Episode 28 – Ideal Beneficiary Designations with guest Matthew Schwartz

Episode: 28
Originally Aired: May 19, 2010
Topic: Ideal Beneficiary Designations with guest Matthew Schwartz

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Ideal Beneficiary Designations
James Lange, CPA/Attorney
Special Guest: Matthew Schwartz
Episode 28

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  1. Introduction of Guest, Matt Schwartz
  2. The Importance of Reviewing Your Current Estate Plan
  3. Benefits of Various Beneficiary Scenarios
  4. Alternatives to the B Trust in Second-Marriage Situations
  5. Naming Multiple Beneficiaries in a Special Needs Trust
  6. Beneficiaries for IRAs and Roth IRAs

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1. Introduction of Guest, Matt Schwartz

Nicole:  Hello, and welcome to the Lange Money Hour, Where Smart Money Talks.  I’m Nicole DeMartino, your host today, and we’re going to go a few different directions, but they will all have one thing in common.  We’re going to be talking about naming beneficiaries, naming them for your IRA, your will, and for those of you that may have special needs situations, such as special needs children or grandchildren, second marriages, we’re going to touch on those, as well.  So, certainly, stay tuned for that.  Before we get started, as always, I am here with Jim Lange, Pittsburgh-based CPA and bestselling author of “Retire Secure! Pay Taxes Later,” and he’s actually sitting here with me with a big smile on his face because right after the show, Jim leaves for Monterey, California, and Jim, I looked at the weather this morning.  It’s going to be beautiful, sunny and seventy.  So, I think I mentioned the last time, Jim’s been invited to address a very prestigious group of people working in the financial services industry, so he’s gonna go out there and knock their socks off.  So, good luck, Jim.  Also sitting here with me is another member of the Lange team, Matt Schwartz.  He’s here with us today, and let me tell you a little bit about Matt.  Matt’s been with the Lange Financial Grop team for almost eight years now, and he focuses on estate planning and administration.  Matt’s a busy guy, to say the least.  In addition to his practice, of course, Matt is very involved in the community here in Pittsburgh.  He is a counsel member of the Allegheny County Bar Association, treasurer of the Allegheny Tax Society, financial secretary of the executive committee for the board of Temple Emmanuel in the South Hills and a member of the Professional Advisory Committee of the Pittsburgh Foundation.  He also does alumni interviews for his alma mater, Northwestern University, and, if that’s not enough, and perhaps this is the toughest job of all because he’s outnumbered just like my dad was, he’s the father of two beautiful girls and he and his family live in the South Hills.  So, thanks for joining us, Matt.

Matt:  Glad to be here.

Nicole:  Great.  Jim, I think we’re ready to go.

Jim:  And I’ll add a quick addition to Matt’s introduction.  He just had a fabulous time, Matt, what was your time for the half marathon?

Matt:  Two hours and thirteen minutes.

Jim:  Two hours and thirteen minutes, so we have some speedy people at the Lange Financial Group.  In addition, I’ve been working with Matt for almost eight years now, and he’s a rare combination of having a very keen intellect, but also being very good with people, and he is able to combine his intellect with his people skills to really help people get the most out of their estate plan.  I’m just really honored that he continues to work with us and has done such a fine job for so long.  Today, I thought what we would talk about is some of what we consider the ideal beneficiaries, and for your IRAs and your wills and estate planning, and some of the problems with traditional estate planning.  And we see this so often, and in the book I call this the cruelest trap of all, and Matt, maybe I thought, if you could tell people a little bit about the problems with the traditional estate plan that I’m convinced that many of our listeners have right now, the problems with the traditional B plan, and then, we can start talking about some of the ways we might address that.  So, I’ll hand it over to you, and then, we’ll also get into what I think is, literally, brand new, not final, but it looks like we have some news on what the estate tax laws are gonna be like in 2010 and in the future.

