I have written this article for information purposes, and I hope you learn something from it. Though I would like to state it is current and up to date, in all candor, I can't. In most cases, the concepts are relatively accurate (except for obviously old and dated materials, primarily related to taxes). You should confer with your own lawyer about issues that affect you and your family.

 

 

MORE TIPS IN ESTATE PLANNING

 

In the best of all worlds, all property placed in trust would be free from creditors' claims, free from all estate and income taxes, force the government to pay for nursing home costs without any contribution on your part, and never violate governent rules. Though we don't live in such a world, progress is being made which accomplishes some of those goals.

 

There are ground rules you should know about:

 

First, estate taxes (death taxes), will not interfere with the transmissing your wealth to your beneficiaries, unless your estate is worth more than $11.18 MM (this doubles for a married couple). Once a couple's wealth tops $22.236 MM, the estate tax rate is a flat 40%. If your net worth is at that level, please talk to a CPA or tax lawyer.

 

Second, there is no income tax on property which is being given to your heirs, unless the property consists of "qualified property" (IRAs, 401k, 403b, and annuities; Roth IRAs generally are not taxable to the beneficiaries). Qualified property is not part of your trust -- unless you want to pay income tax on whatever might be in your IRA (the administrator of your IRA will send you a 1099-R if you attempt to transfer the IRA to your trust -- such tranfers are "taxable events", and you pay income tax whenever you take money out of your IRA, and place it in your trust -- this includes an assignment of your IRA to your trust).

 

Third, homestead property is free from creditor's claims (including claims by the trustee in bankruptcy, and to some extent, claims by the IRS). Homesteads generally protect your home (or at least part of it), your clothes and car and tools of your trade, but the homestead depends on where you live (each state makes its own homestead laws). If you are fortunate enough to live in Oklahoma (which is my home), homesteads include interest in life insurance products and annuities (36 O.S. Section 3631.1, 3632). Oklahoma has an added homestead benefit, which works for married couples who create family wealth preservation trusts for one another (all property placed in a trust of this kind is a homestead asset, free from creditors' claims, but there are special rules which deter most people from creating such a trust -- this topic is covered in another article on this website).

 

Qualified money. My clients are usually surprised to learn they cannot change how IRA distributions are made to their beneficiaries. The government makes the rules, not you. Spouses can inherit an IRA and roll the benefit over to a spousal IRA, and this is not a taxable event. In such a case, the spouse will take ordinary distribution, explained later in the article. Children and all other classes of beneficiaries receive benefits, under the inherited IRA rules. The mechanics of how this works is explained in the next paragraph. If you name your trust as being an IRA beneficiary, the tax may wind up paying up to 37% of the value of the IRA, before making distribution to the trust beneficiaries (plus 5% income tax in Oklahoma, and whatever tax rate applies in the state where you live). In Oklahoma, if a trust is the beneficiary of your IRA, the trust will pay 37% (plus 5% Oklahoma income tax), if the IRA amount paid out is more than $12,700 . If your IRA is worth say $500,000, the trust will pay income taxes of about $220,000, before your heirs receive anything.

 

To avoid this, people generally name human beings (e.g. their children) as beneficiaries. In such a case, your child chooses how he or she wants to be paid: the child can take all of the money (100%) at death (which might place the child in a higher individual tax bracket, since the child will pay the tax); the child can elect to take the entire amount, but be paid over 5 years (the child gets to chose the payout amount, and will pay income tax based on his or her tax bracket); or the child can take elect to paid based on a life expectancy table devised by the government: Here's the government life expectancy table, and here's how it works:

 

SINGLE LIFE TABLE (for use by beneficiaries)

