Life Insurance Is a Good Estate Planning Tool but Needs to Be Done Carefully

With proper planning and the help of a seasoned estate planning or probate attorney, insurance money can pay expenses, like estate tax and avoid the need to liquidate other assets, says FEDweek’s recent article entitled “Errors to Avoid in Using Life Insurance for Estate Planning.”

As an example, let’s say that Reggie passes away and leaves a large estate to his daughter Veronica. There’s a big estate tax that’s due. However, the majority of Reggie’s assets are tied up in real estate and an IRA. In light of this, Veronica might not want to proceed directly into a forced sale of the real estate. However, if she taps the inherited IRA to raise cash, she’ll be required to pay income tax on the withdrawal and forfeit a very worthwhile opportunity for extended tax deferral.

If Reggie plans ahead, he could purchase insurance on his own life. The proceeds could be used to pay the estate tax bill. As a result, Veronica can retain the real estate, while taking only minimum required distributions (RMDs) from the inherited IRA.

If the insurance policy is owned by Veronica or by a trust, the proceeds probably won’t be included in Reggie’s estate and won’t increase her estate taxes.

Along these same lines, here are some common life insurance errors to avoid:

Designating your estate as beneficiary. When you make this move, it puts the insurance policy proceeds into your estate, exposing it to estate tax and your creditors. Your executor will also have to deal with more paperwork, if your estate is the beneficiary. Instead, name the appropriate people or charities.

Designating just a single beneficiary. You should name at least two “backup” beneficiaries. This will decrease any confusion, if the primary beneficiary predeceases you.

Throwing the copy of your life insurance policy in the “file and forget” drawer. You should review your policies at least once every few years. If the beneficiary is an ex-spouse or someone who’s passed away, make the appropriate changes and get a confirmation from the insurance company in writing.

Failing to carry adequate insurance. If you have a youngster, it undoubtedly requires hundreds of thousands of dollars to pay all her expenses, such as college bills, in the event of your untimely death.

Talk to a qualified and experienced estate planning attorney about the particulars of your situation.

Reference: FEDweek (Dec. 12, 2019) “Errors to Avoid in Using Life Insurance for Estate Planning”

From Gentle Persuasion to a No-Nonsense Approach, Talking About Estate Plans

Sometimes the first attempt is a flop. Imaging this exchange: “So, do you want to talk about what happens when you die?” Answer: “Nope.” That’s what can happen, but it doesn’t have to, says The Wall Street Journal’s recent article “Readers Offer Their Advice on Talking to Aging Parents About Estate Plans.”

Many people have successfully begun this conversation with their aging parents. The gentle persuasion method is deemed to be the most successful. Treating elderly parents as adults, which they are, and asking about their fears and concerns is one way to start. Educating, not lecturing, is a respectful way to move the conversation forward.

Instead of asking a series of rapid-fire questions, provide information. One family assembled a notebook with articles about how to find an estate planning attorney, when people might need a trust, or why naming someone as power of attorney is so important.

Others begin by first talking about less important matters than bank accounts and bequests. Asking a parent for a list of utility companies with the account number, phone number and if they are paying bills online, their password, is an easy entry to thinking about next steps. Sometimes a gentle nudge, is all it takes to unlock the doors.

For some families, a more direct, less gentle approach gets the job done. That includes being willing to tell parents that not having an estate plan or not being willing to talk about their estate plan is going to lead to disaster for everyone. Warn them about taxes or remind them that the state will disburse all of their hard-earned assets, if they don’t have a plan in place.

One son tapped into his father’s strong dislike of paying taxes. He asked a tax attorney to figure out how much the family would have to pay in estate taxes, if there were no estate plan in place. It was an eye-opener, and the father became immediately receptive to sitting down with an estate planning attorney.

A daughter had tried repeatedly to get her father to speak with an estate planning attorney. His response was the same for several decades: he didn’t believe that his estate was big enough to warrant doing any kind of planning. One evening the daughter simply threw up her hands in frustration and told him, “Fine, if your favorite charity is the federal government, do nothing…but if you’d rather benefit the church or a university, do something and make your desires known.”

For months after seeing an estate attorney and putting a plan in place, he repeated the same phrase to her: “I had no idea we were worth so much.”

Between the extremes is a third option: letting someone else handle the conversation. Aging parents may be more receptive to listening to a trusted individual, who is of their same generation. One adult daughter contacted her wealthy mother’s estate planning attorney and financial advisor. The mother would not listen to the daughter, but she did listen to her estate planning attorney and her financial advisor, when they both reminded her that her estate plan had not been reviewed in years.