2. The Importance of Reviewing Current Estate Plan

Matt:  Thanks, Jim.  The traditional estate plan was based on the idea that the surviving spouse would have a pot of money equal to the federal estate tax exemption, that could be spent for health and maintenance, that would not be included in his or her estate when they passed away.  And back in 1997, this exemption was only $600,000, and as President Bush changed the tax laws, this exemption increased to $3,500,000, and, often in the traditional estate plan, the trustee of this trust is a child.  So, mom or dad may be stuck begging with their child for money, and when the trust was $600,000 and they had a couple of million dollars of other assets, it wasn’t such a big deal, but many of these plans haven’t been revised in many years.  From seeing some plans in our office, sometimes the most recent will is from 1985, and I know Jim’s seen that too.

Jim:  Many times.

Matt:  So, that’s why it’s important to have your plan reviewed, because your current plan may handcuff you in a way you don’t realize.

Jim:  Yeah, I think it’s really too bad, because the first thing, I’ve been doing this for thirty years now, practically everybody in a traditional marriage, original husband, original wife, same kids, they don’t come in and say the most important thing is to save estate taxes for the children after both of us are gone.  They almost always say the most important thing is to take care of each other.  But then, what the attorneys do, is rather than listening to their clients and leaving each other as the primary beneficiary, they create these B Trusts, and the essence of these B Trusts are, the spouse gets the money, but not outright, but in trusts, so they can only get money for health maintenance support, education, true, they can take out $5,000 for anything that they want, but the point of these trusts is to save estate taxes at the second estate, and what’s happened now with the large exemption amounts, in particular now with the portfolios down, is you have a lot of situations where rather than doing what the clients wanted, which was providing for the surviving spouse, we have this trust in the way, and sometimes, it doesn’t even save estate taxes because the exemption is up, assets are down, so basically, people are handcuffed.  And it’s really ironic because, and a lot of people don’t even know.  Matt, so if somebody is saying, “Oh geez, I wonder if I have that,” and if they wanted to look to their will or try to remember what was in their will, what is some of the language that people might have in their wills that would put this tremendous restriction on the surviving spouse?

Matt:  The language you’d be looking for would normally be in the first couple of pages of your will, and the language may say something such as “I give to my spouse the greatest possible amount that I can give to her, while fully utilizing my applicable credit amount.”  And the applicable credit amount right now is $3,500,000.  So, it’s basically saying if you have over $3,500,000, that amount will go to the spouse either in a marital trust or outright, but everything up to that $3,500,000 would go into this bypass trust that we’ve been talking about that’s restrictive.

Jim:  Well, let’s say you don’t have $3,500,000.  Let’s say you have $2,000,000 or $1,000,000.  Using the language that is in many of these documents right now, how much money would go into the trust and how much money would the spouse get outright?

Matt:  Well, assuming that the assets are controlled by the will, and that’s a key assumption, it’s not a separate IRA that maybe has a different beneficiary designation.  If the assets are controlled by the will, everything would go into the trust for the spouse, and the spouse would have nothing outright.

Jim:  Alright, so understand the implications of this.  Somebody could have a one, two, three million dollar estate, there could be a death, either the husband or the wife, and the survivor, instead of having as much money as they want to do whatever they want, which is usually the intent of both spouses while they are alive, the survivor will actually have no money on their own, and they have to rely on the income from the trust.  Now, it’s true that if the income isn’t sufficient, they could get extra money for health maintenance and support, but they can’t get money to go to Aruba.  They can’t get money for a second home.  They can’t get money to help their grandchildren with their education.  So, this sounds like a terrible restriction.  Have you actually seen this in practice where people have been restricted and not have the money that they wanted?

Matt:  I’ve seen some situations in practice where people have had more restrictions on their money, in this kind of context, that they would like.

Jim:  Alright, and to me, this is really a travesty, because it’s not what the intent is.  The intent of the trust is to save estate taxes at the second death, but the intent of the client is usually to provide for each other first.  And I know in our documents, absence of very strong convincing set of circumstances that would preclude this, we usually start, instead of funding this trust first, we start with the surviving spouse as the primary beneficiary.

Matt:  Correct.

Jim:  Alright, now, I understand that you have some potential news about what might be happening with the federal estate tax, because right now, in May 2010 as we’re sitting here, there is no federal estate tax.  But, I understand that you have literally, within the last couple of hours, some news on what might happen.  Could you tell us what that might be, and then we’ll go back to what the implications of that are, and then how our listeners should react.

