Episode 105 – Avoid These IRA Landmines with guest Seymour Goldberg, CPA, MBA, JD

Episode: 105
Originally Aired: October 30, 2014
Topic: Avoid These IRA Landmines with guest Seymour Goldberg, CPA, MBA, JD

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The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Avoid These IRA Landmines with Guest Seymour Goldberg
James Lange, CPA/Attorney
Guest: Seymour Goldberg, CPA, MBA, JD
Episode 105

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  1. Guest Introduction – Seymour Goldberg, CPA, MBA, JD
  2. Missed Minimum Distribution
  3. The IRS’ Statute of Limitations
  4. How is the Minimum Distribution Requirement calculated?
  5. Preparing for Your IRA
  6. Trusts as Beneficiaries of IRAs
  7. Preparing Beneficiaries
  8. Accumulating and Conduit Trusts?

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1. Guest Introduction – Seymour Goldberg, CPA, MBA, JD

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, here in the KQV studio with James Lange, CPA/Attorney, and author of two best-selling books, Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again.  Individual retirement accounts are powerful, versatile tools you can use to plan your financial future.  But IRA rules can be surprisingly complex.  IRS scrutiny is increasing and the potential for significant future financial penalties is alarmingly real.  For insights on IRA mistakes to avoid, today we welcome one of the country’s top IRA legal experts, Seymour Goldberg, to the show.  A CPA, MBA & JD, he’s senior partner in the law firm of Goldberg & Goldberg and one of the nation’s top experts on IRA legal issues.  He’s been quoted numerously in the New York Times, Wall Street Journal, Forbes, Fortune and Money, and he’s appeared on CNN and NBC.  Mr. Goldberg is also a writer, author of Inherited IRAs: What Every Practitioner Must Know and IRA Guides to IRS Compliance Issues, Including IRA Trust Violations.  They’re both available at www.aba.store.org under ‘bestseller.’  Today’s discussion will touch on changes in IRA regulations, as well as potential pitfalls to avoid.  Listeners, stay tuned for an interesting and informative hour, and since our show is live, you can join the conversation.  Call the KQV studios at (412) 333-9385 with your questions and comments.  And with that, I’ll say hello, Jim and welcome, Sy.

Jim Lange:  Hi there, Sy.

Sy Goldberg:  Hi Jim.  How are you?

Jim:  Very good, and thanks so much for being on the show.  What David said in terms of you being one of the nation’s IRA experts is so true and I remember reading your stuff twenty years ago and just thinking, “Wow, this is just such wonderful information.”

Sy:  Thank you.

Jim:  And one of the ways that I think of you, and maybe this isn’t fair, is that you like to write and talk about all the mistakes that people make and then how to avoid them.

Sy:  That’s true.

Jim:  And I thought what we could do is to go through a couple common, and maybe not so common, mistakes, and maybe you could give our listeners some insights on what they should be doing and what they shouldn’t be doing.

Sy:  Mmm-hmm.  Fine.

2. Missed Minimum Distribution

Jim:  And let’s take maybe one of the most basic mistakes, and one of the…what you would think would not be a problem, but often is, is when people reach April 1st of the year following the year they turned seventy-and-a-half…

Sy:  Mmm-hmm.

Jim:  …and they have a required minimum distribution, but somehow, something gets fouled up and they don’t take it.  So, what happens in that case and how can our listeners avoid that problem?

Sy:  It appears based on the government analyses.  The Treasury Department, the Government Accountability office, found that there are hundreds of thousands of people who haven’t taken required distributions when they’re supposed to.  The way to handle it, and being a former IRS agent, I would say that once you find out you made the mistake, you should then notify the IRS through Form 5329, take the money, and tell the IRS with a statement that there was an error made, give them the reason for it, and then ask them to waive the penalty.  The government doesn’t require you to pay the penalty first, which is 50% of the mistake.  You can now waive it by just explaining and asking the government to waive the penalty, and they’ve been fairly generous.  So, the key, really, is for one to have the accountant file a 5329 for the individual, and confess and own up to it.  It’s much more difficult if the IRS finds the mistake, and then said, “Well, you know, you didn’t do it.  Here’s your 50% penalty.”  It’s tougher to get rid of a penalty once the IRS catches you.  The best approach, I’ve found, is for one to go forward and tell the government and ask them to waive the penalty.  That’s the position I’m recommending to all people who have the problem.

