Originally Aired: January 4, 2017
Topic: It’s Looming… How to Prepare for the Death of the Stretch IRA – Part II
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Senate Finance Committee Vote Means Stretch IRA Is Likely to Die
- If Timed Right, Roth IRA Conversions Can Save Big Money
- How to ‘Get It Right’ on Taking Social Security Benefits
- Flexible Estate Planning Is a Smart Move to Make Now
- Let the Surviving Spouse Make the Final Decision on Beneficiaries
- Charitable Remainder Unitrust Allows Heirs to Delay Paying Taxes
- Reduce Your IRA by Buying Memorable Family Experiences
- Gifts Can Have a Huge Impact on Young Beneficiaries
- Pension Rescue: Life-Insurance Policy Can Ensure Wealth for Heirs
- Combine Tax-Deferring Strategies to Maximize Performance
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. Senate Finance Committee Vote Means Stretch IRA Is Likely to Die
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange. What will happen to your IRA after you die? The laws governing IRAs are very likely to change in 2017, and if you have more than $450,000 in an IRA, tonight’s show is critically important for you. This is the second in a two-part series on the death of the stretch IRA. Now, for many years, inherited IRAs could be stretched, if you will, for the lifetime of the person inheriting them. In other words, they could take minimum distributions and leave most of the money to keep growing income-tax deferred. But all signs point to Congress killing the stretch IRA in 2017 and requiring those who inherit an IRA to pay taxes on all but $450,000 of the money within five years. Now, last week, Jim covered the basics of the current law as well as the coming changes, and this week, he’ll get more in-depth into solutions and strategies to prepare for what’s ahead. This issue, by the way, is covered in-depth in Jim’s new book, The Ultimate Retirement & Estate Plan for Your Million Dollar IRA, and that book is available free to KQV listeners at www.paytaxeslater.com. And this is very important information for so many of our listeners, so let’s get right to it. Good evening, Jim.
Jim Lange: Good evening, Dan. By the way, great summary of our last show and what is coming up. So we talked about what the existing law is regarding the stretch IRA. We talked about what the pending law is on the stretch IRA, and as a quick refresher, the Senate Finance Committee voted 26-0 to kill the stretch IRA, and when that happens, it’s almost inevitable that it will pass the following year. Since the Senate Finance Committee voted on this on September 11, 2016, it is likely to pass in 2017, and the way the law is written now is it will apply retroactively to anybody that dies on or after January 1, 2017, and has an IRA, which probably means you.
So this show is going to say, “OK, so we think that this law is coming. In fact, we’re pretty darn sure this law is coming. What should we do now in preparation for it, and what should we be thinking about when the thing actually does pass?” So that’s what we’re going to concentrate on today. These strategies that I’m recommending, these are not off the top of my head. These are actually very congruent, if not almost exactly the same, as I published in two peer-review articles, both of which are available on my website at www.paytaxeslater.com. Both articles appeared in Trusts and Estates magazine. I gave a talk in front of 400 estate attorneys on this in San Diego at a very prestigious estate-planning event. I wrote the book about this, which is also available on our website at www.paytaxeslater.com, and this is the result of a lot of calculations and a lot of thinking, and it’s something that really you should be thinking about. But remember, first, do no harm. So the suggestions that I’m going to give you, I want them to work for you even if the law doesn’t pass, and then I will distinguish between what you should do only after the law is passed compared to what you should consider doing now.
All right, so here’s a little summary of what is coming up. We’re going to be talking about Roth IRA conversions. We’re going to be talking a little bit about Social Security and getting that right. We’re going to be talking about flexible estate planning and some of the great values of it. We’re going to be talking about the value of a charitable remainder unitrust as the beneficiary of an IRA, and we’re also going to be talking about setting up a gifting program for those listeners who can afford it.
