Originally Aired: October 19, 2016
Topic: Strategic Planning for Your IRA with Bruce Steiner, JD
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of Bruce Steiner: Tax and Estate-Planning Expert, Lawyer, Author
- Comparison of Clinton and Trump Tax Plans
- Impact of the Possible Death of the Stretch IRA
- Charitable-Remainder Trust Is One Way to Save on Taxes
- Roth IRA and Roth IRA Conversions Can Be Tremendously Beneficial
- Conversion to Roth IRA Can Be Done in Increments Over Several Years
- Designating a Trust as IRA Beneficiary Protects Against ‘Ex-Factor’
- Your Spouse Usually Is the Best Choice as Beneficiary
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.
1. Introduction of Bruce Steiner: Tax and Estate-Planning Expert, Lawyer, Author
Dan Weinberg: Welcome to The Lange Money Hour. I’m Dan Weinberg, alongside CPA and attorney Jim Lange. Our guest this evening is New York attorney Bruce Steiner, a prolific author and nationally recognized expert on taxation and estate planning. Bruce is a frequent lecturer at continuing-education programs for bar associations, CPAs and other professionals. Bruce has over 40 years of experience in the areas of taxation, estate planning, business-succession planning and estate and trust administration. He’s a frequent lecturer at continuing-education programs for bar associations, CPAs and other professionals. Among many other positions, Bruce Steiner is a commentator for Leimberg Information Services, Inc. He’s a member of the Editorial Advisory Board of Trusts and Estates and is a technical advisor for Ed Slott’s IRA Advisor. Bruce has been quoted in various publications and on various television outlets, including Forbes, The New York Times, The Wall Street Journal, CNBC, Fox Business and TheStreet.com. Now tonight, Jim and Bruce will discuss topics like the 10 common mistakes people make in retirement planning, Roth IRA conversions, the potential death of the stretch IRA, and the differences between Hillary Clinton and Donald Trump’s tax proposals. It’s sure to be a terrific hour, so let’s get started by saying good evening to Jim Lange and Bruce Steiner.
Jim Lange: Good evening, Bruce.
Bruce Steiner: Hi.
Jim Lange: So, you’ve written extensively in many areas of the tax law, and, of course, what’s on everybody’s mind right now is the election and some of the tax differences between Hillary Clinton and Donald Trump. Could you give us a little bit of an overview of what you think each of the candidates would want, or, at least, are saying that they would want, and perhaps the practical implications of whether they would actually get them?
2. Comparison of Clinton and Trump Tax Plans
Bruce Steiner: Well, those are three very different things: what they may want, what they say they want and what they might reasonably get. Secretary Clinton’s proposals are similar to what President Obama has proposed every year for the last quite some number of years. On the income-tax side, it would plug some things that he refers to as loopholes and that she refers to as loopholes. She goes a step further and would get on a 4 percent increase in the top tax rates for people earning over some very large amount of income. She has said that she would restore the 2009 estate-tax law, which is a 45 percent rate instead of 40 percent and reduce the exemption to 3.5 million instead of the current 5-plus million dollars, and just recently, she proposed additional estate-tax brackets of 50, 55 and 65, with a 65 percent bracket applying to estates over $500 million, which probably affects a fairly small number of people. If that were to happen, we’ll see a flurry of people changing their will to say that the excess over $500 million they’d leave to charity, or to a charitable trust. And Donald Trump has proposed reducing business taxes sharply and some reductions in the personal income-tax rates, and interestingly, some additional child-care benefits. Now, as to what happens, in the real world, again, you need not only the president, but you need a majority in the House, and the House is likely to be fairly evenly balanced between the two parties. As of today, since the Republicans have a fairly substantial majority, and the expectation is the Democrats pick up some seats, the most likely outcome is the Republicans continue to control the House but much more narrowly. And you need 60 votes in the Senate, and at the moment, the Republicans have…I think it’s 54? Is that right?
Jim Lange: Yeah.
Bruce Steiner: I think it’s 54, and it looks like, at the moment, the Democrats are favored to take over either four or five of the present Republican seats, and the Republicans are favored to take over one seat that’s presently held by the Democrats, and there’s two other Republican seats that the Democrats are the underdogs but have a reasonable chance of prevailing. So the likelihood is it’s going to be within a seat or so of 50/50 either way, and it takes 60 votes to get things done in the Senate. So any tax bill has to be the result of a negotiation, much like the tax bill that was enacted on the American Taxpayer Relief Act of 2012, which was passed on January 2nd of 2013 retroactively. I like to say it was passed on December 33rd of 2012 because it was two days into the next year, and that was a negotiation. The president wanted to restore the pre-2002 top tax rates and the Republicans didn’t, and they compromised by restoring it, but only for income above a very high level, and on the estate tax, the president wanted to bring back 45 percent and the Republicans wanted to keep it at 35 percent and they compromised at 40 percent, and they compromised on the exempt amount of the $5 million plus so that you have an estate tax that affects only about 3,000 estates a year. So again, any new tax bill would have to be a compromise. So we’ll see what happens.
