What’s the Best Thing to Do with an Inherited Investment?

Wealth Advisor’s recent article entitled “How to Handle Inherited Investments” provides us with some of the top inheritance considerations:

Consider Cash. Besides cash, the most common inheritances are securities, real estate and art. These assets usually go up in value, but another big benefit is their favorable tax treatment. The heirs won’t pay capital gains on unsold investments that went up in value during the lifetime of the deceased (estate taxes would apply). Those taxes would only apply to the gains that happened after they took possession.  There’s a good reason to hang onto these investments. These types of property carry some risks, so you may consider putting some of your inherited investments into cash, cash equivalents, or life insurance with a guaranteed payout to avoid exposure to undue risk.

Beware of Concentration Risk. It’s not unusual for an inheritance to be heavily concentrated within a specific asset. While the deceased’s instincts may have been accurate at the time of their initial investment, there’s no guarantee that their strategy will continue to pay dividends long term.  Diversifying into other areas—even with high-volatility vehicles that are unrelated to the original inherited investment—can lessen that concentration risk. An even safer strategy would be to build a portfolio of diverse holdings that includes multiple asset classes across different sectors.

Learn about Trusts. Sometimes when people inherit assets through a trust, they don’t think it’s critical to require anything but a superficial understanding of how these work. This is because the trustee assumes nearly all the fiduciary duties. However, this could change when a beneficiary attains a certain age, which often triggers a dissolution of the trust or stipulates a transfer of trustee responsibilities to them. You should understand what will happen at that point. You may want to create your own trust to distribute part or all of your unmanaged inherited assets to heirs in a framework that suits you best, and without having to go through the probate process. In any event, you should learn how trusts work and the difference between revocable and irrevocable trusts. Ask your estate planning attorney about your specific situation and whether there is a trust that may be best for your circumstances.

Reference: Wealth Advisor (Jan. 7, 2020) “How to Handle Inherited Investments”

Some Estate Planning Actions for 2020

Many of us set New Year’s resolutions to improve our quality of life. While it’s often a goal to exercise more or eat more healthily, you can also resolve to improve your financial well-being. It’s a great time to review your estate plan to make sure your legacy is protected.

The Tennessean’s recent article entitled “Five estate-planning steps to take in the new year” gives us some common updates for your estate planning.

Schedule a meeting with your estate planning attorney to discuss your situation and to help the attorney create your estate plan.

You should also regularly review and update all your estate planning documents.

Goals and priorities change, so review your estate documents annually to make certain that your plan continues to reflect your present circumstances and intent. You may have changes to family or friendship dynamics or a change in assets that may impact your estate plan. It could be a divorce or remarriage; a family member or a loved one with a disability diagnosis, mental illness, or addiction; a move to a new state; or a change in a family business. If there’s a change in your circumstances, get in touch with your estate planning attorney to update your documents as soon as possible.

Federal and state tax and estate laws change, so ask your attorney to look at your estate planning documents every few years in light of any new legislation.

Review retirement, investment, and trust accounts to make certain that they achieve your long-term financial goals.

A frequent estate planning error is forgetting to update the beneficiary designations on your retirement and investment accounts. Thoroughly review your accounts every year to ensure everything is up to snuff in your estate plan.

Communicate your intent to your heirs, who may include family, friends, and charities. It is important to engage in a frank discussion with your heirs about your legacy and estate plan. Because this can be an emotional conversation, begin with the basics.

Having this type of conversation now, can prevent conflict and hard feelings later.

Reference: Tennessean (Jan. 3, 2020) “Five estate-planning steps to take in the new year”

How Will the New SECURE Act Impact My IRAs and 401(k)?

The SECURE Act is the most substantial change to our retirement savings system in over a decade, says Covering Katy (TX) News’ recent article entitled “Laws Change for IRA and 401K Retirement Savings Plans.” The new law, called the Setting Every Community Up for Retirement Enhancement (SECURE) Act, includes several important changes. Let’s take a look at them.