2. If Timed Right, Roth IRA Conversions Can Save Thousands of Dollars
All right, so why don’t we first talk about the Roth IRAs and Roth IRA conversions. And by the way, since this is only one of multiple strategies, and we only have even a little bit less than an hour, I’m not going to be able to cover any of these strategies in depth. For the Roth IRA in depth, we actually have a two-hour workshop and we have a video of that workshop. We also have one of our books, which is The Roth Revolution (Pay Taxes Once and Never Again). The DVD, I believe, you can get from our office, and the book, I think you can actually download that for free from our website, www.paytaxeslater.com. So I’ve been talking about Roth IRA conversions literally since even before they came out, I wrote a peer-review article on it before the law even became the law, and I was right. It did become the law, and the people who listened to me and were eligible for Roth IRA conversions, some of them are literally hundreds of thousands, probably millions, of dollars better off if you consider the lifetime value to not only themselves, but also their families, which is what I’m trying to do here with this death of the stretch, which is saying, “Hey, this thing is coming. Here’s what you should do.”
OK, so one thing about the Roth IRA is that the death of the stretch laws does have an impact on Roth IRAs. You might say, “Hey, Jim, but I already paid income taxes on the Roth IRA. I thought that you said that once you pay income taxes, you never have to pay them again, and therefore, if they kill the stretch, how should that have any impact on a Roth IRA?” Well, it is true that if you have a Roth IRA and you die, your heirs will not have to pay income taxes on the inherited Roth IRA. On the other hand, under the existing law, they could stretch that inherited Roth IRA over their lifetimes, but under the proposed law, they would have to withdraw that entire inherited Roth IRA within five years. Now, again, they don’t pay taxes on it, but then, after that five-year period, it would, in effect, be plain old after-tax dollars, meaning that dividends, realized capital gains, interest, et cetera, that would be taxable, where if it was the existing law, or if you qualify under the $450,000 exclusion, then that growth would not be taxable. So Roth IRAs are still a factor. However, if you just think about it, one of the ideas of reducing taxes after you and your spouse die and leave IRA money to your children, since that traditional IRA, anything over that $450,000 is going to be so toxic in terms of the income-tax liability. One of the strategies, and frankly, to some extent, all of the strategies are geared towards reducing the amount of the IRA that you’re going to leave behind. Now, we don’t want to do something stupid like cash in our traditional IRA while we’re alive, so it will help our heirs if it’s going to hurt us. But one of the things that I’ve been talking about for years is doing a Roth IRA, or, more specifically, a Roth IRA conversion. This is where you take a chunk of your traditional IRA — let’s just use $100,000 — and to make it even easier, let’s assume that we put it in a separate account. So now you have a separate account of a plain old IRA for $100,000, and you fill out the appropriate paperwork to make it a Roth IRA, and let’s say, for discussion’s sake, that the money is housed at Schwab, and Schwab sends you a 1099 that, in effect, says ‘Please add $100,000 to your income.’ And then you do that, and your income that you have to pay income taxes on the year that you make that conversion are whatever your taxable income was before plus the additional $100,000. It might have a few changes in some of the limitations, but let’s just keep it simple and say you’re adding $100,000 to your income. All right, so why would you do that voluntarily? And besides, didn’t I say pay taxes later? And the answer is yes, I did, but I said pay taxes later except for the Roth. So if you pay the income taxes on that extra $100,000 of income from money outside your IRA, and then what happens is that money that’s now a Roth will grow income-tax free for the rest of your life, the rest of your spouse’s life, and, under existing law, the rest of the lives of your children or grandchildren. If this death of the stretch IRA passes, you still might be able to use at least part of the $450,000 exclusion. If you’ve used all that up, then what will happen with the Roth as I’d mentioned earlier is that you’ll have to withdraw that $450,000, or your children will. They won’t have to pay tax on it, but within five years after your death, it will no longer be tax advantaged. Again, I don’t have all the time that I would like to go through, but I will just say that, given certain assumptions that are pretty reasonable, if you make a $100,000 conversion, that in 20 years, you’re going to be about $50,000 better off. That is you yourself. Forget your kids. Forget your grandkids. If you live into your 90s, or even a hundred, or even just into your 90s, you might be $200,000 better off. So again, forget estate planning, this is something that is likely good for you. Now, unfortunately, I don’t have time to go into all the assumptions. For people who want that, I have all that. In fact, I have many, many pages of analysis, and then I talk about the advantages of making a Roth IRA conversion and then leaving that to a grandchild, because let’s say, for discussion’s sake, the grandchild survives you by 60 or 70 years, and they get another 60 or 70 years of income-tax-free