Jim Lange: All right. Well, I know one of the things that Hillary is a very likely proponent of, although she hasn’t said it specifically, is something that is called the ‘death of the stretch IRA,’ and it might not be fair for me to think of you like this, Bruce, because you’re probably a very well-rounded estate attorney, but I think of you as being really an expert in the IRA, retirement plan, Roth IRA, benefit area, and one of the things that … and again, to my knowledge, Hillary hasn’t expressly said, “Yes, I want to kill the stretch IRA,” but earlier, you said that she is like Obama in many ways, or, at least that’s the starting point, and Obama certainly wants to kill the stretch IRA. I wonder if you could tell our audience a little bit about what is the stretch IRA, and what are some of the likely consequences of having the death of the stretch IRA actually passed, and then we’ll get into what, if anything, people should do about it. But could you maybe start by saying, OK, what is a stretch IRA, what the proposed legislation would look like? You might even have an opinion on what the chances of it being passed are, but why don’t we start by giving our audience an idea of what is a stretch IRA?
3. Impact of the Possible Death of the Stretch IRA
Bruce Steiner: Sure, Jim. Well, the current law is that a beneficiary of an IRA can take distributions over his or her life expectancies. So if you have, say, a fairly young beneficiary with a 40-year life expectancy, he or she can take 1/40th the first year and 1/39th the second year until the 40th year, when whatever’s left comes out. So that’s a tremendous benefit because the distributions are back-loaded. One-fortieth is 2½ percent, so if you’re earning 4 percent or 5 percent or 6 percent or 8 percent, whatever it is, and you’re taking out 2½ , it’s still growing. It’s only in the last 10 or so years that the distributions come out very, very quickly. So that’s a tremendous benefit because along the way, the IRA is still growing without current tax. The proposal is to require that beneficiaries have to drain the IRA basically within five years. Most of the revenue proposals that have come up over the years don’t seem to get any traction, but every now and then, one does. The basis-consistency rules where beneficiaries have to use the same income-tax basis that was used for estate-tax purposes just got passed in the last year or so, and so the stretch IRA, it could because it raises revenue without raising tax rates. So Congress members and senators can say, “Well, we didn’t raise tax rates. We just closed a loophole.” And I’m not sure the stretch IRA is a loophole. The statute says that IRAs are intended for IRA owners and their beneficiaries, but some people might think it’s a loophole, and it came close to passing in the last couple years once or twice. So this one has a chance of passing. I don’t know how to quantify it, but it could happen.
Jim Lange: All right, so basically, you’re saying … let’s go back to your example. A 40-year old inherits, let’s say, a million dollars. Their minimum required distribution of the inherited IRA would be … you would go to Publication 590. You would get the factor of 40. That is, somebody with a 40-year life expectancy, which, as you said, is 2½ percent, so the minimum required distribution would be $25,000, but if the account is earning, say, 6 percent, then it’s earning $60,000. It’s only paying tax on and distributing $25,000. So you have this massive income-tax deferral. With the stretch IRA, the entire million dollars would be taxed within five years of death. So just very simplistically, the beneficiary wouldn’t have a million dollars that would be earning money, they would have, let’s say, $600,000.
Bruce Steiner: That’s right. It would not only destroy your deferral in your stretch, but if the beneficiary is otherwise in a modest tax bracket, you’d be bunching the income and they’d be in a real high income-tax bracket if they had to take it out over five years.
Jim Lange: So it really would be an income-tax disaster, and like you said, we don’t know if it’s going to pass. I actually believe that in 2013, Obama wanted it, the Republican House actually voted for it and it was actually the Democratic Senate that stopped it 51/49.
Bruce Steiner: Politics make strange bedfellows, doesn’t it?
Jim Lange: Yes, they do. So, if you’re like me, you’ve drafted quite a few estate plans where the IRA is a significant part of the estate plan. What are some of the things that you’re thinking about, and what is some of the advice that you’re giving clients who perhaps have the majority of their resources in their IRA or 401(k) or 403(b)?
