pay income tax on that money.
So, let’s assume, for discussion’s sake, that your child doesn’t need the whole chunk of money immediately, and remember, since nobody has paid income tax on that money, whenever a child takes money out of that IRA, which the proper name for is called an inherited IRA, they will have to pay taxes. Let’s say they have a job, and let’s say that they have a source of income, and they can afford to live on the money that they are earning, and maybe they need a little bit of money from the IRA to help meet expenses. Well, if that’s the case, I would prefer that your child take out the absolute minimum that they are required to take out.
So, the next question is: Okay, what is the minimum that the child, or the beneficiary of the IRA, must take out of the inherited IRA in order to comply with tax laws? And basically, the way that number’s going to be calculated is we’re going to take the child’s life expectancy, which, according to the tables in Publication 590, and it’s not even the child’s actual life expectancy, the health of the child isn’t important, it’s just the determination by the IRS of what they think is a reasonable proximity of life expectancy, but you must use their table. And let’s just assume, for discussion’s sake, the life expectancy (maybe the child is in his 50s) is 30 years. So, you would take one over 30, which is a little bit more than three percent, and multiply it times the balance of the IRA as of December 31st of the prior year. So, again, to make the math easy, the child inherits a $1 million IRA. They must take out roughly (depending on their age, of course) $30,000 and pay income tax on that money, just like you had to pay income tax, whether you liked it or not, when you were over 70. The next year, it’s the same drill except that the life expectancy has gone down, so the child is going to have to use 29 as the divisor, or, looked at another way, one over 29 times the balance of the account as of December 31st of the prior year. Next year, one over 28 times the balance of the IRA, or technically, inherited IRA, and that pattern will continue for as long as that child is alive. And that is known as the ‘stretch IRA’because what you are doing is you are stretching or expanding the period of tax deferral for the IRA well beyond the number of years that the IRA owner was alive.
Dan Weinberg: So, does that then mean that, under existing law, a younger beneficiary would get a greater stretch or ability to defer taxes than an older beneficiary?
Jim Lange: Yeah, that’s correct. So, let’s say, for discussion’s sake, let’s take the extreme. Let’s say the beneficiary is a grandchild, or a grandniece or nephew, and they have a 50- or 60-year life expectancy. In that case, the minimum required distribution of the inherited IRA would be much lower than if, let’s say, for example, you named somebody of your generation or a sibling. Likewise, the inherited IRA is worth more to the child than it is to the parent in most cases, and it is worth more to the grandchild than it is to the child. So, depending on who the beneficiary is, you actually get a much different result on what the required minimum distribution of the inherited IRA is, and that also has implications for who you should name as the beneficiary of your IRA.
Dan Weinberg: Okay, so still talking about the existing law, what do you think is the best estate plan for a traditional family?
Jim Lange: Well, let’s take a typical situation, if there is such a thing, and let’s call it the ‘Leave It to Beaver’ family. I call it a ‘Leave It to Beaver’ because it’s the original husband, the original wife and the same kids, just like the Beaver in the TV show that many of us remember, and we are showing our age when we say that because I think Jerry Mathers is about 60 or something like that. But anyway, what happens in that situation is … and let’s say the Beaver is grown up and we are deciding who should be the beneficiary. And let’s oversimplify and have three, what I’ll call ‘classes’ of potential beneficiaries. The first would be the surviving spouse. Why? We love our surviving spouse. That is the overriding concern with virtually every traditional married couple that I have, which is the first concern is to make sure that we have enough money to live comfortably in the manner in which we are accustomed, or even better, for the rest of both of our lives. The second goal is the same as the first goal, but after the first person dies. In other words, nobody I think that I could ever remember walked into my office and said, ‘My goal is to make my grandchild so stinkin’ rich they never have to work a day in their life.’ What they do is they come in and they say, ‘I want to make sure that my spouse is provided for.’ So, even though the spouse is older, and even though the minimum required distribution of the IRA is likely to be greater for the spouse, which will accelerate income taxes, usually we name the primary beneficiary of the IRA as the surviving spouse because that’s who we want to take care of, not necessarily because it makes the most income-tax sense. On the other hand, there is an argument for naming the child because the child would have a longer life expectancy and the inherited IRA would be worth more to the child than to the grandchild. And likewise, there is an argument for the grandchild, or more typically, a well-drafted trust for the benefit of the grandchild, because that way, the grandchild can take a much smaller minimum required distribution of the inherited IRA and get a much greater tax deferral than either their parent ? that is, the child ? or the spouse of the IRA owner.
