Episode 80 – Using Trusts to Protect your Family with guest Matt Schwartz

Episode: 80
Originally Aired: July 14, 2014
Topic: Using Trusts to Protect your Family with guest Matt Schwartz

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The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Using Trusts to Protect your Family
James Lange, CPA/Attorney
Guest: Matt Schwartz
Episode 80 

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  1. Introduction of Guest – Matthew Schwartz
  2. What Are Trusts?
  3. Trusts for Spendthrifts
  4. Designating A Trustee
  5. What Are Dynasty Trusts?
  6. When the Bulk of Your Money is in IRAs…
  7. The Magic Language You Need To Defer Taxes

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1. Introduction of Guest – Matthew Schwartz

David:  Hello, and welcome to The Lange Money Hour, Where Smart Money Talks.  I’m your host, David Bear, with James Lange, CPA/Attorney and author of two best-selling books, “Retire Secure!” and “The Roth Revolution: Pay Taxes Once and Never Again.”  Joining us in the studio is Matthew Schwartz, Lange Financial Group specialist in estate planning and administration.  A graduate of Washington University School of Law, Matt combines his technical ability and years of experience to ensure accuracy in the wills and trusts that he drafts.  He excels at developing estate planning strategies that result in more money for one’s heirs.  Matt’s a member of the Council of the Allegheny Bar Association, Probate and Trust Section, and immediate past president of the Allegheny Tax Society, and a member of the Pittsburgh Foundation’s Professional Advisory Committee.  When is it smart to establish a trust for your heirs, and when is it not?  Is it wise to designate a trust as the beneficiary of your IRA and/or retirement plans?  Jim and Matt will touch on subjects such as trusts for minors, special needs children, or spendthrift adult children.  They’ll discuss tax-motivated trusts and identify the cruelest trust trap of all.  Stay tuned for an informative hour, and since our show is live, please feel free to call in with questions of comments.  The number at KQV is (412) 333-9385.  Good evening, Jim, and welcome to the show, Matt.

Matt:  Thank you.

Jim:  And thank you, David.  So, what I was hoping to do today is to not just talk about some of the very basic issues like should you avoid probate, and trusts for minors, which is certainly important and we will touch on that, but I thought I would talk about some things that are a little bit more, perhaps, interesting or sexier topics, like trusts for spendthrift adult children, something that has become much more prevalent in our practice in recent years.  Trusts for special needs children, which, unfortunately, has also become one of our specialty areas, if you will, both special needs children and, actually, special needs adults.  Probably one of the things that we’ll talk about at length is actually trusts as beneficiaries of IRAs.  A lot of people, and particularly our clients, have more money in their IRAs and retirement plans than they have outside their IRAs and retirement plans.  So, therefore, the beneficiary of their IRA becomes more important than their will.  If a trust is appropriate, in normal situations, in other words, whether it is a spendthrift child or a special needs, does it still make sense to have that trust as the beneficiary of the IRA, and, if so, are there any special provisions?  So, anyway, there’s a lot to cover here, but the way I would start…and by the way, David, you gave a very nice introduction to Matt.  I’ll mention one other thing: Matt has been working with me for twelve years now in my office.  He’s really a wonderful estate planner, a very smart guy, high satisfaction rating among our clients who have worked with him, and perhaps the biggest difference between him and, let’s say, most attorneys in general is that he wasn’t a history major or a political science major or something like that.  He was actually a math major, all right?  So, he gets the quantitative ideas behind helping people save money and reducing taxes, and I think that that really adds a lot to what our firm offers, is that we’re always not just thinking about mechanically who’s going to get what, but how can we proactively plan the best to save people taxes?

David:  And you think that’s a lot different than other firms do?

Jim:  Well, I suspect that other firms might pay some lip service, and I think, to be fair, there are certainly some estate attorneys who are more tax-oriented than others.  I don’t know if they think about it all the time like Matt and I do.  I don’t think they have best-selling books on how to save money and how to accumulate the most money, and I don’t think that they proactively say, hey, you should really consider a Roth IRA conversion, or hey, you should really consider making gifts to your grandchildren for their college education, or hey, we think that you should consider setting up a trust because you said that your child is not responsible.  So, I don’t want to say that we necessarily know more, although I like to think that our technical knowledge is very good.  I’ll just say that we are very proactive, and that was actually one of the big differences that Matt had coming from one of the big firms to our firm is that he could proactively use his expert tax information.  Is that a fair characterization, Matt?

Matt:  Jim, that’s true.  At my previous firms, the focus was just on death planning, and working with Jim’s team, we focus also on lifetime planning, and that’s where the Roth IRA conversions and the long-term IRA strategy comes into play, and a lot of firms don’t consider how IRAs fit into the estate plan, and they just focus on traditional provisions without considering how IRAs fit into them.