Jim:  And what happens if there is a multiple-year problem?

Sy:  Then, at that point…a great question, Jim.  I am a firm believer in going back to all four years.  The IRS is going to have a major initiative, I can tell you right now.  In October, they’re going to be sending out press releases, notify payroll services, accounting organizations, and AARP that there will be a significant enforcement program in the country.  And I’m going to be, hopefully, having some input and suggesting to the government that possibly they have sort of a leniency arrangement towards this, but the bottom line is that if it’s multiple years, just have the accountant do the 5329 for all delinquent years, and confess all the years and get it off your head.

Jim:  Well, I actually think that’s great advice, and probably contrary to what people would actually do.  I’ve had people who have failed to make their minimum required distributions, they haven’t had any notification from the IRS, and their thinking is, “Well, okay.  It’s water over the dam.  I’ll take it from now on, but hopefully, let the prior periods just kind of, hopefully, go by the wayside.”  But you’re saying, “No, no, no.  You could get in some serious hot water.  Better off confessing, filing the Form 5329, doing some type of petition for abatement of penalty, and hoping that the IRS is going to let you off.”

Sy:  Yes.  That’s exactly the point because they have the capacity…your listeners should know, they have information going back ten years.  So, they have the ability to go back ten years, get copies of your file, and find all the IRA accounts you have as of the end of each year.  They can even compute the amount on your return, and what you have on your return, they compare it to the amount that should have been taken.  So, they have the capacity of going back ten years in their system, as we speak.

3. The IRS’ Statute of Limitations

Jim:  Well, that brings up a question that I was going to ask you later because I know that as, in effect, a scholarly lawyer, as well as a practitioner, and as well as somebody who worked with the IRS, I’m representing them in a former life, that you are on top of the statute of limitation rules, and, normally, people think of the statute of limitations as three years.  So, now, you’re saying, “Wait, no.  The IRS can go back ten years.”  So, which one is it?

Sy:  Well, there was a court case that came out called the “Paschall Case” in, I believe, 2011, and it indicated in a court case that there is no statute of limitations on an access contribution penalty, and, basically, the same rule would apply on phase taken R&D.  If you don’t attach a 5329, and, in a sense, confess, there is no statute of limitations according to the Paschall case.  There is no statute of limitations on an IRA penalty if you fail to advise the IRS after the violation.

Jim:  All right.  So, it would be your advice…now, you’re not speaking here as a proper guy who has formally worked for the IRS.  You’re speaking as a practical practitioner that it is in people’s, not in the IRS’s, but in the people’s best interest to file this 5329 and say, “Hey, I should’ve taken the distribution.  I didn’t.  I messed up.  Will you let me off the hook?” rather than just trying to be sly and do nothing.

Sy:  Mmm-hmm.  Yes.  And, one of the things I’ve sent a memo to the government about recently with Congressman Steve Israel is to recommend that the IRS have a reasonable look back period, because it would be a horror if they went back forever.  So, hopefully, maybe the IRS will have a position on how far back they’ll go.  But right now, they can go back indefinitely as the law.

Jim:  And let’s just say, for discussion’s sake, that you don’t do anything.  And let’s say that this is the thing that you don’t want to happen: the IRS, in their new initiative to go after these things, finds you, and let’s say, for discussion’s sake, your minimum required distribution is $40,000.

Sy:  Mmm-hmm.

Jim:  Can you tell us what would happen to an IRA owner who failed to make a minimum distribution of $40,000?

