Avoid naming Estate as an IRA Beneficiary

September 6, 2022

It is critical to avoid naming your estate as an IRA beneficiary. Usually when an estate planning attorney comes across an estate named as a beneficiary, all they can do is shake their heads. It’s already too late to make any changes and, in most cases, the results are bad, reports a recent article from Kiplinger that warns “Don’t Name Your Estate as Your IRA Beneficiary.”

This usually occurs because the person was in a hurry or didn’t know better. It is sometimes because they don’t know who should become the beneficiary and are advised to just write down their estate to move the application process along. The problem comes after years go by, the account owner dies and the beneficiary designation is revealed.

The SECURE Act eliminated what was once known as the “Stretch IRA,” where beneficiaries could take withdrawals based on an IRS table of life expectancy. The SECURE Act changed how IRA distributions are made and with a few exceptions, beneficiaries have ten years to empty the account.

The people who are not subject to the ten-year rule include: surviving spouses, disabled individuals, chronically ill individuals and individuals within ten years of age of the original owner.

One additional exception: minor children, until they reach the age of majority, at which point they too must empty the IRA in ten years’ time.

Estates may not use the ten-year rule. They must distribute the funds in an even shorter time period: five years. There are a number of reasons to avoid this:

The shorter the time period for withdrawals, the higher the potential for higher taxes.
Higher income levels can lead to higher Medicare charges.
Higher income levels can also lead to more taxes on Social Security income.
Assets left directly to a named beneficiary have some protection against creditors.
Assets in your estate have no protection at all against creditors.
Higher administration costs for probate fees, legal fees, etc.
Increased potential for a disgruntled heir to challenge your will.

The problem is solvable, if you act while you are living. Start by reviewing your accounts and identifying beneficiary designations. If you can’t find the beneficiary form, contact the institution, get a new one, complete it and submit it.

Avoid the serious mistake of naming your estate as an IRA beneficiary. Reviewing beneficiaries is something to be done every three to five years, every time you review your estate plan. Don’t leave this to the last minute—take care of it now. If you would like to learn more about naming beneficiaries to retirement accounts, please visit our previous posts.

Reference: Kiplinger (July 27, 2022) “Don’t Name Your Estate as Your IRA Beneficiary”

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IRS Extending Time to File Portability Exemption

August 9, 2022

When a spouse dies, the surviving spouse has the option of taking the unused federal estate tax exclusion and applying it to their own estate. This is known as electing portability for the DSUE, Deceased Spousal Unused Exemption, according to a recent article “Estates can now request late portability election relief for 5 years” from the Journal of Accountancy. The IRS is extending the time it takes to file a portability exemption.

The portability exemption has grown in use, and the scheduled decrease in the estate tax exemption starting on January 1, 2026, will no doubt dramatically expand the number of people who will be even more eager to adopt this process.

The IRS has extended the amount of time a surviving spouse may elect to take the Deceased Spousal Unused Exclusion (DSUE) from two to five years. The expanded timeframe is a reflection of the number of requests for letter rulings from estates missing the deadline for what had been a two-year relief period. The overly burdened and underfunded agency needed to find a solution to an avalanche of estates seeking this relief. Most of the requests were from estates missing the deadline between two years and under five years from the decedent’s date of death.

To reduce the number of letter ruling requests, the IRS has updated the requirement by extending the period within which the estate of a decedent may make the portability election under the simplified method to on or before the fifth anniversary of the decedent’s death.

There are some requirements to use the simplified method. The decedent must have been a citizen or U.S. resident at the date of death and the executor must not have been otherwise required to file an estate tax return based on the value of the gross estate and any adjusted taxable gifts. The executor must also not have timely filed the estate’s tax return within nine months after the date of death or date of extended file deadline.

If it is determined later that the estate was in fact required to file an estate tax return, the grant of relief will be voided.

Note that this change doesn’t extend the period during which the surviving spouse can claim a credit or a refund of any overpaid gift or estate taxes on the surviving spouse’s own gift or estate return.