Jim:  Well, that’s particularly true, and that’s kind of our specialty area, which is people who have IRAs, or particularly, specific IRAs.  Those are some very specific plans, both, what I would call, financial planning, as well as estate planning, and it’s a real bear (by the way, David’s last name is Bear), it is a real bear if you get even one little word wrong, or one little technical mistake for an IRA.  So, true story: a financial advisor was doing the work for both a father and son.  Dad died with about $1,000,000 in his IRA and left it to his son.  A financial advisor, since he was doing the work for both, transferred it into the name of the son.  Well, that sounds okay, right?  No, he should’ve labeled the account “inherited IRA of Joe Schmo for the benefit of Joe Schmo, Jr.”  But since he didn’t, Joe Schmo, Jr. had to pay tax on $1,000,000.  So, being attentive to details is very important, and that’s what Matt does.

David:  Dotting ‘I’s and crossing ‘t’s.

2. What Are Trusts?

Jim:  But anyway, why don’t we go into some of the meat of the show.  Before we start talking about spendthrift trusts and special needs trusts and trusts as beneficiaries of IRAs, Matt, could you just start with some of the basics, like what is a trust?

Matt:  Well, a trust can either be a standalone agreement where a trustee agrees to administer assets in accordance with your wishes, or it can be under a person’s will.  So, you have trusts under wills, which are known as testamentary trusts, and then you have standalone trusts, and they can either be revocable or irrevocable.  Revocable, you can change your mind as many times as you want during your lifetime regarding the provisions.  Irrevocable, there are estate planning advantages because you’ve lost control of the assets, but you can’t change your mind once you fund the trust.

David:  Is it a common thing for people to establish a document or a plan, and then ten or twenty years go by and the situation changes?  I mean, that must be happening all the time.

Matt:  We see it commonly in our practice.  Even though we try to make our plans last for the long-term, there are always people coming in with changes in the situations of their beneficiaries, but not because their tax provisions are outdated.

David:  Right.

Jim:  No.  In fact, I would actually venture to say that we have about the most flexible estate plan that you could possibly have, and they tend to have a very long shelf life, and I would say more of the reviews that I have of clients who have existing wills and trusts, the action points tend to be strategic.  Like, let’s do a gift.  Let’s set up a 529 plan for a grandchild.  Let’s do a Roth IRA conversion, rather than let’s redo the wills and trusts.  But anyway, Matt, back to the basics for a minute.  So basically, you can have a trust that takes effect while you are alive, and then you can also have one that takes effect after you die?

Matt:  Correct.

Jim:  All right, and we’re mainly going to talk about the ones that take effect after you die tonight.

Matt:  Right.

Jim:  And so that’s going to…the place where these trusts would live, if you would, would just be a piece of paper that would be part of a will, or part of an IRA beneficiary designation, or part of a life insurance beneficiary designation, or an annuity beneficiary designation.  So, that’s what we’re talking about right now, that it’s just basically a piece of paper that doesn’t have any real assets until somebody actually dies.

Matt:  Correct, but just as an important clarification, you can’t create a trust just by having it mentioned in a beneficiary designation.  You need a separate document to create the trust, and you reference the trust in your beneficiary designation.

3. Trusts for Spendthrifts

Jim:  Matt’s going to keep me sharp on the details.  I appreciate that.  Let’s go to, let’s say, what sometimes is an emotionally charged issue, which is trusts for spendthrifts.  So, let’s say, for discussion’s sake, that you have…and I’m going to take an example where you have two kids, all right?  One has, maybe, similar values to you in terms of saving money, and they put money in their retirement plan, and they’re able to hold a job, and they don’t go out and buy new Cadillacs, but they buy cars that are appropriate for their income, and they have, maybe, similar…maybe not the same, and maybe they spend more relative to their net worth than you do, but basically, more or less, what you would consider sound financial judgment.  And then, another one of your adult children, who you still dearly love, either can’t hold a job, or when they get some money, they go out and buy a new guitar, or they give money away, or somehow, they get separated from whatever money they get, and you have helped them out in the past and you have not been happy with the way they have invested, or failed to invest, the money.  Basically, we call that a spendthrift.  Is that a fair characterization?

Matt:  That is a fair characterization, and I think two issues commonly come to mind.  The first one is, how much money is potentially going to go into this trust, because there are certain costs associated with the trust to determine whether it’s definitely worthwhile to have a trust, and that’s one issue for discussion, and the other issue is who’s going to be the trustee of your trust?

