Episode 32 – The Ultimate Retirement Planning Authority with guest Natalie Choate, Esq.

Episode: 32
Originally Aired: July 14, 2010
Topic: The Ultimate Retirement Planning Authority with guest Natalie Choate, Esq.

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen to every episode at our radio show archives page.

Please note: *This podcast episode aired in the past and some of the information contained within may be out of date and no longer accurate. All podcast episodes are intended to be used and must be used for informational purposes only. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment strategy or plan will be successful. Investment advisory services offered by Lange Financial Group, LLC.


The Ultimate Retirement Planning Authority
James Lange, CPA/Attorney
Special Guest: Natalie Choate, Esq.
Episode 32

Click to hear MP3 of this show


  1. Introduction of Guest, Natalie Choate, Esq.
  2. The Current State of Federal Estate Taxes
  3. Best and Worst Ideas for Retirement Benefits  
  4. Contingent/Multiple Primary Beneficiaries, and Disclaimers
  5. Fractional/Percentage vs. Fixed-Dollar Gifts
  6. Caller Q&A: Disclaimers and Trusts
  7. Final Thoughts: Non-Traditional Family Situations

Retire Secure! BookAVAILABLE NOW!
Retire Secure!

A Guide to Getting the Most out of What You've Got

Join our mailing list to receive updates, news and get FREE bonuses.

Sign Up Today and Get your FREE Bonus!


Nicole: Hello, and welcome to the Lange Money Hour, where smart money talks.  This is Nicole DeMartino, marketing director for the Lange Financial Group.  As always, I’m here with James Lange, CPA/Attorney and nationally recognized Roth IRA expert.  Jim has close to thirty years of experience and is the best-selling author of “Retire Secure!  Pay Taxes Later.”  And the last time we were on the air, I mentioned Jim is finishing his third book entitled “The Roth Revolution,” and it’s entirely dedicated to the Roth IRA, and we’re anticipating that coming out at the end of the summer.  We are live again here this evening.  The studio line, I’m going to tell you right up front, is 412-333-9385, and this is a great night to call in because we have Natalie Choate on our show tonight.  Natalie, are you there?

Natalie: Yes, this is Natalie Choate.

Nicole: Well, welcome, welcome, hello, and I was looking at last year’s lineup, and it looks like you were on the show one year ago today.

Natalie: Great!

Nicole: Yeah, it’s funny.  That went very quickly.

Natalie: I always appear on Bastille Day.

1. Introduction of Guest, Natalie Choate, Esq.

Nicole: That’s right, that is today, July 14th.  Alright, well, before Natalie and Jim get into it, I want to give Natalie the introduction she deserves.  Natalie is a Harvard law grad and currently practices in Boston, Massachusetts.  The firm focuses on estate planning and retirement benefit matters.  Natalie has written two books, “Life and Death Planning for Retirement Benefits,” and “The QPRT Manual.”  And the first book I mentioned, in particular, “Life and Death Planning for Retirement Benefits,” is considered the bible on IRAs and retirement planning, and it’s used by estate planning and accounting professionals all over the world.  All the top planners turn to Natalie for advice, on her insight, on her cutting edge retirement planning solutions.  She’s also the editorial advisor for several professional periodicals, including “Trusts and Estates,” “Ed Slott’s IRA Advisor,” who also has been on our show, and she also writes a monthly column and does quarterly pod casts for “Morning Star Advisor.”  As far as accolades, Natalie was one of the first ten attorneys in America to receive the distinguished Accredited Estate Planner Award from the National Association of Estate Planners and Councils, and she’s also listed in the Best Lawyers in America.  Thank you again for joining us.

Jim: And before we get into the content, I will also just say personally that when I sat down and read “Life and Death Planning for Retirement Benefits,” that my personal knowledge of IRAs and retirement plans just skyrocketed, and when I talk to young advisors, and for that matter, older advisors, the older advisors I don’t know if they’ll sit down and do it, I say the best thing that you could possibly do for your career is to read that book and that you’ll just have a better understanding.  So, I would recommend that to all financial professionals without hesitation, and the other thing that Nicole did not mention is Natalie has an excellent work that I think that consumers can get tremendous benefits for, and that’s called “The Hundred Best and Worst Planning Ideas for Your Client’s Retirement Benefits,” and it is just one great idea after another, and bad ideas where Natalie says that they’re the worst, and I actually spent a couple of hours going through it today and I just think that that’s a wonderful resource.  So again, congratulations on a couple of wonderful resources for your clients.

Nicole: And Jim, if anybody wants to learn anymore, Natalie’s website is www.ataxplan.com.  So, I just wanted to mention that.

Jim: Right, and you can order those directly from there.

Nicole: Absolutely.

Jim: So, anyway, thank you so much, Natalie for just providing that great information, and thank you for coming on the show.

Natalie: Well, it’s my pleasure Jim, and thanks for the good feedback.

Jim: Well, we just got some very recent hot news.  George Steinbrenner died, and I believe just his interest in the Yankees alone was worth roughly $1.5 billion.

Natalie: Wow.