The decision by the IRS extending the time to file a portability exemption will become even more popular after December 31, 2025, when the federal exemption changes from $12.6 million per person to $5 million (adjusted for inflation). Given the rise in housing prices, even people with modest estates may find themselves coming close or exceeding the federal estate tax level. If you would like to learn more about the portability exemption, please visit our previous posts.

Reference: Journal of Accountancy (July 11, 2022) “Estates can now request late portability election relief for 5 years”

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When to File a Gift Tax Return

May 2, 2022

The IRS wants to know how much you’re gifting over the course of your lifetime. This is because while gifts may be based on generosity, they are also a strategy for avoiding taxes, including estate taxes, reports The Street in a recent article “How Do Gif Taxes Work?”. It is important to understand when to file a gift tax return and the consequences of not filing.

Knowing whether you need to file a gift tax return is relatively straightforward. The IRS has guidelines about who needs to file a gift tax return and who does not. Your estate planning attorney will also be able to guide you, since gifting is part of your estate and tax planning.

If you give a gift worth more than $16,000, it is likely you need to file a gift tax return. Let’s say you gave your son your old car. The value of used cars today is higher than ever because of limited supply. Therefore, you probably need to file a gift tax return. If the car title is held by you and your spouse, then the car is considered a gift from both of you. The threshold for a gift from a married couple is $32,000. Make sure that you have the right information on how the car is titled.

What if you added a significant amount of cash to an adult child’s down payment on a new home? If you as a member of a married couple gave more than $32,000, then you will need to file a gift tax return. If you are single, anything over $16,000 requires a gift tax return.

529 contributions also fall into the gift tax return category. Gifts to 529 plans are treated like any other kind of gift and follow the same rules: $16,000 for individuals, $32,000 for married couples.

What about college costs? It depends. If you made payments directly to the educational institution, no gift tax return is required. The same goes for paying medical costs directly to a hospital or other healthcare provider. However, any kind of educational expense not paid directly to the provider is treated like any other gift.

Do trusts count as gifts? Good question. This depends upon the type of trust. A conversation with your estate planning attorney is definitely recommended in this situation. If the trust is a “Crummey” trust, which gives the beneficiary a right to immediately withdraw the gift put into the trust, then you may not need to file a gift tax return.

A Crummey trust is not intended to give the beneficiary the ability to make an immediate withdrawal. However, the withdrawal right makes the gift in the trust a “current gift” and it qualifies for the annual exclusion limit. Recategorizing the gift can potentially exempt the person giving the gift from certain tax obligations. Check with your estate planning attorney.

Even when someone does file a gift tax return, the amount of tax being paid is usually zero. This is because the gifts are offset by each person’s lifetime exemption. The IRS wants these returns filed to keep track of how much each individual has gifted over time. Unless you are very wealthy and making gift transfers from a family trust or to family members, it is not likely you will ever end up paying a tax. You are, however, required to keep the IRS informed. If you would like to learn more about gift taxes and ways to limit them, please visit our previous posts.

Reference: The Street (March 31, 2022) “How Do Gift Taxes Work?”

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GRATs are used to Reduce Taxes

April 26, 2022

Estate planning includes using various methods to reduce gift and estate taxes, as described in a recent article titled “Grantor Retained Annuity Trust Questions Answered” from Entrepreneur. GRATs are one type of irrevocable annuity trust used by estate planning attorneys to reduce taxes.

An annuity is a financial product, often sold by insurance companies, where you contribute funds or assets to an account, referred to as premiums. The trust distributes payments to a beneficiary on a regular basis. If you have a Grantor-Retained Annuity Trust (GRAT), the person establishing the trust is the Grantor, who receives the annuities from the trust.

The GRAT payments are typically made annually or near the anniversary of the funding date. However, they can be made any time within 105 days after the annuity date. Payments to the GRAT may not be made in advance, so consider your cash flow before determining how to fund a GRAT. For this to work, the grantor must receive assets equal in value to what they put into the GRAT. If the assets appreciate at a rate higher than the interest rate, it’s a win. At the end of the GRAT term, all appreciation in the assets is gifted to the named remainder beneficiaries, with no gift or estate tax.

