401(k) Plans & IRAs: Don’t Let Heirs Make These Mistakes

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for Every Stage of Life.

401(k) Plans & IRAs: Don’t Let Heirs Make These Mistakes

While annual contributions to individual retirement accounts (IRAs) are still relatively modest, the ability to roll over 401(k) balances to an IRA can result in significant account balances for many investors.

IRAs are thus becoming estate planning tools for investors who don’t use the entire balance during their lifetimes. If you are in that situation, make sure your heirs know how to avoid some common IRA mistakes:

Using the IRA balance too quickly.

After an IRA is inherited, a traditional deductible IRA still retains its tax-deferred growth and a Roth IRA retains its potentially tax-free growth. Your beneficiaries’ goal should be to extend this growth for as long as possible. If the IRA has a designated beneficiary, which includes individuals and certain trusts, then the balance can be paid out over the beneficiary’s life expectancy. Spouses have additional options which can stretch payments even longer. Your heirs can also elect to take the entire balance immediately, paying any income taxes due. Make sure to stress to heirs the importance of taking withdrawals as slowly as possible.

Not splitting the IRA when there are multiple beneficiaries.

When there are multiple beneficiaries, you can split the IRA into separate accounts by Dec. 31 of the year following the original owner’s death. If the account is not split, distributions must be taken by all beneficiaries over the life expectancy of the oldest beneficiary. By splitting the IRA into separate accounts, each beneficiary can take distributions over his or her life expectancy.

This is especially important to a surviving spouse, who can only roll over the IRA to his/her own account if he/she is the sole beneficiary. With the rollover IRA, the surviving spouse can name his/her own beneficiary, thus expending the IRA’s life, and can defer payouts until age 70 1/2. When other than an individual or qualifying trust is one of the beneficiaries, the IRA must be distributed within five years when the owner dies before required distributions begin or over the owner’s life expectancy when the owner dies after required distributions begin.

Separating the account or paying out the non-individual’s portion then allows the individual beneficiary to take distributions over his or her life expectancy.

Rolling the balance over to a spouse’s IRA too quickly.

Once a spouse rolls over the balance to his/her own IRA, some planning opportunities are eliminated. While the IRA balance can typically be spread out over a longer period when the balance is rolled over, the spouse may need distributions.

For instance, spouses under age 59 1/2 may make withdrawals from the original IRA without paying the 10 percent federal income tax penalty. Once the account is rolled over, withdrawals before age 59 1/2 would result in the penalty.

Also, spouses who are older than the original owner can delay distributions by retaining the original IRA. The surviving spouse does not have to take distributions until the deceased spouse would have attained age 70 1/2, even if the surviving spouse is past that age. The spouse may want to disclaim a portion of the IRA, which must be done within nine months of the original owner’s death. If the account is rolled over, that disclaimer can’t be made. Thus, it is usually best for the surviving spouse to determine his or her financial needs before rolling over the IRA balance.

Not properly establishing the inherited IRA.

An inherited IRA must be retitled to include the decedent’s name, the words individual retirement account, and the beneficiary’s name. The IRA cannot simply remain in the decedent’s name. The beneficiaries should also designate beneficiaries for their IRAs.

Have an estate planning question or concern? Please let us know! Call us at 630.665.2300 or click the button to schedule a complimentary consultation.

5 Reasons You May Still Need Life Insurance After Retirement

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5 Reasons You May Still Need Life Insurance After Retirement

Every stage of life has its own unique financial planning and insurance needs and retirement is no different. If your life insurance policy hasn’t changed in twenty years, the coverage it provides may no longer be well suited to your stage in life. That doesn’t mean you should drop all life insurance but you may want to revise it.

Keep in mind that even in retirement life insurance can be an important component of a sound financial plan.