Sy:  Okay.  Two things: in my opinion, they’ll send out a proposed penalty.  You’ll get a notice from the IRS.  “You didn’t take it out.  Please explain to us why you didn’t take it out?”  And then, they’ll say, “If you don’t explain it to us, then we’re proposing you incur a 50% penalty.”  At that point, your accountant will have to work with the client, the IRA owner who violated the rules, and then attach your statement of why he didn’t take it.  Now, it’s very difficult to sort of defend yourself once they catch you, but you’ll have to ask the government to waive the penalty.  Let’s assume they take a position, “Your reason for violating the rules were not valid, unacceptable.”  What’s acceptable?  Well, you were in a nursing home.  You had Alzheimer’s.  You had a mental breakdown.  Your records were destroyed.  But assuming you don’t have that, then you’d have to ask the IRS service center to abate the penalty, assuming they say, “No.”  At that point, you’ll have to make an administrative appeal, and they go to an appeals officer, and try to negotiate a settlement of the penalty.  That becomes expensive for the point of the IRA owner and the appeals officer may say, “No.”  Or, the appeals officer has what’s called the ability to settle the case on a percentage basis.  So, the appeals officer might say, “Well, your $40,000 penalty,” or whatever the number is, “Let’s settle it for half.”  So, if you have a problem and you don’t have a good reason for the violation abatement, then you’re going to have a lot of headaches.  And it could be very expensive.

Jim:  All right.  Well, I think that is a good lesson for our listeners, already: that if there is a, let’s say, missing IRA distribution in your closet, that it would be better to proactively, either yourself, or, preferably, with a CPA, file a Form 5329, that’s IRS Form 5329, explain what happened, and then, even without having to pay the penalty, ask that the penalty be abated.  Is that fair?

Sy:  That’s correct.  Again, I would suggest that all your listeners do that and don’t wait for the notice to come forward.  But, I think they’re going to go back, in my opinion.  I’ve heard and seen, going back to 2011, as we speak.

4. How is the Minimum Distribution Requirement calculated?

David:  I have a question that might be a real layman’s question, but how is the minimum distribution requirement calculated?

Sy:  Yeah.  Basically, you look at the preceding…let’s assume you’re 75 years of age in 2013.  You look at the value of the account as of 12/31/2012 and then you look at an IRS table, generally a uniform lifetime table (there are exceptions), and the table will say what number to use.  You divide the value at the end of 12/31/2012 by the figure that you find in the uniform lifetime table.  There’s an exception to that rule.  A husband and wife, if the wife is more than ten years younger, or vice versa, then the IRA owner can use a special joint table where you can get a better number.

David:  Rate, yeah.

Sy:  But, basically, the uniform lifetime table, in most cases, is the fact that you look up.

David:  But the actual…if you were going to do it at seventy-and-a-half, how do they calculate what the minimum is that you need to take to be legal?

Sy:  If you look at the values of the preceding year, 12/31 of the…well, if you’re seventy-and-a-half, the required distribution isn’t required until April 1st, but you look up the 12/31 value as of 2012 and divide that by the factor in 2013 to come up with the required distribution for the year 2013, the year you’re seventy-and-a-half.

Jim:  And that factor is going to be somewhere around 25 or 26…

Sy:  That’s correct.

Jim:  …so when you work out the math, you’re going to start, typically, depending on how old your wife is, but assuming that she’s not more than ten years younger than you, you’re going to start at somewhere around 4%…

Sy:  That’s correct.

Jim:  …and then, it’s going to get worse and worse.  That is, your minimum distribution’s going to get higher and higher…

Sy:  That’s correct.

Jim:  …as time goes on.

Sy:  Right.  It’s the uniform lifetime table that you’ll find in publication 590.

Jim:  Well, you know, Sy, a lot of our listeners are interested in planning for their estates, and a lot of times, you know, Pittsburgh’s a working town, so we’re not a bunch of silver spoon babies like you New Yorkers!  So, a lot of times, a lot of our listeners might have the majority of their wealth in their IRAs and retirement plans because they have been working and they’re interested in passing it on to their spouse and their children at their deaths, and there are a lot of mistakes being made, and I hate to say this, because frankly, some of the mistakes are made by some of my peers, whether they be CPAs, financial advisors, or even estate attorneys.

Sy:  Mmm-hmm.

5. Preparing for Your IRA

Jim:  Could you give us some guidance on how people should be preparing for their IRAs?  What they should be talking about, in terms of their accountants, their financial advisors and their estate attorneys so that they don’t make some of the mistakes (and maybe we’ll even go into some of the post-death mistakes)?

