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Category: 401(k)

avoid naming a trust as beneficiary of your IRA

Avoid Naming a Trust as Beneficiary of Your IRA

It is generally a good idea to avoid naming a trust as beneficiary of your IRA. The IRA usually loses the benefit of tax deferral, due to the fact that it has to be distributed faster than in other scenarios. There are only a few cases when a trust as beneficiary can avoid this problem.

Wealth Advisor’s recent article entitled “Should A Living Trust Be Beneficiary Of Your IRA?” explains that the general rule is when an IRA beneficiary isn’t an individual, the IRA must be distributed fully within five years. When a trust, an estate, or a business entity is named as beneficiary, the IRA must be distributed quickly, and it’s then taxed. However, there’s an exception when you name a trust that qualifies as a “look-through” or “see-through” trust under IRS rules. To draft this type of trust, work with and experienced estate planning attorney to be certain that it avoids the five-year rule. Even so, the IRA must be distributed to the trust within 10 years, in most instances.

Another exception says there may not be a penalty when your spouse’s revocable living trust is named as the IRA beneficiary. Consider a recent IRS ruling that involved a married couple. The husband owned an IRA and had started to take required minimum distributions (RMDs). He died and had named a trust as sole beneficiary of his IRA. The wife had previously established the trust and was the sole beneficiary and sole trustee of the trust. She could amend or revoke the trust and could distribute all income and principal of the trust for her own benefit. In effect, it was a standard revocable living trust that is primarily used to avoid probate. The widow wanted to exercise the spousal option for an inherited IRA to roll the IRA over to an IRA in her name. The move would give her a new start, letting her manage the IRA, without reference to her late husband’s IRA. She could begin her RMDs based on her own required beginning date and life expectancy. She also could designate her own beneficiaries of the IRA.

The widow asked the IRS to rule that the IRA could be rolled over tax free into an IRA in her name. She wanted to have the IRA balance distributed directly to her to roll it over to an IRA in her own name within 60 days. The IRS said that was okay, noting that she was the trustee and sole beneficiary of the trust. She was entitled to all income and principal of the trust. Moreover, she was the surviving spouse of the deceased IRA owner.

In this situation, the widow was the sole person for whose benefit the IRA is maintained. As such, she can take a distribution from the inherited IRA and roll it over to an IRA in her own name without having to include any of the distribution in gross income, provided the rollover was accomplished within 60 days of the distribution.

Although this was a good answer for the widow, you may not want to name a living trust or your estate as the beneficiary of your IRA, even under similar circumstances. She had to apply to the IRS for a private ruling to be sure of the tax results, which is an expensive and time-consuming process.

Avoid naming a trust as beneficiary of your IRA, unless it is under very limited situations. This can be very complicated, so talk to an experienced estate planning attorney about your specific situation.

If you would like to learn more about IRA distributions, please visit our previous posts. 

Reference: Wealth Advisor (Dec. 29, 2020) “Should A Living Trust Be Beneficiary Of Your IRA?”

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Don’t Fail to Fund Your Trust

Revocable trusts can be an effective way to avoid probate and provide for asset management, in case you become incapacitated. These revocable trusts — also known as “living” trusts — are very flexible and can achieve many other goals. A revocable trust is a great tool, but don’t fail to fund your trust.

Point Verda Recorder’s recent article entitled “Don’t forget to fund your revocable trust” explains that you cannot take advantage of what the trust has to offer, if you do not place assets in it. Failing to fund the trust means that your assets may be required to go through a costly probate proceeding or be distributed to unintended recipients. This mistake can ruin your entire estate plan.

Transferring assets to the trust—which can be anything like real estate, bank accounts, or investment accounts—requires you to retitle the assets in the name of the trust.

If you place bank and investment accounts into your trust, you need to retitle them with words similar to the following: “[your name and co-trustee’s name] as Trustees of [trust name] Revocable Trust created by agreement dated [date].” An experienced estate planning attorney should be consulted.

Depending on the institution, you might be able to change the name on an existing account. If not, you’ll need to create a new account in the name of the trust, and then transfer the funds. The financial institution will probably require a copy of the trust, or at least of the first page and the signature page, as well as the signatures of all the trustees.

Provided you’re serving as your own trustee or co-trustee, you can use your Social Security number for the trust. If you’re not a trustee, the trust will have to obtain a separate tax identification number and file a separate 1041 tax return each year. You will still be taxed on all of the income, and the trust will pay no separate tax.

If you’re placing real estate in a trust, ask an experienced estate planning attorney to make certain this is done correctly.