4. Charitable-Remainder Trust Is One Way to Save on Taxes
Bruce Steiner: Well, it’s hard enough to plan for current tax law, never mind for possible future tax changes. So we’re really not preparing estate plans that cover that possibility because it hasn’t been enacted and the drafting is complicated. But you may remember back before the proposed regulations were overhauled 15 years ago, IRA owners used to have to choose between something called ‘term certain,’ which was the way we were describing it, 1/40th and 1/39th and 1/38th, or something called ‘recalculation,’ which meant that while the IRA owner was alive, you could have slower distributions, but then after you died, it would all have to come out at once. So if somebody had a spouse as a beneficiary, they were OK because the spouse could roll it over, but if they didn’t have a spouse beneficiary, either because they were single or because they were the surviving spouse, it would all have to come out at once, and the workaround was something called a ‘charitable-remainder trust,’ where you would leave your IRA to a trust that would distribute something along the lines of income to one or more individuals, let’s say the children, and upon the death of the last child, whatever was left would go to charity, and you have to have some minimum provision for charity. Essentially, the value of the charity’s interest, as of the inception, has to be actuarially at least 10 percent of the value of the principle as of the inception. So at the cost of giving up 10 percent in value, you got to preserve the stretch, and if this is enacted, I think lots and lots of people will go back to this planning that was done fairly often before, up until about 15 years ago. It’s fairly complicated and there’s a number of technical issues that you have to deal with when you’re drafting this, but I think we’ll see a trend back to that and people will become familiar with it once again.
Jim Lange: Well, first of all, Bruce, I am certainly old enough and have been practicing enough to remember very well the days of recalculation and term certain.
Bruce Steiner: Sure.
Jim Lange: But let’s do a few numbers with this charitable-remainder trust, and as you may or may not know, I’ve actually published articles on this area.
Bruce Steiner: I know, I know, I know.
Jim Lange: I know you know. But let’s just be simplistic for a moment. So, let’s say that you are the beneficiary of a million-dollar IRA, and I’m going to assume a non-spousal beneficiary, most likely a child. So you inherit a million dollars in an IRA right now, and let’s say using the existing laws, you’re taking out what’s called the minimum required distribution of the inherited IRA, which we had just talked about, and over many years, that will be very substantial for you. But if this legislation passes, you’re going to have to take the money out in five years. So let’s be, again, simplistic. You have a million dollars in an inherited IRA. You’re going to have to take out, let’s say, roughly $400,000 to pay the tax on it under the new law. So now, you only have $600,000, and what you’re proposing is well, what if you do a trust where you get the income on the whole million? Because the IRS is not going to tax the charitable trust for income taxes with that five-year acceleration. So, are you better off with the income on the million dollars knowing that, at your death, it doesn’t go to your kids, but it goes to a charity, or are you better off with, let’s say, the amount remaining after you pay the taxes? Is that the basic analysis?
Bruce Steiner: Well, that’s part of it, but if it’s a close call, you might say, ‘Well, I can get a lot of money to charity at no cost to my family, so let’s go do it.’ I just ran some numbers while we were talking, and using current interest rates, if I have a beneficiary who’s 45 years old and I put a million dollars into a charitable-remainder trust, I can have the beneficiary get about 8 percent a year recalculated annually. So if the value of the trust goes up or down, the 8 percent is applied to the current value, and that’s for one life, and at the end of that person’s life, whatever’s left goes to charity. At 8 percent, maybe you might not earn 8 percent, so it the principle might drift down somewhat, but over a long period of time, you’ll earn some reasonable return. So there should be some money left for charity at the end, an in the meantime, you’re getting a substantial annual payout based on the entire million rather than only earning income on, let’s say, $600,000 after taxes. So I think it will be attractive. There’s some inflexibility because ordinarily, if you leave your IRA to the person in a trust, the trustees can distribute as much or as little as they want to every year, and if the person doesn’t need the money, you can just accumulate the money in the trust, whereas with a charitable-remainder trust, the distributions have to go to the person outright every year and there’s no flexibility. You can’t take out more in the year you need more and less in the year you need less. But for people who have some other money so that they’re not so dependent on it and who have other money in case there’s some one-off need that they have in a given year, I think this will be very attractive. It’s what people used to do up until 15 years ago, and I think they’ll do it once again.
Jim Lange: Well, I happen to agree with you. I’ve also run some numbers, and the numbers that we’ve run indicate that if the beneficiary survives for about 15 years, that he will be, let’s say, roughly a breakeven compared to him taking the entire IRA and paying the tax. But if he lives beyond 15 years, that is, 15 years past the death of the IRA owner, he will be better and better off, and even just on a million dollars, that if he lives into his 80s, he will literally be $500,000 better off.