Sy:  Well, there’s a whole host of things.  The first thing is: Who do you want to receive the retirement account on your demise?  Is it your spouse?  Is it your children?  Grandchildren?  All  of that goes into a whole host of rules.  I would say one of the biggest mistakes, even before we get there, is that if one should die and they’re taking required distributions, they die when they’re seventy-five or, you know, after their required beginning date, and that’s April 1st after you’re seventy-and-a-half, if you die on or after that date, then there’s a required distribution for each year, even in the year of death.  And I was involved with the RF regulations on what happens if you die when you’re in a required minimum distribution mode.  What happens?  Well, you’re seventy-five.  You’re supposed to take out $40,000 in 2013 and you didn’t do it.  Well, the question now is: what happened?  If the spouse is a beneficiary, before she can roll over the money into her own spousal rollover account, the IRS regulations say that the required distribution at the year of death must be taken.  Now, publication 590, unfortunately, does not say who has to take it.  So, one of the recommendations I made to the IRS in writing last month was that the publication 590 be updated to say that in the event that an individual passes away and is in payment mode, that the regulations (and I was involved with them) state that a beneficiary must take it out.  So, if the spouse is the beneficiary and the IRA owner died, then the wife has to immediately take out the $40,000 that the IRA owner should’ve taken out, but didn’t take it out because he died.  And, so, this is a common U.S. error.  It happens to almost every IRA owner in the nation.  If they take money out monthly, or at the end of the year, there’s going to be an unpaid required distribution for the year of death.

Jim:  What happens if the named beneficiary is different than the beneficiary of the estate?  Who has to take it out?

Sy:  Okay, that…again, I was involved with that one.

Jim:  I had a feeling you were!

Sy:  I put it to a committee, and that went around and around and around, and, ultimately, the regulation was written that states that A beneficiary must take it out.  Now, that issue is not covered in publication 590.  Either you know the rule or you don’t know it.  So, the interpretation…I’ve had unofficial discussions with the IRS and they take a position of ANY beneficiary can take it out, A beneficiary.  So, it’s easy if the wife is a beneficiary, let’s assume she had a mere $40,000 in the account, and the decedent passed on, who should’ve taken out $40,000.  The wife takes out the $40,000 first, day one, and then day two, rolls over that million dollars to her own IRA.  But, let’s take another step supposing there is no wife, supposing there are three children.  Now, the question is: do they have to prorate the rule?  And, again, according to my informal discussions with the IRS, any of the three children could take that money out.  But, normally, what I do is I suggest that they prorate it for other reasons, the separate share rule, for a lot of technical reasons.  But the bottom line is that the unpaid required distribution in the year of death must be taken out.

Jim:  All right.  And let me ask you one more question before the break: I sometimes recommend, if there are sufficient assets in the estate, that younger beneficiaries be named.  So, let’s say, for example, you have a couple in their mid-seventies with more than a million dollars and more than sufficient resources for the surviving spouse, and even though I typically do it on a disclaimer basis (but that’s another subject for another day), I might name children or grandchildren as the beneficiaries of the IRAs.  So, whose money would that be?  Would that be the spouse’s?  So, let’s say that I did that.  Let’s just say I had a client today, and he was worth a couple million dollars, and I showed him the wonderful benefits of having a stretch IRA for his Roth IRA.  And now he got all excited about it and he wants to leave it in a trust for the benefit of his grandchildren, so his grandchildren can defer the distributions and get all that tax-free income.  So, let’s say, who has to take that money out?  And maybe a Roth IRA isn’t a good example because the wife wouldn’t have to, but let’s just say it was a traditional IRA.

Sy:  Well, are you saying they’re multiple beneficiaries, or…?

Jim:  Well, let’s assume, for discussion’s sake…let’s keep it simple.  We have one grandchild as the beneficiary of the IRA, but the spouse is the beneficiary of the will and revocable trust.

Sy:  Yes.  Okay, the regulation…well, that issue came up when I was involved in negotiating with council for the government treasury and the whole team.  The beneficiary has to take out the unpaid required distribution, is the way that issue is resolved, on a very basic premise that under property law, when an IRA owner dies, whose property is it?  It becomes the beneficiary’s property.  So, the regulations say A beneficiary must take it out.  That was the way that was resolved, not the estate, not anyone, but the beneficiary of the IRA has to take out the unpaid required distribution for the year of death.

David:  Well, let’s take that break now, and listeners, if you have questions or comments for Seymour Goldberg or Jim Lange, call the KQV studios at (412) 333-9385.


