Protect Your Property &
Smart estate planning involves more than having a will, even a complex one. Faced with restrictive privacy rules in health care matters, government mandated rules on how IRA and retirement accounts and annuities must be paid to beneficiaries (and related income tax rules dealing with beneficiaries), financial concerns over nursing home costs, and other financial privacy issues, estate planning is a bit more complex than in years past. You should take into account a realistic assessment of your net worth, the timing of how retirement plans are to be paid and used, and the possible impact of your future medical and living expenses – meaning, estate planning involves not only having wills and trusts, but also includes management of your financial resources while you are still living.
The Estate Tax Component
If much of your net worth consists of retirement funds, you need to know the (1) ground rules, (2) know how IRAs are to be paid to you, (3) then paid to your spouse, and (4) then paid to your children, when you die.
Whenever you withdraw from an IRA, you will pay income tax based on what you withdraw. Income taxes must be paid on the withdrawal while you are alive. This rule applies to normal IRAs, 401ks, 403bs, etc. This rule applies to you, but also applies to your spouse, and to your children. If you own Roth IRAs, there is no income tax on whatever is withdrawn. This concept is easy to understand.
You probably didn’t realize that you cannot decide how your heirs will receive their distributions: you might have assumed you could control distributions to your spouse and your children, by building in conditions on distributions, such as, my wife shall be paid my IRAs so long as she remains unmarried, or my IRAs are to be distributed to my son Billy, but only if he graduates from college, and under no circumstances may he transfer my IRA to his wife. Unfortunately, that isn’t how the system works. The government has trumped all decision making on your part. Here’s how it works: whoever you name as death beneficiary of your IRA has the right to dictate how the funds are to be paid to them (they may take it all at once or take payments over a ten-year period). In each of these instances, the IRA becomes their property, and the beneficiary will name their own death beneficiaries. What they receive from you is known as an Inherited IRA. Spouses are given extra choices: the IRA can be rolled over to the survivor’s IRA, and no income taxes are to be paid, since nothing is taken out. A second option for the surviving spouse is to withdraw the IRA based on his or her life expectancy.
Suppose you try to avoid these payout rules by designating the Trust as a beneficiary of the IRA, and in the trust, you place a bunch of conditions for payout to your spouse and/or kids (such as denying any distribution until your kids graduate from college). Congress has thought of that loophole, and simply decreed that payments from IRAs to trusts, which is a non-qualifying beneficiary, are to be taxed at the 37% income tax bracket, should the amount received be over $12,950 in any given year. Your state will also tax the distribution (e.g., 5%), so the income tax on the trust is 42%.
So, what can you do? Not much. It is better to name human beings (or charities) as death beneficiaries on all your retirement plans (except Roth IRAs). They will be taxed at their individual tax bracket, as they withdraw from the IRA.
As things now stand, there are no federal estate taxes for persons dying in 2021, unless their estates are with more than $11.7 MM. Most states, including Oklahoma, have abolished estate taxes. If your estate exceeds $11.7 MM, the federal estate tax is a flat 40%, and you need to visit with a CPA or estate planning lawyer, to discuss this topic further.
Most people like to control their own affairs, which is to say, they do not like the concept of probate. Probate is a court procedure, in effect in the United States, which deals with administration of your property after you die. Sometimes, the costs of probate are very expensive, and sometimes, there are many delays before your estate is distributed to your heirs.
As a means of avoiding probate, many people place property in a trust (but not their IRAs, since that is an income taxable event). A trust is simply a written agreement as to how property will be held while you are alive, and what happens to the property when you die. As Trustee of your trust, you will be in charge of all property placed in a trust until you die (or are mentally incapacitated), and as the creator of your trust, you can change the provisions of a trust with less formality than required to amend a will.
You'll undoubtedly name yourself as trustee of your own trust, but you'll also have to choose one or more successor trustees to handle affairs if you can't.
You may want to name your spouse as successor trustee, if he or she has a good head for business, good. But you'll still need someone else to assume the office of trustee, if you and your spouse both die in a common disaster or accident. The first consideration for selecting a successor trustee is, obviously, the person must be trustworthy, whether the person is a family member, close friend, or professional, such as your accountant, perhaps your lawyer, or even your bank's trust department.
If you'd like to name a relative as successor trustee, but sense there may be too much pressure and quarreling within your family, it's probably a good idea to name an institution or a professional to handle the job. Keep in mind, however, that there is no such thing as a perfect successor trustee, even your bank's trust department.
As a safeguard, the trust should contain a provision that allows you to remove any successor trustee, for whatever reason, and you can name another, when circumstances dictate. Some trusts name a protector, who can fire the trustee you name -- then name another trustee.
After the trust is signed, you should fund it by changing title to property you own to the trust (so the trustees of the trust will own your property. You need professional counseling and help accomplishing this very important task.