So, let’s assume that we have these three generations of potential beneficiaries. So, Dan, even in your own case, where, you know, your mom and your dad are both alive right now, and then the next generation is you and your siblings, and then the next generation is the children of you and your siblings. So, let’s say that your parents are deciding on who their beneficiary of their IRA and retirement plan should be. Well, the natural first choice would be your mom, or the spouse of the IRA owner. The next natural choice, even though it might be a better choice from an income-tax standpoint, would be the children. And then, even though it’s best from an income-tax standpoint, trusts, or, as I mentioned before, well-drafted trusts that would serve as the beneficiary of the inherited IRA would be great for tax purposes, but maybe your parents don’t want to benefit a grandparent before a child or a child before the surviving spouse. So, that’s the conundrum, and here’s the problem with estate planning: We don’t know what’s going to happen.
So, let’s take three possibilities, and again, we’ll go back to your parents. One, the money’s great. Man, your dad made a lot of money. Whatever they did, the money’s great, and there’s way more than enough money to take care of your mom, and it kind of makes some sense to have the next two generations enjoy some of these tax benefits. Well, that’s a pretty good argument for naming the next two generations for a part of it.
Or, let’s say it’s the other way. You know, we have another 2008. Your dad and your mom lose a good chunk of their investments. Maybe there’s a medical problem, and now, they’re thinking, ‘Oh jeez, it’d be great to help the kids and grandkids, but we just need the money ourselves. We’d better make sure to name each other as a beneficiary.’
Or, let’s say it’s really good, and then the question might be, ‘Well, how are the kids doing financially?’ Maybe one kid is doing very well and it might make sense that they don’t need the inherited IRA, in which case, we can name that child’s portion into a well-drafted trust for the benefit of that child’s children.
So, we have these three generations of possibilities, and the truth is we’re not going to really know what is the best choice because we don’t know what’s going to happen in the future. But what if we did this? And by the way, if your parents were in and I was doing their will, I would turn to your dad and I would actually say, in a very serious voice, ‘Do you trust your wife?’ Hopefully, he would say, ‘Yes.’ I don’t always get a yes, but let’s say he would say yes. Then I would turn to your mom and say, ‘Well, do you trust your husband?’ And let’s again say that they both said yes. So, in that case, and remember, this is the ‘Leave It to Beaver’ family with the same children and the same grandchildren, not a situation where we have children from his marriage and children from her marriage. It’s children from our marriage. So, I would start by naming each other first. Then, as the contingent beneficiary, I would name the children equally. Typically equally, not always. But here’s the thing that we would add that you don’t see in very many estate plans: I would specifically give the survivor, and I would actually put this in writing, the right to, and the legal word is, ‘disclaim’ as much or as little of the IRA ? or, if it ends up going to a child or a grandchild, the inherited IRA ? as they like.
So, let’s take three examples. One, your dad dies with $500,000 in an IRA, and everybody agrees that your mom’s going to need every nickel of it. So, your mom just keeps it. End of story.
Number two: Your dad dies with $3 million of an IRA, and your mom says, ‘Gee, $2.5 million is more than I’m going to need. But at the time, I will disclaim so the children can now split this $500,000.’
And now, let’s take it a step further: Let’s say one child is doing very, very well financially and the other one is not. The one that is doing not so well, they’ll say, ‘Hey, I’d love to help out my kids, but I need the money. So therefore, I’m going to keep the inherited IRA. I will, as Jim mentioned, take out the minimum required distribution of the inherited IRA, and even though I’d love to have some of it go to my children, I just need it for myself.’ But maybe the child that has a lot of money can say, ‘Hey, I can have some of the money, or maybe even all of the inherited IRA, instead of going directly to me, having it go to a well-drafted trust for the benefit of my children.’ So, if the paperwork is set up properly by your parents, where we give, at first, the parents the right to keep or disclaim any or all of the IRA, then to children equally, and then each child has the right to keep or disclaim any part of the inherited IRA, or to well-drafted trusts for the grandchildren. But keep in mind, you’re probably not as interested in benefitting your nieces and nephews as your children. So, if you were to disclaim, we would have the disclaimer for you go into well-drafted trusts for your children. Likewise, if a sibling of yours was to disclaim, we would have a trust specifically set up for the children of that disclaiming parent. So, this very, very flexible approach, which, frankly, I’ve been doing since the ‘90s, and it’s actually coined in the literature. You can find, I think, like a hundred thousand references to it if you type it in Google, and it might go under two different names. One is the proper name that The Wall Street Journal called it on multiple occasions, the Cascading Beneficiary Plan, and the other one is called Lange’s Cascading Beneficiary Plan, which is, of course, the one that I favor.