Matt:  Sure.  There was a news report that the Senate Finance Committee met recently and has reached a tentative agreement on the details of the tax.  There’s some nuances we don’t know yet, but what we’re hearing is the exemption’s going to be $3,500,000, gradually indexed up to $5,000,000 with no inflation and a 35% federal estate tax rate.

Jim:  Okay, and that’s why you said it’s not $3,500,000.  So basically, the way we should be thinking about it, at least in the short term, is that the federal exemption amount is $3,500,000, which means that you can die with up to $3,500,000 in your estate and not have to pay any federal estate tax.

Matt:  Correct.

Jim:  Alright.  So, let’s say that somebody has…I’m getting this look from Nicole.  I think it’s time for a break.

Nicole:  He knows me so well.  We do need to take a break.  We’ll be right back.  You’re listening to the Lange Money Hour, Where Smart Money Talks.


Nicole:  We’re back and we’re talking smart money today.

3. Benefits of Various Beneficiary Scenarios

Jim:  Okay, Matt, so we had this B Trust, which is the, let’s call it, the dominant type of estate plan that many of our clients have.  We’ve just said some of the reasons why we don’t like it.  But is there some reason we still might want to have it as an option, even if we don’t want the B Trust to be the primary beneficiary.  Are there times when it might be handy to have the B Trust as an option?

Matt:  Absolutely, because there is always the possibility, as we’ve seen with Congress changing the federal estate tax law, that there could be a federal estate tax at a future date, and using this trust could still help shelter tax at the second death.

Jim:  Alright, so, up to now, we have, let’s say, two potential beneficiaries that we might want.  We might want the surviving spouse, which is probably the most common, and then also the B Trust.  Are there times when we wouldn’t want other beneficiaries in both either the will or the beneficiary of the IRA, such as children or a well-drafted trust for grandchildren?

Matt:  Sure.  There’s situations where the surviving spouse is at a point in their lives where they don’t even need access to all the income from the assets, and they see where their children are in their lives, and it’s a wonderful opportunity for them to give some of mom or dad’s money directly to the children at that time.

Jim:  Alright, so in other words, after the first death, the idea is the children could get some money while they’re still young enough, presumably to enjoy it more, and you obviously want to do that only if mom or dad, the survivor, has more than enough money for themselves.  Are there times when you want money going directly to grandchildren after the first or second death?

Matt:  Sure, I mean, it depends on your fact pattern.  If the children are comfortable at the second death and they’re taken care of financially, just giving them more money is just going to exacerbate their estate tax problems.  So, it can be a nice opportunity to give money to grandchildren.  However, I think you have to be cautious about how you give the money to the grandchildren.

Jim:  Well, we certainly want a well-drafted trust, but that goes back into some of the stretch IRA concepts that we talk about, and we like having very young beneficiaries.  So, for example, even in the Roth IRA case, if you make a Roth IRA conversion of $100,000 and you leave it to your spouse, and then your spouse dies and leaves it to your children, and if you’re in the upper tax brackets today, you will be $93,000 better off.  Your children, if you leave it to them, will be $690,000 better off.  But your grandchildren will be $12,000,000 better off.  So, the difference between your children being $890,000 better off and your grandchildren being $12,000,000 better off is a reason that, if the children can afford it, you might want to have some of that money going to the grandchildren.  So, at this point, it sounds like we have four potential options.  We have the surviving spouse, we have the B Trust, we have the children and we have the grandchildren.  What do you think is a good way to decide how much and who gets what and when should you decide?

Matt:  Well, I think it’s most important not to set the decision in stone, which is what traditional estate planning does.

Jim:  So, that’s what the traditional A/B wills do.  They decide, in advance, who gets what, and whatever happens, happens.  But it’s already a done deal on who’s gonna get what?

Matt:  Correct.

Jim:  Alright.  So what’s the better alternative?

Matt:  I think the better alternative is to let the surviving spouse, who’s been the life partner of the deceased spouse, be in charge of the decision making, and let him or her decide whether to keep all the assets, pass some of the assets to a trust where they can take the income from it, or pass assets directly to children, and then, it would be up to the children if they wanted to pass it down into trusts for their children.