Bruce Steiner: Well, it’s scalable. If you had a $2 million IRA, well, the numbers would just be twice as much, and if you had a $500,000 IRA, the numbers would only be half as much.
Jim Lange: Right. The only thing that I have been thinking about in practice is if you have too small of an IRA, or if you have multiple beneficiaries, that, to me, you do have to take into consideration the aggravation of not only drafting it, which, as you said, is a little bit tricky, but perhaps more importantly, the aggravation of preparing a separate trust-tax return.
Bruce Steiner: Sure, sure.
Jim Lange: So if you’re talking about $100,000 or $200,000 per beneficiary, or even maybe $250,000 or $300,000, I think you’re getting to the point where the drafting costs, and more importantly, the tax-preparation costs would, let’s say, outweigh the tax benefits or benefits to the person. But other than that…
Bruce Steiner: Well, with a regular IRA, if you’re leaving it to multiple beneficiaries, if it’s in trust, it would be a separate trust for each one because one might need more money in a given year than another one, or they might want to invest it differently. In a charitable-remainder trust, it’s easier to pool it into a single trust because the distributions are fixed. But still, in all, I agree. There’s a point below which it’s just not practical to administer it. The drafting, I think, you know, the first one or two times, it’s an effort, and by the third or fourth time you do it, it becomes easier, but administering it is going to be more effort, especially since people aren’t used to charitable-remainder trusts, and their accountants might not be used to preparing returns for them.
Jim Lange: And Bruce really is a national expert. He has written countless articles. He is actually, on Election Day, he’ll be speaking at a very prestigious annual estate conference in Seattle. He has a host of resources available at KKWC.com, and then if you go to Bruce Steiner, you’ll see the many articles he’s written. I think I’m allowed to say on the radio that I have referred a number of cases to Bruce and I’ve heard nothing but good things, so I think he’s a great resource for both information and for actual work, and Bruce, you’re licensed in New York and New Jersey? Is that right?
Bruce Steiner: New York, New Jersey and Florida.
Jim Lange: Oh, you did get Florida also? OK.
Bruce Steiner: Long ago. People up here often end up in Florida.
Jim Lange: Well, that’s smart, because I just don’t feel like taking the Florida bar exam. By the way, actually, that’s great to know that you’re licensed in Florida. Oh boy, I wish I would have known that before.
Bruce Steiner: Well, it’s on the website.
Jim Lange: Well, I don’t read your whole website, but anyway, you’re going to get a lot more referrals!
Bruce Steiner: OK!
Jim Lange: But anyway, why don’t we go back to some of your information? I thought it was interesting that within about one minute, you came up with the 8 percent rate of return that an individual …
Bruce Steiner: Well, there’s a software program called ‘Number Cruncher.’
Jim Lange: Oh yeah, I know that one well, too!
Bruce Steiner: It’ll do it for you.
Jim Lange: Well, to be fair, a lot of quantitative attorneys have it because they think in terms of numbers and they think in terms of what is best for their clients and not just the words within a will or a trust, but they actually think of the numbers. And I know that, from the beginning, you have been a Roth IRA advocate and a Roth IRA conversion advocate. Is this still something that you are advocating for your clients, and does the potential death of the stretch IRA have any impact on your recommendations?