There is a higher age for RMDs. The current law says that you must start taking withdrawals or required minimum distributions from your traditional IRA and 401(k) or similar employer-sponsored plan when you turn 70½. The new law delays this to age 72, so you can hold on to your retirement savings a while longer.

No age limit for contributions to traditional IRAs. Before the new law, you could only contribute to your traditional IRA until you were 70½. However, now you can now fund your traditional IRA for as long as you have taxable earned income.

Stretch IRA Limitations. Previously, beneficiaries could stretch taxable RMDs from a retirement account over his or her lifetime. Under the SECURE Act, spouse beneficiaries can still take advantage of this “stretch” distribution, but most non-spouse beneficiaries will have to take all the RMDs by the end of the 10th year after the account owner dies. Therefore, non-spouse beneficiaries who inherit an IRA or other retirement plan could have tax issues, because of the need to take larger distributions in a shorter amount of time.

Early withdrawal penalty eliminated for IRAs and 401(k)s when new child arrives. Usually, you must pay a 10% penalty when you withdraw funds from your IRA or 401(k) if done prior to 59½. However, the new legislation allows you take out up to $5,000 from your retirement plan without paying the early withdrawal penalty, provided you withdraw the money within a year of a child being born or an adoption becoming final.

There are provisions of the SECURE Act that primarily impact business owners, which include the following:

New multi-employer retirement plans. The new law allows unrelated companies to coordinate to offer employees a 401(k) plan with less administrative work, lower costs and fewer fiduciary responsibilities than individual employers now have when offering their own retirement plans.

Tax credit for automatic enrollment. There’s now a tax credit of $500 for some small businesses that create automatic enrollment in their retirement plans. A tax credit for establishing a retirement plan has also been increased from $500 to $5,000.

Annuities in 401(k) plans. The Act makes it easier for employers to add annuities as an investment option within 401(k) plans. Before the SECURE Act, businesses avoided annuities in these plans because of the liability related to the annuity provider. However, the new rules should help decrease any concerns.

Talk to an experienced estate planning attorney to examine the potential impact on your investment strategies and determine any possible tax and estate planning implications of the SECURE Act.

Reference: Covering Katy (TX) News “Laws Change for IRA and 401K Retirement Savings Plans”

How Can Life Insurance Help My Estate Plan?

In the 1990s, it wasn’t unusual for people to buy second-to-die life insurance policies to help pay federal estate taxes. However, in 2019, with estate tax exclusions up to $11,400,000 (and rising with the cost-of-living adjustments), fewer people would owe much for estate taxes.

However, IRAs, 401(k)s, and other accounts are still 100% taxable to the individuals, spouses and their children. The stretch IRA options still exist, but they may go away, as Congress may limit stretch IRAs to a maximum of 10 years.

Forbes’ recent article, “3 Ways Life Insurance Can Help Your Estate Plan,” explains that as the IRA is giving income from the RMDs, it may also be added, after tax, to the life insurance policy. If this occurs, it’s even possible that the death benefits could grow in the future, giving a cost-of-living benefit to children. This is one way how life insurance can be used creatively to help your estate plan.

For married couples, one strategy is to consider how life insurance on one individual could be used to pay “conversion tax” at death, using tax-free benefits. When the retiree dies, the spouse beneficiary can then convert all the IRA (taxable money) to a Roth IRA, which is tax-exempt with new, lower income tax rates (37% in 2018-2025 versus 39.6% in 2017 or earlier).

This tax-free death benefit money can be used to pay the taxes on the conversion, letting the surviving beneficiary have a lifetime of tax-exempt income without RMD issues from the Roth IRA. The Social Security income could also be tax-exempt, because Roth withdrawals don’t count as “income” in the calculation to see how much of your Social Security is taxed. However, you’d have to be within the threshold for any other combined income.

Life insurance for both individuals (if married) may also be a good idea. If the spouse of the IRA owner dies, the money from the life insurance can be used once again. If this is done in the tax year of the death for married individuals, the tax conversion could be done under “married filing status” before the next year, when the individual must use single tax filing status.