Jim:  Alright.  Well, Matt, you’ve been with us for eight years, and then you were with some big firms before that.  Have you seen some of the results of this type of flexible planning, and could you say how this actually works in practice after people have died?

Matt:  Sure, it’s been a wonderful opportunity for many families.  If they were in the traditional estate plan, there were situations where children were able to use money, to receive money and change their lives, that in a traditional estate plan, they would’ve had to wait on that money until after the surviving spouse died.  And the surviving spouse was no worse for the wear.  It was great for him or her to see their children be able to enjoy some of the inheritance now, and it really made a difference in their lives emotionally, and then, when you look at the potential tax savings to the family in the wealth generation, it’s just a win-win for everybody.

Jim:  Well, that’s what I’ve always thought.  And this plan, which is known as Cascading Beneficiary Plan, is all over the literature.  It first came out, we first published it in 1998 in “The Tax Advisor,” and it’s been all over the place.  Is this for everybody, and do you not have to have trust between spouses in order for this plan to work?

Matt:  As you said, the keystone of this plan is trust between spouses.  So, if you have a situation where a spouse is very concerned that money left to the surviving spouse after death may not go to the children, and may, unfortunately, go to a future spouse’s family, then maybe the Cascading Beneficiary Plan isn’t the best plan for you.

Jim:  Well, what if it’s a second marriage?  Would a Cascading Beneficiary Plan be appropriate then?

Matt:  It can be.  It depends on how the spouses feel about their children.  I mean, we have a lot of Brady Bunch combinations where they treat the children from each of the first marriages as one united family.

Jim:  Yeah, by the way, Matt is giving you kind of a gutsy answer.  Usually, the answer is no, you never want to trust the surviving spouse to provide for your children, because you’re afraid that she’s going to change the answer, change the beneficiary to her children, but Matt’s saying if there is sufficient trust among the spouses that that is okay, which is not the traditional way to go.  So, I will salute you, Matt, for recognizing that not all families are the same.

Matt:  Well, when we can get to that level of trust, as Jim can expand on, it really leads to tremendous opportunities for the stretch IRA that you would not have otherwise if money was forced into trusts for that spouse of the second marriage.

Jim:  Alright, well, let’s take a different situation.  Let’s say that we don’t have this perfect trust, and let’s assume that we have a situation where we have a second marriage, and we have kids from different marriages, and I know that, you know, we’ve actually had a show where we talked about the Q-Tip Trust, and, you know, we talked about leaving money in trust when the surviving spouse got the money, got the income from the trust, and if they’re death, it went to the children from the first marriage, is there an alternative that we have used in practice in second marriages when you have different children from different marriages?

Matt:  Well, absolutely.  There’s always alternatives, and I think there’s a distinction, though, whether you’re talking about passing down IRA assets because their tax attributes, and if you’re talking about passing down regular liquid cash or investments…

Jim:  Alright, well, why don’t you take each case then?

Matt:  Okay.  I want to break it down and make it a little more straightforward for the listeners.  If you’re dealing with regular investments or cash, leaving money in a trust for a surviving spouse, just means that whatever income is earned by that cash ends up being taxable to the surviving spouse if it’s distributed to him or her.  And most of these trusts are structured that the income gets paid out to the surviving spouse, but when you talk about an IRA, and let’s not talk about Roth IRAs for a minute, let’s just talk about IRAs.  Tax has never been paid on that money.  So, when that money gets paid into a trust for the surviving spouse, 100% of it is subject to income tax, and sometimes in these trusts, the deceased spouse doesn’t want to give that spouse from the second marriage a great rate of withdrawal because they assume that any money withdrawn is not gonna be left to the children from the first marriage.  So, if that money accumulates in that trust and is not distributed to the surviving spouse, then there’s very extreme tax consequences.

Jim:  And then, also, the stretch IRA concept is just murder for that B or Q-Tip Trust.  So, what are some of the alternatives?  Let’s say you have somebody that has a very significant IRA, and they don’t want to get into this high income tax situation after they die.  Have you ever just broken it up into, what I might call, a carve out, where the surviving spouse gets ‘X’ percent and the children from the first marriage get ‘X’ percent?

Nicole:  And actually, Matt, before you get to those alternatives, we’re going to take a short break.  You’re listening to the Lange Money Hour, Where Smart Money Talks.