David:  And welcome back to The Lange Money Hour with Jim Lange and Seymour Goldberg, author of Inherited IRAs: What Every Practitioner Must Know, and IRA Guide to IRS Compliance Issues: Including IRA Trust Violations, both of which are available at www.abastore.org.

Jim:  And by the way, I should mention, I know we have a lot of estate attorneys and financial advisors as listeners, not only just in Pittsburgh, but actually airing on the web live.  For you guys, to me, this is kind of essential information that you should have.  You should have Sy Goldberg.  You should also have Natalie Choate’s Life and Death Planning for Retirement Benefits.  This is just something that practitioners should have, and, unfortunately, I’m not terribly proud of the estate attorneys or financial planners who often bollocks up IRAs, particularly after death, but even during the planning stages.  I think Sy has partly spent a good chunk of his career correcting mistakes, or trying to avoid some of these terrible mistakes that financial advisors and attorneys make.  And Sy, I know we could easily spend the rest of the program on post-death distributions and problems, but I know one of the things that you have a strong opinion about is the issue of unprepared beneficiaries.

6. Trusts as Beneficiaries of IRAs

Sy:  Yes.  Again, before we go back to that, in the IRA compliance, or the IRA trust, is a 70-point checklist, and all the things that the attorney should consider, because they don’t tie in to the state.  Uniform principle income act and the IRS rules, and there’s a big problem U.S.-wide because, as I spoke to Jim earlier, a lot of attorneys and accountants are not aware of the uniform principle income act that’s in 46 states, and you have to dovetail the trust with the state law and the IRS rules.  In terms of the beneficiary forms, we found, going back into the 80s…I don’t want to date myself, late 80s, most beneficiary forms were improper.  If you had a number of children, the form only had room for one or two children.  If a child died, even today, a lot of banks say the surviving child gets the money.  If one child should die, it goes over to the survivor.  We’ve amended thousands of forms over the years, and we state that if the child dies and has children, then it goes to the child’s children.  But again, if you don’t know about it, and you look at a common form with the banking institutions primarily, you’ll find that they don’t provide for what happens if a child dies and it goes to their issue.  Instead, it goes over to the surviving child.  So, it’s a big problem and you really have to dovetail the form to get what you want.  Otherwise, you’re going to wipe out the issue of the predeceased child.  So, I found that to be a big problem and I would say most people who come into the office aren’t even aware of it.  They don’t realize the forms are an essential will and the forms override the will.  So, there’s one of your biggest problems.  Some IRA institutions now have default beneficiaries.  If you don’t do anything, it goes to the spouse, then to the issue, and then to the estate, or some of the forms say if you don’t have a beneficiary designated, then it goes to the estate.  So, one has to read the form and go over it with their accountants to make sure the form is consistent with their objectives.

Jim:  And another problem that I have found frequently…and in fact, interestingly enough, one of the big problems that really has to be done right, and, in my opinion, this, kind of like packing your own parachute, is not a do-it-yourself project, is in the event that you do have a young beneficiary, or in the event that you have a spendthrift beneficiary, or a beneficiary with special needs, or somebody that would require a trust, that the drafting of that trust must be very, very specific and can’t be done wrong, or else you lose the designated beneficiary advantages and you have massive income tax acceleration.

Sy:  Yeah.

Jim:  And this is a nightmare for people who get this done wrong, and I think, as far as I can tell, when you have trusts as beneficiaries of IRAs, it’s done wrong more than it’s done right.

Sy:  I would agree with you.  I would say that the biggest error, and even publication 590, and I sent that memo I spoke to you about that went to the IRS last month, publication 590 does not cover the rules when you have a trust as a beneficiary in a matter that is detailed enough.  The biggest mistake I found is a lot of lawyers don’t know the October 31st deadline and, basically, that states that if you have an IRA payable to a trust by October 31st following the year of death, the trustee has to send a copy of the trust document to the IRA institution.  And I found that it’s not being done, and that blows the whole stretch payment.  And that’s one of the things I’m asking the IRS to look into because, truthfully, a lot of attorneys don’t know the post-death October 31st deadline and publication 590 is not clear on it.  And that’s crucial for all the attorneys who draft trusts because if they don’t administer it right and they don’t follow up post-death, the October 31st deadline will be blown, and you’ve lost the stretch, and you’re going to wind up with massive tax issues at the trust level, and you could destroy a good piece of the retirement fund.