5. Roth IRA and Roth IRA Conversions Can Be Tremendously Beneficial
Bruce Steiner: The Roth is generally beneficial, often tremendously beneficial. The math is really pretty simple. I have an extra thousand dollars that I’m deciding whether to put into my IRA or my 401(k) or to pay the tax first, and let’s say I’ve got somebody who’s always going to be in a 40 percent tax bracket just to make the math simple. So if they put the money into the IRA, they have a thousand dollars in their IRA. If they pay their tax first, they pay $400 tax and they have $600 in their taxable bank account. So if you put the thousand dollars into your IRA, and over a long period of time, it grows from a thousand to 10 thousand and you take it out, you have $6,000 and the government has $4,000. So that IRA is really 60 percent yours and 40 percent the government’s always, and your $600 share that you put in, because had you not put it in, you would’ve only had $600 after tax, your $600 grew to $6,000 tax-free, and the government’s $400 share you don’t really care about. If instead you didn’t put the money into an IRA and you had $600 in your bank account, it would not have grown to $6,000 because every year, you would have paid income tax on whatever it earned. The Roth conversion is really just a way of putting more money into your IRA, because you have that $10,000 IRA, but it’s really only $6,000 yours and $4,000 of it is the government’s, and let’s say you have $4,000 on the side in your bank account at that point, and you convert your $10,000 IRA to a Roth IRA, and you use your other money to pay the tax. Now, you have a $10,000 Roth IRA and it’s all yours, and let’s say over the next few years, it doubles from $10,000 to $20,000 and it’s all still yours. If you did not convert because you didn’t want to pay your tax sooner, you’d have a $20,000 traditional IRA because your $10,000 IRA would’ve grown to the very same $20,000. You take it out, you paid $8,000 of tax, you have $12,000 left, you still have your $4,000 of other money, but it didn’t double to $8,000 because every year, you paid income tax on what it earned. So, at a constant tax bracket, the Roth conversion always wins. The only thing to think about is, ‘But if I do a big conversion all at once, maybe I’m bunching the income into a high tax bracket.’ So for many people, what makes the most sense is not to convert it all at once, but to either convert it over time, to convert as much each year as you can without it putting you into too high a tax bracket. Occasionally, if you have a year when you have no income, or if you’re Donald Trump and you have that one year when you had a $900 million loss, that would have been a great year to convert his IRA to a Roth IRA because he wouldn’t have paid any tax on the conversion. It would’ve all been covered by that big loss that he had. So we had people do that. If they have a business, maybe it’s a partnership or just in their own name, a proprietorship, and they have a year when they lost money, that’s the year they do a Roth conversion. We’ve done a couple of deathbed Roth conversions because that’s your last chance unless you have a spouse that you’re going to leave it to. We just had one; we did a $3.5 million deathbed Roth conversion.
Jim Lange: I actually love that.
Bruce Steiner: The benefit there is not quite as much as if you had done smaller conversions over time, but with that much money, it’s really hard to dribble it out into lower tax brackets because you’re going to be in a high tax bracket no matter what you do and your beneficiaries will probably be in high tax brackets no matter what they do if you didn’t convert.
Jim Lange: Well, you said a lot of good things there. I happen to actually heard that type of explanation for why the Roth and Roth conversion is so powerful. In our office, what we do is we have some rules of thumb that probably aren’t all that different than yours, but what we like to do is we like to, what we would call, run the numbers, and we do different scenarios. So let’s say somebody comes in. They have ‘X’ after-tax dollars, ‘X’ IRA dollars, ‘X’ Roth dollars, that maybe they have Social Security, maybe they don’t. We like to actually make projections, and we test different Roth-conversion strategies, different amounts, and then we might actually combine different scenarios. So, for example, one of my favorite things is to have people hold off on Social Security and enjoy the 8 percent raises that they get every year for holding off, and while they’re waiting for their Social Security, while they are waiting for their minimum required distribution, but after they have retired so they don’t have the income from their wages, that their income is at an all-time low, and then do Roth conversions at that point.
Bruce Steiner: Oh, that’s a great window, especially if somebody retires fairly early. They have quite a big window until they’re 70.
Jim Lange: Right. So what we like to do is literally run the numbers and we test it, and the other thing that we like to do is we like to actually have the client in the room while we are running the numbers.
Bruce Steiner: Oh, wow!
Jim Lange: Well, the advantage of that is, a lot of my clients are somewhat quantitative, and even the ones that aren’t, they’re from Missouri ? Show Me! ? and you show them, and if you’re asking somebody to write a check, I mean, in your case, you were asking somebody to write a check for a million dollars …
Bruce Steiner: A million-and-a-half, yeah!
Jim Lange: Yeah, and they’re dying. That probably finished them off!
Bruce Steiner: Well, it’s wonderful because they get a basis step-up at death for all their appreciated assets so they don’t have to cash in appreciated securities and pay capital-gains tax to get the money to pay the tax.
Jim Lange: Yeah, it really is wonderful, with the exception that they’re going to die soon.
6. Conversion to Roth IRA Can Be Done in Increments Over Several Years
Bruce Steiner: Well, sure. And for a lot of plain, ordinary folks who don’t have, you know, $3 million IRAs, if they just convert each year the amount they can convert and stay in, say, the 15 percent bracket, that largely gets the job done if they have enough time to do it.
Jim Lange: Well, sometimes, the difference is literally hundreds of thousands, or, if you’re looking into the next two generations with the existing tax law, sometimes even millions of dollars.
Bruce Steiner: And maybe they’ll convert up to the top of the 28 percent each year, and then sometimes you just convert the whole thing because people are going to be in high brackets all the time anyway.