Nicole:  Welcome back to the Lange Money Hour, Where Smart Money Talks, and Jim, why don’t you give that question one more time to Matt before our break?

4. Alternatives to the B Trust In Second-Marriage Situations

Jim:  Yeah, Matt, I was asking, what are some of the alternatives to the B Trust when you have a second marriage situation?

Matt:  Often, one alternative that many people come up with is to divide a portion of the retirement account or IRA and leave it to the surviving spouse from the second marriage, and then leave the remainder to kids from the first marriage.  Now, there’s an emotional benefit here that the surviving spouse doesn’t sort of have to be watching over her shoulder until she passes away, and the kids from the first marriage finally get their money.  It’s sort of a clean split from a money perspective.

Jim:  I like that.  Clean, cheap, easy to administer, you know, spouse, you get yours, kids from first marriage, you get yours, goodbye.  Much, much cleaner that the B Trust where you have to worry about how the money is invested and you have to worry about the kids competing with the surviving spouse for their different interests.  I like that a lot better.

Matt:  Plus, when you have a B Trust situation, say your surviving spouse is seventy years old, under the minimum required distribution rules, the money that’s in that IRA has to be spent down during the spouse’s remaining life expectancy, and it’s only seventeen years under the single life table.  So if that spouse lives more than seventeen years, the tax deferral from your IRA is gone.  Whereas, if we look at the alternative of the carve out, the surviving spouse has a much better life expectancy, ten years more, plus the way the recalculation works, money will never run out of the IRA as long as she continues to take the minimum required distribution.

Jim:  Yeah, I think it’s better for both the spouse and for the children of the first marriage.  In addition to second marriage situations, something that has come up more and more often is special needs for different beneficiaries.  So, for example, just recently in the office, we’ve had, maybe, four or five families who’ve had a child or a grandchild that, whether you want to call them disabled children or, let’s say, for my purposes, the defining moment is actually whether they’re getting government benefits or not.  So let’s say, you have a child or perhaps a grandchild who is receiving government benefits of some type, whether it’s state or federal or both, how would you handle leaving money to a child like that where you don’t want to jeopardize the government benefits, but you still want to provide for that child for expenses that the child may incur over and above the government benefits, or just to afford that child a better lifestyle than they could living just off the government benefits?

Matt:  Well, you have to be careful when setting up a pot of money for the benefit of this child.  I mean, it would be clear to most people that it should be a trust, but you have to make sure the trust is drafted in a way that the government’s not going to consider it an available resource that’s going to disqualify that beneficiary from public assistance.

Jim:  Alright, so, in other words, if you don’t draft the trust correctly, the government can say, hey child, you can pay for your own expenses out of your own pocket because you have this pot of money.

Matt:  That’s right.

Jim:  Alright, now, can the government ever go back and say, well, now that you’ve inherited all this money, we want some of our money back, or is it only just prospectively, that is, in the future?

Matt:  It would be prospectively.

5. Naming Multiple Beneficiaries in a Special Needs Trust

Jim:  Okay.  Alright, so let’s say you have a situation where the child is getting government benefits, but you want income to supplement the benefits.  You’re saying that you have to have a special trust that has the appropriate language in it that will, in effect, defend the trust or the money from the government?  Now also, if the money is IRA money, aren’t there five rules that any trust that is the beneficiary of an IRA must meet?

Matt:  Well, that’s true, but let’s speak for a moment to what you were saying about some language that you would want to make sure is in that trust, and there’s probably two key components to it.  One is that you want to make sure that the benefits supplement and they don’t supplant your public benefits, and in addition, it’s useful to have multiple beneficiaries, maybe other children, as beneficiaries of that trust, even if you really only mean it for one child.  As far as whether you want an IRA to be a beneficiary of that trust, most of the time, you’re gonna be accumulating income in that trust because, to the extent that you pay out too much of it, most disabled beneficiaries can only have $2,000 of assets, and you have to be very careful to pay out directly for their needs rather than pay out to them.  You have a situation where you can accumulate income in that trust and that’s not good for tax purposes.  So, I think you want to be cautious when using IRA money for special needs trusts, and to the extent possible, if you have regular investments or after-tax money, you avoid a lot of those five rule considerations that you mentioned with having a trust as an IRA.