2. The Current State of Federal Estate Taxes

Jim: And apparently, this year, he may or may not be paying any estate tax on that, and I know that you have some opinions on what is going on with the Federal estate tax and how people should respond in this year when there is no Federal estate tax right now, but then, at least, if nothing happens, the exemption amount is going to go to a million dollars next year.  So, I thought that you could respond to that.

Natalie: Jim, you’re right.  It’s an amazing situation, and I do get a laugh when people ask me at a seminar, well, what do you think Congress is going to do with the estate tax, because everyone who’s asked me that question for the last ten years, I told them there’s no way they’re going to let it just expire in 2010.  So, I was completely wrong about that, but people still want to know what I think is going to happen next year.  But, we have a serious situation now that people are in limbo.  You can’t plan, and it’s a very, very tough situation for the estate planning community and for the clients.  I’d say before we start with what might happen with the estate tax, that the urgent message is if you have an estate plan now, this contains a formula that’s tied to the estate tax, and most people who are wealthy do have such a formula in their estate plan, you need to review it and see how it’s going to work if, perish the thought, you die this year, because your estate plan could be cockeyed if you say I leave the Federal exemption amount to my children and the rest of the estate to my wife.  That formula would give your wife nothing if you died right now, so that wouldn’t be too good.

Jim: No, I’m smiling because that’s what I warn people about at workshops, and it’s a terrible situation.  Let me ask you this: let’s say, later on this year, and I don’t know if they’re going to get around to it this year, or if nothing’s going to happen this year and they’re going to do it next year, do you think that it is possible that later this year, perhaps even after the elections, that there will be a law passed that is retroactive to January 1st, 2010 that would, in effect, tax George Steinbrenner’s estate?

Natalie: Well, if you want my prediction, knowing my track record…

Jim: By the way, mine too, and to my knowledge, everybody that I talked with, I don’t think anybody predicted that nothing would happen.

Natalie: The ability for them to enact a retroactive tax on people who already died, I mean, lawyers are going to debate that, but it’s pretty unlikely, it seems to me, that they could really do that.  Maybe if they’d done it in the first two weeks of January, but it’s already July, and so what seems likely that they may do, which is going to be a nightmare for people administering estates, but if they do put in estate tax now, they might say for all the estates of someone that’s already died this year, we’re making the tax effective now in September, or whenever we enact this new tax, so if you die after September, it’s going to be in the new tax, and if you died in the first nine months of the year, your estate can choose the zero estate tax regime or to pay the estate tax.  And why would anyone pay the estate tax?  Because the estate tax does come with a benefit, which is a stepped-up basis for income tax purposes for your appreciated assets.  So, some families are actually better off with the so-called estate tax.  So that’s my prediction at this moment.  I don’t recommend putting money on it though.

Jim: Alright.  Now, George Steinbrenner is married now, so if he wanted to, he could actually, and I have not obviously reviewed his documents, but he could have left his estate to his wife, and if that happened, there would be no estate tax because of the unlimited marital deduction, assuming she’s a U.S. citizen, but then upon her death, if she dies, let’s say, in 2011 or some other year where there is an estate tax, it could get caught.  It might make more sense for him, in effect, to skip over her, have it go directly to his children, obviously providing her enough money that she’s comfortable, and thereby nobody paying that estate tax on the $1.5 billion Yankees.

Natalie: Right, or leave it in a trust where she has the use of it while she’s living, but it’s not part of her estate at death because she doesn’t own it.  She’s just a life beneficiary.  So, we hope that he did some of those things, and thought it through before he, unfortunately, passed away.

Jim: That’s right.  Although, I think that, and I don’t know this and we haven’t spoken about this, but I think something that some of the people in Pittsburgh and Boston where you are from and practice, have in common is a natural dislike of the New York Yankees, and in Pittsburgh, our finest moment was actually in 1960 when Bill Mazeroski hit a home run in the bottom of the ninth of the seventh game against the heavily favored New York Yankees.

Natalie: Well, that’s important too.

Jim: And I understand Boston’s had a few fine moments in the last couple of years against the Yankees.

Natalie: Yeah, Boston’s pretty anti-Yankee and we set aside that for a day of mourning for the loss of Mr. Steinbrenner, but we’ll go back to normal pretty soon, I think.

3. Best and Worst Ideas for Your Retirement Benefits

Jim: Alrighty.  Going through some of your best and worst ideas, which I just think is such a wonderful resource, I thought that we could talk about a couple of them.  First, in the issue of Roth IRAs and Roth IRA conversions, one of the things that I thought was very good, and it was actually your first idea under Roth IRA conversions, was after retiring before age seventy-and-a-half, do partial Roth IRA conversions to use up lower income tax brackets, and I thought, maybe, if you could expand on that a little bit.  I thought it made a lot of sense.