growth, that would just be a fabulous, fabulous bequest to make to a grandchild. And then I have some statistics that show, even in today’s dollars, that you might not be better off by $50,000 if you take inflation into account, but you’re still better off by $28,000, your kids are better off by $160,000, and grandkids are better off by $800,000. Again, that’s using today’s laws, certain assumptions, and we are, let’s say, using today’s law or using the $450,000 exclusion. Again, I love to talk about Roths more at length. I love to do conversions in the years after you retire, but before you are age 70½. If you think about it, that’s going to be your lowest income years the rest of your life because you don’t have your income from your wages, you don’t have your income from your minimum required distribution. If you follow my strategies on Social Security, you’re going to be holding off on your Social Security for the most part between 65 and 70. So you’re going to have these really low income years, and those are the best years to make Roth conversions. Why? Because you’re going to be in the lowest income-tax bracket, which means you’re going to be able to do more and more Roth conversions for cheaper and cheaper. So while you’re working, I’m not saying you shouldn’t look at Roth conversions, you certainly should, but it might not be the best time, at least for big ones, because you have to add the income from the conversion onto your existing salary. After you are 70, and let’s say you and your spouse are both over 70, you’re getting two Social Securities, and you’re getting a minimum required distribution, now your income tax bracket again is high. So should you still look at Roth conversions? Certainly. But would that be the ideal time to make a Roth conversion? Probably not. Probably that time after 65 or after you’re retired, but before 70. All right, so, again, I’d love to … again, I actually do an eight-hour talk just on Roth conversions, but we’re going to have to move on.
3. How to ‘Get It Right’ on Taking Social Security Benefits
Another thing that way more people get wrong than get right is Social Security, and again, I do two-hour workshops on Social Security. I’m going to give you the super-mini version. Here’s the super-mini version: if you hold off on your Social Security, and I’m going to oversimplify for the moment, but basically, you’re going to get … and this actually isn’t oversimplifying. This is accurate. Holding off between age 66 and 70, you get an 8 percent raise for every year that you wait, and it’s not quite that much, but it’s similar to that waiting between 62 and 66. So if you were to take two people, they each had the same earnings record and they’re both 62 years old, and, for the moment, assume that they are both single, and one takes it at 62, and let’s say, whatever he collects, he saves, because we’re going to try to do apples-to-apples, and the other person waits until he is 70. What will happen is, obviously, the person who is taking it early is going to accumulate, accumulate, accumulate, but the person who waited (and let’s assume that they are saving the money), they’re starting at zero, and compared to the person who started at 62, he’s had eight years of collection, but we’re getting a much higher monthly payment. So just picture two lines that converge, and the convergence is the breakeven point, which, depending on the assumptions that you make, is somewhere around maybe age 82 years old. Well, you might say, “Well, gee, Jim, I’m not sure if I’m going to make it to age 82. I want to be sure to get the money.” Well, one of the nice things about having this radio show is you get the top experts in the country, including Larry Kotlikoff, who wrote the best-selling book on Social Security in the country. Mine, by the way, was the second best. I think we’ve gone a little down since then. But anyway, Larry says, “Don’t think like an actuary. Think like an economist. If you die early, you’re dead, and that isn’t what you should fear for financial purposes. What you should fear for financial purposes is living a long time and outliving your money.” So having that raise is very important. In addition, remember that the spousal benefit is the higher of your or your spouse’s benefit. So let’s just say, for discussion’s sake, that you have one of these old fashioned marriages where you were the worker and your spouse stayed home, and you hold off on Social Security, and then you die and your spouse lives another 10, 20, 30 years. Your spouse will get a 100 percent spousal benefit — assuming certain assumptions are made about survival and the length of marriage — literally for the rest of their life. So the decision of when to take Social Security to me is a marital decision because you’re also protecting your surviving spouse.
All right, now, of course, the home run is to get the combination of Roth IRA conversions and Social Security right, and we think it’s a synergistic calculation because if we are holding off on Social Security, then we could do more Roth conversion at a lower rate. On the other hand, if we’re taking our Social Security early, then that’s going to have an impact of how much money we can convert to a Roth IRA at some of the lower rate. So I would say that they are synergistic calculations, and the chart I’m looking at shows literally the difference over time can easily be a million dollars or more between getting Social Security and Roth IRA conversions right and not getting them right. Again, I’d love to talk more about Roths. We are limited as to time.