You should also consult with an attorney before placing life insurance or annuities into a revocable trust and talk with an experienced estate planning attorney, before naming the trust as the beneficiary of your IRAs or 401(k). This may impact your taxes. Remember, if you fail to fund your trust, your heirs may be in for a huge headache.

If you would like to learn more about funding a trust, please visit our previous posts. 

Reference: Point Verda Recorder (Nov. 19, 2020) “Don’t forget to fund your revocable trust”

 

charitable contribution deductions from an estate

Pay for Your Debts at Death

When you pass away, your assets become your estate, and the process of dividing up debt after your death is part of probate. Creditors only have a certain amount of time to make a claim against the estate (usually three months to nine months). So how do you pay for your debts at death?

Kiplinger’s recent article entitled “Debt After Death: What You Should Know” explains that beyond those basics, here are some situations where debts are forgiven after death, and some others where they still are required to be paid in some fashion:

  1. The beneficiaries’ money is partially protected if properly named. If you designated a beneficiary on an account — such as your life insurance policy and 401(k) — unsecured creditors typically can’t collect any money from those sources of funds. However, if beneficiaries weren’t determined before death, the funds would then go to the estate, which creditors tap.
  2. Credit card debt depends on what you signed. Most of the time, credit card debt doesn’t disappear when you die. The deceased’s estate will typically pay the credit card debt at death from the estate’s assets. Children won’t inherit the credit card debt, unless they’re a joint holder on the account. Likewise, a surviving spouse is responsible for their deceased spouse’s debt, if he or she is a joint borrower. Moreover, if you live in a community property state, you could be responsible for the credit card debt of a deceased spouse. This is not to be confused with being an authorized user on a credit card, which has different rules. Talk to an experienced estate planning attorney, if a creditor asks you to pay the credit card debt at death. Don’t just assume you’re liable, just because someone says you are.
  3. Federal student loan forgiveness. This applies both to federal loans taken out by parents on behalf of their children and loans taken out by the students themselves. If the borrower dies, federal student loans are forgiven. If the student passes away, the loan is discharged. However, for private student loans, there’s no law requiring lenders to cancel a loan, so ask the loan servicer.
  4. Passing a mortgage to heirs. If you leave a mortgage behind for your children, under federal law, lenders must let family members assume a mortgage when they inherit residential property. This law prevents heirs from having to qualify for the mortgage. The heirs aren’t required to keep the mortgage, so they can refinance or pay for your debt entirely. For married couples who are joint borrowers on a mortgage, the surviving spouse can take over the loan, refinance, or pay it off.
  5. Marriage issues. If your spouse passes, you’re legally required to pay any joint tax owed to the state and federal government. In community property states, the surviving spouse must pay off any debt your partner acquired while you were married. However, in other states, you may only be responsible for a select amount of debt, like medical bills.

You may want to purchase more life insurance to pay for your debts at death or pay off the debts while you’re alive. If you would like to learn more about debts and other vital issues to address when someone dies, please visit our previous posts. 

Reference: Kiplinger (Nov. 2, 2020) “Debt After Death: What You Should Know”

 

charitable contribution deductions from an estate

How Do You Handle A Large Inheritance?

How do you handle a large inheritance? Wealth Advisor’s recent article entitled “Death by inheritance: Windfall can cause complications” cautions that in a community property state, if you’re married, your inheritance is separate property. It will stay separate property, provided it’s not commingled with community funds or given to your spouse. That article says that it is much harder to do than it looks.

One option is for you and your spouse to sign a written marital agreement that states that your inheritance (as well as any income from it) remains your separate property. However, you have to then be careful that you keep it apart from your community property.

If your spouse doesn’t want to sign such an agreement, then speak to an attorney about what assets in your inheritance can safely be put into a trust. If you do this, take precautions to monitor the income and keep it separate.

Another route is to put your inheritance into assets held in only your name and segregate the income from them. This is important because income from separate property is considered community property.

Another tip for handling a large inheritance, is to analyze it by type of asset. IRAs and other qualified funds take very special handling to avoid unnecessary taxes or penalties. If you immediately cash out your inherited traditional IRA, you’ll forfeit a good chunk of it in taxes. If you don’t take the mandatory distribution of a Roth IRA, you’re going see a major penalty.

Inherited real estate has its own set of issues. If you inherited only part of a piece of real property, then you’ll have to work with the other owners as to its use, maintenance, and/or sale. For example, your parents’ summer home is passed to you and your three siblings. If things get nasty, you may have to file a partition suit to force a sale, if your siblings aren’t cooperative. Real estate can also be encumbered by an environmental issue, a mortgage, delinquent taxes, or some other type of lien.