Here are five reasons why you might still need life insurance:

1. 1. Funeral expenses. According to the National Funeral Directors Association, the average funeral (including the vault and casket but not cemetery costs, tombstone or miscellaneous costs such as flowers and obituaries) is $8,508. This amount can easily go much higher and pose a heavy financial burden on your survivors. Paying for the costs associated with death is a crucial role of life insurance.
  2. Health care expenses. If you incur large medical bills before you die, life insurance can help pay these bills so they don’t get passed on to your loved ones.
  3. Estate taxes. Depending on the size of your estate, your heirs could be responsible for paying federal and state estate taxes. Life insurance can be used to cover this tax burden. And if your estate is made up primarily of a business or real estate, insurance can prevent your family from being forced to sell the assets to pay the tax bill
  4. Caring for dependents. Life insurance can help a surviving spouse continue to enjoy a comparable lifestyle especially if he or she will not receive your full retirement income, pension or Social Security benefits.
  5. Charity. Some people choose to give life insurance policies to not-for-profit organizations so they can help their favorite charities and collect tax breaks. Generally, the tax deduction for a life insurance policy gift is equal to the premiums you paid minus any dividends you received.

If you are interested in this type of gift, however, make sure the charity is a qualified organization that will accept a policy. Some organizations are not equipped to go through the necessary processing to handle these types of donations and others can do so only if an insurance policy is structured in a specific way. You can deduct claim deductions if you name the charity as the irrevocable beneficiary. Charitable gifts of life insurance can pose problems if they aren’t structured properly so seek advice.

Transferring a Policy? Don’t Wait Too Long

If you intend to transfer your life insurance policy for the purpose of reducing your estate tax, you might not want to wait too long.

Here’s why: Life insurance transfers made within three years of your death are disallowed for federal estate tax purposes. In other words, the proceeds of the policy will still be included in your estate.

To effectively eliminate the proceeds from your estate, you must give up all rights of ownership. So give the decision careful thought. Suppose you transfer the policy to your spouse and later get divorced. You won’t be able to take back ownership. Transferring a policy means you no longer have the right to:

- - Name a beneficiary, or change the current beneficiary.
  - Borrow against the policy or cash it in.
  - Cancel, surrender or convert the policy.
  - Decide how payments to the beneficiary will be made — in a lump sum or installments.

Have an estate planning question or concern? Please let us know! Call us at 630.665.2300 or click the button to schedule a complimentary consultation.

There May be Hidden Tax Deductions in Your Retirement Community Fees

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for Every Stage of Life.

There May be Hidden Tax Deductions in Your Retirement Community Fees

You or someone you love may be ready for a retirement community living arrangement, which typically includes lifetime residential accommodations, meals, and some degree of medical services. These facilities can be quite expensive. The good news: Unexpected tax write-offs may help offset the cost.

The tax-saving idea is that you may be able to deduct part of the retirement community’s one-time entrance fee and ongoing monthly fees as medical expenses on your Form 1040, regardless of your current health status. Since the fees we are talking about here can be quite large (see right-hand box), meaningful deductions may be possible despite the limitation on medical write-offs. You can only deduct medical expenses to the extent they exceed 7.5% of your adjusted gross income in 2018 (and 2017).

Note: This percentage rose to 10% for some taxpayers, but thanks to the passage of the Tax Cuts and Jobs Act of 2017, it reverts to 7.5% for 2017 and 2018.

Costs Can Be Substantial

In many cases, retirement community deals start off by providing a certain level of medical care, which can then be increased as the resident grows older and has more health-related challenges. The costs are generally structured as a large one-time payment upon entering the community (up to several hundred thousand dollars or more) plus monthly fees thereafter (this can amount to $5,000 per month or more).

Court Decision Shows the Way

For proof that substantial deductions are possible, we can point to a 2004 Tax Court decision. Source: Delbert L. Baker v. Commissioner (122 TC 143 (2004)). In 1989, Delbert Baker and his wife bought into a resort-style retirement community. It provided four living arrangement categories:

- - Independent living with minimal medical services,
  - Assisted living with more medical help,
  - Special care (for victims of Alzheimer’s and dementia), and
  - Skilled nursing with maximum medical services.

The Bakers paid a one-time entrance fee of about $130,000 plus monthly fees of over $2,000 in exchange for lifetime residential and medical care privileges for both spouses. (This was back in 1989. Today’s prices would be much higher in many areas.)

