What to Do with an Inherited IRA? – Annapolis and Towson Estate Planning

Most of us do not have to worry about paying federal estate taxes on an inheritance. In 2021, the federal estate tax does not apply, unless an estate exceeds $11.7 million. The Biden administration has proposed lowering the exemption, but even that proposal would not affect estates valued at less than about $6 million. However, you should know that some states have lower thresholds.

Kiplinger’s recent article entitled “Minimizing Taxes When You Inherit Money” says that if you inherit an IRA from a parent, taxes on mandatory withdrawals could leave you with a smaller legacy than you anticipated. With IRAs becoming more of a significant retirement savings tool, there is also a good chance you will inherit at least one account.

Prior to last year, beneficiaries of inherited IRAs (or other tax-deferred accounts, such as 401(k) plans) were able to move the money into an account known as an inherited (or “stretch”) IRA and take withdrawals over their life expectancy. They could then minimize withdrawals which are taxed at ordinary income tax rates and allow the untapped funds to grow. However, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 stopped this. Most adult children and other non-spouse heirs who inherit an IRA on or after January 1, 2020, now have two options: (i) take a lump sum; or (2) transfer the money to an inherited IRA that must be depleted within 10 years after the death of the original owner.

Note that this 10-year rule does not apply to surviving spouses. They are allowed to roll the money into their own IRA and allow the account to grow, tax-deferred, until they must take required minimum distributions (RMDs), which start at age 72. If it is a Roth IRA, they are not required to take RMDs. Another option for spouses is to transfer the money into an inherited IRA and take distributions based on their life expectancy. The SECURE Act also created exceptions for non-spouse beneficiaries who are minors, disabled or chronically ill, or less than 10 years younger than the original IRA owner. Any IRA beneficiaries who are not eligible for the exceptions could wind up with a big tax bill, especially if the 10-year withdrawal period coincides with years in which they have a lot of other taxable income.

Note that the 10-year rule also applies to inherited Roth IRAs. However, there is an important difference. You still deplete the account in 10 years. However, the distributions are tax-free, provided the Roth was funded at least five years before the original owner died. If you do not need the money, waiting to take distributions until you are required to empty the account will give up to 10 years of tax-free growth.

Heirs who simply cash out their parents’ IRAs can take a lump sum from a traditional IRA. However, if you do, you will owe taxes on the entire amount, which could push you into a higher tax bracket.

Reference: Kiplinger (Oct. 28, 2021) “Minimizing Taxes When You Inherit Money”

 

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Estate Planning when So Much Is Uncertain – Annapolis and Towson Estate Planning

Negotiations in Washington continue to present a series of changing scenarios for estate planning. Until the ink is dry in the Oval Office, taxpayers face an uncertain legislative environment, says a recent article titled “Estate Planning in an Uncertain Time” from CPA Practice Advisor. Many people hurried to use lifetime gifting strategies because of estate tax provisions contained in earlier versions of the infrastructure bill, but even with these provisions dropped (for now), there are still good reasons to use lifetime gifting strategies.

The current $11.7 million estate/gift tax exemption will still be reduced on January 1, 2026, even if Congress takes no other action. Taxpayers who have not taken advantage of this “extra” exemption before then will lose the opportunity forever.

Any post-appreciation transfer on gifted assets accrues outside of the taxpayer’s estate. For younger individuals and for transferred assets with high potential for appreciation, this could have a major impact. Taxpayers who reside in states with a state estate tax, but no state gift tax, may find that lifetime gifting could reduce state estate tax liability.

For those who have already used all of their estate/gift tax exemption, the current low interest rate environment makes certain advanced estate planning techniques more appealing. Sales to IDGTS (Intentionally Defective Grantor Trusts, a type of irrevocable trust), intra-family loans and GRATS (Grantor Retained Annuity Trusts) are more effective when interest rates are low.

The two interest rates to watch for these strategies are the federal Section 7520 rate and the short-term, mid-term and long-term applicable federal rate (AFR). If transferred assets appreciate faster than the benchmark interest rate, any excess appreciation passes without any estate/gift tax exemption being used.