Here is a step-by-step look at how a GRAT is set up.

First, an individual transfers assets into an irrevocable trust for a certain amount of time. It’s best if those assets have a high appreciation potential.
Two parts of the GRAT value are the annuity stream and the remainder interest. An estate planning attorney will know how to calculate these values.
Annuity payments are received by the grantor. The trust must produce a minimum return at least equal to the IRS Section 7520 interest rate, or the trust will use the principal to pay the annuity. In this case, the GRAT has failed, reverting the trust assets back to the grantor.
Once the final annuity payment is made, all remaining assets and asset growth are gifted to beneficiaries, if the GRAT returns meet the IRS Section 7520 interest rate requirements.

The best candidates for GRATS are those who face significant estate tax liabilities at death. An estate freeze can be achieved by shifting all or some of the appreciation to heirs through a GRAT.

A GRAT can also be used to permit an S-Corporation owner to preserve control of the business, while freezing the asset’s value and taking it out of the owner’s taxable estate. Caution is required here, because if the owner of the business dies during the term of the GRAT, the current stock value is returned to the owner’s estate and becomes taxable.

GRATs are used most often in transferring large amounts of money to beneficiaries, helping to reduce taxes. A GRAT allows you to give a beneficiary more than $16,000 without triggering a gift tax, which is especially useful for wealthy individuals with healthy estates.

There are some downsides to GRATs. When the trust term is over, remaining assets become the property of the beneficiaries. Setting a term must be done mindfully. If you have a long-term GRAT of 20 years, it is more likely that you may experience serious health challenges as you age, and possibly die before the term is over. If the assets in the GRAT depreciate below the IRS’s assumed return rate, any benefits of the GRAT are lost. If you would like to learn more about GRATs, please visit our previous posts.

Reference: Entrepreneur (March 17, 2022) “Grantor Retained Annuity Trust Questions Answered”

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There are the New IRA Distribution Rules

April 20, 2022

The IRS recently announced there are new IRA distribution rules in the works. Many of the proposed distribution rules, which will be subject to further action in late spring, depend upon whether or not the original IRA owner died before or after the applicable required beginning date for distributions. As explained in the article “The Internal Revenue Service (IRS) Issues Proposed Minimum Distribution Rules” from The National Law Review, the age changed as a result of the SECURE Act, to 72.

Spousal Beneficiaries. If the spouse of the deceased IRA owner is the sole designated beneficiary and elects not to rollover the distribution, the surviving spouse may take RMDs over the deceased’s life expectancy. However, if the owner died before their required beginning date and the spouse is the sole beneficiary, the spouse may opt to delay distributions until the end of the calendar year in which the owner would have turned 72.

If the decedent died after turning 72, the annual distributions are required for all subsequent years and the spouse may take distributions over the longer remaining life expectancy.

Minor Children Beneficiaries. If the beneficiary of the IRA is a minor child, under age 21, annual distributions are required using the minor child’s life expectancy. When the minor turns 21, they must take annual distributions and the account must be fully distributed ten years after the child’s 21^st birthday.

Adult Children Beneficiaries. If the account owner dies after their required beginning date (age 72), an adult child who is a beneficiary must take annual distributions based on the beneficiary’s life expectancy. The account must be completely emptied within ten years of the original IRA owner’s death.

This applies only to adult children who are beneficiaries and are not disabled or chronically ill. Disabled or chronically ill adult children fall into a different category under the SECURE Act, with different distribution rules.

Special Rules for Roth IRAs. The benefits of Roth IRA accounts remain. There are no minimum distributions from a Roth IRA while the account owner is still living. After the death of the Roth IRA owner, the required minimum distribution rules apply to the Roth IRA, as if the Roth IRA owner died before their required beginning date.