4. Flexible Estate Planning Is a Smart Move to Make Now
So we started with talking about Roth IRA conversions, and then we also talked a little bit about Social Security, and then the synergistic calculation of getting the Social Security and the Roth IRA conversions right. The next area that we’re going to talk about that is a preparation for the death of the stretch IRA — which, by the way, again, is a very good strategy even if the death of the stretch IRA doesn’t come — is flexible estate planning. So here’s the basic initial premise of estate planning, and for my purposes right now, I’m going to assume a couple things: one, I’m going to assume that you are, what I call, a “Leave It to Beaver” family, meaning original husband, original wife, same kids. I’m a “Leave It to Beaver,” and I know that we are a dying breed, but at least with our listeners and the people that tend to show up at my workshops and read my material, we have a fair amount of them, probably a disproportionate among the population. But anyway, let’s assume that you are one of these “Leave It to Beaver” couples, so again, you have the same kids, you have the same grandkids. We’re not talking about kids from his marriage or kids from her marriage. It’s kids from our marriage. So you have the same heirs, and let’s make life simple and talk about the three main potential beneficiaries. We’ll talk about charitable remainder trusts later, but the three main beneficiaries, or sets of beneficiaries, for that type of traditional family is, Number 1: surviving spouse. OK? We love our surviving spouse. We want to provide for our surviving spouse. Nobody in the history of the world ever came to the estate planner and said, “I want to make my grandchildren so stinkin’ rich they never have to work a day in their life, and I don’t care about my surviving spouse.” That’s not what people say. They always say, “The first thing that’s the most important is to take care of both of us while we’re both alive. The next thing is to take care of the surviving spouse after one of us dies.” So the surviving spouse becomes the natural choice as the primary beneficiary of the IRA, the 401(k), the Roth IRA, and under the estate plan that we recommend, which is known in the literature as Lange’s Cascading Beneficiary Plan, which, by now, is actually quite famous. It’s been in the Wall Street Journal multiple times. It’s been in three of my books. It’s been in a lot of journals. If you even just Google “cascading beneficiary plan,” or “Lange’s Cascading Beneficiary Plan,” there’s literally thousands of entries, the vast majority of which point back to me. So basically, it’s a very, very flexible estate plan because the first choice is typically surviving spouse. The next choice tends to be children equally. There’s obviously exceptions and sometimes we need a trust for one of the children, and sometimes there’s situations where one child is doing really well and the other child is in poverty, and we sometimes leave more money to the child in poverty, but let’s just say, subject to exception, the contingent beneficiary tends to be after the surviving spouse, children equally. And then, if either something happens to the children, or, in my world, we often have grandchildren receive money from Grandpa, even if it was originally meant for the children. So money could go down to grandchildren, and we talked earlier in the last show about the enormous stretch IRA that is available to grandchildren both under existing laws and perhaps using at least a portion of the $450,000 exclusion of the death of the stretch IRA in the proposed law. All right?
5. Let the Surviving Spouse Make the Final Decision on Beneficiaries
So we have these three choices, and it’s going to be surviving spouse, children equally, or trusts for grandchildren, and, in my world, remember, we can have the trusts for grandchildren as a choice even if the child is alive. By the way, that is different than traditional estate planning. Traditional estate planning, the only way the grandchild typically gets any money is if their parent dies. In my estate plans, I am anticipating that since there could be enormous tax benefits with this stretch IRA, or the $450,000 exclusion with the death of the stretch IRA, that it might make sense for the grandchild to inherit a portion of the IRA or the Roth IRA. So to me, what I want to do, since we already know who the choices of the beneficiaries are, let me tell you what we don’t know. We don’t know when you’re going to die. We don’t know who’s going to die first. We don’t know what the tax laws … we don’t even know what the tax laws are going to be next year. We don’t know what the estate-tax laws are going to be. We don’t know what the income-tax rates are. We don’t know what they’re going to do with the Roth IRA. We don’t know, at this point, what they’re going to do with the stretch IRA. We also don’t know what the market’s going to do. We don’t know what position you’re going to be in at the first death. So doesn’t it make sense that you can make a much better decision as to who gets what, not today when you’re actually drafting your wills and estate plans, but actually in the future after the first death? Because then you’re going to know what the estate-tax laws are. You’re going to know what the amount of money left is. You’re going to know who died first. You’re going to know the needs of the kids and grandkids, et cetera. So why not devise an estate plan that doesn’t fix in stone who gets what, but devise an estate plan so that the surviving spouse makes the choice of who gets what after you die? That’s a minor oversimplification, but that is the essence of Lange’s Cascading Beneficiary Plan, and we’ve been doing these since the ’90s. I put it in a peer-review article in 1998, Jane Bryant Quinn picked up on it in 2001, and that’s when it really took off, and it was in the Wall Street Journal and a zillion other places and it’s all over the web. So I have been really advocating this flexible estate planning.