Age

Life Expectancy

Age

Life Expectancy

Age

Life Expectancy

Age

Life Expectancy

0

82.4

28

55.3

56

28.7

84

8.1

1

81.6

29

54.3

57

27.9

85

7.6

2

80.6

30

53.3

58

27.0

86

7.1

3

79.7

31

52.4

59

26.1

87

6.7

4

78.7

32

51.4

60

25.2

88

6.3

5

77.7

33

50.4

61

24.4

89

5.9

6

76.7

34

49.4

62

23.5

90

5.5

7

75.8

35

48.8

63

22.7

91

5.2

8

74.8

36

47.5

64

21.8

92

4.9

9

73.8

37

46.5

65

21.0

93

4.6

10

72.8

38

45.6

66

20.2

94

4.3

11

71.8

39

44.6

67

19.4

95

4.1

12

70.8

40

43.6

68

18.6

96

3.8

13

69.9

41

42.7

69

17.8

97

3.6

14

68.9

42

41.7

70

17.0

98

3.4

15

67.9

43

40.7

71

16.3

99

3.1

16

66.9

44

39.8

72

15.5

100

2.9

17

66.0

45

38.8

73

14.8

101

2.7

18

65.0

46

37.9

74

14.1

102

2.5

19

64.0

47

37.0

75

13.4

103

2.3

20

63.0

48

36.0

76

12.7

104

2.1

21

62.1

49

35.1

77

12.1

105

1.9

22

61.1

50

34.2

78

11.4

106

1.7

23

60.1

51

33.3

79

10.8

107

1.5

24

59.1

52

32.3

80

10.2

108

1.4

25

58.2

53

31.4

81

9.7

109

1.2

26

57.2

54

30.5

82

9.1

110

1.1

27

56.2

55

29.6

83

8.6

111 +

1.0

 

Suppose you name your child as beneficiary of your IRA, and at your death, your child is 55 years old. The child will use the above table, and as you can see, the life expectancy factor for age 55 is 29.6. If the child inherits $500,000, simply divide $500,000 by 29.6, and the distribution that year will be $16,891, which will be taxed at the child's income tax bracket (which hopefully is less than 37%). The next year, the child will be 56, so the distribution factor will equal 28.7, and each year thereafter, the factor will be different.

 

So how can you control distribution of your IRA? You can't, because the government has trumped your estate plan. There are, to my knowledge, only two brokerage firms, who have been issued private letter rulings from the IRS, which permit structured settlements for beneficiaries -- meaning, you can control payout to a rebellious child through a structured settlement, if the IRS has pre-approved the plan with a private letter ruling.

 

Some financial advisors will tell you they have access to companies (insurance companies), which permit structured settlements. Problem is, the insurance companies cannot guaranty results (they do not have private letter rulings from the IRS).

 

So what if you name a trust as the beneficiary of your IRA? Does this automatically mean the trust will pay the 37% tax, plus applicable state income taxes, and the remaining amount goes to the trust beneficiaries? Not always -- much depends on the IRA plan administrator, and what options they give your trustee.

 

First consider the worst case scenario. The next table gives the tax rates applicable for trusts (there are lower rate tax tables for single and married people, but a trust is not regarded as being a human being) -- if an IRA is distributed to the trust, because you named the beneficiary of the IRA as your trust, the applicable trust rates are based on the amounts distributed to the trustee, and here they are:

 

2019 INCOME TAX RATE SCHEDULES (ESTATES AND NONGRANTOR TRUSTS)

Taxable Income

 

 

 

Over

But Not Over

Pay

+ % on Excess

Of the amount over

$0

$2,600

$0

10%

$0

2,600

9,300

260.00

24

2,600

9,300

12,750

1868.00

35

9,300

12,750

...

3,075.50

37

12,750

 

To avoid these higher tax rates, there are alternatives for the trustee, which permit him or her to bypass these higher tax rates -- though there is additional paperwork to complete. By following these extra steps, the trustee can distribute the beneficial interest directly to the beneficiary, who will then be taxed at the beneficiary's income tax rate (which should be less that the rates used in the above tax table); by doing this, the trust will become nothing more than a conduit for distribution.

 

The plan administrator for the IRA will then deal directly with the residual beneficiary instead of the trustee. The beneficiary will receive the same choices mentioned earlier in the article, and receive either 5 year payouts, 100% payout, or payout based on the beneficiary's life expectancy.

 

In such cases, financial advisors call such trusts as being "look through" trusts, and a lawyer will probably be called upon to opine the following conditions have been met:

 

1) The Trust must be a valid trust under state law.

 

2) The Trust must be irrevocable upon death of the account owner or contains language to the effect it becomes irrevocable upon the death of the IRA owner.

 

3) Individual beneficiaries of the trust must be identifiable from the trust document.

 

4) Required trust documentation must have been provided to the IRA custodian or administrator no later than October 31 of the year following the IRA owner's death. The trustee is responsible for providing this trust documentation to the IRA custodian.

 

There are additional technical rules, and I suggest you contact a lawyer or CPA or financial advisor, in such instances.

 

Bottom line: be prepared to plan around who becomes the beneficiary of IRAs. This can be done, through a trust, but your lawyer must know what he or she is doing.

 

Homestead property. Whatever you currently own will either fall in the category of being homestead property, meaning, not subject to creditors' claims, or the property will be subject to creditors' claims (similar to the concept of piercing the corporate veil -- the property owned by a trust falls in this category, unless the trust is irrevocable, and this technique doesn't always work -- trusts may be "pierced" or may be unenforceable, depending on circumstances leading up to the trust creation, including spendthrift trusts for your own benefit. 60 O.S. Section 175.25H).

