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Category: SECURE Act

estate planning for a second marriage

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”

 

estate planning for a second marriage

Inherited IRAs Require Care

For those who inherit IRAs, the intersection of taxes, estate law and financial planning can be a tricky place. There are many choices, maybe too many, and making the wrong choice can be costly, according to the recent article “6 inherited IRA rules all beneficiaries must know” from Bankrate. This is why inherited IRAs require care.

There are two categories of beneficiaries. Surviving spouses, minor children, chronically ill or disabled individuals, or someone who is not less than 10 years younger than the original owner are subject to one set of rules. Everyone else has another set of rules.

You’ll need to know if the original owner had taken any RMDs—required minimum distributions—before they passed.

Did you want to minimize taxes, or is it more important for you to maximize cash distribution?

These are just a few of the issues to be addressed. Already complicated, inherited IRAs got even more complicated because of the SECURE Act, which changed some longstanding practices. Some experts tell beneficiaries not to do anything, until they meet with an estate planning attorney. The worst thing someone could do is make a wrong step and lose half of the IRA to taxes.

Here are the six rules for the careful handling of inherited IRAs:

1–Spouses have the most flexibility. The surviving spouse may treat the IRA as her own, naming herself as the owner. She can also roll it over into another account, such as another IRA or a qualified employer plan (including 403(b) plans). She could also treat herself as the beneficiary of the plan. However, each choice leads to further choices and decisions. She might let the IRA grow in the account until she reaches age 72, the new age for RMDs. Or she can roll the IRA into an IRA of her own, which lets her then name her own beneficiary.

2—When do you want to take the money? If you fall into the category of surviving spouses, minor children, chronically ill or disabled individuals, or someone who is not less than ten years younger than the original owner, then you can take the distributions over your own life expectancy. That’s the “stretch” option. Otherwise, you need to take distributions from the account over ten years, according to the SECURE Act. Depending on the size of the IRA, that could be a nasty tax bill. You can take as little or as much as you want, but by year ten after the owner’s death, the account must be empty.

3—Know about year of death required distributions. If the owner of the IRA did not take his RMD in the year of his death, beneficiaries are required to do so. If a parent dies in early January, for example, it’s not likely he took his RMD. The IRS doesn’t care if you didn’t know—you’ll be liable for a penalty of 50% of the amount that wasn’t taken out. If someone dies close to the end of the year, it’s possible that heirs might not know about the accounts until after the deadline has passed. If the deceased was not yet 70½, there is no-year-of-death distribution.

4—Get all the breaks you can—tax breaks. For estates subject to the estate tax, IRA beneficiaries will get an income-tax deduction for estate taxes paid on the account. The taxable income earned but not received by the deceased is called “income in respect of a decedent.” When someone takes a distribution from an IRA, it’s treated as taxable income. However, the decedent’s estate is paying a federal estate tax, so beneficiaries get an income-tax deduction for estate taxes paid on the inherited IRA. For a $1 million income in an inherited IRA, there could be a $350,000 deduction offset against that.

5—Beneficiary forms matter. An entire estate plan can be undone by a missing beneficiary form, or one that is not filled out correctly or is ambiguous. If there is no designated beneficiary form and the account goes to the estate, the beneficiary will need to take the distribution from the IRA in five years. Forms that aren’t updated, are missing, or don’t clearly identify the individuals create all kinds of expensive headaches.

6—Improperly drafted trusts are trouble. If they are done wrong, a trust can limit beneficiary options in a big way. If the provisions in the trust are not properly drafted, some custodians won’t be able to see through the trust to determine the qualified beneficiaries. Any ability to maximize the time to take money out of an IRA could be lost. An experienced estate planning attorney who knows the rules about inherited IRAs and trusts is a must.

Reference: Bankrate (July 17, 2020) “6 inherited IRA rules all beneficiaries must know”

 

estate planning for a second marriage

Utilizing the SECURE and CARES Acts?

Are you utilizing the SECURE and CARES Acts in the best way possible? The SECURE Act made a number of changes to IRAs, effective January 1, 2020. It was followed by the CARES Act, effective March 27, 2020, which brought even more changes. A recent article from the Milwaukee Business Journal, titled “IRA planning tips for changes associated with the SECURE and CARES acts,” explains what account owners need to know.

Setting Every Community Up for Retirement (SECURE) Act

The age when you have to take your RMD increased from 70½ to 72, if you turned 70½ on or before December 31, 2019. Younger than 70½ before 2020? You still must take your RMDs. But, if you can, consider deferring any distributions from your RMD, until you must. This gives your IRA a chance to rebound, rather than locking in any losses from the current market.