The Bakers started off in the independent living category and resided in a two-bedroom, two-bath duplex unit. The duplex was equipped with a monitored emergency pull-cord system for medical crises. In addition, independent living residents had access to other medical services from the community’s on-site health center. They could also take advantage of other on-site health-related amenities such as a pool, spa, and exercise facility.

On their Form 1040 for 1989 (their initial year in the community), the Bakers claimed about $35,000 of the entrance fee as a medical expense deduction. However, that return was not audited. In 1997 and 1998, the Bakers claimed medical write-offs equal to about 40% and 42%, respectively, of the total monthly fees paid in those years. These percentages were derived by a committee of residents of the community, based on financial data supplied by the non-profit outfit that ran the community. Basically, the percentages were calculated by dividing the community’s total annual medical expenses by the total amount of annual fees collected from the residents.

IRS Disallows Deductions

The IRS audited the Bakers’ 1997 and 1998 returns and initially allowed deductions equal to about 19 percent of the monthly fees (as opposed to the much-higher percentages claimed by the taxpayers). Auditors completely disallowed claimed deductions for costs allocatable to use of the pool, spa, and exercise facility. The Bakers decided to take their story to the Tax Court. At that point, the IRS changed its position and stated that any allowable medical expense deductions had to be figured using complex actuarial calculations that involve assumptions regarding the longevity of the community’s residents and the degree of healthcare utilization at the community. The quick-and-easy method used by the Bakers to calculate their claimed deductions didn’t suit the IRS.

Court Says Deductions are Acceptable

As its first order of business, the Tax Court concluded that the simplified calculation method used by the Bakers was permissible (although the court quibbled with one aspect of the number crunching). The court observed that the government had repeatedly approved the simplified method in its own guidance. (IRS Revenue Rulings 67-185, 75-302, and 76-481)

However, the Tax Court agreed with the IRS that the Bakers could not claim medical write-offs for the husband’s use of the pool, spa, and exercise facility. This was mainly because the Bakers did not present the court with supportable calculations of costs incurred by the community to provide these amenities. In any event, fees attributable to the pool, spa, and exercise facility wouldn’t be deductible as medical expenses if taking advantage of these amenities was simply beneficial to the taxpayer’s overall health as opposed to treatment for a specific medical condition.

Deduction Requirement
According to the IRS, you must enter into a contractual lifetime care arrangement (as the Bakers did) in order to claim current medical expense deductions for amounts paid to the retirement community that do not depend on medical services actually provided to you. (IRS Revenue Ruling 93-72)

Bottom Line Is Good for Taxpayers

The Tax Court’s Baker decision was good news on two counts. First, it confirms that taxpayers who pay retirement community fees can often qualify for significant medical expense deductions — especially in the initial year when a large one-time fee is usually required. In effect, deductions for prepaid medical expenses are allowed, because the amount of permissible write-offs does not in any way depend on the level of medical services actually received by the taxpayer (if any). Second, the decision confirms that substantial medical expense deductions can be calculated using relatively simple arithmetic procedures without any need for expensive actuarial advice. In summary, while full-service retirement communities can be quite costly, tax savings may help offset the financial pain. Don’t overlook this favorable consideration.

Have an estate planning question or concern? Please let us know! Call us at 630.665.2300 or click the button to schedule a complimentary consultation.

Tax-Smart Strategy: Leaving IRA Money to Charity

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Tax-Smart Strategy: Leaving IRA Money to Charity

These days, many people have a large percentage of their wealth in the form of traditional IRA accounts. In most cases, this is because significant distributions have been rolled over tax-free from qualified retirement plans to these IRAs. A lot of people also have charitable intentions. If this sounds familiar, there’s a tax-saving strategy you should know about:

Consider designating your favorite charity or charities as beneficiaries of all or a portion of your IRAs. Then leave other assets to family members or other heirs.

Without Planning, Double or Even Triple Taxation is Possible

Take a look at how it works:

- - First, your traditional IRA account is included in your estate for federal estate tax purposes when you die. That’s tax number one.
  - Next, the taxable portion of the IRA balance (which is often the entire amount) is counted again as “income in respect of a decedent” (IRD) for federal income tax purposes. That means federal income tax will be owed when IRA withdrawals are taken by your estate or your heirs. That’s tax number two.
  - To make matters even worse, state income tax may be due as well. If so, that’s tax number three.