Another benefit of the IRA-to-Roth conversion is the passing of Roth IRAs to heirs, which could create a lasting legacy, if planned well. New life insurance policies that add long-term care features with chronic care and critical care benefits can also provide an extra degree of benefits, if one of the insureds has health issues prior to death.

Be sure to watch the tax rates and possible changes. With today’s lower tax rates, this could be very beneficial. Remember that there are usually individual state taxes as well. However, considering all the tax-optimized benefits to spouses and beneficiaries, the long-term tax benefits outweigh the lifetime tax liabilities, especially when you also consider SSI tax benefits for the surviving spouse and no RMD issues.

Life insurance in retirement can help protect, build and transfer wealth in one of the easiest ways possible. If you’re not certain about where to start with your life insurance needs, speak with an experienced estate planning attorney.

Reference: Forbes (November 15, 2019) “3 Ways Life Insurance Can Help Your Estate Plan”

How Do I Reduce My Blended Family Fighting Concerning My Estate Plan?

The IRS recently announced that in 2020, the first $11.58 million of a taxable estate is free from federal estate taxes. Therefore, a vast majority of estates won’t have to pay federal estate taxes. However, a TD Wealth survey at the 53rd Annual Heckerling Institute on Estate Planning found that family conflict was identified as the leading threat to estate planning.

Investment News’ recent article, “Reducing potential family conflicts,” explains that a blended family can result from multiple marriages, children from a current or former marriage, or children involved in multiple marriages. There are more “blended families” in the U.S. than ever before. More fighting over estate planning occurs in blended families.

The key element in any conflict resolution is open and honest communication. It’s especially the case, when it involves a blended family. In many instances, it’s best to explain a proposed estate plan to the family in advance.

If anyone objects, listen to their point of view and try to be empathetic to their position. You may wind up with a compromise, or, if no changes are made, at least the family member had an opportunity to air their grievances.

One potential solution to minimize conflicts within a blended family may be a prenuptial agreement. The agreement is signed prior to the marriage and outlines the financial rights of each spouse, in the event of a divorce or death. Prenups are particularly useful in second marriages, especially when there is a disparity in age and wealth between the parties.

However, not every married couple in a blended family has a prenuptial agreement. Even if they do, blended families can still have family conflicts in estate planning.

It is important to remember communication, reducing the chances of a will contest with a “no-contest” clause, asking your attorney about a revocable living trust and compromise.

Estate planning can be particularly difficult for blended families. Talk with an experienced estate planning attorney about the techniques that can help reduce potential family conflicts.

Reference: Investment News (December 9, 2019) “Reducing potential family conflicts”

What Should I Know about Estate and Inheritance Taxes with Property in Two States?

If you’re set to receive your full Social Security benefits next year, you may want to make sure you understand the estate and inheritances taxes of owning property, especially if it’s in more than one state.

Let’s say you own two co-ops in Manhattan and a home in New Jersey. All are all mortgage-free but you have a $69,000 home equity loan on the house. You may wonder if it’s better to continue to live in New Jersey with assets in New York or to move back to New York—or even somewhere else. This decision should be based at least in part on how your assets will be taxed, when you pass away. You also want to think about the beneficiaries of your property.

nj.com’s recent article asks, “Are estate and inheritances taxes worse in New York or New Jersey?” The article explains that estate and inheritance taxes are two different things, and it’s important to understand them.

An estate tax is levied on the estate of the decedent. An inheritance tax is paid by the beneficiary who gets the distribution from the estate. Few states have inheritances taxes. New Jersey abandoned their estate tax effective Jan. 1, 2018. However, New Jersey still has an inheritance tax. It is only applicable to non-Class A beneficiaries, which typically are heirs who are not lineal descendants. Children or grandchildren are Class A beneficiaries, so the inheritance tax would not apply to them.

There’s no inheritance tax in New York. However, the estate tax is imposed on taxable estates in excess of the state exemption. That’s $5.49 million in 2019 and will go up to $5.85 million in 2020. New York estate tax rates begin at 3.06% and increase to 16.0% for taxable estates in excess of $10.1 million.