Natalie: Oh, right.  That’s a good one because the Roth IRA, I think everybody agrees, it would be wonderful to own a Roth IRA.  I mean, you’d have an account that was totally tax-free, and you’re not required to take any distributions out during your lifetime.  With your regular IRA, you are forced to take money out at age seventy-and-a-half and older.  But not with a Roth.  You can let it grow to the sky if you want to.  So, it’s not a question of Roth IRAs good or bad, it’s a question of what’s the price tag?  You know?  It would also be nice to own a chateau in France.  It would be nice to own a Rolls-Royce, but they’re too expensive.  And a Roth IRA is expensive because when you transfer money from your traditional IRA to your Roth IRA, that is a taxable transaction just as if the money was distributed to you.  So, if you’re in a high tax bracket, you’re really going to think twice before you say well, gee, I’m going to transfer my million dollar IRA to a Roth and that’s going to cause me to pay $350,000 of extra income taxes that I could have deferred, so it’s a big decision.  But, the idea you’re referring to there, there are some retirees who are in that sweet spot between age fifty-nine-and-a-half and age seventy-and-a-half, and they’re retired, so the income has gone down, but they haven’t hit seventy-and-a-half when they will have to start taking money out of the IRA every year, and they may be in a much lower tax bracket then they were when they were working, and in a lower tax bracket than they will be in after seventy-and-a-half when they start taking money out.  And they can do partial Roth conversions each year to just use up those lower tax brackets.  You don’t even have to talk about paying tax at 35%.  If you’re living on $75,000 of taxable income, you could convert $300,000 from your IRA to a Roth, and that would give you $300,000 more of taxable income, but you still wouldn’t even get into the top bracket at 35% this year.  So, that’s the idea, you know.  It doesn’t apply to everybody, but if that describes you, you should think about that.

Jim: Yeah, I think that’s a great idea, particularly assuming that you have the money to pay the tax from outside of the IRA.

Natalie: Yes, that’s a pretty big key.

Jim: And you mentioned that in some of your next ideas, I think that it’s consistent with the idea of getting a Roth IRA conversion for cheap or nothing, you mentioned doing a Roth IRA conversion at the zero tax bracket, and I, for example, just had a client who was buying into one of those lifelong care-type situations, and they actually do the allocation of what qualifies as a medical expense.  In his case, it was $162,000.

Natalie: Wow.

Jim: So he could do a very substantial Roth IRA conversion and, in effect, pay no taxes, where if he didn’t do a Roth IRA conversion, he would have to, in effect, more or less waste his medical expenses.  So, maybe you could talk about the zero tax bracket, the low tax bracket, and help your beneficiaries with a Roth IRA conversion, but maybe starting with zero tax and low tax bracket conversions.

Natalie: Right.  It gets back to the idea that, you know, the price tag is the obstacle with a Roth conversion.  So, if we could find people, if advisors have a client who is in a very low tax bracket, abnormally, like you say, because of medical deductions or some charitable deductions or something like that, or if they have a very high proportion of after-tax money already in their plan, like someone who maybe has an IRA that he’s only had it for a few years, it’s all funded with non-deductible contributions.  So, it’s mostly after-tax money, and it’s his only IRA, well, he’s already paid the taxes.  So, it’s pretty cheap for him to convert that account, because it’s his only IRA, to a Roth IRA.  So, it’s nice when a Roth decision can be easy, and it is easy if the tax bracket is abnormally low or the tax on the transaction is abnormally low.  Unfortunately, for most people, it’s not going to be an easy decision, because, for most people, they’re going to have to pay a pretty high rate of taxes to do the conversion.

Jim: Well, that’s right, but you actually, and another one of your ideas that is closely related to this, it’s to roll the pre-tax dollars from an IRA to a qualified retirement plan, or a 401(k), and that will enable you to be left with after-tax dollars inside the IRA not be subject to the aggregation or the pro-ration rules, and then make a Roth IRA conversion for free.

Natalie: That is something that if you have the right constellation of plans, you have a qualified plan that accepts rollovers, you have an IRA that has some after-tax money, you can manipulate it so that you’re just left with the after-tax money.  And when I figured that out, or when someone explained it to me a couple of years ago, I thought that was a great idea, and I don’t think it’s such a great idea anymore, because I realized what happened is, a lot of people are now just focused on, well, I’m just going to convert the after-tax money in my plan.  Well, if you could figure out how to do it, it’s a no-brainer, but it’s not that easy to do.  And for most people, the after-tax money in their plan is a very small part of the plan.  The real hard work and the hard thinking comes with converting the pre-tax money, where you have to pay, and I’m concerned that I’ve contributed to the trend of people focusing on just converting the after-tax money and not doing the hard work, which is thinking about the pre-tax money.  So, you can do it, and if you can, that’s great, but it’s not that easy, and, you know, it’s not the elephant in the room.  The elephant in the room is the pre-tax money.

Jim: Well, actually, I think I’m guilty of the same crime of telling people about this, and so sometimes, what I’ve told retirees even, is if they were to get some earned income, maybe do a little consulting, doing something, and setting up their own 401(k) plan, and then using that 401(k) plan to roll their pre-tax dollars into their new one-person 401(k) plan, being left with the after-tax dollars in the IRA and making a conversion of that.  But hopefully, and I would agree with you 100% on this one, that’s the easy decision.  Then the tougher decision is how much do you convert and actually pay tax on.

Natalie: Right.  We should ask the tough questions, Jim, like I should ask you, how much have you converted?