Interest rates have increased in recent months. However, by historical standards, they remain low.

IDGTs are expected to remain popular for making lifetime transfers. They are a type of trust outside the taxpayer’s estate for estate tax purposes and are considered to belong to the grantor for income tax purposes. The grantor is responsible for paying the income tax of the trust, which permits the grantor to make a tax-free gift, while the assets of the IDGT may grow without income taxes.

The grantor may also sell assets to an IDGT without creating a realization event for income tax purposes. Congress may consider this a little too effective for estate taxes, but for now, this strategy is still available.

Speak with an experienced estate planning attorney to review your current lifetime gifting plan and see if it needs to be revised. Of course, if you do not have an estate plan, now is the time to get that underway.

Reference: CPA Practice Advisor (Nov. 17, 2021) “Estate Planning in an Uncertain Time”

 

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Can I Change My Estate Plan During Divorce? – Annapolis and Towson Estate Planning

Divorce is never easy. Adding the complexities of estate planning can make it harder. However, it still needs to be included during the divorce process, says a recent article entitled “How to Change Your Estate Plan During Divorce from the Waco Tribune-Herald.

Some of the key things to bear in mind during a divorce include:

Is your Last Will and Testament aligned with your pending divorce? The unexpected occurs, whether planning a relaxing vacation or a contentious divorce. If you were to die in the process, which usually takes a few years, who would inherit your worldly goods? Your ex? A trust created to take care of your children, with a trusted sibling as a trustee?

Are your beneficiary designations up to date? For the same reason, make sure that life insurance policies, retirement accounts and any financial accounts allowing you to name a beneficiary are current to reflect your pending or new marital status.

Certain changes may not be made until the divorce is finalized. For instance, there are laws concerning spouses and pension distribution. You might not be able to make a change until the divorce is finalized.  If your divorce agreement includes maintaining life insurance for the support of minor children, you must keep your spouse (or whoever is the agreed-upon guardian) as the policy beneficiary.

Once the divorce decree is accepted by the court, the best path forward is to have a completely new will prepared. Making a patchwork estate plan of amendments can be more expensive and leave your estate more vulnerable after you have passed. A new will revokes the original document, including naming an executor and a guardian for minor children.

The will is far from the only document to be changed. Other documents to be created include health care directives and medical and financial powers of attorney. All of these are used to name people who will act on your behalf, in the event of incapacity.

It is a good idea to update these documents during the divorce process. If you are in the middle of an ugly, emotionally charged divorce, the last person you want making life or death decisions as your health care proxy or being in charge of your finances is your soon-to-be ex.

Talk with your estate planning attorney so your attorney knows you are going through the divorce process. They will be able to make further recommendations to protect you, your children and your estate during and after the divorce.

Reference: Waco Tribune-Herald (Oct. 18, 2021) “How to Change Your Estate Plan During Divorce”

 

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How to Protect Assets from Medicaid Spend Down? – Annapolis and Towson Estate Planning

Medicaid is not just for poor and low-income seniors. With the right planning, assets can be protected for the next generation, while helping a person become eligible for help with long-term care costs.

Medicaid was created by Congress in 1965 to help with insurance coverage and protect seniors from the costs of medical care, regardless of their income, health status or past medical history, reports Kiplinger in a recent article “How to Restructure Your Assets to Qualify for Medicaid.” Medicaid was a state-managed, means-based program, with broad federal parameters that is run by the individual states. Eligibility criteria, coverage groups, services covered, administration and operating procedures are all managed by each state.

With the increasing cost and need for long-term care, Medicaid has become a life-saver for people who need long-term nursing home care costs and home health care costs not covered by Medicare.

If the household income exceeds your state’s Medicaid eligibility threshold, two commonly used trusts may be used to divert excess income to maintain program eligibility.

QITs, or Qualified Income Trusts. Also known as a “Miller Trust,” income is deposited into this irrevocable trust, which is controlled by a trustee. Restrictions on what the income in the trust may be used for are strict. Both the primary beneficiary and spouse are permitted a “needs allowance,” and the funds may be used for medical care costs and the cost of private health insurance premiums. However, the funds are owned by the trust, not the individual, so they do not count against Medicaid eligibility.