Now, with this impending death of the stretch IRA, it becomes a really good choice because there is a level of uncertainty, and again, if time allowed, I would go into all of the details. It’s basically built on disclaimer and leaving money to spouse first with the right to disclaim the children, then anything that a child gets, they could disclaim into a trust for their own children, which is the grandchildren of the IRA owner.
All right, so now, I’m going to give you one super-cool strategy that I’m going to say nine out of 10 estate attorneys are going to miss. So let’s say there’s a fair amount of money in the family, and let’s assume that there is more than $900,000, or even more than $450,000, in the IRA, and you have one spouse that has more than $450,000 in their IRA, and they die. Now, usually, probably 98 out of 100 times, what’s going to happen is that the surviving spouse is going to be named the beneficiary of that IRA and that transfer will actually happen. Well, what happens if the surviving spouse, even under the new proposed law, doesn’t need or want all the money? What if we take $450,000 and we name either children, or, better yet, grandchildren, or the real home run, $450,000 of a Roth IRA to the grandchildren, and the surviving spouse gets everything else? So what would happen then? $450,000 would qualify as the exclusion, so now, the family is benefitting by one $450,000 exclusion. Then when the surviving spouse dies, they get a second $450,000 exclusion. So a total of $900,000 would be included even with the death of the stretch IRA, but if you don’t do that and you just mechanically leave everything to the surviving spouse, and then the surviving spouse leaves their money to, say, some combination of children and grandchildren, then you only get one $450,000 exclusion. And we already showed that that exclusion might be worth, maybe, a half million dollars to the child, even more to a grandchild. So that huge mistake of not thinking about leaving $450,000 to child or grandchildren, or, in my world, I want to do it by disclaimer, and I’ll tell you why. If we carve out $450,000 to children and grandchildren and leave everything else to the spouse, what happens if things go wrong? I have conservative clients and they’re always telling me, “Oh, what if I get sick? What if the market goes down? What if we don’t have as much money as we thought, and I’m worried about the surviving spouse?” Well, rather than poo-poo it, let’s take that as a real possibility. If the market goes down or there isn’t enough money and you’ve left too much money to kids and grandkids, you might have underprovided for the surviving spouse, and that’s the first rule of estate planning. That’s what people come in and want. They want to protect themselves while they’re both alive. They want to protect the surviving spouse. So what I’m saying is, since there’s a possibility of saving a ton of money, but the most important thing is not saving a ton of money in taxes, it’s to provide for the surviving spouse, you let the surviving spouse decide. When does the surviving spouse decide? Nine months after your death when they know more, and they would have the benefit of counsel, whether it’s attorneys or, sometimes, CPAs. Obviously, our firm, it’s a combination. But anyway, this very, very flexible estate planning, which I’ve always been a big fan of, I think would work even better in, let’s say, today’s environment of uncertainty, and it will also work very well in the event that they do indeed kill the stretch IRA. All right, so that’s something that I would probably do, and you don’t even have to wait for the law to pass.