Jim: Well, as a matter of fact, between my wife and me, we converted $250,000.  We had a little bit of an unusual situation in 1998, which was the first year you were allowed to make a conversion.  Our office suffered a fire.  We were above a pizza shop in Squirrel Hill, and by the way, never put your office above a pizza shop.

Natalie: I remember that office.

Jim: So, we were below $100,000, and between us, my wife and I were in our early forties at the time, we had $250,000 in our traditional IRAs since we, now everybody qualifies because we don’t have the $100,000 limitation, but back then, we did, and so we converted everything we had, and since that time, I have put everything into a Roth 403(b) at work, so I’ve taken advantage of those, and then also, a non-deductible IRA, which was easily converted to a Roth IRA later.  So, could I ask you the same question?

Natalie: Well, first I’m going to say good for you, Jim, because you are a doctor who’s taken your own medicine, and it sounds like you’ve done some very good planning there, and it also shows that having your office burn down is not necessarily always totally a bad thing because you may get a Roth IRA out of it.

Jim: That’s true.  Otherwise, I would’ve had to have waited until this year.

Natalie: Right, right.  Now, I was debating how much of my retirement money to convert, and I thought, a million, you know, all of it, what do I convert?  And I finally got around to following my own advice, which I would advise to everyone who’s listening to your show, that after the show is over, the next chance you get, if you haven’t got a Roth IRA yet, you need to open a small Roth IRA right now.  Move $1,000 from your traditional IRA into a Roth IRA just to get the account set up, name a beneficiary and now you’ve got a Roth IRA, and that gives you two advantages.  It gets your five year clock started for having tax-free earnings.  Not all Roth IRA earnings are tax-free.  You have to have an account in existence for five years, any account, any Roth IRA.  And the other advantage it gets you is how do you convert from an IRA to a Roth?  You move money or securities from the traditional IRA over to the Roth.  But first, you have to open the Roth, so there’s two steps.  And I have a feeling that, this year, there could be a rush of people doing this at the end of the year.  People are not focusing on this.  They’re going to say, “Oh my gosh, I’ve gotta do a Roth conversion.”  In December, it could be a madhouse because tax rates are going to go up.  And if you’ve already got your Roth IRA open and you decide to convert more, all you have to do is move money into it.  You’ve already opened it.  So, get it open now, and then decide about how much to convert later.  See, I ducked your question.

Jim: Well, that’s fine, but I actually really like that answer, and frankly, I’m hope to be contributing to that mess to a lot of people making a Roth IRA conversion, because my book probably isn’t going to be coming out until early fall, and hopefully, some people will buy it and read it and then act on it and actually want to be inspired to make a Roth IRA conversion, and you’re absolutely right.  If they have an account in place, that’s going to be a lot easier than setting up a new account at the last minute.

Natalie: Yes.  So to answer your question, though, I did move $100,000 of security from the traditional IRA to the Roth, and I picked securities that, I just read an article in Barron’s that said that all of these securities are, they think they’re undervalued, so I figured if they’re at a low price, that’s a good time to move them.  But, now having moved $100,000 and knowing I’m going to have to write a check for $35,000 to pay for that, it’s like giving me heart palpitations.  I don’t know if I’m going to be able to do any more than that.  You know, I’m not a doctor who may be able to take my own medicine.

Jim: Well, I remember last year, you were also giving the perfectly reasonable advice that, just theoretically, you don’t want to do what I did, which is convert everything and put all your eggs in one basket, but that you want to actually have both types of accounts of Roth IRAs and traditionals, where I guess, I tend to be a little bit quantitative and tend to want to do what works best after making financial projections based on tax brackets, etc.

Natalie: Um-hmm.

Jim: But I think yours is probably a very practical way of thinking about it.  The other thing that you have that I don’t think a lot of people are familiar with, and it is one of the advantages of keeping money in an existing 401(k) plan or even your own 401(k) plan, is that beneficiaries may not know that they are allowed to make a Roth IRA conversion of an inherited qualified retirement plan, but they’re not allowed to make a Roth IRA conversion of an inherited IRA.  And I thought maybe if you could expand on that because that’s one of those anomalies in the law that I don’t really see any good reason for, but it’s there anyway, and I think that one of the things that you do so well in your books, and particularly the best and worst ideas, is to kind of find, I don’t know if you want to use the word “loophole,” but to find areas that your clients can benefit from what might not make sense in the tax law.