So anyway, with existing law, my big desire for estate planning is to build flexibility into the estate plan, and then you can let events that occur between now and the first and ultimately the second death determine which choices make the most sense, and then we empower certain people to make those choices.
Dan Weinberg: You went through all this trouble of explaining the current law surrounding the stretch IRA, and my question to you is: Can we count on this remaining the law?
Jim Lange: Well, up until several years ago, while there could always be changes in the tax law, we didn’t have any specific reason to think that that law, which I will refer to as the ‘stretch IRA,’ was in danger. In fact, we have drafted over 2,200 wills, trusts and estate plans and beneficiaries of IRAs and retirement plans, where we have used that flexible approach, and that flexible approach is ideal under the existing law, and we didn’t really have any reason to doubt that that would not continue to be the law. Except the problem is, in recent years, Congress wants more and more money from us taxpayers, and it’s not politically feasible, or, at least popular, to raise income-tax rates. So, Congress is kind of looking to get the money by maybe sneaking through the back door. So, what they came up with was a proposal that instead of stretching, or allowing the inherited IRA to continue for the life of the beneficiary, that the beneficiary of the IRA would have to pay income tax on the entire IRA, or the entire inherited IRA, within five years of the parent’s death, or of any IRA owner’s death. So, think of the difference on how devastating this could be. You have one situation where a child inherits an IRA worth a million dollars and they’re allowed to take relatively small, maybe three percent, starting at three percent and ever rising, but basically a three percent minimum-required distribution of the inherited IRA. Then the next year, a little bit more, and the next year, a little more, and the next year, a little more, et cetera, et cetera. But the IRA continues to grow, or, I should say, the inherited IRA continues to grow, and we end up with a great result. If we can afford to, again, disclaim to a grandchild or a trust for the grandchild, then we have an even smaller minimum-required distribution of the inherited IRA, and we also get a great result. But the government doesn’t want your children to enjoy life and to enjoy the lifetime of work money that you have socked away for their benefit. They want to get their greedy paws on the money as soon as they can. So, they came up with an idea that they’re going to tax the entire inherited IRA going to a non-spousal beneficiary for the purposes of federal income taxes within five years of the IRA owner’s death, assuming that the beneficiary is a non-spousal IRA. So, just think about that. You know, before, under the existing law and the way it’s been for many years, the beneficiary might have to take out three percent, and then maybe four percent, and five percent, et cetera, while the big mass of the inherited IRA continues to grow tax-deferred. Under this new proposed law, what would happen is the non-spousal beneficiary would have to pay income tax on the entire inherited IRA within five years of the IRA owner’s death.
So, let’s take two examples. Number one, Dan ? we’ll pick on you ? your dad dies, he leaves you a million dollars of an IRA, you then, using the right titling, which is another very important thing, you use the right titling and you’re taking out a minimum required distribution of the inherited IRA and you get a great result.
Example number two: They pass the law, and then your dad dies. Then, instead of doing this stretch IRA, you would have to come up with income tax on the million dollars of the IRA that he left you within five years of his death. No matter how much tax planning you use, if you have a million dollars coming in in five years, it’s very hard for that not to be taxed at the highest rates. So, you’re going to end up with a massive income-tax burden. Then, not only do you have this massive income-tax burden, but then the money that is left over is plain old after-tax dollars, meaning that the interest, dividends and accumulations on that would be subject to tax, compared to the existing law, where the money would just sit as an inherited IRA in your name, which would ultimately lead to an enormous benefit for you.
Dan Weinberg: And how certain are you that this potential death of the stretch IRA law is going to pass?