6. Charitable Remainder Unitrust Allows Heirs to Delay Paying Taxes
The next issue is, OK, what is a great strategy that maybe I don’t want to do now, but I probably, or at least want to consider, under certain circumstances, when they do kill the stretch IRA? And that’s going to be a charitable remainder trust. But you say, “Wait, wait, wait! Hold on, Jim! Who’s talking about charity? I want to name my kids as the beneficiary. Yeah, charity’s great, but I’m more worried about my kids.” Well, what if I could show you a trust where your kids, if they live beyond the age of, say, 72, they would actually end up with more money as the income beneficiary of a charitable trust than if you had left it to them outright? Well, how the heck does that work? Let’s think about what a charitable trust is and the numbers. So, to oversimplify, you name one child as the beneficiary of your million-dollar IRA. This is after the new law takes effect. Boom! They have to pay income taxes on the whole … well, I’m going to forget the $450,000. Let’s say you leave $450,000 to a grandchild. Let’s just leave the $450,000 exclusion out, OK? So they have to pay income taxes on the full million. All right, well, that’s not good news. So let’s assume, and let’s even figure that there’s some way to pay it, but basically, you’re going to have a huge, huge reduction of that million-dollar IRA. It might be worse, but let’s just say there’s a $400,000 tax on it. So now, there’s $600,000 left, and remember, the $600,000 after the five years is no longer tax-protected. All right, so that’s what your kid’s going to end up with.
Example Number 2: You draft a charitable trust, and, to oversimplify, the terms of the trust are, your kids get the income, or your one child gets the income and at his death, it goes to the charity of your choice. Now, under today’s rules, without getting into too many technical details, the income rate is actually very favorable. In fact, it’s so high that the trust might actually be extinguished by the time the child dies. But forgetting that complication, your child’s getting a really good income, and if you choose the right rate, the child gets a really good income, not on the $600,000, which is what he would be getting if you just left it to him outright, but on the entire million because they don’t have to pay the income taxes upfront. They’re only paying taxes on what they inherit. So the question then becomes, are you better off getting the income on a million or the principle of $600,000? And the answer, of course, is it depends on how long the child lives. Now, we did a peer-review article that said that the breakeven point, meaning the number of years the child has to live, given certain reasonable assumptions, is roughly age 72, meaning that if the child lives longer, the child gets even more money, and if the child dies prematurely, that the charity ends up with more money. And you might say, “Well, gee, aren’t you really hurting the grandkids?” And potentially you are if the child dies early, but let’s say the child doesn’t die early. Let’s say he lives into his 80s. Then, depending on what assumptions you use, he might be $500,000 better off, and if he lives longer, he’s even better off. Now, there’s some complications of drafting. There’s some complications of actually administering the estate, and you do have to consider the possibility of disinheriting grandchildren, but for people who have large IRA balances and few beneficiaries, it is a very interesting strategy, but I would not utilize this strategy until the law is actually passed.
OK, in the prior show, we talked about the stretch IRA, the proposed death of the stretch IRA and how that was going to work, and up to now, we have talked about some of the things that you can do to reduce taxes, and we talked about Roth IRAs and Roth IRA conversions, and we talked a little bit about Social Security, then we talked about flexible estate planning, then we talked about a charitable remainder trust, which is one of the strategies that I think we should keep in our back pocket if we have big IRAs and few beneficiaries, but something I would not do until it (the death of the stretch IRA) actually became law. By the way, the reason I don’t want you to do it until it becomes law is because the current law is actually more favorable for IRAs than even the charitable remainder trust. So if they don’t pass the law and you did a charitable remainder trust to save taxes and you end up actually hurting the child, then I have violated the first rule, which is first, do no harm. The other strategies are going to be advantageous whether the new law passes or not.