An estate of a New York non-resident is required to file a New York State estate tax return, if the estate includes any real or tangible property in New York State and the amount of the non-resident’s federal gross estate, plus the amount of any “includable gifts,” is more than the state’s exclusion amount at the time of death. “Includable gifts” are gifts made while the decedent was a New York resident during the preceding three-year period ending on the date of death. These aren’t included in the decedent’s federal gross estate.

In the example above, it looks like New Jersey would be the better domicile in which to claim residency, because no estate or inheritance tax would be due. Depending on the value of the two co-ops in New York, he may owe New York estate tax, if the value exceeds the New York State estate exclusion amount. That’s true whether he’s a New York or New Jersey resident.

Under current New Jersey law, moving to another non-estate tax state, like Florida, won’t help him with any additional estate tax benefit. As always, talk with an estate planning attorney regarding the above specifics and to make certain that your estate plan is complete and follows your goals.

Reference: nj.com (December 4, 2019) “Are estate and inheritances taxes worse in New York or New Jersey?”

What Do I Need to Know About Owning Property with Someone Other than My Spouse?

Have you ever considered owning property jointly with a family member, friend, or a business associate? Inside Indiana Business’ recent article, “Risky: Property Owned with a Non-Spouse,” says that you should think about the negatives, such as loss of control, unknown creditor issues and tax consequences.

Loss of Control. When you choose to co-own an asset with another person, you can enter into a legal ownership agreement known as “joint tenants with rights of survivorship” or “JTWROS.” When one of the owners dies, the surviving owner automatically becomes sole owner of the property. However, you give up some control of ownership, when you own property in this way. For example, you can’t direct your portion to go to a spouse or a child after your death in your will or other estate planning documents. OK, you can, but your co-owner’s ownership title takes precedence over your estate documents. As a result, she will become the sole owner. You can also lose some control over the property, if the non-spouse co-owner transfers her interest in the property to another individual without your consent. It’s also tough to remove a co-owner from the property title without his or her full cooperation.

Creditors. Another issue with jointly held property is that it’s subject to creditors’ claims against both owners. If your brother, as a co-owner of your cabin, has financial troubles and files for bankruptcy, his ownership in the cabin could possibly be claimed by a creditor. He could also be forced to sell it to pay off his debts. So, unless you can buy out his ownership in the cabin, you may now own the property with a stranger.

Potentially Higher Taxes. Adding a non-spouse as co-owner of an asset, allows for a simple property transfer at your passing. However, it could also mean both a gift tax to you and an increased capital gain tax for your heir. By adding a non-spouse to the property title, you’re making a gift to the new joint owner. Therefore, based on the current value of the property being gifted, you could be liable for gift tax. In addition, the heir of the property may have to pay increased capital gain taxes. Property transferred at death receives a step-up in basis. This means the heir’s cost basis is equal to the fair market value of the property at your death, instead of your cost basis (the amount you paid for the property). Receiving a step-up in basis reduces the heir’s capital gain on the appreciation of the property when it’s sold. However, if you add a co-owner, only your interest in the asset has the benefit of stepped-up basis at your death, not the entire property. When the property is sold, this may mean a higher capital gain tax.

JTWROS vs. Tenants in Common. When deciding to co-own an asset with another person, you can also enter into an ownership agreement known as “tenants in common.” Here’s a key difference: holding property JTWROS with another person means that when one owner dies, the other owner receives the property outright and automatically. When owning property as tenants in common with another person, when one owner dies, the owner’s heirs receive his share in the property. A co-owner can again transfer his interest in the property without approval as the other co-owner. This loss of control may place you in a difficult position.

When considering property ownership with another party, look at the pros and cons of both JTWROS and tenants in common. The cons usually outweigh the pros. However, if owning property with a non-spouse is what you want, discuss this with a qualified estate planning attorney.

Reference: Inside Indiana Business (December 1, 2019) “Risky: Property Owned with a Non-Spouse”

What Should I Keep in Mind, When I Remarry?

Before you remarry, discuss any past financial issues with your fiancé, and plan for success, by considering some important ideas.