Natalie: Well, you’re absolutely right to identify that as an anomaly or a loophole or whatever you want to call it.  Unfortunately, our tax code and, especially, the retirement plan rules are full of these distinctions that just don’t make any sense.  You die, you leave your 401(k) plan to your daughter, and she can convert that to an inherited Roth IRA.  But if you die and you leave a traditional IRA to your daughter, she cannot convert that to an inherited Roth IRA.  It just…what’s the difference?  I don’t know.  Write your congressman.  Maybe they have a reason for this distinction.  But what makes it kind of tough is now we’ve got to say to clients, the client is retiring, the client has money in his 401(k), the client says, “Should I leave the money in the 401(k) plan, or should I roll it over to an IRA where I’ve got broader investment choices, greater control, or whatever?”  And normally, even for estate planning purposes, you’re better off to have it in an IRA instead of a 401(k) because it’s much easier to get the stretch payout for your beneficiaries if you have an IRA.  But now, are we supposed to tell the client, “Well, no, leave it in the 401(k) so your kids can convert it to a Roth IRA after you die.”  So, I agonized about that, but my bottom line on that one is, I don’t think it’s a viable thing because experience tells us that when we meet with heirs and beneficiaries and they find out that they’ve inherited an IRA, what they want to do is cash it out immediately and go buy something, and so, you have to use all your good persuasion and sound advice to persuade them, don’t cash out this IRA you inherited.  Leave it in the IRA and take it out gradually over your lifetime and you get all this tax deferred.  You’ve got a ready-made retirement plan.  So, it’s hard enough to persuade the beneficiaries to take advantage of the stretch payout they’ve inherited.  Can you see, Jim, sitting with a beneficiary and saying, “You’ve inherited your dad’s 401(k).  Not only are we going to suggest that you don’t take the money out, we’re going to suggest that you pay income taxes on it.”  This is like a negative inheritance.  So, no beneficiary’s going to want to do that, in my opinion.

Jim: Yeah.

Natalie: So I don’t think, definitely it’s something we’re going to look at in any estate that we’re administering, but I don’t think it’s going to be a big planning factor for the retiring employee.

Jim: Well, it’s interesting.  I actually had a terminally ill client, and to me, it’s a terrible thing, but when I think of, when I hear somebody’s terminally ill, I think “Oh boy, I wonder if that’s a Roth IRA conversion opportunity,” and we looked at his situation with his family, and his children were in a much lower tax bracket.  So, we actually ended up doing Roth IRA conversions at his children’s tax bracket.

Natalie: By leaving them the 401(k) and they converted to an inheritance?

Jim: Yeah, that’s right.

Natalie: Interesting.

Jim: Now, in that case, there was liquid money available for the children besides the IRA, and that I think is a reasonable argument for having life insurance that creates a pool of money for the children so that they can do things like stretch the Roth IRA or even disclaim some of the Roth IRA to well-drafted trust for the benefits of grandchildren.  So, that way, there is still money for the children to buy their toys and to do what they want to do, but also still some money for their retirement, and then also, I love inherited Roth IRAs for the benefit of grandchildren.

Natalie: Um-hmm.  I think what you’ve just told me, I’m going to have to change my writing again, because you’re absolutely right.  You’ve got a perfect case there for it.

Jim: Well, that was a little bit of an unusual situation, but you know, it is interesting and, to me, when you’re in the field doing a lot of Roth IRA planning like we do, we think it’s absolutely essential to understand the whole family issue, and that’s what I’d like to talk about coming up is some of the family issues and beneficiary designations, but I think it is time for a commercial.

Nicole: Okay.  It is time for a quick break.  I want to remind our listeners out there that we are live with Jim and Natalie, and the line is 412-333-9385.  You can certainly call in.  You’re listening to the Lange Money Hour, Where Smart Money Talks.


Nicole: Welcome back to the Lange Money Hour, Where Smart Money Talks.  I’m here with Jim Lange and nationally-recognized estate planning attorney Natalie Choate.  Welcome back.

Natalie: Thank you, Nicole.

Nicole: Sure!

4. Contingent/Multiple Primary Beneficiaries, and Disclaimers

Jim: Another thing that I think that you are probably, at least in my mind, maybe the most famous for, although I think you’re just so well known with so many ideas in the IRA and retirement planning world, is actually the beneficiary form of the IRA and the retirement plan.  And I know you have a whole section in your best and worst ideas book, and one of them is to name a contingent beneficiary talking about multiple primary beneficiaries and, let’s say, related to that is specifying that the contingent beneficiary takes in case of a disclaimer and not just death.  So, I was wondering if you can expand on the contingent beneficiary, multiple primary beneficiaries and disclaimers not just in case of death.