Jim:  Well, specifically, in my mind, the trust has to be drafted properly while the client is alive, and then has to be administered properly after the client dies.  And, just to quantify the mistakes, because I’ve actually analyzed this exact issue, if you have a guy die, or a woman die, with a, let’s say, a million dollars in their IRA, and they leave it to their child, that if you blow the stretch, it actually, over the child’s lifetime, will cost the child a million dollars.  So, you’re literally losing as much money as you’re leaving the child if you blow the stretch.  And interestingly enough, I had Bill Steiner, who is also an excellent New York state estate attorney with a specialty in IRAs, and there was an article in the Wall Street Journal that said, “Oh, it’s very complicated to draft trusts as beneficiaries of IRAs.  So, therefore, we recommend that you not name a trust as beneficiary of IRAs.”  And when I saw that article, I was very offended, and I said, “That’s the wrong advice.”  I wrote a letter to the editor and said, “The right advice is to just seek out a practitioner who knows it and does it right, and that way, you can get your cake and eat it too.”  That is, have a trust as the beneficiary and have it done properly.  I had Bill Steiner on that exact day, and Bill, without me saying anything, he said, “You know, there was an article in the Wall Street Journal today and it was dead wrong!  And I was so infuriated that I wrote a letter to the Wall Street Journal saying, ‘No, that’s the wrong advice!’”

Sy:  Yeah, I know the reporter.  I told her there were a lot of mistakes being made, so maybe that’s the reason she put that in.

Jim:  Well, yeah.  I don’t want to mention that reporter’s name because I think that the advice that she gave was not accurate.

Sy:  That’s correct.

Jim:  But I think your advice, that this thing has to be done properly ahead of time and perhaps as, or even more, importantly, be administered correctly after death, is critical.

Sy:  I found that’s true, Jim.  I found that when death takes place, the attorney who did the trust is nowhere to be found.  He’s no longer retained and the accountant who administers the trust, he doesn’t know about these rules, the trust rules.  He has difficulty even interpreting the IRA trust.  There are any number of cases in the last year or so where the attorney didn’t know the October 31st deadline, didn’t administer the trust, left it to the accountant, and everything went haywire.  So, it’s pretty serious if the attorney draftsman doesn’t get involved training the trustee, or the accountant and the trustee, with the rules, and that’s the policy I’ve taken, that the attorney draftsman should work with the accountant and trustee and say, “This is what’s got to be done,” and follow through.  Otherwise, the whole thing is a real problem.

7. Preparing Beneficiaries

Jim:  Well, this goes back to the original question, how this thing all started, which is the issue of unprepared beneficiaries.

Sy:  Yes.

Jim:  So, one of the things that I like to do when I draft…and by the way, you know, we, again, in Pittsburgh, I would say the majority of my clients have more money in their IRAs and retirement plans than money outside their IRAs and retirement plans.

Sy:  I see, mmm-hmm.

Jim:  So, to me, the beneficiary designation of the IRA is actually more important than the will or revocable trust.

Sy:  I can see that.

Jim:  And I like to get the family involved to give them an idea of what to do when, I should say, the estate matures or when one of the IRA owners, or the spouse, dies.

Sy:  Mmm-hmm.

Jim:  So, is there anything that you could tell people…?

Sy:  Well, normally, what happens when our office does a probate, we tell the client, “Do you want the accountant to get involved with the administration of the trust, or do you want our law firm to have hands on and go step by step on all the rules and implement?”  Well, if it’s a small IRA and it’s directly to a child, they’ll say, “Well, a broker will help us out.”  And then, I’ll say, “Who?”  And she says, “Well, our broker.”  Or they’ll say the accountant.  Unfortunately, a lot of times, there’s no one there who did anything.  So, that’s where the post-death R&Ds will be a big order item.  The biggest thing that I think is going to happen is that a lot of people, on death, the children or the heirs, regardless of a trust directly, there’s no one who tells the child or the grandchild what the post-death rules are, whether it be a Roth, which requires post-death distributions, or a traditional, but there’s no one there to help them.  So, one of the things that I’m suggesting to the IRS is that they work with the state bars and the accounting organizations and financial planners, and insist on a higher level of education so that it’s not just Jim Lange and myself, or Bruce Steiner or Natalie Choate, but someone has to handle the post-death R&D rules for the family or else nothing happens.  Then, there’s going to be a lot of 50% penalties that will be potentially leveled at the inheritor of the inherited IRA.  So, that’s where I think the untapped money, in terms of tax and penalty, lies as to the post-death effects.