If you qualify as disabled, you may be able to use a Pooled Income Trust. This is another irrevocable trust where your “surplus income” is deposited. Income is pooled together with the income of others. The trust is managed by a non-profit charitable organization, which acts as a trustee and makes monthly disbursements to pay expenses for the individuals participating in the trust. When you die, any remaining funds in the trust are used to help other disabled persons.

Meeting eligibility requirements are complicated and vary from state to state. An estate planning attorney in your state of residence will help guide you through the process, using his or her extensive knowledge of your state’s laws. Mistakes can be costly—and permanent.

For instance, your home’s value (up to a maximum amount) is exempt, as long as you still live there or will be able to return. Otherwise, most states require you to spend down other assets to $2,000 per person or $4,000 per married couple to qualify.

Transferring assets to other people, typically family members, is a risky strategy. There is a five-year look back period and if you have transferred assets, you may not be eligible for five years. If the person you transfer assets to has any personal financial issues, like creditors or divorce, they could lose your property.

Asset Protection Trusts, also known as Medicaid Trusts. You may transfer most or all of your assets into this trust, including your home, and maintain the right to live in your home. Upon your death, assets are transferred to beneficiaries, according to the trust documents.

Right of Spousal Transfers and Refusals. Assets transferred between spouses are not subject to the five-year look back period or any penalties. New York and Florida allow Spousal Refusal, where one spouse can legally refuse to provide support for a spouse, making them immediately eligible for Medicaid. The only hitch? Medicaid has the right to request the healthy spouse to contribute to a spouse who is receiving care but does not always take legal action to recover payment.

Talk with your estate planning attorney if you believe you or your spouse may require long-term care. Consider the requirements and rules of your state. Keep in mind that Medicaid gives you little or no choice about where you receive care. Planning in advance is the best means of protecting yourself and your spouse from the excessive costs of long term care.

Reference: Kiplinger (Nov. 7, 2021) “How to Restructure Your Assets to Qualify for Medicaid”

 

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Is Estate Tax Exemption Going to Change? – Annapolis and Towson Estate Planning

In 2022, the estate and gift tax exemption increases from $11.7 million in 2021 to $12.06 million per individual, according to new inflation-adjusted numbers from the IRS. The gift tax annual exclusion also increases, from $15,000 to $16,000. The IRS announced these numbers, as well as tax brackets, standard deductions and more, as reported in the article “New Higher Estate And Gift Tax Limits for 2022: Couples Can Pass On $720,000 More Tax Free” from Forbes.

The estate tax is 40% on the biggest estates, but wealthy individuals use legal strategies, like transferring wealth to heirs while they are living, making big gifts and also making multiple $16,000 annual exclusion gifts that do not count against the $12 million lifetime limit.

In 2022, a wealthy person may leave $12.06 to heirs with no federal estate or gift tax. A married couple may leave $24.12 million. If by some chance a couple has maxed out their lifetime gifts, this latest increase means they have the option to give away another $720,000 in 2022.

A series of annual exclusion gifts of $16,000 can add up, especially when they are done in a planned method over an extended period of time. Since these gifts do not count toward the $12 million amount, they are especially valuable for managing estate tax liability.

Estate sizes may also be reduced by making direct payments for medical and tuition expenses, for as many people as desired, with no gift or tax consequences. There is no limit on the amount to be paid, as long as these payments are made directly to the institution.

There are any number of ways to take money out of an estate. These include outright gifts, loans to family members and special trusts. A variety of trusts are created to preserve family wealth, from simple to complex trusts used to extend wealth across many generations.

In addition to planning for the increased numbers for 2022, this is also the time to check on basic estate planning documents and be certain they are up to date. These include a will, any kind of revocable living trust, a durable power of attorney, a healthcare directive and a living will. If the family includes a special needs member or a disabled individual, there are other planning methods to be discussed with an experienced estate planning attorney.