Natalie: Be glad to.  The key thing is to get the beneficiary form filled out and up to date for every retirement plan that you have.  It’s not a complicated thing for most people, fortunately.  The hard part of it is just getting it done.  It’s just another piece of paperwork, but it’s extremely important because even if you have a will and you have a trust, and you may have paid a lawyer thousands of dollars for these documents, they do not govern your IRA and retirement benefits.  Those go under your beneficiary designation form.  So, you have to fill out a beneficiary form for every plan you’re in and every IRA that you own.  If you moved your IRA from mutual fund X to mutual fund Y because you thought you’d get a better return, you have to fill out a new beneficiary form along with that, and it has to be coordinated with the rest of your estate plan.  You can’t just do it in a vacuum.  You should either pay your estate planning lawyer to do it, or pay him or her to review it at the very least.  But then, you’re going to get down to the question of, “Okay, now I’m going to do it.  Who should I name?”  And, of course, you name the person you want to have receive the money, but certain beneficiaries are very, very tax- favored when it comes to retirement benefits.  With other assets, you know, just leave the money to the person you want to benefit, but with a retirement plan, it’s worth more to some people than other people.  For example, if you leave a retirement plan to your surviving spouse, the spouse can just take that plan, roll it over to his or her own IRA and keep the deferral going, or keep the tax-free growth growing in the case of a Roth IRA.  So, the surviving spouse is a very, very tax-favored choice of beneficiary.  But, you can’t forget to name a contingent beneficiary, and the tragedy is when, you know, sometimes a lawyer will hear the client say, “Well, you know, if my spouse predeceases me, I’ll come back in and I’ll fill out a new beneficiary form.”  Well, the trouble with that is, you could die in the same car accident, or close in time, and you wouldn’t have time to fill out a new beneficiary form, and the danger is if you leave the whole thing blank, you don’t fill out the form, probably what’s going to happen is that the IRA gets dumped into your probate estate.  Not only does that increase your probate expenses, it accelerates the income tax.  You don’t get the life expectancy stretch payout that you can get by naming individual family members, such as children or grandchildren, as your contingent beneficiaries.  So, it’s a way, way, very important thing to do with any retirement plan, and naming multiple beneficiaries, I think the key danger there, which we see, is let’s say you have three adult children, and you want to name them as your beneficiary or contingent beneficiary, so you say, “I leave my IRA to my three children A, B & C equally.”  You’ve got to look at the fine print in the IRA agreement.  The IRA providers can be a little bit lazy, and they would tend to provide if, perish the thought, one of your children predeceases you, all of the money goes to the surviving children.  Well, you may prefer that if your child A should die before you, A’s children, your grandchildren, would get a share, and so, you do have to check that very closely.  If you’re naming children who have their own children, you’ve got to work out what that document says about the contingent beneficiaries on your account.  And that’s the key thing with multiple beneficiaries.

Jim: Yeah.  What we tend to do in our practice is, we tend to be, let’s assume, for example, you have a, I call it the “Leave it to Beaver” family, or the traditional husband and wife who have the same kids, not kids from his marriage or her marriage, but kids from our marriage, and let’s assume there are some grandchildren there.  I will typically have, in effect, a multi-layer IRA beneficiary where I will typically name the surviving spouse as the primary, and then, children equally as the contingent.  But each child would then have the, and then if, I agree with you by the way, if one of the children predeceases, rather than it going to the other children, I think most people would prefer it going into a well-drafted trust for the benefits of the children of the predeceased child.

Natalie: Exactly.

Jim: But then, I also have a provision in there that the children can further disclaim their inherited IRA or inherited Roth IRA into the well-drafted trust for their children and not their nieces and nephews, and that way, we can do, I think, more effective planning after somebody has died.  So, I like the idea of naming contingents, and I think I, and probably a lot of other attorneys and I even would imagine you, have multiple layers of contingent beneficiaries.

Natalie: Yes, that is the most sophisticated and tax-effective and everything else way to do it, and anticipate that maybe your children are so wealthy and high income already that they would prefer to have the money go directly to their children, and you can give them that option by having the third layer of beneficiaries, like you say, who could get the money in case of a disclaimer.

Jim: Yeah, it’s kind of interesting.  We had a case where both the husband and the wife had considerable retirement plans, and at the first death, the survivor figured that they had more than enough in their own name, and they disclaimed that money and that money went to their children at the first death, and then at the second death, the children figured that they already had money that they received that they inherited at the first death, and then they disclaimed those shares that went to the grandchildren.  So, we ended up with a situation where we ended up with a very good stretch with having flexible beneficiaries, which I think that you’re talking about, and specifying that the contingent beneficiary takes in disclaimer, not just death.

Natalie: Yes, very important.

Jim: So, the other thing that you talk about, and this comes up in practice a lot, and this is under your best practices, and by the way, I keep referring to this one book, and it’s “The Hundred Best and Worst Planning Ideas for Your Retirement Benefits.”  It has been updated for 2010.

Natalie: And by the way, it’s up to 194 ideas now.

Jim: Right, it’s called a hundred, and then it’s 194.  For the financial professionals listening here, I really think you should get “Life and Death Planning for Retirement Benefits,” and for consumers, I think “The 194 Best and Worst Planning Ideas for Your Retirement Benefits” is absolutely wonderful, and you can reach that, both the consumers and the professionals can reach that on Natalie’s website, www.ataxplan.com.  By the way, there’s also some good, free information there, so you don’t just have to buy anything.  The other thing that you talk about in some of your best practices is you say, “Change the fixed dollar gifts to fractional gifts.”  And that is an issue that comes up relatively frequently in practice, and I thought if you could expand on why you would prefer fractional or percentages to fixed dollar gifts.

5. Fractional/Percentage vs. Fixed-dollar Gifts

Natalie: Well, if it’s going through a trust, a retirement plan going through a trust, then using $6 gifts can sometimes accelerate the taxes on the IRA.  If you have an IRA beneficiary designation, if you use fractional shares instead of fixed dollars, it makes it easier to divide up the account after your demise among the different beneficiaries, so that each beneficiary can take over his or her share of the account.  But, I’m interested in those questions, Jim, because that would be something that I would figure the client would have no interest in that subject, and, you know, the estate planning attorneys better know that, so I hope there’s estate planning attorneys listening tonight to get the benefit of that.  But, I wouldn’t think that the average consumer would want to get into this level of detail on the drafting.