Jim:  Alright.  So you’re saying, basically, if you have two pots of money, after-tax and IRA, you would rather fund the disability trust with after-tax dollars, but if you had to with IRA, and you need to meet the appropriate language to defend the trust from the government, and also the five conditions to get the stretch.  Is that right?

Matt:  Right, although often, in special needs trusts, it becomes difficult to draft it in a way that meets the requirements for a stretch IRA, and to make sure it’s accomplishing the goals you want for a special needs trust.  You have a conflict, often.

Jim:  Alright, now but you said something about that it’s good to have multiple beneficiaries.  So, let’s say that there’s three kids in the family, and two of them do not have special needs but one of them does have special needs, and let’s further assume that this is a family that really has a lot of trust in each other where you really trust the kids, and you know that the kids are actually going to look after their disabled brother or sister.  What is the point of naming the children who don’t have a disability in the trust for the child that has the disability?

Matt:  That’s an excellent question, and the reason to name those other children is, you’re trying to make it as clear to the government as possible that this pot is not exclusively for the disabled child.

Jim:  Alright, so in other words, it wouldn’t be fair for the government to take money from a trust that has multiple beneficiaries that haven’t received government money?

Matt:  Correct.

Jim:  And what has been the result of this?  I assume that this has been litigated and people have fought for this.  Have you found better results with the types of trusts that do have multiple beneficiaries?

Matt:  We have.  Sometimes you run into problems when you only have one beneficiary if the trust isn’t tightly drafted.

Jim:  Alright, so if we have that trusting situation, is it normally your preference that you have multiple beneficiaries of that trust even if there is an understanding that the majority of the money is for the needs of the disabled beneficiary?

Matt:  When possible, it’s preferable.

Jim:  Alright.  Now, another situation that we run into is, we sometimes, we often run into situations where people have different values than their children, and it’s kind of amazing.  We have a lot of wealthy clients and their children aren’t nearly as wealthy as they are, but the children usually have much bigger houses and much bigger modern kitchens.  But, I’m not even talking about that situation.  I’m talking about a situation where the child is really a spendthrift, just has no control over money, would be completely inappropriate if they inherited a large amount of money, would either give it away, or blow it on drugs or alcohol, or do something bad.  Could you tell us a little bit about what kind of trust that you might draft in a situation where you had not necessarily a bad kid in terms of bad or evil, but a kid who, for one reason or another, would not be responsible if they inherited a large sum of money, and let’s assume that we’re not even talking about a child, but maybe somebody who’s thirty or forty or even older?

Matt:  Well, one great benefit of a trust for a beneficiary is it’s protected from creditors, so if you run into a situation where you have a drug problem, or a gambling problem, or you just have lots of debts, the trusts can pay directly for benefits for you by paying your rent directly, paying for your other necessary expenses, without that money being garnished by a creditor out of your bank account.  So, there’s a tremendous creditor protection benefit to these trusts.

Jim:  Could one of the potential creditors be a future ex-spouse?  In other words, if you are worried about the no-good son-in-law walking away with your money, could some variation of this trust make sure that the money stays in the bloodline?

Matt:  Absolutely, and we’ve seen that, I think, more often over the last couple of years that there’s people coming in to the office, their children are not in good marriages, they’re concerned that if they leave an outright inheritance to their child, that their child’s going to co-mingle it with this son-in-law that they don’t trust, and that that money is not going to be protected in the long term for their grandchildren.

Jim:  Or even if it’s not co-mingled that, in the event of a divorce, appreciation or principle would actually end up going to the future ex-son-in-law, so I think we sometimes call it the “I Don’t Want My Son-in-Law to Get One Red Cent of My Money” trust.

Matt:  That’s what I’ve heard you call it over the years, yes.

Jim:  I call it that, and then you have the pleasure of drafting it.

Matt:  That’s how we sell it to our clients too.

Jim:  Alright, so what are some of the other situations we’ve run into where we have utilized trusts, either as a beneficiary of the IRA, or after-tax dollars, or even for life insurance purposes?