Despite the good news of these increases, the $12 million estate tax exemption will be halved at the start of 2026. The historical high exemption was created under President Donald J. Trump by the 2017 Tax Cuts and Jobs Act, which temporarily doubled the estate tax exemption from 2018 to 2025. While there was a lot of discussion about the Infrastructure Bill and funding through estate taxes, any provisions impacting estate planning were dropped before the bill was passed.

One more reason to gift now: state estate taxes and inheritance taxes are still alive and well in many states. If you live in a state with these taxes, the state tax bite could be just as bad, if not worse, than the federal tax.

Reference: Forbes (Nov. 11, 2021) “New Higher Estate And Gift Tax Limits for 2022: Couples Can Pass On $720,000 More Tax Free”

 

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Do I Need a Living Trust? – Annapolis and Towson Estate Planning

Yahoo Finance’s recent article entitled “What Is a Living Trust in Real Estate?” says that a living trust is a legal document that makes it easier for you to pass assets to your loved ones after you die. It allows property to be transferred directly to your designated beneficiaries without needing to go through probate. A living trust will be managed by a trustee, while you are still living (that can be you).  You will name a successor trustee who will manage the trust, if you become incapacitated and distribute its assets after you pass away.

While the trust holds these assets, you are still considered in possession of them while you are alive (assuming you named yourself the trustee). Therefore, you can move assets in and out of the trust as you see fit. If you have a revocable trust, you can even cancel or change it at any time.

Creating a living trust can simplify the inheritance process for your family when you die. That is because any property you own is subject to the probate process when you die. Probate can be a very lengthy process.

While waiting, your family may be unable to manage, use, or sell the property you left behind. Until probate is complete, your executor will be responsible for maintaining the property, including paying taxes, making repairs and paying the bills (like insurance).

A living trust is a beneficial financial product for many reasons. First, it bypasses the probate courts. There are some types of assets that will pass on to your beneficiaries directly, and others will need to clear the probate courts before they can be disbursed to your beneficiaries. This probate process can take months or even years and can be both costly and complicated.

Another benefit of a trust is that you keep control of your estate, even after you pass away. A living trust lets you set rules, timelines and stipulations for your estate. This may be something like keeping your children from getting a substantial sum of money in their early 20s. With a living trust, you can state instructions for your trustee as to when your kids receive that inheritance. For example, you may provide that they receive their inheritance in stages, like a third at 30, 35 and 40.

Finally, a trust is private. Unlike a will, your trust can be kept as private as you want. Once you pass away, and your will is filed with the probate court, it becomes public record. However, if you would rather have your estate and your wishes kept out of the public eye, a trust can help you do so.  Because a trust skips the probate process, it is also much harder for someone to challenge your directives.

Reference: Yahoo Finance (Oct. 7, 2021) “What Is a Living Trust in Real Estate?”

 

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How to Approach Parents about Estate Planning – Annapolis and Towson Estate Planning

One of the lessons learned from the pandemic is not to wait for the “right time” to prepare for death or incapacity. Aging parents who do not have a plan in place leave their children with a number of obstacles, says this recent article entitled “Why (and How) To Talk To Your Parents About Estate Planning” from NASDAQ.

One is scrambling to unravel the family finances at a time when you are still grief-stricken. Another is managing costs associated with severe illness and death. Incapacity can be even more complicated. It is more so, if the family has to apply for guardianship to make medical and financial decisions for a parent who cannot speak for themselves or manage their financial affairs.

To prevent a host of problems and expenses, start talking with aging parents about estate planning.  They do not have to live in an  “estate” to have an estate. This is simply the term used to describe all assets owned by a couple or individual.

An estate plan is a tool to convey intentions about assets and health. The first step may be to create an inventory of all assets and belongings, from the family home to personal belongings and digital assets. Next, is to have some tough conversations about their wishes for end-of-life care and medical decisions.

A few questions to get started:

  • Who should be the primary caregiver and decision maker?
  • How will health care expenses be paid?
  • Who do you want to make medical decisions?
  • What do you want to happen to your property after you die?
  • Should the family sell the home, or should one of the children inherit it?
  • Do you have any estate planning documents, and where are they kept?