Jim:  And the other thing is, if you have somebody who isn’t really knowledgeable about these areas…this is a true story.  A financial planner in California was handling the account for dad and son.  Dad died with a million dollar IRA.  Instead of using the appropriate title of the account, which might have been something like ‘Inherited IRA of Joe Schmoe for the Benefit of Joe Schmoe, Jr.,’ he just titled the account ‘Joe Schmoe, Jr. IRA,’ which was a penalty, and basically accelerated income tax on a million dollars.

Sy:  Yeah, with that and all the salaried income taxes and access contribution, a 76% penalty on top of it.

Jim:  Yeah.  So, that’s a nightmare.  So, people really have to get good advice and I would say both in the planning stages, that if it’s a husband and wife, while husband and wife are still kicking, and then, after death, whether it’s the first death or the second death, to make sure that this be taken care of.  And I don’t want to say anything bad about brokers or any financial advisors, but I think people are taking a chance if the person that they are trusting doesn’t have a reputation for really being IRA knowledgeable.

Sy:  Mmm-hmm.  Well, that’s probably the 99%, Jim, because how will the individual beneficiary know who to go to?  Who knows or doesn’t know?  And that’s the problem.  They’ll probably do nothing, and they will wind up with a massive problem.

David:  Well, let’s talk about that after our break.

Sy:  Okay, that’s fine.


David:  And welcome back to The Lange Money Hour with Jim Lange and Sy Goldberg, author of Inherited IRAs: What Every Practitioner Must Know, and IRA Guide to IRS Compliance Issues: Including IRA Trust Violations.

8. Accumulating and Conduit Trusts?

Jim:  Sy, one of the things that you have been very well known for is getting it right when you have a trust as a potential beneficiary of an IRA.

Sy:  Yes.

Jim:  And that is something that is very commonly botched, and a lot of times, in the natural scheme of things, it is appropriate.  So, let’s say, for discussion’s sake, you have a spendthrift child, or you have a child with a drug or an alcohol problem, or you even have young children or young grandchildren, and you don’t want to just leave a ten-year old a half a million dollars in an IRA.  You don’t want to do that for a spendthrift.  You don’t want to do that for a child with a problem marriage, or God forbid, that you have a special needs child where it’s appropriate.  So, can you give our listeners some guidance?

Sy:  Generally, if you’re getting the special needs approach, there’s a special handling of that, but, basically, I tend to use the conduit trust approach.  A conduit trust approach says the required distribution comes out of the IRA and goes into the trust, and then the trust pays it out.  Now, if it’s a fifty-year payout, and it’s a million dollars, it’s $20,000.  But let’s assume it’s a minor.  The trust document should say (and in most jurisdictions, you’re allowed to do this), you can say that the trustee doesn’t pay out to the minor because it’ll get loused up with the court, but it’s payable to a custodian under the Uniform Transfers to Minors Act until the minor hits age twenty-one.  So, I cover minority up to twenty-one, and most states will value at twenty-one.  In fact, I believe Washington State allows you twenty-five, but most jurisdictions are twenty-one.  So, you can, in the trust, say, “Under twenty-one, the money goes to a custodian account for the benefit of the minor.”  And that’s the way I handle that, and then, thereafter, it goes directly, when the person hits twenty-one, to the person.