If the sole beneficiary is the Roth IRA owner’s surviving spouse, the surviving spouse may delay distribution until the decedent would have attained their beginning distribution date.

Now that there are new IRA distribution rules to consider, speak with your estate planning attorney to determine if you need to update your estate plan. There are strategies to protect heirs from the significant tax liabilities these changes may create. If you would like to read more about IRAs and other retirement accounts, please visit our previous posts.

Reference: The National Law Review (March 25, 2022) “The Internal Revenue Service (IRS) Issues Proposed Minimum Distribution Rules”

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Take care managing ABLE Account Expenses

April 4, 2022

An ABLE account can be a life saver for individuals with disabilities. Those establishing one need to take care managing ABLE account expenses. An ABLE Account (Achieving a Better Life Experience Account) is a tax-advantaged savings account available to individuals diagnosed with disabilities. It lets them save without putting their public benefits at risk. Contributions to the ABLE account may be made by the account owner, family members, friends, trusts or any other person, as explained in the article “What Qualifies as Eligible Expenses for an ABLE Account?” from Investopedia. The money can be maintained in the account tax-free or spent on certain expenses, which are called “eligible expenses” or “Qualified Disability Expenses” (QDEs) and cover a broad range of goods and services. In some cases, figuring out if an expense meets the criteria is easy. However, in others, it is not so clear.

Typical QDEs include education, employment training, food, shelter, transportation, assistive technology, health, prevention and wellness, financial management of the ABLE account, including oversight and monitoring, legal fees, funeral and burial expenses. In all cases, keep detailed records of how ABLE funds are spent, just in case there is a dispute about whether an expense qualifies.

The law governing ABLE accounts does not spell out every single QDE. Sometimes the IRS or Social Security Administration will issue guidance to clarify whether an item is a QDE. The law says the term should be “broadly constructed to permit the inclusion of basic living expenses and should not be limited to items for which there is a medical necessity, or which provides no benefits to others in addition to the benefit to the eligible individual.”

Note that ABLE account funds may be used for a vacation, if it helps maintain or improve the health, independence, or quality of life for the disabled individual. The food category includes more than groceries: food delivery and restaurant meals are included.

A few tips:

If in doubt, use non-ABLE money and save the ABLE funds for eligible purchases.
Use public funds when possible. For instance, Medicaid may pay for transportation to a health care provider or educational programs.
Keep extensive records, especially for items you are not sure about.

It is great for the disabled individual to have this much flexibility. However, it can also be confusing. That is why you must take care in managing ABLE account expenses. An elder law estate planning attorney will be familiar with the guidelines and help ensure that the funds are used properly. If you would like to learn more about ABLE accounts, please visit our previous posts.

Reference: Investopedia (Feb. 25, 2022) “What Qualifies as Eligible Expenses for an ABLE Account?”

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Alternatives to replace Stretch IRA

March 28, 2022

The idea of leaving a large inheritance to loved ones is a dream for some parents. However, without careful planning, heirs may end up with a large tax bill. When Congress passed the SECURE Act in December 2019, one of the changes was the end of the stretch IRA, as reported by Kiplinger in a recent article titled “Getting Around the Stretch IRA Block.” There are alternatives to replace a stretch IRA.

Before the SECURE Act, people who inherited traditional IRAs needed to only take a minimum distribution annually, based on their own life expectancy. The money could grow tax-deferred for the rest of their lives. The tax impact was mild, because withdrawals could be spread out over many years, giving the new owner control over their taxable income. The rules were the same for an inherited Roth IRA. Distributions were based on the heirs’ life expectancy. Roth IRA heirs had the added benefit of not having to pay taxes on withdrawals, since Roth IRAs are funded with post-tax dollars.

After the SECURE Act, inherited traditional and Roth IRAs need to be emptied within ten years. Heirs can wait until the 10th year and empty the account all at once—and end up with a whopping tax bill—or take it out incrementally. However, it has to be emptied within ten years.