Matt:  Well, one situation we haven’t discussed is when there’s an elderly couple.  Sometimes, there’s situations where with elderly families, it’s often that the husband’s traditionally made the financial decisions, the husband passes away, the wife might be near 85 or 90 years old and has never written a check and just is terrified of any financial matters, and often, in that situation, if there’s trust in the children are gonna do the right thing for Mom, then it often makes sense to have a trust just to protect Mom, because we know of all the scams out there for seniors, so it’s sort of a protection mechanism to make sure that Mom’s taken care of.

Jim:  Would that also be appropriate if Mom has some type of dementia or Alzheimer’s or other type of disability?

Matt:  Absolutely.

Nicole:  This is really great information, but we have to take one last break.  We’ll be back in 90 seconds.  You’re listening to the Lange Money Hour, Where Smart Money Talks.


Nicole:  We’re back and we’re talking smart money today.

Jim:  Matt, now a lot of our clients, and particularly, we haven’t talked much about Roth IRA conversions today, which is kind of unusual for us…

Nicole:  That’s a little rare.

6. Beneficiaries for IRAs and Roth IRAs

Jim:  …but, usually, after clients have seen us, they often end up with three pots of money.  One, which I’ll just loosely call after-tax dollars, that is money that is not in an IRA or a retirement plan, then they will still end up with at least some IRA and traditional 401(k) or 403(b), and then they will, almost inevitably, end up with some Roth IRA conversions, and, as you know, it’s usually our recommendations that people don’t make Roth IRA conversions of their entire IRA or retirement plan, but only a portion of it.  So, let’s assume that a married couple or even, for that matter, a single person has these three pots of money, after-tax dollars, IRA dollars and Roth IRA dollars, and let’s also assume that there are different beneficiaries.  There might be beneficiaries that have different ages.  There might be different beneficiaries that have significantly different tax brackets.  We might want to leave some money to charity.  Can you comment on what money we tend to leave to which beneficiaries?

Matt:  Sure.  You mentioned there at the end of your question charities, and one asset that’s great to leave to charities is IRAs, because charity does not pay income tax on IRAs and everybody else does.  And I’ve seen situations where people have done a Roth IRA conversion, and they had a beneficiary under their IRA that was a charity, and they didn’t think to say, “Do I want this charity to benefit from my Roth IRA,” because we would generally rather substitute an individual in that situation, then maybe name the charity for a larger portion of the traditional IRA.

Jim:  Well, I actually love that strategy of doing a Roth IRA conversion, which actually creates significant additional wealth for the family, and perhaps take a portion of that additional wealth that is still in the traditional IRA and leave that to charity, in which case, not only does the family do better, but then, in addition, a portion of your money goes to the charity of your choice.

Matt:  Agreed, and another consideration that you mentioned is the different income tax situations of your beneficiaries.  If you have a beneficiary that’s in a low income tax situation, then they don’t have nearly as much of a tax burden when they accept a traditional IRA, but a beneficiary with a high income tax burden, if they receive a traditional IRA, it’s just adding to their tax burden.  So, a Roth IRA is a much better asset for them to inherit.

Jim:  I think what you’re basically saying, then, is that by strategically cutting the pie, you’re actually creating a bigger pie, that is, more people are going to be able to spend more money if we’re smart and strategic about this.  Do you see other estate plans do that very often, or would you say that it’s more the exception where the attorneys are really thinking this out, where you see these strategies in place?

Matt:  I would say probably in three-quarters of the estate plans I see, there’s very little attention given to the beneficiary designations at all.  They often say “Spouse primary, children contingent” and half the time they unintentionally disinherit grandchildren if there’s an unusual order of death, and what I mean by that is suppose that you’re married and you have two children, and let’s say you have a son and a daughter.  Suppose your son passes away and you never update your beneficiary designation, and your son left two children.  Well, instead of those two children receiving the son’s share, the default language under most of these beneficiary designations is, at the second death, that money would all go to the daughter.