Jim Lange: Well, of course, we can never be certain of anything, but this is what I will tell you: the law came up for a vote in 2013. President Obama was all for it. The Republican House was all for it. It was actually the Democratic Senate that stopped it by a vote of 51 to 49. You might say, ‘Well gee, why would a Republican want something like that?’ And I think the answer is because Republicans need money, too, but since they don’t want to raise tax rates, this is kind of a, let’s call it, back door way of collecting a lot of taxes because a lot of baby boomers are going to be dying with big IRAs in the next five, 10, 20 years, and this way, the government can get their money from the IRAs much faster. Now, that said, I don’t think anything’s going to happen before the election, although, of course, I could be wrong. And even right now, it’s not nearly as hot as it was, say, a year ago. That said, the issue was hot enough that my proposal for two peer-review articles on this exact topic was accepted, we wrote the articles, they were published, which, by the way, is nice for the listener because that means that they are getting information that has, in effect, been, if not sentence for sentence, but at least the major ideas, peer reviewed, and, in this case, by a magazine called Trusts & Estates, which is a very prestigious estate-planning and retirement-planning magazine.
So anyway, they thought it was important enough to do two articles. I’m being invited around the country to give talks on this thing. Might it happen later on? Yes. Is it possible that it’ll never pass? Well, I don’t think … likely, I think that it’s just going to be too tempting for some administration or another to grab the money, and then, once they do and they’re drunk with power, the next administration is probably going to want to keep it. So, I do think that it is coming. It’s a matter of when. So then, what you have to do is say, ‘Gee, in the light of this uncertainty, what’s the best course to take from here?’
Dan Weinberg: Okay. So, is there a precedent where you talked about a proposed law and then took actions ahead of time that benefitted your clients?
Jim Lange: Well, this happened in 1997 when the Roth IRA conversions and the Roth IRAs were just a proposed law, and I knew it was going to be huge, and I actually was working on peer-review articles back then regarding Roth IRAs and Roth IRA conversions, even before the law was passed, and I’m doing the same thing now because as we’re going to see coming up, there are things that people can do proactively, even though the law has not yet passed, and if they take some of these actions, a) they can be much better prepared if and when the law does pass, and b) the actions that we’re going to recommend will not hurt them in the event that the law is never passed or is passed after their death. So, I think we have kind of a foolproof answer on how people should interpret what they should be doing in light of the new laws.
Dan Weinberg: Now Jim, let’s talk about dollars-and-cents-wise what the potential impact would be on the IRA recipient if the death of the stretch IRA does indeed come to pass.
Jim Lange: Okay, so let’s take two examples. One, you and your spouse die, or perhaps, you die and your spouse disclaims, and to use a nice, even number, use a million dollars of an IRA, or what’s really going to be technically called an inherited IRA under the old law, and let’s assume that your child is appropriate, chooses to take advantage of the stretch IRA laws, takes only the minimum required distribution of the inherited IRA and does that consistently, and if you leave them a million dollars, they will have a regular steady income, and when they are, let’s say, in their 90s, depending on spending, interest rates, et cetera, they will have $2 million left. If they spend the exact same amount, however, under the new law, that is the law passes before you die and you die with the new law, and given the identical investments, identical spending, identical everything, instead of your child having close to $2 million when they are in their 90s, they will be dead flat broke. So, the difference between, let’s say, the new law and the old law (and by the way, part of it is getting this thing done right, knowing that we have this potential death of the stretch IRA looming) is that we can save a lot of money. In this case, close to $2 million for the children over their lifetime. And even if this is an extreme case, it’s often over a million dollars.
Dan Weinberg: And let’s also talk about what listeners can or should do to prepare themselves in the event that this law does pass.
Jim Lange: Well, there’s going to be two broad categories, and I’m only going to cover one in this show, and then we will cover some others in a subsequent show. One thing that is really miserable is when you have this massive income-tax acceleration. So, let’s say, for discussion’s sake, Dan, you inherit a million dollars, but now, you have to come up with income taxes on that million dollars, and depending on a number of factors, let’s say it’s $300,000 or $400,000, or to split the difference, maybe $350,000. So now, after you pay the IRS $350,000, you don’t have a million dollars to invest anymore. You only have $650,000. And remember, you’re going to have to pay income taxes every year on the interest, dividends and capital gains that that $650,000 generates, compared to the stretch IRA that would have much smaller minimum required distributions that would be much more favorable.