Jim:  Okay.  By the way, both very good questions.  In other words, if, you know, if there’s only $10,000, does it really make sense to set up a trust?  Not only the costs of setting it up in your will, but then also at death, now you have a trustee, and then the issue is who’s going to be a trustee, and then the trust has a separate tax return.  Does that really make sense for $10,000?  Obviously not.  Does it for $1,000,000?  Obviously yes, somewhere in between.  But what are some of the things that you will typically allow a trustee to do with the money in a trust?  So, let’s say that you have that child, and your worst fear, and it’s a very legitimate one, is that this kid that you have, that you dearly love, maybe they’re thirty years old, or maybe they’re forty years old, and they’re nowhere near where you were when you were thirty or forty, and you’re afraid that, you know, one day, you’ll presumably predecease them, and then, when they’re older, maybe sixty or seventy or even older, that they’ll be under a bridge because they have no money.  So, you certainly don’t want that.  On the other hand, you don’t want to say you can’t have this money unless you’re absolutely starving.  So, what are the kinds of provisions that you would typically put in a document that would provide for this spendthrift child?

Matt:  Broadly speaking, you want to give the trustee discretion, and under most circumstances, because you don’t know exactly what the beneficiary’s needs are going to be, and the general purposes for distribution might be for the beneficiary’s health, their maintenance, their support, maybe they never completed their education, and it depends.  Sometimes, you’ll be a little broader than that, and you might say a down payment on a house, depending on the situation of the beneficiary.

Jim:  What about a new BMW?  Would that work?

Matt:  If I’m the trustee, I’m not giving that to the beneficiary!  And sometimes, I’m asked to be the trustee.

Jim:  But what if the beneficiary says, “Hey, I need to get to work.  I have this new job and I need a car to get to work.”

Matt:  I’ll swap them my Matrix for their BMW.

4. Designating A Trustee

David:  What kind of people would you want to be the trustee?

Jim:  Well, that’s a really good question, and I think Matt and I agree with this, and we might get in a little bit of trouble with somebody from Mellon Bank, or…I shouldn’t even say Mellon Bank because any of the corporate banks are probably not going to particularly enjoy hearing this, but our office has a, let’s call it, built-in preference for using family members, if we can.

Matt:  That’s correct.  I mean, we don’t have anything personally against the banks, but often, there’s a suitable family member who has the right characteristics, and it’s not necessarily being an expert in finance.  It’s really having good decision-making skills and good judgment and not being a pushover that are the best characteristics towards being a trustee, and they tend to be a lot cheaper than the banks.

Jim:  And also, they actually have a real, live relationship, typically, with their sibling, which is, by the way, one of the downsides of using a family member.  They know what’s going on in the sibling’s life.  And the other thing is they are much more likely to be the same trustee and the same person who interacts with the beneficiary.  At one of the banks, you might end up with a turnover situation where maybe you’re dealing with a different person each time.  And then, the other thing is, unfortunately, a lot of times the bank that you set your trust up with ends up being bought out, and then all of a sudden, you started out with a local independent bank, and now you’re with, you know, one of the multi-national giants.

David:  How about the expenses for managing a trust in a bank?  Is that higher, or…?

Jim:  Well, yeah.  I think they usually are.  I think family members will typically either waive a fee or charge a much more reasonable fee.

Matt:  That’s been my experience, but sometimes, there’s just not a suitable family member, but I still recommend, in that situation, to have someone, as Jim mentioned, who knows the beneficiary to at least be a co-trustee who can advocate for the beneficiary because the banks sometimes are pretty stingy about distribution, sometimes with good reason and sometimes with less than good reason.

Jim:  Yeah.  To me, we have certainly used banks in the past, but usually, it’s not our first choice.  And by the way, there’s often no perfect choice.  In fact, there never is, because the siblings…so, let’s go back to my original example where we have one responsible child and one irresponsible child.  One of the downsides of the responsible child being the trustee for the irresponsible child is that might not go very well for their own personal relationship.  So, in other words, the irresponsible child says, “Hey, I want a new BMW!  I need to get a car to get to work!”  And the responsible one says, “Well, I’m delighted to hear that you have a job, but I was thinking maybe a used Chevy.  Oh, by the way, what time are you coming over for Christmas dinner?”  That sometimes is a little bit awkward.  On the other hand, usually, we don’t have a better choice, which is why we typically do end up naming a family member.

Matt:  And the responsible trustee may have responsibilities with their own life and their own family, so it makes it an even bigger challenge, but the parents can’t think about anybody else, and it’s sort of the best choice they have.

David:  Do you serve in any way as ongoing council in a situation where someone else is the trustee but they have questions about how to proceed?  Do you provide that?

Matt:  We have been council to trustees, and often, it’s more on the tax end to help them with their compliance responsibilities, but when they do have strategic questions about distributions, we give them our best judgment and experience as far as the advice we can give them.