After all these taxes have been paid, your heirs may receive only a very small fraction of your IRA money while tax collectors get the lion’s share.

Take a look at how it works:

- - First, your traditional IRA account is included in your estate for federal estate tax purposes when you die. That’s tax number one.
  - Next, the taxable portion of the IRA balance (which is often the entire amount) is counted again as “income in respect of a decedent” (IRD) for federal income tax purposes. That means federal income tax will be owed when IRA withdrawals are taken by your estate or your heirs. That’s tax number two.
  - To make matters even worse, state income tax may be due as well. If so, that’s tax number three.

After all these taxes have been paid, your heirs may receive only a very small fraction of your IRA money while tax collectors get the lion’s share.

A Charity as IRA Beneficiary is the Cure

A tax-smart solution is to leave some or all of your IRA money to charitable beneficiaries while leaving everything else to other heirs you choose. The net result will be more after-tax cash for them. At the same time, you can satisfy charitable inclinations after you die. Sound good? Here are the details.

By naming one or more tax-exempt charitable organizations as beneficiaries of your IRA, you leave that money to the charities after your death. Under our current federal tax system, that is the only way to leave IRA balances directly to charity, although proposals have been made to change that. Alternatively you could take money out of your IRAs while you are still alive, pay the resulting income tax, and then give cash to the charities. Your contributions may be fully deductible for income tax purposes, although income-based restrictions might limit your charitable write-offs. In that case, you may have to claim your charitable deductions over several years. Depending on your taxable income, you may never be able to completely write off large donations. As you can see, this is an inefficient way to satisfy your charitable desires.

On the other hand, leaving IRA money directly to charities upon your death by designating them as account beneficiaries is very tax-efficient. First, an IRA balance left to charity avoids the federal estate tax, since it is removed from your estate for federal estate tax purposes. Second, there’s no federal income tax due on the IRA money (the IRD rules don’t apply). There’s no state income tax either. Finally, no income taxes are due when your favorite tax-exempt charities take their withdrawals from the IRAs. So you avoid double or triple taxation in a simple way.

Strategies for Your Loved Ones

If you are planning to make bequests to your loved ones, you can leave gifts of assets that are eligible for the federal income tax basis “step-up” to fair market value, as of the date of your death. These include common stocks and mutual fund shares held in taxable investment accounts, ownership interests in your small business, real estate, and just about anything else that qualifies for capital gain treatment when it is sold. Thanks to the basis step-up break, these assets can be sold by your heirs with little or no income tax (only post-death appreciation would be taxed). So there are no double taxation worries. However, they will be included in your estate for federal estate tax purposes, assuming your estate is taxable.

When all is said and done, this strategy allows you to leave more to your favorite charities, more to your loved ones, and less to the tax collector.

You can generally take the same steps with other types of tax-deferred retirement plan accounts as long as the accounts have specific balances. These include 401(k), corporate profit-sharing, SEP, and Keogh retirement accounts. If you’re married, however, state law may require you to obtain your spouse’s permission to name charities as beneficiaries of these accounts.

Conclusion: Designating your favorite charity as a beneficiary of your traditional IRA (and other tax-deferred retirement accounts, if your spouse approves) can be a tax-smart maneuver. With advance planning and the federal estate tax exemption, you have much more opportunity to minimize both federal and applicable state income and estate taxes. Contact your tax advisor if you have questions or want additional information.

Don’t Leave Roth IRA Balances to Charity

Naming a charity as the beneficiary of your Roth IRA is generally not advisable. Instead, you should leave Roth balances to your loved ones by designating them as the account beneficiaries. Here’s why: As long as your Roth IRA has been open for more than five years before withdrawals are taken by your heirs, all their withdrawals will be federal-income-tax-free.

But if you leave Roth IRA money to charity, this valuable tax break is completely wasted.