U.S. News & World Report’s recent article, “6 Financial Considerations for Remarriage,” lists six financial considerations and crucial steps to take before you remarry:

  1. Revise Your Budget. Whether this is your first, second, or third marriage, couples need to create a budget for daily spending, monthly expenses and big-ticket purchases. You should also talk about your household expenses and costs related to children from a prior marriage. If you have to pay alimony, let your new spouse know. It’s also a good time to talk about credit card debt, past investments you’ve made and retirement accounts. You may want to draft a prenuptial agreement.
  2. Inform your Fiancé of Any Financial Obligations, Including Child Support. Before getting married, review the laws to see how child support may be impacted by marriage to a new person. While it’s unlikely that you would lose your child support if you remarry, the family court may reduce the amount. If a person paying the child support is remarrying, they should talk to their partner prior to the marriage to make certain they understand the amount of the payments.
  3. Check Insurance and Benefits. A frequent mistake when remarrying, is not updating the beneficiaries of life insurance policies. You also may have to look at other updates to your coverage, like who will be on your health plan, and you may need to modify your homeowner’s insurance with a spouse and children in residence. Understand that if you get government benefits, like Medicaid or Social Security, you could forfeit your Medicaid eligibility when you remarry if your spouse’s income is too high to be eligible. You might also discover that your Social Security benefits from an ex-spouse will stop, after you remarry.

A second marriage may also increase a parent’s income for federal financial aid purposes for college. If a parent is the custodial parent for the FAFSA (Free Application for Federal Student Aid), their income now may include their new spouse’s income. It is important to discuss saving for college and tuition costs, as well as if either partner has children from a prior marriage, whether each spouse will save money for tuition costs.

  1. Estate Planning Is Critical. Check your estate planning before remarrying. That includes a will, medical powers of attorney, do not resuscitate orders, durable powers of attorney, designations of guardianship or consent to adoption and various trusts, including trusts for special needs children. If you have children from a prior relationship, hire a qualified estate planning attorney.
  2. Create an Inheritance Plan. If you have children from a prior relationship, you need to put the right estate planning documents in place to protect them from being disinherited. In some states, a last will and testament may be enough, but in others it may make sense to also have a revocable living trust.

The biggest mistake that couples commit when entering their second marriage, is thinking that their own children will inherit any of their estate, if they die first. Perhaps the adult children will inherit some of the estate, but you should speak to an estate attorney to create a customized strategic plan. In many instances, the living spouse will change the plan and leave everything to their children and nothing to yours.

Reference: U.S. News & World Report (November 18, 2019) “6 Financial Considerations for Remarriage”

What Can I Do with an Inherited 401(k)?

Inheriting a 401(k) at the death of the account owner isn’t always as simple as inheriting a home or a piece of jewelry. The IRS has rules that 401(k) beneficiaries must follow that say when and how much tax they’ll pay to inherit someone else’s retirement plan. If you’re currently the beneficiary of a 401(k) or you’ve recently inherited one, here are some important things you need to know.

Smart Assets’s recent article entitled “A Guide to Inheriting a 401(k)” explains that if a spouse of the account owner waives their right to inherit a 401(k) or the account owner is unmarried, they can leave their account to whomever they want at their death.

An inherited 401(k) is taxed is based on three key factors: (i) your relationship to the account owner; (ii) your age when you inherit the 401(k); and (iii) the account owner’s age when they die.

There’s also several ways to take a distribution from a 401(k) when you’ve inherited it: you can do a lump sum, periodic payments, or distributions stretched out over your life expectancy.