Some types of assets are just a plain headache: timeshares, partnership, or entity interests that don’t have a buy-sell agreement, along with Title II weapons (which may be banned in your state).

You can also refuse an inheritance by use of a disclaimer. It’s a procedure where you decline to take part or all of an inheritance.

Finally, speak with an experienced estate planning attorney that is familiar with how to handle a large inheritance, so you can incorporate that inheritance into your own estate plan.

If you would like to learn more about inheritance, please visit our previous posts. 

Reference: Wealth Advisor (Nov. 10, 2020) “Death by inheritance: Windfall can cause complications”

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Benefit from a Roth IRA and Social Security

When originally created, Social Security was designed to prevent the elderly and infirm from sinking into dire poverty. When most working Americans enjoyed a pension from their employer, Social Security was an additional source of income and made for a comfortable retirement. However, with an average monthly benefit just over $1,500 and few pensions, today’s Social Security is not enough money for most Americans to maintain a middle-class standard of living, says the article “3 Reasons a Roth IRA Is a Perfect Supplement to Social Security” from Tuscon.com. It’s important to plan for additional income streams and one to consider is the Roth IRA. So how do you benefit from a Roth IRA and Social Security?

Roth IRAs can be funded at any age. Many seniors today are continuing to work to generate income or to continue a fulfilling life. Their earnings can be put into a Roth IRA, regardless of age. If you are still working but don’t need the paycheck, that’s a perfect way to fund the Roth IRA.

Withdrawals from a Roth won’t trigger taxes on Social Security benefits. If your only income is Social Security, you probably won’t have to worry about federal taxes. However, if you are working while you are collecting benefits, once your earnings reach a certain level, those benefits will be taxed.

To calculate taxes on Social Security benefits, you’ll need to determine your provisional income, which is the non-Social Security income plus half of your early benefit. If you earn between $25,000 and $44,000 as a single tax filer or between $32,000 and $44,000 as a married couple, you could be taxed as much as 50% of your Social Security benefits. If your single income goes past $34,000 and married income goes past $44,000, you could be taxed on up to 85% of your benefits.

If you put money into a Roth IRA, withdrawals don’t count towards your provisional income. That could leave you with more money from Social Security.

A Roth IRA is flexible. The Roth IRA is the only tax-advantaged retirement savings plan that does not impose Required Minimum Distributions or RMDs. That’s because you’ve already paid taxes when funds went into the account. However, the flexibility is worth it. You can leave the money in the account for as long as you want, so savings continue to grow tax-free. You can also leave money to your heirs.

While you don’t have to put your savings into a Roth IRA, doing so throughout your career—or starting at any age—will allow you to benefit from a Roth IRA and Social Security throughout retirement.

If you would like to learn more about Social Security and retirement accounts, please visit our previous posts. 

Reference: Tuscon.com (Oct. 5, 2020) “3 Reasons a Roth IRA Is a Perfect Supplement to Social Security”

 

charitable contribution deductions from an estate

Your Estate Plan May Need an Audit

You should have an estate plan because every state has statutes that describe how your assets are managed, and who benefits if you don’t have a will. Most people want to have more say about who and how their assets are managed, so they draft estate planning documents that match their objectives. If you created an estate plan years – or even decades ago – your estate plan may need an audit.

Forbes’ recent article entitled “Auditing Your Estate Plan” says the first question is what are your estate planning objectives? Almost everyone wants to have financial security and the satisfaction of knowing how their assets will be properly managed. Therefore, these are often the most common objectives. However, some people also want to also promote the financial and personal growth of their families, provide for social and cultural objectives by giving to charity and other goals. To help you with deciding on your objectives and priorities, here are some of the most common objectives:

  • Making sure a surviving spouse or family is financially OK
  • Providing for others
  • Providing now for your children and later
  • Saving now on income taxes
  • Saving on estate and gift taxes in the future
  • Donating to charity
  • Having a trusted agency manage my assets, if I am incapacitated
  • Having money for my children’s education
  • Having retirement income; and
  • Shielding my assets from creditors.

Speak with an experienced estate planning attorney about the way in which you should handle your assets. If your plan doesn’t meet your objectives, your estate plan should be revised. This estate planning audit will include a review of your will, trusts, powers of attorney, healthcare proxies, beneficiary designation forms and real property titles.

Note that joint accounts, pay on death (POD) accounts, retirement accounts, life insurance policies, annuities and other assets will transfer to your heirs by the way you designate your beneficiaries on those accounts. Any assets in a trust won’t go through probate. “Irrevocable” trusts may protect assets from the claims of creditors and possibly long-term care costs, if properly drafted and funded.