Remember: the required five-year period before federal-income-tax-free withdrawals can be taken starts on January 1st of the year for which you made the initial contribution to your Roth IRA. This includes contributions made by converting traditional IRA balances to Roth status.

For example, let’s say you made your initial Roth IRA contribution for the 2018 tax year on April 15th of 2019. You nevertheless start counting on January 1, 2018 for purposes of meeting the five-year rule.

Have an estate planning question or concern? Please let us know! Call us at 630.665.2300 or click the button to schedule a complimentary consultation.

Should You Name Your Trust as Beneficiary of Retirement Plan Assets?

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Should You Name Your Trust as Beneficiary of Retirement Plan Assets?

As you may know, the person (or persons) designated as the beneficiary of your tax-deferred 401(k) plan, 403(b) plan traditional IRA, Roth IRA and other retirement plans will receive that money when you die. These retirement plan assets are transferred by “operation of law,” which means that your will has no effect on them.

In other words, they pass outside of your will and are considered non-probate assets.

In general, married retirement account owners name their spouses or children as beneficiaries (it may even be required to name a spouse).

But in some situations, you may not want to name a person (or persons) as the beneficiary of your retirement plan. You may want to name a trust.

Here are some examples:

- - You may not want the beneficiary to receive all the money in the retirement account at once. A trust will allow they money to be distributed over time.
  - An individual may want to name his or her siblings as beneficiaries of a retirement account. But in the event one of the siblings dies, the account holder wants the children of the sibling to receive the money. A trust would allow this type of flexibility.
  - You may want to restrict the use of the money by a beneficiary (for example, to pay for college) or to care for a special needs child. Again, a trust would allow this while simply designating the beneficiary on your account would not.
  - The bulk of your money is held in retirement accounts and you want to set up a marital bypass trust to be the beneficiary in order to decrease estate tax.
  - An individual is remarrying and wants to set up a trust to ensure his new spouse and his children from a previous marriage receive a certain amount of money from the retirement accounts.

In these cases, as well as in other situations, you may be able to meet your goals by designating a trust as the beneficiary of your retirement account(s).

Tax Implications

However, naming a trust as the beneficiary of your retirement plan has tax implications.

In general, when a distribution is made from a tax-deferred retirement plan, the amount is taxable in the year it is received.

When a trust is named as the beneficiary of the retirement plan, the plan itself is not transferred. The assets are eventually distributed from the plan to the trust after the account holder’s death, and distributions are taxable at that time.

Therefore, if you are setting up a trust and funding it with retirement plan assets, you need to look at the tax costs and benefits. For example, if you want to leave retirement assets to your spouse and you want to defer taxes for years into the future, it is generally better to name the spouse outright as a beneficiary of the account rather than name a trust as the beneficiary. With a trust, a federal (and possibly state) income tax bill would be due in the year of the retirement plan distribution to the trust while as an outright beneficiary, your spouse has the ability to take a distribution or allow the tax deferral to continue for years.

Naming a trust as a beneficiary of your retirement plan can be a complex transaction. You need to first find out if the plan administrator allows a trust to be a beneficiary. You should also consider alternatives. For example, more emphasis on a properly prepared look-through trust can avoid negative income tax consequences and allow the trust beneficiary to take distribution over years. Consult with your estate attorney or a qualified adviser before finalizing any decisions.

Have an estate planning question or concern? Please let us know! Call us at 630.665.2300 or click the button to schedule a complimentary consultation.

Are You Getting a Late Start on Retirement Saving?

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Estate Planning Advice

for Every Stage of Life.

Are You Getting a Late Start on Retirement Saving?

Have you suddenly realized that you’re getting older and still haven’t saved much for retirement? Don’t just avoid the entire topic, knowing you won’t like the answers. If you’re getting a late start on saving, you need to take some drastic steps:

Go back to the drawing board.

You need to thoroughly analyze your situation, calculating how much you’ll need for retirement, what income sources will be available, how much you currently have saved, and how much you need to save annually to reach those goals. Can’t save the amount needed? Then change your retirement goals.

Postponing retirement for a few years will give you more time to accumulate your savings and delay when withdrawals from savings begin. Or consider working after retirement on at least a part-time basis. Even a modest amount of income after retirement can substantially reduce the amount needed for retirement.