Jim:  Well, I think that’s an excellent point and it’s a great irony that we have a lot of clients, and because we are IRA and retirement plan experts, that we get a lot of people who have a significant portion of their wealth in IRAs and retirement plans, and they sometimes come in with ten or twenty page wills, and the beneficiary of their IRA or retirement plan is literally two lines when that is the source of the vast majority of their money.  They sometimes don’t understand it’s the beneficiary of the IRA or that retirement plan that is by far the most important estate planning document, not their will, and I think that if you’re saying that three quarters of them, you know, are not paying attention to what might be the majority of their estate, that’s a pretty scary thing.

Matt:  Absolutely.

Jim:  Alright, and that is something that we obviously work on quite a bit.  In fact, I’d say that we probably think out the beneficiary designation of the IRAs and the retirement plans as much, or even more, than the traditional wills or irrevocable trusts.

Matt:  And I think that’s a benefit to how we service our clients is we’re looking at the whole picture.  There’s too many times where I talk to attorneys, and they think their sole role is just putting together a document and not understanding how all the assets, particularly the non-probate assets, the retirement plans and the life insurance, tie in to the estate plan.

Jim:  Well, that’s true, and by the way, Matt is speaking slightly against self-interest because a lot of times, the engagements that we have is first to develop a plan, which we often call running the numbers, to think out all the strategies, and then after we’re done with the strategies, then we sometimes do the actual drafting of the documents, which is what Matt does, and sometimes Matt would, let’s say or selfish reasons, want to get the work started, but he knows that the appropriate order is to first come up with a strategic plan, whether that strategic plan might be Roth IRA conversions or a series of Roth IRA conversions, some gifts, 529 plans for grandchildren, whatever that might be, and come up with a strategic plan first, which, by the way, might have significant impact on what Matt does.  So, for example, if we have charities or beneficiaries of different income levels, and I will salute you, Matt, because sometimes, you’ll pick that up on your own if somebody has these attributes, and you’ll say, “Hey, wait, wait, wait, we didn’t really talk about this, but what about this?”

Matt:  And that’s one of the benefits of experience is that you’re able to look at a lot of different situations and apply the best ideas you have to them.

Jim:  Well, I think that’s probably generous, because frankly, you could have a lot of people that have experience that still don’t get it.  But that’s one of the things I enjoy working with you so much for, because you do get it, and you proactively use both your experience, your knowledge and your strategic thinking in every estate plan that you do.  So, it’s not necessarily a cookie-cutter type situation, and for example, I think even if I don’t say anything to you, routinely, you would have the amount going to charity coming from the IRA, so nobody pays the income tax, and the after-tax dollars or Roth IRAs going to private heirs like children or grandchildren.

Matt:  When you mention that to most clients, they look at you as though a light bulb went on, and you sort of think, “Why has no one else ever mentioned this?”  It’s great that we’re able to do that.

Jim:  Yeah, even that simple idea that if you have some after-tax dollars or Roth dollars, and then you have, and you want to have, let’s say, most families want most of the money to go to the family and some go to the charity, but we see wills that have money going to the charity, and then what we do instead is, we say, “No, the charity should get the money from the IRA beneficiary and have the after-tax dollars and Roth dollars go to the children and grandchildren.

Matt:  That works as long as everybody’s on the same page, and there’s a lot of trust.  Sometimes, there’s a charitable request that the family desires to be given at the second death, and the first spouse is concerned that the second spouse won’t follow through on the charitable intent.  So, sometimes, we do have to put it in the document, but we try to discuss these tax advantages with our clients so they realize the benefits of using the IRA to fund the charitable gift.

Jim:  Right, and as you mentioned, it’s sometimes a lot more comfortable to provide for charity as the beneficiary of the IRA at the second, not the first, death, and I’m thinking of one client in particular who is very charitable after she’s gone, but she’s not so charitable while she’s still around.

Nicole:  Is that your final thought, Jim?

Jim:  I think it is.

Nicole:  I think it has to be.

Jim:  It’s not my final thought, but I think we’re out of time.

Nicole:  I don’t think you ever have a final thought.  Well, we are out of time, and I want to thank everybody out there for listening to us today.  Matt, thanks for joining us.

Matt:  Thanks for having me.

Nicole:  Certainly.  You gave us some great information.  That’s all for us today.  Thanks for listening.  We’ll see you back here in two weeks.  You’ve been listening to the Lange Money Hour, Where Smart Money Talks.

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.