Another question is what happens in the event you become mentally or physically incapacitated and who will see to your financial and medical affairs. Use a power of attorney to name a person to act as your agent in these situations.

If you have decided that your estate plan needs an audit and you find that your plans need to be revised, follow these steps:

  1. Work with an experienced estate planning attorney to create a plan based on your objectives
  2. Draft and execute a will and other estate planning documents customized to your plan
  3. Correctly title your assets and complete your beneficiary designations
  4. Create and fund trusts
  5. Draft and sign powers of attorney, in the event of your incapacity
  6. Draft and sign documents for ownership interest in businesses, intellectual property, artwork and real estate
  7. Discuss the consequences of implementing your plan with an experienced estate planning attorney; and
  8. Review your plan regularly.

To learn more about estate planning documents such as a trust or will, please visit our previous posts.

Reference: Forbes (Sep. 23, 2020) “Auditing Your Estate Plan”

 

charitable contribution deductions from an estate

How 401(K) Beneficiaries Work

For anyone who thinks that their will or trust can be used to distribute assets in a 401(k) after they pass, think again. It is important to understand how 401(k) beneficiaries work with your estate plan. The beneficiaries listed in a 401(k), insurance policy or any account with the option to name a beneficiary supersede whatever directions are placed in a will or a trust. If you’re not careful, warns the article “What You Should Know About 401(k) Beneficiaries” from The Motley Fool, your assets could end up in the wrong hands.

Here are some basics about beneficiaries that you need to know.

After you die, your estate goes through probate, which can be a costly and lengthy process. However, assets like 401(k) plans that have named beneficiaries are typically passed to heirs outside of probate. The asset goes directly to the beneficiary.

When you opened a 401(k), you were almost certainly directed to name a beneficiary in the paperwork used to establish the account. That person is usually a spouse, child or a domestic partner.  The beneficiary is sometimes a trust (a legal entity that manages assets for the benefit of beneficiaries).

If no beneficiary was named and you were married when you established the account, most 401(k) plans designate your spouse as the default beneficiary. The surviving spouse is allowed to treat the account as if it is their own when they inherit it—they can delay withdrawing money until they are 72, when the IRS requires withdrawals to begin. The surviving spouse uses their own life expectancy, when calculating future withdrawals.

If someone other than a spouse was listed as the beneficiary, the assets are to be transferred into an inherited 401(k) and the amounts received are based on the percentage listed on the beneficiary designation form. Most plans give the beneficiaries the option to roll over an inherited 401(k) into an inherited IRA. This gives the account owners greater control over what they can do with their inheritance.

Once you have named a beneficiary on these accounts, it’s wise to list contingent beneficiaries, who will inherit the accounts, if the primary beneficiary is deceased. For most families, the children are the contingent beneficiaries and the spouse is the primary beneficiary.

The list of mistakes made when naming beneficiaries is a long one, but here are a few:

  • Setting up a trust to keep IRA or 401(k) assets from going to a minor or to protect services for a special needs child, then failing to list the trust as a beneficiary.
  • Not naming anyone as a beneficiary on an IRA or 401(k) plan.
  • Neglecting to check beneficiary names every few years or after big life changes.

If you set up a trust for your beneficiaries, you must list the trust as the beneficiary. If you don’t specifically list the trust, the account will pass to any person listed as a beneficiary, or the accounts will go through probate.

If you have had more than a few jobs and have more than a few 401(k) accounts, it can be challenging to track the accounts and the beneficiaries. Consolidating the accounts into one 401(k) account makes it easier for you and for your heirs.

If you do list a trust as a beneficiary, talk with your estate planning attorney about how to do this correctly. The trust’s language must take into consideration how taxes will be handled. This could have big costs for your heirs.

If you would like to learn more about beneficiaries, please visit our previous posts. 

Reference: The Motley Fool (Aug. 24, 2020) “What You Should Know About 401(k) Beneficiaries”

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What is an Eligible Designated Beneficiary?

What is an eligible designated beneficiary? An eligible designated beneficiary (EDB) is a person included in a unique classification of retirement account beneficiaries. A person may be classified as an EDB, if they are classified as fitting into one of five categories of individuals identified in the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The bill passed in December 2019 and is effective for all inherited retirement accounts, as of the first of this year.

Investopedia’s recent article explains that these people get special treatment and greater flexibility to withdraw funds from their inherited accounts than other beneficiaries.