Jim:  I would agree with that, but I would say perhaps the most important function that we serve as advisors tends to be at critical junction points.  Critical junction points might be when you are a) setting up the trust and determining what provisions go in the trust and b) perhaps maybe the most important is what to do at a death, and if you’re talking about a husband and wife, what to do at the first death, and then what to do at the second death.  Those are really some pretty intense times, and times that either the surviving spouse or the trustee would probably be well-served by getting some advice from competent council, whether it be us or somebody else.

David:  But clearly, decisions should have been made well before that time.

Jim:  Well, the decisions should be made, but to be fair, by the nature of the type of drafting that Matt and I do, we usually leave as much flexibility as we can.  And the reason for that…and by the way, we do that with our general thinking as the Cascading Beneficiary Plan, which is a tremendously flexible estate plan, as well as the specific provisions, and the reason is is because we just don’t know what’s going to happen.  We don’t know who’s going to die first.  We don’t know how much money they’re going to be.  We don’t know what the tax structure’s going to be.  We don’t know what the needs of the beneficiary are.  We don’t know the needs of the…whether the beneficiary’s going to have a job, whether the beneficiary’s going to have a child out of wedlock, whether the beneficiary’s going to have a drug problem, an alcohol problem, and all of these things are going to have an impact on how the trust should be distributed, and if we tried to cover every single contingency, a) it would take us a ridiculously long time, and b) perhaps more importantly, whatever we decided wouldn’t be right.  Something different than we expected to happen happened, but what we would prefer to do is within the tax structure that we need to preserve the IRA or to preserve the tax benefits of the trust, we would prefer to give the trustee, who we prefer to be a trusted family member, a lot of discretion.  Is that a fair characterization, or is that oversimplifying?

Matt:  No, I don’t think that’s oversimplifying at all.

Jim:  Okay.

David:  Well, listen.  Why don’t we get ready, and it’s time to take a quick break now.  It’s a good jumping off point.  When we return, we’ll continue the conversation, and I wanted to remind listeners out there that we are live, so call us with any questions at (412) 333-9385.


David:  Welcome back to The Lange Money Hour.  I’m David Bear, here with Jim Lange and Matt Schwartz.  If you have a question for either, call (412) 333-9385.

Jim:  So, we were talking about different types of trusts and different types of beneficiaries, and I know that there are some listeners out there who have children, or perhaps even grandchildren who receive some type, or potentially will receive some type of benefit from the government, whether it’s the state of Pennsylvania, or the U.S. government, and I wanted to talk about a situation where a child or a grandchild either has in the past or can reasonably be anticipated to receive some type of government benefit, and one of the things that you probably don’t want to do is leave money outright to that child who is receiving, or will receive, a government benefit because they might lose that government benefit or have the benefits stop.  So, Matt, maybe, why don’t you just talk about that for a minute, and then we have a question from Maryann that we’ll take about dynasty trusts.  So, why don’t you just give us a little bit about special needs trusts, and then we’ll take the question from Maryann?

Matt:  Sure.  The special needs trust allows a beneficiary who’s receiving a government benefit to continue to receive that government benefit, but it must be drafted very carefully so that the money left to that trust doesn’t disqualify that beneficiary from the benefit.  It might say something like ‘the trust can supplement what is provided through the government, but can’t supplant or replace a government benefit.’  So, if someone needs a wheelchair, that could be something that’s paid for by the trust, but it can’t provide for their basic living expenses.

5. What Are Dynasty Trusts?

Jim:  Okay.  I do want to get back to that, but we do have a live question from Maryann from Mt. Lebanon.  So, Maryann, could you ask your question please?

Maryann:  Hi Jim.  I’m wondering what a dynasty trust is?  I heard that term on the radio on Sunday, and I wonder if you can elaborate on that?

Jim:  All right.  Let me ask you a question, Maryann: do you have children?

Maryann:  Yes.

Jim:  And do you have grandchildren?

Maryann:  Yes.

Jim:  Do you have great-grandchildren?

Maryann:  No, no.

Jim:  If you did have great-grandchildren, either while you’re alive, or after you’re gone, would you care if they got any money or not?

Maryann:  Well, I don’t think I’d care, no.