Estate planning is different for everyone, so be wary of downloading basic estate documents from the web and hoping they will be valid. An experienced estate planning attorney will create the necessary documents, as per the laws of your parents’ state of residence, and reflecting their wishes.

If there is no will, or if a will is deemed invalid by the court, the laws of the state will govern how assets are distributed. Making sure a will is properly prepared, along with other estate planning documents, is a more efficient and less costly way to go.

Estate planning includes tax planning, which occurs when property passes from one person to another. Estate and inheritance taxes are the most common concern. While most Americans do not need to worry about the federal estate tax, individual states have their own rules and thresholds. Some states have both state estate taxes and inheritance taxes. There are ways to minimize taxes, from gifting during your parent’s lifetimes, to establishing trusts for beneficiaries.

An estate plan includes a Will, a Power of Attorney for financial matters, a Health Care Proxy so someone can make health care decisions, a Living Will (also known as an Advance Care Directive) and usually some kind of trust. Each serves a different purpose, but all name a designated person to act in a legal manner to handle the affairs of the person, while they are living and after they have passed.

Some families are more comfortable than others about talking about death and money, so you probably already know what to expect from your parents when trying to have this conversation. Be mindful of their feelings, and those of your siblings. These are hard, but necessary conversations.

Reference: NASDAQ (Nov. 10, 2021) “Why (and How) To Talk to Your Parents About Estate Planning”

 

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You May Need a ‘Durable’ Power of Attorney – Annapolis and Towson Estate Planning

An individual (the “principal”) can execute a power of attorney authorizing another person (known as an “agent”) to act on his or her behalf to handle finances, sign contracts on their behalf, buy and sell investments and other decisions of this nature.

Powers of attorney are frequently drafted as people age and find these matters burdensome, even though they may be mentally and physically able to address them on their own.

Fed Week’s recent article entitled “Considerations for Providing a Power of Attorney” suggests that you be sure to execute a “durable” power of attorney.

Some seniors may wonder about giving such authority in a power of attorney to someone else while they are still competent.

In many states, a senior can sign a “springing durable power of attorney,” which takes effect only under certain specified circumstances.

A common example is when a springing power is to take effect only after two doctors, including a senior’s personal physician, have determined that the principal has become incapacitated.

Regardless of the type of power a person selects, it should be reviewed and updated every few years with the help of an experienced estate planning or elder law attorney.

The reason is that a person’s situation may change. This may result in the need to name another agent. Some financial institutions also will not accept old powers of attorney.

Ask your bank, broker and mutual fund company about whether they will accept your power, or if they will insist that their own form be used—which is a common practice in the financial world.

Reference: Fed Week (Nov. 1, 2021) “Considerations for Providing a Power of Attorney”

 

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How Long Is Probate? – Annapolis and Towson Estate Planning

Yahoo Finance’s article entitled “How Long Does Probate Take?” gives us an overview of the main things you need to understand about the probate process, so you can prepare.

During probate, a judge determines the way in which to distribute assets to heirs. The court will also authenticate the will (if there is one) and appoint an executor of the estate to supervise the probate process. Probate procedures depend to a large part on the state the decedent lived in and the type of estate he or she had.

After authenticating the decedent’s will and appointing an executor, the executor locates and assesses all the property owned by the deceased. If there are any debts, the executor uses estate assets to pay these. The remaining estate is then distributed to the heirs.

The probate process takes time to make certain that everything is done according to the law. As a result, it can take from a few months up to over a year. There is a long list of variables that can contribute to the duration. A few of the common factors are discussed below.

Estate Size. An estate’s size contributes significantly to the time in probate. Most states use the total value of the estate to determine its size. This depends on state laws and the type of assets included in the estate. Many states now have a small estate probate process, and some waive it altogether for low-value properties. The state may have a small estate limit of a certain dollar amount. The executor or beneficiaries can complete a Small Estate Claim Form or an Affidavit for Transfer of Personal Property to avoid probate for estates below that value.