7. Reduce Your IRA by Buying Memorable Family Experiences
And the same thing I’m going to say for the next basic concept, which is one of the ways that you don’t die with this enormous IRA is you make withdrawals from it. Now, if you just make a withdrawal and you pay the income taxes on it, that may be good for your heirs, but I’ll tell you what it’s not good for: It’s not good for you because that’s a violation of my rule, don’t pay taxes now, pay taxes later, except for the Roth. So you’ll be worse off. So I’m not going to recommend that. But let’s say that you are not a spender, and most of my clients, frankly, are not, and let’s assume that there is enough money that you could take some type of IRA distribution, maybe as small as 1 percent a year, and then use that money in some type of, what I would call, leverage gift. So let’s say that you took 1 percent of your IRA every year. You took that money out, you paid income taxes on it, and then what was left, you gave that to your kids or your grandkids in some type of gifting form, and preferably, a gifting form, assuming they don’t need the money, although actually just giving it to them and having them use it and enjoy it while they’re young has a lot of benefits, but even forgetting that type of benefit, if you use that money in, for example, after paying the taxes on it, that money is then invested in a 529 plan, you actually get an impact not all that far from a Roth conversion. Or you take that money and you make a gift and you use those proceeds to fund a retirement plan for a child or a grandchild. Again, that’s an example of a leverage gift. One of my favorite uses for that money — which isn’t exactly a financial use, but I’ve been talking about it more and more lately because I really think it’s important, and it sure beats the heck out of dying and paying a third of your money in taxes to the IRS — is taking some of that money, paying the tax on it and using the proceeds to finance a family vacation. “OK, Dad, big shot, I’m interested in you taking the whole family, you know, renting a house by the shore, going on a cruise, doing something where you take the whole family.” My family has been doing it for many years. My father-in-law, I think, is a genius because he has kept the family together, and I actually think that is the best way to spend your money. So that’s maybe a little bit off-topic, but I think that that’s really important, and it sure beats the heck out of paying a third of it in taxes after you die.
8. Gifts Can Have a Huge Impact on Young Beneficiaries
All right, now, there are other forms of gifts. And by the way, don’t forget the as-needed gifts. You know, somebody needs a down payment for a home. Somebody needs a car. Somebody needs ballet lessons. Whatever it is, if you can afford it, frankly, I would rather your children and grandchildren enjoy that money while they are young enough to make a difference. So just think about this for yourself. Let’s say that you’re in pretty good shape and you’re maybe in your 60s or 70s or even older, for a lot of my clients, if they inherited an extra million dollars right now, they literally wouldn’t do anything differently. They wouldn’t go out to dinner one more time. It wouldn’t change their life. But if you ask them what it would mean to even inherit a half a million dollars, or be gifted a substantial amount of money when they were much younger, it might have had a huge impact on their life in what we think is a positive way. So sometimes, just giving money, helping your kids out while they are younger, is better.
9. Pension Rescue: Life-Insurance Policy Can Ensure Wealth for Heirs
But if you’re thinking in terms of long-term wealth preservation for the family, there’s also an old strategy that is now coming to the forefront again. So the old strategy was called pension rescue, and here’s how that worked: You would take maybe 1, maybe 2 percent of your IRA, cash it in, pay the taxes, then take what’s remaining and use that to pay for a life-insurance premium, typically on a second-to-die life insurance policy, which means that the policy doesn’t pay until both husband and wife die. And they used to run numbers showing that if you did that, your kids would be way, way better off. And I always resented, or didn’t think that those calculations were fair. Now, we’re serious number crunchers. In fact, that’s what we like to pride ourselves on that very few firms are really doing it at the level that we are. So we really run the numbers and take this seriously, but what I didn’t like about those old projections was they always assumed that the kids were going to cash in the whole IRA immediately after Mom and Dad died. So the idea of cashing it in early and then using some of that money to pay for life insurance, and then the life insurance grown income-tax free, a little bit like a Roth conversion, by the way, that is, taking some money that’s taxable, paying some taxes, then using that money to buy a tax-free investment, that was very good. But I always used to say, “Well, gee, that’s not really a fair assumption because what if the kid stretches the IRA?” And then the insurance guys would say, “Ah, the kid never stretches the IRA. Don’t count on that.” And I would think, “Well, in my practice, we stretch the IRA all the time.” So I kind of rejected that analysis. But under the new law, with the five-year rule, that analysis is really pretty much back in play, and what we did is we ran some numbers, and again, I’m going to oversimplify with the results, but I have all this both in my books and my articles and everywhere else, but it often shows that your kids might be a million dollars better off over time if you were to do this, in effect, pension rescue and get a million-dollar second-to-die policy. But under the new law, or the proposed law, that million-dollar difference is under the old law where your children would have the ability to stretch. If they didn’t have the ability to stretch, then your kids are really going to be much, much, better off, and depending on how long they live, they can be maybe $1.5 million better off over time. So it can really make a big difference. Or if we throw spending into the assumption, it could be the difference between literally your kid running out of money into their 80s versus having maybe $1.6 million left. It’s really pretty remarkable what a difference it is, and life insurance, for those of you who can afford it, and for those of you who may have been thinking of it anyway, that is a very, very interesting strategy that would work either under the existing law or if they change the law.