Jim:  Well, you might not be the greatest candidate for a dynasty trust!  A dynasty trust tends to be a trust that is meant to benefit multiple generations.  So, for example, let’s say that you were perhaps from a different culture, or in a different mindset, and you said, “Hey, you know, it’s really important that…,” I’m not going to ask you your last name, but let’s call it the Maryann…”that a lot of money stays in the Maryann family for the next two hundred years, and I want to make sure that no one particular generation blows the whole wad, and then there’s no more money for the Maryann family.”  And that is what I typically call a dynasty trust, although, frankly, I have used that term to even apply to trusts for two generations.  Sometimes, we talk about, or I like to talk about, what I call a tax-free dynasty where we do Roth IRA conversions, and let’s say, Maryann, that we do a Roth IRA conversion for you, and then potentially, at your death, that might go to your children, or it might even go to your grandchildren.  So, we might get seventy years of tax-free growth in what I would call a dynasty trust, but I think a true dynasty trust goes further than that.  Is that fair, Matt?

Matt:  A dynasty trust can actually start at about two generations and go beyond that.  Several years ago, we used to have a rule against perpetuities, which basically didn’t allow a trust to last beyond twenty-one years beyond the last person who was living at the time of the trust, and now, Pennsylvania’s abolished that rule.  So, you can have a trust that lasts for hundreds of years.

Maryann:  Can some of your heirs, I guess, disavow the trust and take the money now?

Jim:  No, we wouldn’t want them to do that because that’s the whole point.  If you wanted to just give your heirs the option of taking money, you could just say, “Here’s the money,” or perhaps you could have a trust that says ‘I will give heirs the right to take maybe a certain percentage,’ or ‘I will allow heirs to get some money, maybe beyond interest and dividends, for certain purposes.’

Maryann:  If you have two children, and one wanted the money and the other one had no need for the money and enjoyed having it in trust for future generations, could the one who needed the money take their share?

Jim:  Would you want to leave this money to your children equally?

Maryann:  Yeah.  I have two children, two sons.

Jim:  All right.  Well, one thing that we do, we like flexible planning.  So, one thing that we could do is we could, let’s say, say that at your death, or at you and your husband’s death, if you’re married, and let’s keep it simple that you have two kids, that you leave it 50/50, and then, what I might want to do is say, “I’m going to give each child the choice of what they want to do with their money.”  So, if they want to, they can take the money, they can spend it, they can burn it, they can invest it, they can do whatever they want.  If, on the other hand, they would prefer having that money go into a trust, and maybe the terms of the trust might be that they get income from the trust, and then, at their death, it goes to their kids, that is, your grandchildren, or even several generations.  I think that we could do that, and that way, you’re not forcing a trust on somebody that doesn’t want it, and the other thing is you’re actually letting more time elapse between now and when the decision has to be made.  So, for example, let’s say one of your kids says, “Oh yeah, Mom, when you die, I really want the money in trust.  All I’ll need is the income, but I’m very concerned about my children and my grandchildren,” and then you say “Okay,” and then you draft that, and then you die, and it turns out, in the meantime, they lost their job, they’re broke, and they’re not worried about their kids or grandkids, they’re worried about themselves.  So, I would prefer a flexible approach.  Matt, what would you do with that one?

Matt:  I agree overall with the flexible approach.  In addition, something we haven’t mentioned is because the current federal estate tax exemption is over $5,000,000, for many families, the purpose of the dynasty trust was to defer estate taxes over multiple generations, and with the exemption at its current level, that has become a less relevant consideration.  So, using a plan as Jim advocated allows the flexibility for the child to decide whether they want to keep the money or disclaim (which is another word for disavow) to pass it into trust for the benefit of their children.

Maryann:  If the political arena grows sour as far as estate planning, can the trust be challenged?

Jim:  Well, this is a pretty interesting issue about what’s going to happen in the future with estate taxes because right now, as Matt mentioned, there’s a $5,000,000 exemption, actually $5,120,000 if we’re going to be technical.  If nothing happens, that is, Congress cannot agree on any change, then that’s going to go down to $1,000,000 next year, and you might be thinking, “Oh, well certainly, Congress will get it together to do something.  They’ll never let it go back to $1,000,000.”  But I wouldn’t bet on it, because in 2009, if you had asked me what are the odds of George Steinbrenner dying with a $1.5 billion interest in the New York Yankees, leaving it to his kids and them not having to pay one nickel of estate tax, I would’ve said “Oh, no.  That’s not likely.  Certainly, Congress will get it together to come up with some number.”  Now, you bring up a really good point, Maryann, because one of the problems is even if there is a change in the estate tax, and let’s say, you know, it happens in 2013 or 2015, I don’t get all that excited about a change like that, and the reason is is because my guess, Maryann, at least in your situation and probably the vast majority of our listeners, you’re not going to likely die in 2013 or 2014.  You’re likely to die many, many years from now, hopefully, and who knows how many times they’re going to change the estate tax.  So, what they do in 2013 or 2014 is not of huge interest to me.  What I would prefer when I would do an estate plan is to say, “Well, geez, we really don’t know what the estate tax law’s going to be, so what kind of flexibility can we build into the estate plan that it will have a good result no matter what the estate tax law is?”