With the SECURE Act, there are now three types of beneficiaries. It is based on the individual’s connection to the original account owner, the beneficiary’s age, and his or her status as either an individual or a non-person entity. However, an EDB is always an individual. On the other hand, an EDB can’t be a trust, an estate, or a charity, which are considered not designated beneficiaries. There are five categories of individuals included in the EDB classification. These are detailed below.

In most instances, except for the exceptions below, an EDB must withdraw the balance from the inherited IRA account over the beneficiary’s life expectancy. There is optional special treatment allowed only for surviving spouses, which is explained below. When a minor child reaches the age of majority, he or she is no longer considered to be an EDB, and the 10-year rule concerning withdrawal requirements for a designated beneficiary applies.

Here are the five categories of eligible designated beneficiaries.

Owner’s surviving spouse. Surviving spouses get special treatment, which lets them step into the shoes of the owner and withdraw the balance from the IRA over the original owner’s life expectancy. As another option, they can roll an inherited IRA into their own IRA and take withdrawals at the point when they’d normally take their own required minimum distributions (RMDs).

Owner’s minor child. A child who isn’t yet 18 can make withdrawals from an inherited retirement account using their own life expectancy. However, when he or she turns 18, the 10-year rule for designated beneficiaries (who aren’t EDBs) applies. At that point, the child would have until December 31 of the 10th year after their 18th birthday to withdraw all funds from the inherited retirement account. A deceased retirement account owner’s minor child can get an extension, up until age 26, for the start of the 10-year rule, if he or she is pursuing a specified course of education.

An individual who is disabled. The tax code says that an individual is considered to be disabled if he or she is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long continued and indefinite duration.” A disabled person who inherits a retirement account can use their own life expectancy to calculate RMDs.

An individual who is chronically ill. The tax code states that “the term ‘chronically ill individual’ means any individual who has been certified by a licensed healthcare practitioner as—

  • being unable to perform (without substantial assistance from another individual) at least two activities of daily living for a period of at least 90 days, due to a loss of functional capacity,
  • having a level of disability similar (as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services) to the level of disability described in clause (i), or
  • requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.”

A chronically ill individual who inherits a retirement account can use their own life expectancy to determine the RMDs.

Any other person who’s less than 10 years younger than the decedent. This is a catch-all that includes certain friends and siblings (depending on age), who are identified as beneficiaries of a retirement account. This also excludes most adult children (who aren’t disabled or chronically ill) from the five categories of eligible designated beneficiaries. A person in this category who inherits a retirement account is permitted to use their own life expectancy to calculate RMDs.

Reference: Investopedia (June 25, 2020) “There is a New Type of Beneficiary”

 

charitable contribution deductions from an estate

Selecting a Beneficiary for My 401(k)

What is the best way to select a beneficiary for your 401(k)?  WTOP’s article “How to pick a beneficiary for your 401(k) plan” instructs us on how to make certain your 401(k) savings get to your intended heir.

  1. Name a Beneficiary. Designating a beneficiary of your retirement account lets that person receive your financial bequest without the need to access to your will, financial documents, or go through probate. In designating a beneficiary, carefully think about who that will be, just as you would for any other asset you intend to leave to your heirs.
  2. Name Contingent Beneficiaries. A contingent beneficiary will get the assets from the account in the event that all of the primary beneficiaries have died. Review your beneficiary designations at least annually to ensure each beneficiary, and their assigned percentage, is still appropriate.
  3. Update Your Named Beneficiaries After Significant Life Events. When you begin a job in your 20s, you might list your parents or siblings as the beneficiary of your account. However, when you marry, you may change your beneficiary to your spouse. If you want to leave your retirement account balance to your children, you must update your beneficiary form upon the birth of each child, or you might leave the youngest out, if you die unexpectedly.

Divorce or remarriage is another reason to change your beneficiary forms. If you remarry and do not select a new beneficiary, your ex-spouse may get your remaining retirement assets.

Note that beneficiary forms are unique to each 401(k) plan. This means that if you have multiple 401(k) accounts with previous employers, you’ll have to update each one.

You can also consider combining old 401(k) accounts or rolling them over into an IRA to make your beneficiary designations and investments easier to manage.

Many 401(k) plans let you update your beneficiaries online.

  1. Inform Your Beneficiaries About Your Accounts. Your heirs may be required to get in touch with the financial institution to get their inheritance. Tell them where you have accounts, so they know what to expect and can claim your unused retirement funds. Be certain that everyone has the information. That way, there’s no question and access to those funds will be easy.

Reference: WTOP (June 8, 2020) “How to pick a beneficiary for your 401(k) plan”