Multiple beneficiaries. If an estate has a number of heirs, it may gum up the works. Multiple beneficiaries can slow down the probate proceedings because disputes can drag out an otherwise smooth legal process. Disagreements among family members or other heirs can result in delays or even a total halt.

No Will. If a person dies without a will, it means that there is no guidance from the decedent. As a result, the court and executor have to work through the estate and distribution from scratch.

Debts. Taxes and debts are major factors in the time needed to close an estate. Creditors must be paid before the beneficiaries can receive anything. When a person dies, his or her creditors must receive formal notice. They have a deadline to make a claim for money the estate owed. The longer the claims period, the longer the delay in the probate process.

Taxes. Taxes on an estate also can take a while to process. The estate must receive a closing letter from the IRS and the state taxing authority to close out the probate process. This can take up to six months.

Reference: Yahoo Finance (Sep. 27, 2021) “How Long Does Probate Take?”

 

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Do Gifts Count Toward Estate Taxes? – Annapolis and Towson Estate Planning

With all of the talk about changes to estate taxes, estate planning attorneys have been watching and waiting as changes were added, then removed, then changed again, in pending legislation. The passage of the infrastructure bill in early November may mark the start of a calmer period, but there are still estate planning moves to consider, says a recent article “Gift money now, before estate tax laws sunset in 2025” from The Press-Enterprise.

Gifts are used to decrease the taxes due on an estate but require thoughtful planning with an eye to avoiding any unintended consequences.

The first gift tax exemption is the annual exemption. Basically, anyone can give anyone else a gift of up to $15,000 every year. If giving together, spouses may gift $30,000 a year. After these amounts, the gift is subject to gift tax. However, there is another exemption: the lifetime exemption.

For now, the estate and gift tax exemption is $11.7 million per person. Anyone can gift up to that amount during life or at death, or some combination, tax-free. The exemption amount is adjusted every year. If no changes to the law are made, this will increase to roughly $12,060,000 in 2022.

However, the current estate and gift tax exemption law sunsets in 2025. This will bring the exemption down from historically high levels to the prior level of $5 million. Even with an adjustment for inflation, this would make the exemption about $6.2 million. This will dramatically increase the number of estates required to pay federal estate taxes.

For households with net worth below $6 million for an individual and $12 million for a married couple, federal estate taxes may be less of a worry. However, there are state estate taxes, and some are tied to federal estate tax rates. Planning is necessary, especially as some in Congress would like to see those levels set even lower.

Let us look at a fictional couple with a combined net worth of $30 million. Without any estate planning or gifting, if they live past 2025, they may have a taxable estate of $18 million: $30 million minus $12 million. At a taxable rate of 40%, their tax bill will be $7.2 million.

If the couple had gifted the maximum $23.4 million now under the current exemption, their taxable estate would be reduced to $6.6 million, with a tax bill of $2,520,000. Even if they were to die in a year when the exemption is lower than it was at the time of their gift, they would save nearly $5 million in taxes.

There are a number of estate planning gifting techniques used to leverage giving, including some which provide income streams to the donor, while allowing the donor to maintain control of assets. These include:

Discounted Giving. When assets are transferred into an entity (commonly a limited partnership or limited liability company), a gift of a minority interest in the entity is generally given a discounted value, due to the lack of control and marketability.

Grantor Retained Annuity Trusts. The donor transfers assets to the trust and retains right to a payment over a period of time. At the end of that period, beneficiaries receive the assets and all of the appreciation. The donor pays income tax on the earnings of the assets in the trust, permitting another tax-free transfer of assets.

Intentionally Defective Grantor Trusts. A donor sets up a trust, makes a gift of assets and then sells other assets to the trust in exchange for a promissory note. If this is done correctly, there is a minimal gift, no gain on the sale for tax purposes, the donor pays the income tax and appreciation is moved to the next generation.

These strategies may continue to be scrutinized as Congress searches for funding sources, but in the meantime, they are still available and may be appropriate for your estate. Speak with an experienced estate planning attorney to see if these or other strategies should be put into place.

Reference: The Press-Enterprise (Nov. 7, 2021) “Gift money now, before estate tax laws sunset in 2025”

 

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