Maryann:  Okay.

Jim:  Does that make sense?  Do you like the idea of flexibility?

Maryann:  It does, but if you did all of this work and set up these trusts and this estate plan, what my question is if the laws change, can that negate your planning?

Matt:  With many firms, if the laws change, you have to update your plan.  But we design our plan in a way that the spouse can decide and the children can decide what to do at the time of death, irrespective of what the federal estate tax laws are.

Maryann:  Okay.  Thank you, Matt.

Matt:  Oh, you’re welcome.

Jim:  Yeah, and to be more specific, because Matt just touched on what we kind of think of as our signature estate plan, and the difference between our plan and the plan you might receive from many people downtown is that we recognize that there can be a huge difference in circumstances between now and the time, let’s say, the first spouse dies.  So, if we have the luxury…and I didn’t want to ask that to Maryann because I think that that would be too personal, but I would ask Maryann if she was married, and then, if she was a client, I would say, “Well, do you trust your husband?”  And I would turn to her husband and say, “Well, do you trust Maryann?”  I don’t always get a ‘yes.’

Maryann:  Wow!

Jim:  Oh, she’s still on?  Okay.  Well, I can’t ask you that.  But then, if I get a ‘yes,’ and if I have the luxury…this I think I can ask you, Maryann.  Do you have the same children as your husband?

Maryann:  Yes, the last I looked.

Jim:  The last you looked?  All right.  Well, see, you’re what we call a ‘Leave it to Beaver’ couple, meaning original husband, original wife and the same kids, and doing an estate plan for you is actually a huge luxury for us because we’re not worried that if one of you dies, the other one is going to cut out the other one’s children.  So, in other words, let’s say your husband had two kids from a prior marriage, and you had two kids from a prior marriage, and he died and he left everything to you.  He has to be afraid that you’re going to change your will, leave everything to your kids and cut out his kids.

Maryann:  Right.

Jim:  Or vice-versa.  But see, you guys, this is a huge luxury for an estate attorney because you guys have the same kids, and you’re going to have the same grandkids.  So, ultimately, you might have some differences about money and, you know, you might have some differences about charity and things like that, but in the very big picture, you have the same beneficiary.  So if you have the same beneficiary, and if you trust each other, then to me, rather than having the traditional fixed-in-stone estate plan that determines where the money goes no matter what the circumstances are, I would rather give you a choice, Maryann, if, let’s say, your husband dies before you.  Without knowing more, here’s maybe four choices that I would want you to have if your husband died before you: the first choice is I would want you to have complete control of all the money.  So, let’s say you just need the money, which frankly, particularly today, a lot of time, you just would.  Another choice I would want you to have, if estate taxes become a problem, is to have the money in a trust for your own benefit, and the purpose of that trust is to save estate tax.  The other choice I might want is for you to have money to be distributed to your children, and the other choice might be a trust for the benefit of your grandchildren.  And then, here’s the key to Lange’s Cascading Beneficiary Plan: we don’t make the decision of which of those four choices takes effect today.  We would give you that choice and we would ask you to make it not today, but within nine months after your husband died.  And the reason we would give you the choice then instead of today is because you’re going to know more then.  You’re going to know how much money there is.  You’re going to know what the estate tax laws are like.  You’re going to have a much better idea of your own needs, and this very flexible planning, if you have the luxury of ‘Leave it to Beaver’ marriage with the same children and the same grandchildren, I think has a much better chance of having a good result than a more traditional plan.

Maryann:  Well, thank you very much, Jim.

Matt:  Yeah, and please feel free to come to one of our upcoming workshops or call our office.

Maryann:  Okay.  Thank you, Matt.  I’ll do that.

Matt:  Sure.

Maryann:  Thank you.

David:  Well, that’s a good time to take another break.  Jim and Matt will continue the conversation when we return, and like Maryann, if you have a question for either of them, call (412) 333-9385.


6. When the Bulk of Your Money is in IRAs…

David:  And welcome back to The Lange Money Hour with Jim Lange and attorney Matt Schwartz.  If you have a question, call us at (412) 333-9385.