Contribute the maximum to your 401(k) plan.

Your contributions are deducted from your current year gross pay. If you are age 50 or older, your plan may allow additional catch-up contributions. Earnings and capital gains on investments grow tax deferred until withdrawn. If your employer matches contributions, contribute at least enough to receive the maximum matching amount.

Look into traditional deductible and Roth individual retirement accounts (IRA).

Even if you participate in a company-sponsored retirement plan, you can make contributions to a deductible IRA, provided your adjusted gross income does not exceed certain limits. The income limits for nondeductible Roth contributions are even higher.

Use your peak earning years to substantially increase your savings.

Typically, your last years of employment are your peak earning years. Instead of increasing your lifestyle as your pay increases, save all pay raises. Consider lowering your standard of living, putting any cost reductions into savings. This can also reduce the cost of your retirement. A lower standard of living now typically means you’ll be satisfied with a similar lifestyle after retirement.

Buy a smaller home.

Consider selling your home and moving to a smaller one, especially if you have significant equity in the home. If you’ve lived in your home in at least two of the last five years, you can exclude $250,000 of gain if you are a single taxpayer and $500,000 of gain if you are married filing jointly. At a minimum, this strategy will reduce your living expenses, allowing you to save more. If you have significant equity in your home, you may be able to set some of the proceeds aside in savings.

Restructure your debt.

Check if refinancing your mortgage will reduce your monthly mortgage payment. Find less costly options for consumer debts, including credit cards with high interest rates. Systematically pay your debts down. And the most important point – avoid incurring new debt. If you can’t pay cash for something, don’t purchase it.

Stay focused on your goals.

At this age, it’s imperative to maintain your commitment to save.

Someone who is respected by your heirs and a good communicator also may help make the process run smoothly.

Above all, an executor should be someone trustworthy, since this person will have legal responsibility to manage your money, pay your debts (including taxes), and distribute your assets to your beneficiaries as stated in your will.

If your estate is large or you anticipate a significant amount of court time for your executor, you might think of naming a bank, lawyer, or financial professional. These individuals will typically charge a fee, which would be paid by the estate. In some families, singling out one child or sibling as executor could be construed as favoritism, so naming an outside party may be a good alternative.

Whenever possible, choose an executor who lives near you. Court appearances, property issues, even checking mail can be simplified by proximity.

Also, some states place additional restrictions on executors who live out of state, so check the laws where you live.

Whomever you choose, discuss your decision with that person. Make sure the individual understands and accepts the obligation — and knows where you keep important records. Because the person may pre-decease you — or have a change of heart about executing your wishes — it’s always a good idea to name one or two alternative executors.

The period following the death of a loved one is a stressful time, and can be confusing for family members. Choosing the right executor can help ensure that the distribution of your assets may be done efficiently and with as little upheaval as possible.

Have an estate planning question or concern? Please let us know! Call us at 630.665.2300 or click the button to schedule a complimentary consultation.

401(k) Plans & IRAs: Don’t Let Heirs Make These Mistakes

Using the IRA balance too quickly.

Not splitting the IRA when there are multiple beneficiaries.

Rolling the balance over to a spouse’s IRA too quickly.

Not properly establishing the inherited IRA.

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5 Reasons You May Still Need Life Insurance After Retirement

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There May be Hidden Tax Deductions in Your Retirement Community Fees

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Tax-Smart Strategy: Leaving IRA Money to Charity

Without Planning, Double or Even Triple Taxation is Possible

A Charity as IRA Beneficiary is the Cure

Strategies for Your Loved Ones

Don’t Leave Roth IRA Balances to Charity

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Should You Name Your Trust as Beneficiary of Retirement Plan Assets?

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RECENT POSTS

Are You Getting a Late Start on Retirement Saving?

Go back to the drawing board.

Contribute the maximum to your 401(k) plan.

Look into traditional deductible and Roth individual retirement accounts (IRA).

Use your peak earning years to substantially increase your savings.

Buy a smaller home.

Restructure your debt.

Stay focused on your goals.

Categories

RECENT POSTS