But let’s say that they do pass that law. So, what are some of the ways that you can avoid this massive income-tax hit for your children after you die? Well, interestingly enough, I’m going to bring up the idea of an old tool that we used to use that had its purpose, but today, I think it’s going to be much more interesting, and that is to consider naming a charitable remainder trust, and it could be either a CRUT, which is a unitrust, or an annuity, which is an annuity trust, meaning that the distributions are more or less the same, where with the CRUT or unitrust, you typically will vary the distributions depending on investment performance. But anyway, if you name a charitable trust rather than your children as beneficiaries … so, again, Dan, let’s go back to you. Instead of your dad naming you as the beneficiary of his million dollar IRA, he names a charitable trust. What are the terms? And I’m going to oversimplify here, but during Dan’s life or during the child’s life, the child gets the income from the trust. But then, at the child’s death, rather than the money going to the child’s heirs, it goes to the charity of either the parent’s or the child’s choice. Now, you might think, ‘Well gee, that’s not great. I’m not really that charitable. Maybe a couple bucks, but most of the money I want to go to my family.’ Well, interestingly enough, let’s think about this, Dan. With the charitable trust, you’re getting the income, not on $650,000, which is what you would actually have the principle and the income from in the first example, where we just took the tax hit. But you would actually be the beneficiary of a trust that has a million dollars in it.
So, the question then becomes: Would you rather have the income on a million dollars or would you rather have $650,000 outright? Well, the answer, of course, like any answer that you ask an attorney, is ‘It depends.’ But I will try to give you some guidelines. If you are the beneficiary of this charitable trust, so let’s say your parents leave you a million dollars, and the terms of the trust are income to Dan, and at Dan’s death, it goes back to the charity of your parent’s, or even your, choice. And let’s say that your parents die, and a month later, you die, and then all that money that was intended for your family ends up at a charity. So, that works out pretty badly. But let’s say that you live into your 90s or something like that. Well then, the difference, as we had discussed before, could be as high as $2 million. That is, that’s how much better off you might be.
So, there’s an enormous difference on the power of the stretch IRA versus the death of the stretch IRA, and one of the ways to significantly reduce the exposure that your children will have to massive income taxes is rather than naming them directly is to name the charitable trust as the beneficiary of the IRA, and if you work out the math, which, of course, we have because we love to work out math, is that the beneficiary, if they live into their early to mid-70s, then it’s about a tie. But if they live beyond their early to mid-70s, then they would be much better off in the event that they were just receiving the income, and the reason for that is if they just have the, let’s call it $650,000, that will run out in their 70s compared to, again, depending on the assumptions, having the money continue to grow. So, these charitable trusts are a very interesting solution.
Now, let’s talk about a couple of the downsides. Number one, they’re going to have to pay some money to set them up. But frankly, that’s the easy part. The hard part is maintaining them, because after one or both of your parents die, somebody must be the trustee of this trust. Somebody must do investments for this trust. Somebody must prepare a tax return for this trust. This trust becomes a living, breathing entity, and as an attorney and a CPA, I know attorneys love to set up trusts, and then CPAs are stuck dealing with them after people die. There might be enough merit in this trust that it is worth the additional fees, and, you know, the numbers that we have in front of us are the child might be better off by a half a million dollars over their lifetime if they are the beneficiary of the trust rather than the beneficiary of the IRA. The trust, again oversimplifying, says ‘Income to child, and at child’s death, goes to the charity of mom and dad’s choice.’
Dan Weinberg: And is this a strategy that you would do now?
Jim Lange: Well, the problem with doing this strategy now is that it is not as good as the existing solution of the stretch IRA. So, if the stretch IRA is still around, I would prefer to do the stretch IRA unless people are truly charitable. So if they’re truly charitable, then it might be a reasonable thing to do now. But most people are more interested in providing for their family than for their charity.
So here’s what I would do with the charitable trust as the beneficiary of the inherited IRA. I would keep it on the shelf, ready to pounce on it, ready to change as soon as the law passes. So, I wouldn’t proactively go changing your wills right now, assuming that everything is correct, which probably it isn’t, by the way. But even assuming it was, I would not change it right now. Then when the new law does pass, and again, we’re thinking maybe 2017, maybe longer though, whenever it does pass, to take a long, hard look and re-evaluate the strategy of where your parents are going to get their income, and how they are going to utilize both a flexible and effective estate plan.