Jim Lange: Yeah. The other thing that you mentioned is if somebody has a low-income year. So one of the things that we are doing is, let’s say that somebody moves into a nursing home and we are able to get a large tax deduction for the cost of the nursing home because at least a portion of it was for medical reasons. We can often get a very substantial Roth IRA conversion for little or no cost. So that’s one of the great areas that I think is overlooked.
Bruce Steiner: Well, that argues for holding some money back, to say that when you’re in the nursing home.
7. Designating a Trust as IRA Beneficiary Protects Against ‘Ex-Factor’
Jim Lange: Yeah. So, I know you have a peer-reviewed article talking about 10 mistakes, and maybe we’ll do that after a break, but I think it would really be a shame if we had you on, I consider you one of the great experts for drafting trusts and planning for trusts when the underlying asset is an IRA. So, can you tell us a little bit about some of the planning that you do when your clients have, let’s say, a very significant IRA, perhaps even the majority of their estate, and for one reason or another ? and maybe you can even expand on this ? the beneficiary of that IRA should be some type of trust?
Bruce Steiner: Well, in broad brush, our clients generally provide for their children in trusts rather than outright. Until about 20 years ago, the child couldn’t really control the trust, but in 1995, the IRS conceded the point and you can basically leave money to a child in a trust and let the child effectively control the trust, and that way, the money is not included in the child’s estate for estate-tax purposes. It’s less important now that the estate-tax exclusion amount is 5 million plus. And it’s protected against the child’s creditors and spouses and Medicaid, and we used to talk about it in terms of estate tax, and we found that the thing that the clients were most concerned about was their children’s spouses in case of a divorce. They fear the chance that if your client has several children that one of them might get divorced. It happens. Or a child could outlive his or her spouse and remarry and want the protection against claims by the new spouse, and the same reasons for leaving other assets in trust apply to IRA benefits. They’re an asset like anything else. So we like to have, unless the amount is too small for it to be practical, we have our clients provide for their children in trust for their benefit, and that includes IRAs just like it does anything else.
Jim Lange: Who do you typically name as the trustee for the trust where the IRA is the underlying asset?
Bruce Steiner: Well, if the reason for providing the trust is asset protection, and you would’ve otherwise left the money to the child outright, then the child is going to be a trustee of his or her own trust, together with a co-trustee who the child wants as his or her co-trustee, and we give the child the power to remove and replace his or her co-trustee. The only limitation is that the replacement trustee can’t be a close relative or somebody who works for the child, but that still leaves a few billion people to pick from.
Jim Lange: All right, and as I understand it, that is … well, I don’t know how you would define relatively new, but that is since 1995, did you say?
Bruce Steiner: 1995; Revenue Ruling 95-58. The IRS had first said, ‘Oh no, you can’t.’ It was in the context of someone creating a trust, though we all assumed that a beneficiary would fall in the same thing. The government at first said, “You can’t have an unrestricted power to change the trustee because it’s too much control.” And then the government lost a couple of court cases and conceded the point, provided that the replacement has to be an independent. But still, if I have the power to remove … Jim, if you were my co-trustee, and I have the power to remove and replace you, you’re supposed to consider my needs anyway, but for sure you’re going to consider my needs if I have the power to fire you.
Jim Lange: Right, and you said that there’s some limitations in terms of family members?
Bruce Steiner: The replacement trustee can’t be a close relative or a subordinate employee. You know, but it can be my best buddy. It can be my accountant. It can be …
Jim Lange: Can it be your brother?
Bruce Steiner: It can’t be my brother. It can be my …
Jim Lange: Not the replacement.
Bruce Steiner: Oh, the initial co-trustee can be my brother. My initial co-trustee can be my spouse. Maybe better yet, my initial co-trustees can be both of them because if my brother and my spouse both get together to outvote me, it means that I’m no longer my old self, so for sure, I’m going to get one of them to agree with me if I want to go left or I want to go right, and if they both disagree with me, then I probably am no longer all that capable anymore.
Jim Lange: OK, so let’s talk about advantages and disadvantages of this. The advantages are, it is a creditor protection, including what you had mentioned as the most frequent creditor, which is what I call the ‘future ex-spouse.’
Bruce Steiner: Future ex-spouse, and in about 10 states, inheritances are in the pot for equitable distribution on divorce. In about three-quarters of the states, your inheritances are protected against divorce, assuming you can trace the money. But in about a quarter of the states, they’re in the pot.
Jim Lange: So we actually have a name for that purpose. We call it the ‘I don’t want my no-good son-in-law to inherit one red cent of my money’ trust.