I don’t like using an accumulation trust, which basically says you can pay out or not.  The reason for that is according to the case law and the regulations and the rulings, that, basically, you have to then use the age of the oldest beneficiary.  So, let’s assume the minor is five years old, and the remaining diminish is forty.  If you have a conduit trust, then use the age of the five-year old.  If you say that you could accumulate income or not, it’s discretionary.  All the regulations and a lot of rulings all say then that four or five-year old is deemed to be aged forty or fifty, whether the age of the oldest beneficiary is or not.  So, I don’t like taking that chance.  So, I tend to use a conduit trust in every case except for special needs, and then it’s handled a certain drafting way, which is pretty complicated.  I don’t want to confuse your listeners, but there is a way to handle a special needs scenario.  I tend also to sometimes allow the trustee to go beyond the R&D rules, and to give the child…the trustee can invade above and beyond the required distribution for health, education, maintenance and support, and sometimes, I even add a 5% right where the beneficiary can ask for an initial 5% of the value of the fund after, say, age 25.  So, I tend to put all that in.  I also have special language about what’s income, what’s principle, all kinds of…and, again, I have a 70-point checklist, and the ABA guide, options that the attorney draftsman should consider.  He could put them in.  He could not put them in.  The pros and cons of each point are covered.  So, it’s a guide for the attorney who’s not an expert in drafting the IRA trust.

Jim:  Well, for whatever it’s worth, I happen to agree with everything that you said, and one of the reasons that the conduit trust, in my opinion, is so powerful, and something that might appeal to the cheap hearts of our many listeners, is that by doing it the way you have suggested, you are also reducing income taxes because, in an accumulating trust, if the money just sits there in the trust, you’re going to have to pay income tax at the highest rate.

Sy:  That’s correct.

Jim:  Whereas, if you are distributing to a minor, for example, you might be at a zero percent tax bracket, or even a 15% bracket.  So, what you’re saying is not just good for legal purposes, I mean, you’re actually saving significant amounts of money in taxes for the beneficiary.

Sy:  Yeah.  There’s one interesting issue that I’d like attorneys to be aware of, whether or not this court case I’m going to give you makes any sense or not.  But there’s a case I’d like your listeners to look at.  It’s online.  It’s Commerce Bank vs. Bolander…

Jim:  By the way, about three minutes are remaining.  But go ahead.

Sy:  Oh, okay.  I won’t hold you on that.  But if you’re in a uniform trust code states, that suggests that if the IRA owner has credit rights personally, you and I know that, basically, he’s protected, but on death, the Commerce Bank vs. Bolander case said in a uniform trust code state that an IRA payable to a revocable trust is subject to claims or creditors of the deceased IRA owner.  Whether you like the case or not, every attorney should read it and say, “Well, do I want to now start drafting irrevocable trusts?”  As the beneficiary, New York State may become a trust code state in a year or two from now, and if that happens, I may have to go back and change the trust from a revocable trust to an irrevocable trust, just because of that Kansas case.

Jim:  And that’s a miserable…well, I don’t want to knock the court system, but I think that that’s a miserable case…

Sy:  It’s a horrible case.

Jim:  …that gives me headaches.

Sy:  So, because of that, the client has to make the call.  The last point I’d like to make is if you’re an executor of an estate, and the decedent had IRA violations, and the executor is aware of it, and he distributes assets, then he has personal liability to the IRS and can be sued under statute U.S. Code 3713, where the executor’s personally liable for the tax violation, whether it be income tax violations, a penalty under an R&D penalty, or an excess contribution penalty.  So, executors have to be very careful and cautioned by their attorney that if you’re aware of the violation, you can’t distribute assets or have a reserve because you’re going to wind up holding the bag if the IRS comes after you.

David:  Well, I’m afraid we’re going to have to stop here, just because we’re running out of time.  We could go on for a while, and I wanted to say thanks to Seymour Goldberg.  You can reach him directly at his firm’s website, GoldbergIRA.com.  Thanks also to Dan Weinberg, our in-studio producer, and program coordinator Amanda Cassady-Schweinsberg.  As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning, here on KQV, and you can always access the audio archive of past shows, including written transcripts, at the Lange Financial Group website, www. paytaxeslater.com, and while there, check out the series of video clips from Jim’s interview with John Bogle, founder of the Vanguard Group.  You can also call Lange directly at (412) 521-2732.  And finally, please remember to join us on Wednesday, August 21st at 7:05, when we’ll welcome Ray LeVitre, author of “20 Retirement Decisions You Need to Make Right Now,” to the next edition of The Lange Money Hour.




jim_photo_smJames Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans.  Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.