Jim: Alright, well, why don’t we move back a step in terms of details and drafting, and let me throw out two, what seems to be more and more common situations that I’m running into, which is the beneficiaries are adult children that show no responsibility in terms of savings, or, let’s call them spendthrifts because I think that’s the common legal word, and the related issue, although it’s much different, but it’s the same idea in terms of a trust as the beneficiary of a retirement plan, is when somebody has some type of disability where they are very likely to get government benefits, and I thought you had some very good material in here that maybe we don’t have to get into the real nitty-gritty, but maybe you could give some general guidelines for any parents out there that have either children who like to spend way more money than they think it appropriate, or perhaps children, or even grandchildren, that have special disabilities or are receiving government benefits.

Natalie: Jim, that is a great question because, if I write another book, it’ll be on the subject of these children who are not good with money, and the sadness I see sometimes when we have parents from the older generation, the World War II generation with exposure to the Depression, and just people who grew up with good saving and careful spending habits, and they’re very financially prudent, and somehow, they end up with a kid, I think it’s just the luck of the draw.  You come with some children and adult child, and there seems to be one in every family who cannot handle money.  They just don’t get it.  They don’t save, they get into debt, they tend to change from job to job if any job, and I have a little message about those kids that, first of all, in terms of just the estate plan, you’re right.  The IRA should, if you leave money outright to those types of individuals, it’s going to get taken by creditors, it’s going to get taken in business losses, it’s going to get misspent probably, and we are looking at naming a trust as beneficiary to protect the money and make sure that kid doesn’t end up on the street someday, because the trust fund will be there.  But on a more personal note, what I sadly see is when parents try to solve that problem with more money, and it doesn’t work that way.  They buy a house for the child.  They think, “If he just had a house, it would be okay.”  This is a true story.  The parents bought the house for the child, the adult child, and it was in a faraway state, and they went to visit him, and they found out he’d rented out the house to get the money and he was living in the same shack he’d always lived in.  There’s a different mindset that is going on here, and you’ve just gotta except it that you can’t solve the problem with money.

Jim: And one of the things that I think is very ironic is, in this generation that you’re referring to, and you might want to call it depression-era mentality or whatever it is, which are people who are very good at saving, and then they sometimes have children that are very good at spending and not so good at saving, and the irony is a lot of these people will die with substantial estates, and the children who were not very good at saving will, if they at least do the right thing with their inheritance, will, in effect, get bailed out by their parents, because…

Natalie: They got a second chance there, and if they can hang on to it, they can make good use of it.

Jim: Right, but let’s say, in practice, when I have a client come in that says, “Hey, you know, my son’s 35 or 40 years old, and doesn’t…”

Natalie: He hasn’t found himself.

Jim: “He hasn’t found himself and is spending money inappropriately,” I almost always recommend a spendthrift-type trust, and I even say, you know, “Hey, if the child finds himself, we could always change it and leave it to them directly,” but I would rather err on the side of having the aggravation of the trust than risking the child being under a bridge when he’s 70.

Natalie: Yes, that’s good advice, and the other case that you mentioned, that calls out for needing a trust as beneficiary, is when there’s a disabled child in the family who is receiving government benefits, if you leave money outright to that beneficiary, they’ll probably lose their eligibility for the benefits, and it’s legal to leave money in a supplemental needs trust where the trust will pay for things that are not covered by the government benefits, such as, I don’t know, eyeglasses, but various things that, you know, the government benefits may pay for basic medical care, housing and food, and the supplemental needs trust can provide the other things that are needed to make that person’s life much more comfortable and bearable.

Jim: Natalie, we have Robert from Chicago.  Do you want to take a question and see what comes up?

Natalie: Absolutely, sure.

Jim: Alright, Robert, are you there?

Robert: Yes, I am.  Hi, how are you?

Jim: Good.

6. Caller Q&A: Disclaimers and Trusts

Robert: Okay, my question was related to your discussion on the beneficiaries?

Natalie: Yeah?

Robert: And talking about people disclaiming their portions, and you discussed about putting it into a trust.  What type of trust are you using, and what would you recommend?

Natalie: With a disclaimer?

Robert: Yes, as far as about maybe putting their portions into the trust, and would that actually trigger at a higher tax bracket on the trust rates, or how does that work?

Natalie: Well, if the trust does earn income and keeps the income inside the trust, trusts do get into the top tax bracket at a very low level of income.  So that’s a drawback of a trust if the trust is going to accumulate the income inside the trust.

Robert: Okay.

Natalie: What Jim was talking about for a disclaimer there, is maybe a grandparent dies, he leaves money to child, and child is already a high income person with enough assets and does not want to increase his estate, he disclaims the money inheritance.  And that works if the grandparent already set up the grandchildren as the next contingent beneficiary with a trust.  The child who’s doing the disclaimer can’t, at that point, create a trust for his children and disclaim into it.  All he can be is like a domino falling down the line on the estate plan that the grandparent already set up.  And so, that’s a requirement of disclaimers.  It has to be set up in advance.

Robert: Okay.