10. Combine Tax-Deferring Strategies to Maximize Performance
Then, what are some of my really favorite things to do? Well, what if we combine some of these strategies? So for example, what if we combine, let’s say, life insurance and Roth IRA conversions? Then, you end up doing really well. Again, I’m not going to have time to go through all the numbers and all the choices, but that might be a great combination. Another great combination might be to combine a charitable remainder unitrust, or a CRUT, that we had talked about, maybe a Roth, maybe insurance, maybe some variation of that. So one of the ways, to me, that you try to determine what is the best strategy is, we call it running the numbers, and we say, “OK, what do we do, let’s say, ‘X’ amount or ‘X’ percent of a Roth for this many years,” and we use the optimal Social Security strategies, and then you test different estate plans, and then maybe you test with a CRUT, or with life insurance, or with a gift, and really your imagination is probably the limit on what you can do when you do this number-crunching. Now, we have an advantage. We have some pretty sophisticated estate planners who are really like master number crunchers, and they sit and do this literally all year round, except for tax season because these guys, well, and one woman, are real tax preparers, and, to me, those are probably the only people who are really qualified to run these numbers because they’re so tax dependent, and we not only use the Roth IRA conversion software, but we also use some financial software, and we also use actually plain old 1040 prep software, and what we do when we test different things, particularly Roth, we literally input your entire tax return into our tax computer program, and then we test different ideas and different levels, and we see what the tax impact is like. So that is actually, in reality, my favorite thing, which is to look at everything, crunch the numbers, say “Does it make sense to make Roth IRA conversions, and, if so, how much?’ Does it make sense to hold off on Social Security? Does it make sense to look at the synergistic, let’s say, combination of Roth IRA conversions and Social Security? What about getting your flexible estate plans in place? That probably makes a lot of sense. For most of my existing clients, you probably don’t have to do anything unless a CRUT, a charitable remainder unitrust, becomes a great strategy, which will mainly be for people who have very significant IRAs and relatively few beneficiaries. So that becomes another strategy. Then we talked about gifting, and then a variety of forms. Perhaps 529 plans, or giving money to a grandchild or a child to put into a retirement plan, which is what I would call a leverage gift. Then maybe look at life insurance. Then maybe look at some combination of these policies, and again, running the numbers is the best way to go, and particularly for what I would call you two marshmallow people, the people who are willing to have some deferred gratification, you’re going to end up with a lot more money if you take into account, OK, these laws are coming. What should we do about it? Let’s be proactive about it, and at the risk of sounding self-serving, having meetings with the appropriate people in our office might be very useful for both retirement and estate planning.
So I hope that I have not bored you during these two hours. I did feel honor bound to explain this. I am going to do more. We’re going to have a webinar on, I believe, January 31st. We’re going to have a workshop on January 28th. I will likely be talking about this until the law actually passes, and then actually when that law passes, I will be ready with a new book.
So what can you do right now? Again, I have lots of information for you. You can download the book, The Ultimate Retirement & Estate Plan for Your Million Dollar IRA, by going to www.paytaxeslater.com. You can get the addendum at www.paytaxeslater.com/addendum. You can listen to both the predecessor show and this show. You can sign up for my webinar on January 31st by going to the website. You can go to the workshop on January 28th. This is important information. Please take this warning to heart, and become educated and take action to preserve money for you and your family.
Dan Weinberg: All right, thanks so much, Jim. We hope you, the listener, have enjoyed this discussion about the death of the stretch IRA. Again, you can download the book at www.paytaxeslater.com for free. Special thanks to the Lange Financial Group’s marketing director, Amanda Cassady-Schweinsberg, and to Amy Vallella in KQV master control. I’m Dan Weinberg. For Jim Lange, thanks so much for listening and we’ll see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.