There are some exceptions: spouses, disabled or chronically ill individuals, or those who are not more than ten years younger than the original owner can stretch out the distribution of the IRA funds. If an underage minor inherits a traditional IRA, they can stretch it until they reach legal age. At that point, they have to withdraw all the funds in ten years—from age 18 to 28. This may not be the best time for a young person to have access to a large inheritance.

These changes have left many IRA owners looking for alternative ways to leave inheritances and find a work-around for their IRAs to protect their heirs from losing their inheritance to taxes or getting their inheritance at a young age.

For many, the solution is converting their traditional IRA to a Roth, where the IRA owner pays the taxes for their heirs. The strategy is generous and may be more tax efficient if the conversion is done during a time in retirement when the IRA owner’s income is lower, and they may be in a lower tax bracket. The average person receiving an IRA inheritance is around 50, typically peak earning years and the worst time to inherit a taxable asset.

Another alternative to replace the stretch IRA is life insurance. Distributions from the IRA can be used to pay premiums on a life insurance policy, with beneficiaries receiving death benefits. The proceeds from the policy are tax-free, although the proceeds are considered part of the policy owner’s estate. With the current federal exemption at $12.06 million for individuals, the state estate tax is the only thing most people will need to worry about.

A Charitable Remainder Trust can also be used to mimic a stretch IRA. A CRT is an irrevocable split-interest trust, providing income to the grantor and designated beneficiaries for up to twenty years or the lifetime of the beneficiaries. Any remaining assets are donated to charity, which must receive at least 10% of the trust’s initial value. If the CRT is named as the IRA beneficiary, the IRA funds are distributed to the CRT upon the owner’s death and the estate gets a charitable estate tax deduction (and not an income tax deduction) for the portion expected to go to the charity. Assets grow within the charitable trust, which pays out a set percentage to beneficiaries each year. The distributions are taxable income for the beneficiaries. There are two types of CRTs: Charitable Remainder Unitrust and a Charitable Remainder Annuity Trust. An estate planning attorney will know which one is best suited for your family. If you would like to read more about managing retirement accounts, please visit our previous posts.

Reference: Kiplinger (March 3, 2022) “Getting Around the Stretch IRA Block”

What Happens to HSA when Owner Dies?

January 5, 2022

An HSA, or Health Savings Account, can be an excellent way to save for medical expenses. For wage earners with high-deductible HSA-eligible health insurance plans, the IRS allows generous contributions on a pre-tax basis to an HSA ($3,600 per year for individuals, $7,200 per year for a family plan as of 2021), according to the article “HSAs and Estate Planning” from The Street. The money can be withdrawn, including both principal and earnings, with no taxes, as long as the withdrawals are used for qualified medical expenses. Here’s a look at what happens to an HSA when the owner dies.

Seems like a no brainer, doesn’t it? This unique account allows for triple-tax savings. However, when Health Savings Accounts become large, savvy planning is needed to understand how they work in estate planning and taxes.

The inherited HSA becomes the surviving spouse’s HSA, if the spouse had been designated as the beneficiary on the HSA. The money remains in the HSA and the spouse’s name is added to the account. They may make tax-free distributions from the HSA to pay for their own qualified medical expenses, as if they were the original owner. The HSA is not included in the estate, since it has become the property of the surviving spouse.

What if a non-spouse is the designated beneficiary? Upon the death of the original owner, the HSA is no longer considered an HSA for tax purposes. An immediate and taxable distribution of the entire amount goes to the non-spouse beneficiary. The beneficiary must include the HSA balance in their taxable income in the year of the original owner’s death.

The normal 20% penalty applying to distributions for non-qualified medical expenses doesn’t apply. The beneficiary pays income taxes at their marginal tax rate on the full amount of the HSA balance. However, at least there are no penalties.

However, any portion of an inherited HSA balance used to pay for outstanding medical expenses of the account owner within one year of the date of death (DOD) is not taxable to the non-spouse beneficiary. In this case, the HSA is also not included in the estate, since it is fully taxed to the non-spouse beneficiary on their own individual tax return.