Jim: And further, personally, although you may or may not agree, Natalie, in fact, you actually have data, and I may be guilty of one of the worst ideas, is I typically do what you call a conduit trust, meaning that I usually do require at least a minimum required distribution be distributed, so that it can be taxed at the young child, or the grandchild’s tax rate, as opposed to being forced to stay in the trust.  Now Natalie, I think, appropriately points out if the child is a drug addict, then we might not want to force a distribution, but let’s say in other circumstances.  And the other way I would answer your question in terms of what type of trust I would draft, and assuming that we’re talking about children here, I would typically do a typical minor’s trust that might say something like, “Income plus invasion of principal for health maintenance, support, and education,” and depending on what ages that you feel are appropriate, maybe a third at thirty, a third at thirty-five and terminate the trust at age forty.  I don’t know, Natalie, if you have some opinions on that?

Natalie: I think that sounds like a very sound approach.

Jim: And one of the things that I did like about what you said, Natalie, where I’m in total agreement with you, is I we don’t need a trust for the IRA, I personally will not draft a trust for a perfectly responsible adult child, where I think other attorneys and other advisors might say, “No, the default is a trust, as opposed to outright.”  And maybe you have an opinion on that one?

Natalie: You’re right.  There is a kind of a split in the professional community on that point, and I’m on your side on that.  The other side is always looking at the worst case and saying, “Well gee, the kid could get divorced or have creditor problems.”  Well, if you know he’s in a business where he’s going to have creditor problems, yes, consider leaving the money to a trust, but that’s not the case with most of the adult children, who are responsible and are not in a situation where they’re not likely to get sued and so forth.  So I’m with you on that, that the default is to leave it outright.

Robert: Can I ask one more question?  When you guys say trusts, are you just talking like an irrevocable trust or, what kind of trust do you mean?

Natalie: Well, two parts to that answer.  It typically is an irrevocable trust during your lifetime, and you name it as beneficiary of the IRA.

Robert: Okay.

Natalie: It becomes irrevocable upon your death.  The other key element of it is that with the IRA, the great advantage is to stretch the distributions out after the IRA owner’s death over the life expectancy of the beneficiary.  And for a trust to get that stretch payout, the trust has to be written in accordance with IRS rules.  So, it wouldn’t be just one you might pick up at an office supply store.  You need an attorney who’s not just knowledgeable on estate planning, but definitely knows the retirement plan trust rules.

Jim: And I’ll just throw in one other thought before we have to take a break, and that is I think we are both talking about what are called testamentary trusts, meaning that this trust is not funded with any money until somebody dies.  We’re not talking about setting up a trust and funding it today.  We’re talking about a trust that basically is going to sit in a safety deposit box or in a lawyer’s office that’s not going to get any money until somebody actually dies.

Robert: Very good.

Natalie: That is correct.

Robert: And we can get more information on this on your websites or in your books?

Natalie: My book has full details about the trust rule.

Robert: Okay.

Jim: Yeah, and I would say for you, rather than getting the really heavy-hitting book, which I think is, again, the best IRA book for professionals, I think “The 194 Best and Worst Planning Ideas,” and you can get that at www.ataxplan.com.

Nicole: Alright, with that, we’re going to take a quick break, and we’ll be right back with more of the Lange Money Hour, Where Smart Money Talks.


Nicole: Okay, we’re back, and thank you for joining us.  Jim, do you have a few closing thoughts here?  We’re at the end of our hour.

7. Final Thoughts: Non-Traditional Family Situations

Jim: Well, I realize that time is short, but I also like some of Natalie’s ideas on what to do, we talked about the traditional family unit.  What about the non-traditional, Natalie?  How do you typically handle a husband or a wife or a second marriage with children from a first marriage?

Natalie: One quick recommendation on that.  The saddest story I heard this year, and I heard it twice: widowed parents remarried and did not realize that when you marry, your spouse becomes entitled to your benefits under your company pension plan.  So, mother remarried, she’d named her children as beneficiaries of her 401(k) plan, and that was just wiped out by the marriage, and the second husband automatically became the beneficiary.  So, marriage has an effect on your retirement plan, and don’t get married if you don’t like that effect, or move the money to an IRA where you have more control.

Jim: Or she could have either have had a prenuptial agreement, or had him sign off…

Natalie: Strangely enough, a prenuptial agreement does not affect the federal pension rights on company plans.  It does work for IRAs, and that’s why I would suggest to the people who are getting remarried and want their children to be beneficiaries, move the money to the IRA before the wedding.

Jim: Alright, well, that’s even news to me.  So you can’t have a prenup that forces the beneficiary of a 401(k) to go to the children?

Natalie: You got it.

Jim: Alright, well, on that note…

Nicole: On that note, we’re going to have to say goodbye, Natalie.  Thank you so much for joining us.

Natalie: Okay, thank you, Nicole.  Good night, Jim.  Great talking to you.

Jim: Good night.

Nicole:  Thank you.  For those of you who want more information on Ms. Choate, you can certainly go to her website, www.ataxplan.com, and if you want to reach out to us at the Lange Financial Group, you can jump on www.retiresecure.com, or give our office a call at 412-521-2732.  We’ll be back in two weeks when we’re talking more smart money on 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.