 

As an example of owning homestead property, let's look at doctors. Physicians windup in court more than most, but the claimants cannot strip the physician of his or her homestead property .

 

Logic suggests that if you own property of any kind, it is better to have the property classified as being classified as homestead property. Let's illustrate this: you have $100,000 in cash, which is in a bank account. Is this homestead property? In Oklahoma, we would examine Title 31, the Homestead Laws, and discover that bank accounts are not classified as being homestead assets. So the next question is, how do we turn the $100,000 into a homestead asset?

 

You could buy an annuity, which is, under 36 O.S. Section 3631.1, 3632, a homestead asset. Thus, presto chango, a homestead asset.

 

Far be it from me to suggest you do this, because you will probably discover than when you invest in almost any type of annuity, you can't withdraw the funds as you need them. You have to live under the rules of the annuity, which in most instances, requires you to keep the investment in place for 9 years. You can normally withdraw about 10% a year, but you will forfeit certain other rights (such as, interest income), if you make an early withdrawal.

 

Without listing all of your options to convert property into a homestead asset, let me mention this: qualified properties (IRAs, 401ks, and the like) are homestead assets in Oklahoma (and also under federal law). You can''t buy an IRA, however, from ordinary property, such as a bank account. You must use wage (earned income) to qualify, and there are limitations on what you can contribute (study a bit on your own, on the IRA rules on yearly contributions). The tax and court systems favor saving towards retirement nest eggs, but as I described earlier, there are withdrawal issues which affect you and your heirs. To add to these income tax woes, the homestead benefits of retirement programs are available only for the wage-earner, not his or her children. Once the IRA owner dies, the homestead protection over the IRA is lost for the beneficiary. (Clark v. Rameker, 134 S.Ct. 2242 (2014).)

 

To bring this article to a close, let me explain how the required minimum distribution (RMD) is calculated for you, and your spouse if you die before him or her. There is some logic to these rules, when you take into account the two-fold benefits of investing in an IRA: first, you will enjoy an income tax deduction, for the year you invest in the IRA. Second, you can control, more or less, the investments placed in the IRA, but more importantly, you pay no taxes for growth, trades, sales, or other things that are otherwise subject to the income taxes (this is a key point, because I can be a day-trader within my IRA, and have no extra tax forms to file, since gains and losses are not taxed). Income taxes are only paid when I withdraw from the IRA. The government does not want you to keep your investments forever, and requires you to make withdrawals.

 

The two dates to remember are these: once I attain age 59, I am not penalized for any future IRA withdrawal I might make (before that age, I must pay penalties for early withdrawals -- there are exceptions to this rule, found in IRC Section 72(t), but these are limited exceptions). Second date: age 70 1/2, when I must begin making withdrawals (the minimum amount is called Required Minimum Distribution, or RMD). My life expectancy has been determined by the IRS (the table is different for the one dealing with an inherited IRA), and here it is:

 

UNIFORM LIFETIME TABLE

Age of Employee

Distribution Period

 

Age of Employee

Distribution Period

70

27.4

 

93

9.6

71

26.5

 

94

9.1

72

25.6

 

95

8.6

73

24.7

 

96

8.1

74

23.8

 

97

7.6

75

22.9

 

98

7.1

76

22.0

 

99

6.7

77

21.2

 

100

6.3

78

20.3

 

101

5.9

79

19.5

 

102

5.5

80

18.7

 

103

5.2

81

17.9

 

104

4.9

82

17.1

 

105

4.5

83

16.3

 

106

4.2

84

15.5

 

107

3.9

85

14.8

 

108

3.7

86

14.1

 

109

3.4

87

13.4

 

110

3.1

88

12.7

 

111

2.9

89

12.0

 

112

2.6

90

11.4

 

113

2.4

91

10.8

 

114

2.1

92

10.2

 

115+

1.9

 

When you reach age 70 1/2 you would use this table, and determine the factor (your life expectancy), which is 27.4. Take the total value of your IRA (using the IRA value on January 1st), and divide 27.4 into that value. The resulting number is your required minimum distribution for that year. At age 71, the factor is 26.5, so divide this number (represents your life expectancy) into the IRA value on January 1st, and that is your RMD for that year.

 

The other topics of interest, dealing with nursing home costs and investments, are addressed in other articles on this website. I hope this article is helpful.

 

 

©2019 James H. Beauchamp

 

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