Beneficiary rules changed. The “stretch” feature of the IRA was eliminated. Any non-spousal beneficiary of an IRA owner who dies after Dec. 31, 2019, must take the entire amount of the IRA within 10 years after the date of death. The exceptions are those who fall into the “Eligible Designated Beneficiary” category. That includes the surviving spouse, a child under age 18, a disabled or chronically ill beneficiary, or a beneficiary who is not more than ten years younger than the IRA owner. The Eligible Designated Beneficiary can take distributions over their life expectancy, starting in the year after the death of the IRA holder. If your estate plan intended any IRA to be paid to a trust, the trust may include a “conduit IRA” provision. This may not work under the new rules. Talk with your estate planning attorney.

IRA contributions can be made at any age, as long as there is earned income. If you have earned income and are 70 or 71, consider continuing to contribute to a Roth IRA. These assets grow tax free and qualified withdrawals are also tax free. If you plan on making Qualified Charitable Distributions (QCD), you’ll be able to use that contribution (up to $100,000 per year) from the IRA to offset any RMDs for the year and not be treated as a taxable distribution.

Coronavirus Aid, Relief and Economic Security (CARES) Act

The deadline for contributions for traditional or Roth IRAs this year is July 15, 2020. The 2019 limit is $6,000 if you are younger than 50 and $7,000 if you are 50 and older.

RMDs have been waived for 2020. This applies to life expectancy payments. It may be possible to “undo” an RMD, if it meets these qualifications:

  • The RMD must have been taken between February 1—May 15 and must be recontributed or rolled over prior to July 15.
  • RMDs taken in January or after May 15 are not eligible.
  • Only one rollover per person is permitted within the last 12 months.
  • Life expectancy payments may not be rolled over.

Individuals impacted by coronavirus may be permitted to take out $100,000 from an IRA with no penalties. They are eligible if they have:

  • Been diagnosed with SARS-Cov-2 or COVID-19
  • A spouse or dependent has been diagnosed
  • Have experienced adverse consequences as a result of being quarantined, furloughed or laid off or having work hours reduced due to the virus, are unable to work because of a lack of child care, closed or reduced hours of a business owned or operated by the individual or due to other factors, as determined by the Secretary of the Treasury.
  • Note that these distributions are still taxable, but the income taxes can be spread ratably over a three-year period and are not subject to the 10% early distribution penalty.

Keep careful records, as it is not yet known how any of these distributions/redistributions will be accounted for through tax reporting. All of these tips will allow you to utilize the SECURE and CARE Acts effectively.

Reference: Milwaukee Business Journal (June 1, 2020) “IRA planning tips for changes associated with the SECURE and CARES acts”

 

estate planning for a second marriage

How Does Planning for a Special Needs Child Work?

Funding a Special Needs Trust is just the start of the planning process for families with a family member who has special needs. Strategically planning how to fund the trust, so the parents and child’s needs are met, is as important as the creation of the SNT, says the article “Funding Strategies for Special Needs Trusts” from Advisor Perspectives. Parents need to be mindful of the stability and security of their own financial planning, which is usually challenging.

Parents should keep careful records of their expenses for their child now and project those expenses into the future. Consider what expenses may not be covered by government programs. You should also evaluate the child’s overall health, medical conditions that may require special treatment and the possibility that government resources may not be available. This will provide a clear picture of the child’s needs and how much money will be needed for the SNT.

Ultimately, how much money can be put into the SNT, depends upon the parent’s ability to fund it.

In some cases, it may not be realistic to count on a remaining portion of the parent’s estate to fund the SNT. The parents may need the funds for their own retirement or long-term care. It is possible to fund the trust during the parent’s lifetime, but many SNTs are funded after the parents pass away. Most families care for their child with special needs while they are living. The trust is for when they are gone.

The asset mix to fund the SNT for most families is a combination of retirement assets, non-retirement assets and the family home. The parents need to understand the tax implications of the assets at the time of distribution. An estate planning attorney with experience in SNTs can help with this. The SECURE Act tax law changes no longer allow inherited IRAs to be stretched based on the child’s life expectancy, but a person with a disability may be able to stretch an inherited retirement asset.

Whole or permanent life insurance that insures the parents, allows the creation of an asset on a leveraged basis that provides tax-free death proceeds.

Since the person with a disability will typically have their assets in an SNT, a trust with the correct language—“see-through”—will be able to stretch the assets, which may be more tax efficient, depending on the individual’s income needs.

Revocable SNTs become irrevocable upon the death of both parents. Irrevocable trusts are tax-paying entities and are taxed at a higher rate. Investing assets must be managed very carefully in an irrevocable trust to achieve the maximum tax efficiency.

It takes a village to plan for the secure future of a person with a disability. An experienced elder law attorney will work closely with the parents, their financial advisor and their accountant.

Reference: Advisor Perspectives (April 29, 2020) “Funding Strategies for Special Needs Trusts”