Dan Weinberg: And what are some of the things that you could do now?
Jim Lange: Well, one of the things that we should be thinking about is, since it is likely, in my opinion, that this law will likely pass before our listeners, that we should consider ways to reduce the amount of traditional IRA and retirement plan that we leave our children. So, I’ll tell you one way that is getting more and more popular ? you might not like this idea as much, Dan ? is to spend it! Don’t plan on dying with such an enormous IRA. That is one way. On the other hand, I’ve been relatively unsuccessful at trying to convince people that could afford to spend a lot more money than they are to spend that additional money. On the other hand, a lot of people have said, ‘Gee, I’m not going to go out and spend more money tomorrow, but I’m going to be much happier knowing that I could.’ Or, ‘I’m not going to quit my job tomorrow, but I’m not going to take any you-know-what from my boss anymore.’ So, sometimes, that kind of information is liberating.
But simplistically, you don’t want to die with as big an IRA. So, let’s assume though that the plan isn’t to spend it, it’s to be smart about money without spending it. Well, there, I’m interested in getting into the tax-free world. See, up to now, with the IRAs and the 401(k)s and the 403(b)s, we’ve been talking about the tax-deferred world. Now, I’m interested in the tax-free world. What do I mean by the tax-free world? Now, I’m interested in Roth IRA conversions that grow income tax-free. I also become much more interested in life insurance, which is also a tax-free investment, and I have been a fan specifically of a product called second-to-die life insurance, which doesn’t pay until both husband and wife are gone, and combined with a flexible estate plan on the IRAs and retirement plans is really a very powerful combination.
Anyway, we have been advocates of both Roth IRA conversions and second-to-die life insurance at least since the ‘90s, but interestingly, if the law does pass, then the IRA conversions to a Roth are starting to look much better for the end beneficiary, and, in addition, the charitable remainder trust as the beneficiary of the IRA looks very interesting, but that, again, is something that we wouldn’t do right now, but we would consider spending more. By the way, gifting and life insurance in that situation is just a variation of a gift. That is, you’re taking, let’s say, one percent of your IRA, you’re cashing it in, you’re taking the money that’s left and you’re using that to buy a life-insurance policy. That becomes a very interesting opportunity.
So, what we are looking at is we’re looking at Roth IRAs and Roth IRA conversions that I would maintain are a good thing for you now whether they change the law or not. The other thing that I would be looking at is the life insurance and the way the life insurance is a good deal now, even without the changes in the law, but then if they do change the law, your children, depending on assumptions, could end up being literally millions of dollars better off. On the other hand, if you can’t afford to make a gift, then this isn’t really on the table at all.
So, this is another way to pass wealth with the least amount of income-tax burden that you possibly can, and that is the name of the game in estate planning these days. It is not to avoid estate tax. It is actually to avoid income tax. So, one of the ways that you can do this with the death of the stretch IRA looming is to consider a charitable remainder trust as the beneficiary, but again, don’t actually do anything about that until after the law passes, and two, take a much closer look at Roth IRAs, Roth IRA conversions and second-to-die life insurance as something that will preserve money for your family. Now, today, we talked more about the charitable trust, but in a subsequent show, we will talk much more about Roth IRA conversion and life insurance and Social Security and the interplay between all three of those in order to help our listeners get the most out of what they’ve got, given those limitations with both existing and future tax law.
Dan Weinberg: And with just a minute or so to go, how can listeners get more information on all of this?
Jim Lange: Well, we do have two peer-review articles on this subject, and they can both be found at www.paytaxeslater.com. And then, what they should do is sign up for the newsletter because we’re actually doing a book on this exact topic, and if they sign up for the newsletter, we will either notify them when the book is done or, like we did with the last book that we did, which was Social Security, we just gave them a link and let them access the book for free, and we literally got thousands of downloads of that book, and I love to create meaningful content that people can use to empower themselves and have a better financial future. But basically, an answer to your question is going to the website at www.paytaxeslater.com. Or if you’re actually interested in meeting with me, to call Alice, who is our client coordinator, her telephone number is (412) 521-2732, and see if you qualify for a free appointment with me, and that is another possibility, particularly for residents of western Pennsylvania.