Bruce Steiner: Yeah, yeah, yeah, that’s right.
Jim Lange: All right, so we have that benefit. So we’re protecting against the future ex-spouse, we’re protecting against other creditors in the event of a bankruptcy or a tort liability or somebody runs over Ben Roethlisberger’s toe or something like that. So you have those protections. It will not be included in the child’s estate. There will be provisions about what happens to the money when the child dies.
Bruce Steiner: Or the child can have the power to say where it goes when he or she dies.
Jim Lange: OK. Now, let’s talk about the downside. Of course, this might be biased coming from an estate attorney who’s drafted a lot of these trusts; to me, like you had said earlier, after you do a couple of them, it’s not that big a deal. So, for us, it doesn’t really substantially add to the cost of doing an estate plan. So let’s say that there might be some cost, maybe more significant if you go to a non-expert estate attorney, but what about the cost of the tax return? Because now we have to file a 1041 and a K1, and then the K1 has to transfer onto the beneficiary’s personal tax return. Would you see that as one of the major downsides of this?
Bruce Steiner: I think the cost of a tax return for a trust is fairly small because trusts don’t do all that much. You can get a diversified portfolio with a very small number of mutual funds, and then you get, you know, one or two or three 1099s, and in the case of the IRA, you get another 1099 for the money coming in from the IRA. So it’s a fairly easy 1041. I think a lot of trustees can probably do it themselves, maybe not the first year, but like anything else, the second time, it’s not so hard. So they can look at the one from the first year and sort of follow the pattern and do it the second year, or they can hire an accountant. Some accountants are more familiar with tax returns for trusts than others, but for the ones who are familiar with it, it’s not a difficult return because the trust doesn’t really do all that much.
8. Your Spouse Usually Is Best Choice as Beneficiary
Jim Lange: I will confirm that because we do have a tax firm. And Bruce really is a national expert. He’s licensed in New York, New Jersey and Florida. He is speaking literally on Election Day, November 8th, in Seattle at a very prestigious estate-planning conference, and he has a wealth of articles and information at his website, which is www.kkwc.com, where he has a wealth of information and articles, including one, which is an excellent article, called “Ten Common Errors” that was published in the peer-review journal Trusts and Estates. We only have time for a few of those, but if we could talk about a couple of the 10 common mistakes, and why don’t we start with your Number 5, which is failing to leave retirement benefits to the spouse? Why is that necessary, or why is that often a mistake?
Bruce Steiner: Well, it’s not always a mistake, of course, because there are sometimes reasons to leave the IRA in some other way, but spouses can roll the benefits over into their own IRA. They can complete the Roth conversion if you died before you’ve had a chance to do it. They can name new beneficiaries and get a longer stretch, assuming the stretch is still with us. For example, if the spouse lives to be 80 years old and the children she sees are already successful, maybe she leaves the IRA to or in trust for the grandchildren, who are younger and can stretch it out over a longer period of time. So there are a number of benefits to leaving it to the spouse, and for most people, the estate tax with portability is no longer a concern. If your IRA is your only asset and you leave it to your spouse, your spouse inherits your estate-tax exclusion amount and now has a 10-plus million dollar exclusion amount. So the estate tax is rarely going to be a factor in this. But for most people, leaving it to the spouse, assuming that there’s no non-tax reason to do something else, is usually best.
Jim Lange: In fact, Bruce, that’s actually one of the benefits of actually getting married. So in a show that we’re having, I believe, in the early part of the year, I talk about some of the financial benefits of getting married, and in my own family, I have my brother, who is 65 years old and has a substantial retirement plan. I very much wanted him to get married because, assuming he dies and leaves the money to his either partner or spouse, the benefits of leaving it to a spouse will be significantly greater, and particularly if they do pass that law known as the death of the stretch IRA. So leaving money, at least the first or primary beneficiary as your surviving spouse, is usually a great idea.
Why don’t we talk about your mistake Number 8, collecting benefits upon death? So, this is assuming that an IRA owner ? let’s just use a million dollars as an example ? leaves a million dollars to their child. So now, the child has an inherited IRA. What is the mistake that you often see, and what, in effect, should a child do in that situation?