Jim:  The next topic that I was hoping to cover, and it’s a tiny bit technical, but it’s very important for people who have IRAs and retirement plans.  We have a lot of clients who actually have more money in their IRAs and in their retirement plans than they have outside their IRAs and retirement plans, and some people can say, “Hey, how can you have so much money in an IRA?  You can only put what used to be $2,000, now $5,000 or $6,000 depending on your age, how can you have a very substantial base in IRAs?”  And the reason is is because you might have a retirement plan at work, and for a lot of our clients, let’s say, for discussion’s sake, and this…I guess there is no such thing as a typical client, but this is a very common story for a lot of our clients, is they got married relatively young, and they didn’t have a lot of money, and one or both people went to work, and there were a lot of expenses, and the salaries weren’t necessarily fabulous.  So, they had a mortgage, they had car payments, they had to pay for their kid’s braces, and they had to pay for their kid’s college, and all of this really takes quite a financial toll, and even if they have a good job and they are financially prudent, it’s very hard to save money.  But if they are prudent, what often happens for a lot of our clients is they put money into their retirement plan, one of the common ones is the Westinghouse 401(k) for the engineers, or TIAA-CREF for the professors, but really, almost any retirement plan, they put money in, they continue doing this for thirty or forty years and now they’re in their sixties or seventies or sometimes older, and they often have a very substantial amount of money in their IRAs and retirement plans, and not so much money outside their IRAs and retirement plans.

David:  You mean, like is a house or property or other assets like that?

Jim:  Right, and they might have a house, and they might have a couple of cars, but if you think about it, let’s say that you’ve been putting money…if you work at the University of Pittsburgh, by the way, and professors somewhere else can be a little bit jealous when they hear this, if you put in 8% of your salary, they’ll put in 12%, and it’s been that way for many years.  So, if you think about it, even at a relatively low salary base, if you’re putting in 20% of your earnings, and you do that for thirty or forty years, you’re going to have quite a substantial accumulation that’s worth much more, much more than your house or your cars or even any money that you have accumulated outside of that.  So, when you do an estate plan for somebody who has a significant IRA or a retirement plan, you not only have to do the wills, but perhaps more importantly than the wills is the beneficiary of that IRA or that retirement plan.

Matt:  Jim, what does the typical beneficiary designation say that you see come into the office?

Jim:  Well, unfortunately, it often doesn’t have the right language that we want.  Unfortunately, it will say ‘Husband first, children equally second.’  And what’s really a shame is when people have gone to an estate attorney, they’ve paid a lot of money, they have a twenty or thirty-page will, and then they have a two-line beneficiary designation like husband first, children equally second, and you say “Where’s the majority of your money?”  And they say, “In my retirement plan.”  And I say, “Let me understand this.  You have this twenty or thirty-page document that controls not very much money at all, and you have two lines that control the vast majority of your money.”  Is that what you’re referring to?

Matt:  Correct.

7. The Magic Language You Need To Defer Taxes

Jim:  Okay.  Well, what about the situation where somebody has a substantial IRA?  It may or may not be the majority of their estate, but it’s more than $5,000 or $10,000.  It’s a substantial amount of money, and let’s assume, for discussion’s sake, that it is appropriate, or at least a trust is anticipated, either because the beneficiaries are very young, like grandchildren, or because there is a special needs, or because there is a spendthrift.  Could you talk a little bit, Matt, about the, let’s say, interaction of trusts as beneficiaries for IRAs in those situation when you have either a special needs child or grandchild or a spendthrift?

Matt:  Well, let’s talk about the spendthrift child first.  With a spendthrift child, one of your questions is how important is it to qualify for continued tax deferral, or the stretch IRA?  With individuals that we give money to outright, just by naming an individual as a beneficiary on a beneficiary designation, they can use their life expectancy to take out distributions and further stretch out their IRA.  If you don’t have the right provisions in your spendthrift trust, then you’re basically causing an income tax bomb inside your trust, which is causing lots of taxation to happen which is really diminishing the principle that’s available to help your beneficiary.

Jim:  Well, let’s actually put a number to it.

Matt:  Sure.

Jim:  I’m just going to use $1,000,000 because it’s a nice round number, although it can certainly be a lot less than that.  So, let’s say that you are a parent, and you’re planning for your children, and let’s say that your beneficiary is a spendthrift and you leave them $1,000,000 in your IRA.  And let’s say that you don’t have the magic language that you’re talking about.  What would happen in terms of income taxes to that IRA or that inherited IRA that the spendthrift child would receive?

Matt:  Depending on the age of the person who passed away, let’s just say, for purposes of discussion, that the person was 75 years old.

Jim:  Okay.

Matt:  The best-case scenario is we’re going to get the remainder of his life expectancy under the IRS tables, which is maybe going to be twelve, thirteen years.

Jim:  So you’re saying that then basically, the beneficiary’s going to pay tax on an average of $100,000 a year for ten or twelve years, and then poof!  So, basically, you’re talking about a massive income tax acceleration.  Why don’t you talk about what the taxation would be like if it does have the magic language that we would prefer as the beneficiary of the IRA?