If the Health Savings Account owner designates their estate as the beneficiary when they die, the account balance is included in the owner’s gross income for the year of their death. The HSA is still not included in the estate and is treated as income for the last year of their life, when it is reported as income on the final tax return.

A charity may be listed as a beneficiary for a has. Any charity will receive the full amount of the HSA with no taxes or penalties.

For most people, it’s best to use the HSA as you need it. Once you reach age 65, you are no longer subject to the 20% penalty for withdrawals not spent on medical expenses. If you have a sizable HSA, talk with your estate planning attorney on how to efficiently use it, while living and for other beneficiaries after you have died. If you would like to learn more about what happens to accounts such as an HSA when the owner dies, please visit our previous posts.

Reference: The Street (Dec. 9, 2021) “HSAs and Estate Planning”

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gift-tax is treated differently by IRS and Medicaid

Gift-Tax treated differently by IRS and Medicaid

October 13, 2021

Different government agencies have different rules for the same things. It’s a hard lesson, especially for those who try to use their $15,000 annual gift tax exclusion for asset protection for long term care. The results are not good. The gift-tax is treated differently by IRS and Medicaid.

A recent article from The News Enterprise makes it clear: “Medicaid and IRS don’t view gift-tax-exemption in same way.”

To understand the exclusion better, let’s start by looking at what the amount is being excluded from. The IRS generally allows each person to gift a total of $11.7 million in gifts during their lifetime and after death without incurring a gift tax. There are exceptions, but this is true in most cases. However, that first $15,000 given to each person within each calendar year is excluded from the total amount.

If a woman gives her three children $15,000 each per year for five years, she has given away a total of $225,000. However, this amount is not deducted from the $11.7 million that she is allowed within her lifetime non-taxable gift amount.

However, if the same woman gave her children $16,000 each for five years, the extra $3,000 per year must be deducted from her lifetime non-taxable gift limit. Unless she reaches the $11.7 million after her death, her estate will still not pay taxes on the gifts. She will be required to file a form every year letting the IRS know that she is reducing her limit.

The $15,000 gift tax exclusion each year simplifies the ability to give gifts without cumbersome reporting requirements. However, it creates huge—and costly—problems when used in an attempt to become eligible for Medicaid. This federally funded program was created to help low-income people pay for medical and nursing home care. A person’s assets and any financial transactions made within a five-year lookback period are considered when determining eligibility.

What most people don’t know is that Medicaid does not allow the gift tax exclusion to be used for the lookback period.

Remember the woman who gave her three children $15,000 each year for five years? If she goes into a nursing facility in the fifth year, after giving her final set of gifts, the IRS won’t count any of those gifts made against her lifetime gift tax exemption. However, Medicaid will count the full amount—$225,000—as if those assets were available to pay for her care. The penalty period will make it necessary for her or her family to pay for care, possibly for five years.

To take advantage of the annual gift tax exclusion safely when Medicaid may be in the future, an estate planning attorney can create an Intentionally Defective Grantor Trust to hold assets. This is a hybrid trust used to separate assets from the grantor just enough to begin the five-year lookback period while holding property within the grantor’s taxable estate, allowing for a continuing opportunity to take advantage of the annual gift tax exclusion without triggering a new five-year look back at each gift.

The gift-tax exemption is treated differently by IRS and Medicaid because they work under different rules. Understanding what each agency requires can protect the family and those needing nursing home care without creating expensive and stressful results. In addition, some Medicaid planning techniques may work in some states but not in others.

If you would like to learn more about the gift tax, and other estate taxes, please visit our previous posts.

Reference: The News Enterprise (Sep. 14, 2021) “Medicaid and IRS don’t view gift-tax-exemption in same way”

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Category: IRS

IRS Extending Time to File Portability Exemption

When to File a Gift Tax Return

GRATs are used to Reduce Taxes

There are the New IRA Distribution Rules

Alternatives to replace Stretch IRA

What Happens to HSA when Owner Dies?

Gift-Tax treated differently by IRS and Medicaid

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