Bruce Steiner: Well, we hope, Jim, that we never see it, but an IRA is not a probate asset, so it passes immediately to the beneficiary without having to wait a couple of weeks until the will is probated. And so if you’re the beneficiary of a million dollar IRA, you can walk into that bank and take out the million dollars. Well, an IRA owner or a spouse can roll it back in within 60 days. A non-spouse beneficiary can’t do that. One of the nice things in the (Obama) administration’s revenue proposal for the last several years would be to let a non-spouse beneficiary do that, but Congress hasn’t yet passed it and may or may not ever pass it. So if the beneficiary takes the money out, the stretch is gone. The beneficiary has a million dollars of income all in that year and loses the benefit of having the IRA grow for many, many years.
Jim Lange: And I’ll even take it a step further. They don’t even necessarily have to take it out, and with the purpose of blowing it, they can literally have an administrator who’s sloppy about the titling. So instead of having the appropriate title and have the money being transferred to an account that might be ‘Inherited IRA of Joe Schmoe for the benefit of Joe Schmoe, Jr.,’ if they just transfer the account to Joe Schmoe, Jr., they have, in effect, accelerated the income tax.
Bruce Steiner: That’s right. Even if they take it out to put it into another financial institution in the IRA, it’s too late.
Jim Lange: Yeah. So this is really a brutal mistake. I understand, while I suspect that it has never happened in your or my office, but that it happens very frequently throughout the country because somebody botches it, whether it’s the client, whether it’s the CPA, whether it’s the financial advisor, whether it’s the attorney, but somebody doesn’t know about the importance of stretching the IRA and then makes this terrible mistake.
All right, so why don’t we now talk about something that’s a little bit more selfless, unless you consider the overall family wealth to be a good thing, and that is the concept of disclaimer, because this is basically what my entire estate plan …
Bruce Steiner: I know, I know.
Jim Lange: … known as Lange’s Cascading Beneficiary Plan, I’ll put in a plug for my own plan, and we’ve done, I think, close to 2,100 of these where we are providing enormous flexibility for the surviving spouse and ultimately the children and potentially even the grandchildren. But Bruce, why don’t we have our audience hear from an objective source some of the advantages of a disclaimer?
Bruce Steiner: Well, a disclaimer is exactly what it sounds like. If somebody gives or leaves something to you, you can say, ‘No thanks. I don’t want it.’ And if it’s a gift, then the gift doesn’t happen and it goes back to the donor, but if it’s something upon a person’s death, it goes as if the person disclaiming had predeceased, unless the decedent makes some other provision. So with an IRA, for example, if my beneficiary designation says ‘I leave it to my children, but if a child predeceases me, then his or her share goes to his or her children,’ and if the child says, ‘I disclaim it, I don’t want it,’ then it goes to that child’s children, same as if the child had died first. So the benefits of doing it are, if it were outright and not in trust, the disclaimer would keep it out of the child’s estate, and more important, even if it is in trust, is it gets a longer stretch if it goes to the grandchildren. So we have one right now. The woman just died, and her beneficiary designation is exactly that. It says, ‘my children, and if one of them dies, then to that one’s children,’ and so on. So the first thing we’re doing is going to the three children and telling them if they have the opportunity to disclaim, one of them needs money so he’s not going to, one of them has plenty of money so she probably will, and the third one is in between and we don’t know yet. The one who has plenty of money, who is probably going to disclaim, she has three children and two of them have plenty of money. So they’re likely to disclaim so that those shares will go to the great-grandchildren on that line who will be able to stretch the IRA out for a very, very long period of time.
Jim Lange: And by the way, to quantify something like that, you might, over the life of the inherited IRA, be talking about a difference of literally hundreds of thousands, or even millions, of dollars. So this is a great opportunity that people do unfortunately often miss.
Unfortunately, we are out of time, but Bruce, you have been a great source of information. Again, I’m going to encourage people to take advantage of some of the many resources that you have at your website. Again, that’s www.kkwc.com, and if they ever have an opportunity to hear you anywhere, that would be wonderful, and I’ve heard you myself, but the one coming up is the annual estate-planning conference on Election Day, November 8th, in Seattle. Thank you again for agreeing to be a guest.
Bruce Steiner: Thanks for having me, Jim.
Dan Weinberg: All right, and thanks to Bruce and to Jim. To our listeners, if you missed any part of this program, catch an encore presentation Sunday morning at 9. Of course, all of The Lange Money Hour episodes are archived soon after they air on the Lange Financial Group’s website, www.paytaxeslater.com, and just click on ‘Radio Show.’ Special thanks as always to the Lange Financial Group’s marketing director, Amanda Cassady-Schweinsberg, and to our producer today, KQV’s Amy Vallella. I’m Dan Weinberg. For Jim Lange, thanks so much for listening and we’ll see you again in two weeks for another edition of The Lange Money Hour, Where Smart Money Talks.