Matt:  If the magic language is in the trust, then what happens is you can look at the individual beneficiary’s life expectancy.  So, let’s say it was a twenty-year old who was the beneficiary.  Their life expectancy under the tables might be sixty years.  So, if we’re talking about $1,000,000, instead of having to take out $100,000 a year, they’re only having to take out about $15,000 or $16,000 a year.

Jim:  All right.  Now, that’s so significant, and if you think about that, in one scenario, you’re paying taxes of, let’s say, $100,000 on $100,000.  Maybe that will shoot the beneficiary into the 28% bracket.  So, you could very conceivably pay $30,000 in income taxes, and then that $30,000 that’s paid in income taxes is no longer available for investment, because it goes to the IRS.  If we have the magic language in there and you’re only taking out, let’s say, what did you say?  A sixty-year life?  So, you’re talking about a $25,000 distribution…

Matt:  Maybe even a little less than that, yeah.

Jim:  …or even less.  So, you’re basically deferring the tax, which, by the way, I mean, that’s a familiar theme with us.  The subtitle of our best-selling book “Retire Secure!” is “Pay Taxes Later.”  We actually did some calculations that showed if you died with a million dollars in an IRA and the stretch, or it was done properly, your child would still have a million dollars when they’re age seventy, even after all the spending that would be appropriate.  If you compare that to the identical situation where you don’t have that magic language, your child, and given the exact same spending, the exact same interest rate, the exact same tax rate, etc., but you don’t have that magic language, then your child would have nothing at age seventy, and the main difference is the timing of the taxes.  So, you really want to get this part right.  So, if you do have a trust in mind as the beneficiary of an IRA, that’s great, but make sure then that you have the right language that qualifies as a designated beneficiary of the IRA before you actually name that trust.  Is that fair, Matt?

Matt:  I think that is fair, and something to be aware of is just because you name a trust as a beneficiary on a retirement account beneficiary designation, you have to make sure the trust has the right language.  It’s not enough just to name the trust, but the language has to be in the trust.

David:  And those are the magic words?

Jim:  Well, the magic words are actually five specific conditions, and I don’t think we want to get into the technical terminology of what needs to be in the trust.

Matt:  The end result is that the required minimum distribution, which is the amount that the beneficiary has to take each year, rather than it staying in the trust, it has to get distributed to the beneficiary.

David:  Right.

Matt:  That’s the best way to qualify.

Jim:  Yeah.  Actually, it was kind of interesting.  On a previous show, we had a guy named Bruce Steiner, who’s a New York City estate attorney, and there was an article the day before we were on the air, and the article in the Wall Street Journal, and I don’t want to mention the author of the article because if I were her, I would feel terrible.  Her advice was hey, it’s really complicated to do trusts as beneficiaries of IRAs, particularly for children, so since it’s complicated, you’re better off not doing it.  And I was so incensed because I thought no, that’s the wrong response.  The right response is it’s so valuable to have a IRA stretched or tax-deferred for so many years, maybe ten, twenty, thirty, forty years for your kids, maybe fifty, sixty, seventy years for your grandchildren.  Rather than avoiding that enormously beneficial tax situation, that just find the proper estate attorney that understands that.  And I was so incensed because I thought the advice was so wrong, I called her.  She didn’t really feel like writing a retraction, and I wrote a letter to the editor.  Anyway, I was on with Bruce Steiner that day and he did the exact same thing.  He was incensed at the advice and he wrote a letter to the editor, and they didn’t publish either one.

David:  They didn’t publish either one?

Jim:  No, they didn’t.

David:  Well, it must have been too complicated for them!

Jim:  Maybe.  I think the lesson is is that if you have the magic language, you can get your cake and eat it too.

David:  Well, in addition to deferring the taxes, you get the benefit of being able to use that money and have it grow over a long period of time, as well.

Jim:  And let’s go back to the underlying purpose of the trust, is to make sure that your child doesn’t blow the money, and unfortunately we don’t have enough time to talk about it, but not only your child, but your son-in-law, daughter-in-law, future ex-son-in-law, future ex-daughter-in-law…

David:  It can get complicated!

Jim:  Well, no.  This is a very real situation.  So, I have a situation.  We’re doing a spendthrift trust, not because the child is irresponsible with money, but because their spouse is!

David:  Well, anyway, thank you for joining us for another Lange Money Hour, Where Smart Money Talks, and thanks to Matt Schwartz.  As always, you can catch a rebroadcast of this show at 9:05 this Sunday morning right here on KQV, and you can also access the complete library of past shows, including written transcripts, on the Lange Financial Group’s website at www.RothIRAAdvisor.com.  Please join us for our next new show on August 1st at 7:05, right here on KQV 1410.  I’m David Bear.


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.