If you inherit a 401(k) from your spouse, what you decide to do with it and the subsequent tax impacts may be based primarily upon your age. If you’re under age 59½, you have a choice of three things:

  1. Keep the money in the plan and take distributions. You can take withdrawals from the account without the 10% early withdrawal penalty. You’d still pay regular income tax on any distributions you take. If your spouse was age 70½ or older when they passed away, you would have to take required minimum distributions from this account. There’d be no early withdrawal penalty. However, you’d pay income tax on the withdrawals. If the spouse was younger than 70½ when they died, you could wait to take RMDs until you turn 70½.
  2. Move the money to an inherited IRA. This is an IRA that’s designed to hold rollover funds from an inherited retirement plan, including 401(k)s. You can make withdrawals without any early withdrawal penalty. With this type of account, you’d need to take RMDs. However, the amount would be based on your own life expectancy, not the amount your spouse would have been required to take.
  3. Move the money to your own IRA. If you already have an IRA, you could roll an inherited 401(k) into it with no tax penalty. However, if you’re under age 59½ when you execute the rollover, the withdrawal will be treated like a regular distribution, so you’ll pay income tax on the full amount, along with the 10% early withdrawal penalty. If you’re over age 59½, you won’t pay an early withdrawal penalty with any of these options. If your spouse was taking RMDs from their 401(k) when they died, you’d have the option to continue taking them or delay taking them until you turn 70½. If you’re already 70½ or older, you’d need to take RMDs, regardless of whether you leave the money in the 401(k), transfer it to an inherited IRA or roll it over to your existing IRA.

If you inherit a 401(k) from someone other than your spouse, your options are linked to how old the account owner was when you inherited the plan and the plan’s distribution rules. If the account owner hadn’t yet turned 70½, the plan may let you spread distributions out over your lifetime or spread them out over a five-year period. If you take the five-year option, you may have to fully withdraw all of the account assets by the end of the fifth year following the account owner’s death. In either case, you’d pay income tax on the withdrawals.

You could also roll the account over to an inherited IRA, if the plan permits this. Here, the RMDs would be based on your life expectancy, assuming the account owner hadn’t started taking them yet. If they had started with their RMDs, you’re required to continue taking those distributions. However, you could base the distribution amount on your life expectancy, rather than that of the account owner.

Speak with an experienced estate planning attorney to help you determine the route that makes the most sense to reduce taxes, while planning ahead for the future.

Reference: Smart Asset (October 22, 2019) “A Guide to Inheriting a 401(k)”

What Are the Rules About an Inheritance Received During Marriage?

A good add-on to that sentence is something like, “provided that it is kept separate from marital assets.” To say it another way, when an inheritance or any other exempt asset (like a premarital asset) is “commingled” with marital assets, it can lose its exempt status.

Trust Advisor’s recent article asks, “Do I Have To Divide The Inheritance I Received During My Marriage?” As the article explains, this is the basic rule, but it’s not iron-clad.

A few courts say that an inheritance was exempt, even when it was left for only a short time in a joint account. This can happen after a parent’s death. The proceeds of a life insurance policy that an adult child beneficiary receives, are put into the family account to save time in a stressful situation. You may be too distraught to deal with this issue when the insurance check arrives, so you or your spouse might deposit it into a joint account. However, in one case, the wife took the check and opened an investment account with the money. That insurance money deposited in the investment account was never touched, but the wife still wanted half of it when the couple divorced a few years later. However, in that case, the judge ruled that the proceeds from the insurance policy were the husband’s separate property.

The law generally says that assets exempt from equitable distribution (like insurance proceeds) may become subject to equitable distribution, if the recipient intends them to become marital assets. The comingling of these assets with marital assets may make them subject to a division in a divorce. However, if there’s no intent for the assets to become martial property, the assets may remain the recipient spouse’s property.

Courts will look at “donative intent,” which asks if the spouse had the intent to gift the inheritance to the marriage, making it a marital asset. Courts may look at a commingled inheritance for donative intent, but also examine other factors. This can include the proximity in time between the inheritance and the divorce. Therefore, if a spouse deposited an inheritance into a joint account a year before the divorce, she could argue that there should be a disproportionate distribution in her favor or that she should get back the whole amount. Of course, the longer amount of time between the inheritance and the divorce, the more difficult this argument becomes.

Be sure to speak with your estate planning attorney about the specific laws in your state. If there is a hint of trouble in the marriage, it might be wiser to simply open a new account for the inheritance.

Reference: Trust Advisor (October 29, 2019) “Do I Have To Divide The Inheritance I Received During My Marriage?”

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