Reference: The Wall Street Journal (December 16, 2019) “Readers Offer Their Advice on Talking to Aging Parents About Estate 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”

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 Does Portability Mean, and How Do I Use It?

WMUR’s recent article, “Money Matters: Portability and estates,” explains that each taxpayer is typically permitted what is called an applicable exclusion amount. This is the amount of assets that, at your death, you can bequeath to others tax-free for estate tax purposes. Prior to the law change, spouses couldn’t share their exclusions. However, the Tax Cuts and Jobs Act increased this exclusion significantly. In 2019, the exclusion is $11.4 million per person.

The portion that’s not used by the deceased spouse can be transferred to the surviving spouse. The exclusion is indexed for inflation. However, this exemption level is only in effect until 2025. It will then again lower, probably to around half of its current level.

Before this tax law change, the most frequent way to maximize the exclusion was to set up a trust for each spouse—sometimes known an A/B trust. When the first spouse passes away, an amount equal to the exclusion would go to the B trust (also called a credit-shelter bypass trust).

The assets in this trust would be outside the surviving spouse’s estate and, because the exclusion was applied, were not subject to estate taxes. Anything remaining in the estate of the first to die, would be given to the survivor or could be placed in another trust. This trust is often called an A trust (or marital trust). Transfers to spouses aren’t usually subject to estate tax, so assets passing to the A marital trust would have no estate tax liability. At the surviving spouse’s death, his exclusion would be applied to the assets in the A trust. That way, both spouses would get the benefit of their exclusion.  However, this changed with the new tax law. The first spouse to die now uses the exclusion against assets in his estate. Any unused exclusion amounts can then be used by the surviving spouse with their own, at her death.

This would appear to simplify estate planning, for some, the use of two separate trusts will no longer be needed. However, remember these thoughts: (i) the unused applicable exclusion amount from an earlier marriage usually isn’t available, and you can use the amounts only from your last deceased spouse in your estate planning; (ii) these unused exclusion amounts aren’t indexed for inflation, so the property your spouse receives at your death may increase in value in the future, and its value could ultimately be greater than the unused exclusion; and (iii) to use portability, an estate tax return must be filed, so the estate executor must make an election to do so, by filing a return—even if the estate wouldn’t usually be required to do so.

Because of the tax law changes, estate documents drafted before 2010 may not accurately reflect your desire,s because portability and the increase in the exclusion amount can have an effect. Review the changes with your estate planning attorney.

Reference: WMUR (November 21, 2019) “Money Matters: Portability and estates”

Can You Explain the Concept of Step-Up Basis?

If you inherit assets—especially real property—you need to understand the step-up in basis rules. These rules can save you a lot of amount of money on capital gains and depreciation recapture taxes.

Motley Fool’s recent article on this subject asks “What is a Step-Up in Basis?” The article explains that step-up in basis has significant implications for inherited property. When an asset is inherited because the original owner has passed away, in many cases, it’s worth more than when it was first purchased. To avoid a huge capital gains tax bill when the inherited property is sold, the cost basis of the asset is modified to its value at the time of its owner’s death. This is called a step-up in basis. Note that this only applies to property transferred after death. If a property was gifted or transferred before the original owner dies, the original cost basis would transfer to the recipient.

This is a gigantic tax benefit for estate planning, regardless of whether you go ahead and sell the inherited asset immediately or hold on to it for a time. While a step-up in basis can let heirs avoid capital gains taxes, it doesn’t allow heirs to avoid estate taxes that apply to big inheritances.

The estate tax this year is imposed on property in excess of $11.4 million per individual and $22.8 million per married couple. Therefore, if you and your spouse leave a $25 million estate to your heirs, $2.2 million of this will still be taxable, even though your heirs’ cost basis in assets they inherited will be stepped up for capital gains tax purposes.

There are many strategies that a qualified estate planning attorney can advise you on to avoid estate taxes, but step-up in basis doesn’t exclude the value of inherited property from a taxable estate all by itself.

There are two significant ramifications of stepped-up cost basis regarding inherited real estate assets. First, like with other assets, you don’t have to pay capital gains on any appreciation that occurred before you inherited the property. Selling an investment property after years of holding it, can mean a massive capital gains tax bill. Therefore, a stepped-up cost basis can be a very valuable benefit. A step-up in basis can also give you a larger depreciation tax benefit. The cost basis of residential real estate can be depreciated (deducted) over 27½ years: a higher number divided by 27½ years is a greater annual depreciation deduction than a smaller number would produce.

Estate transfers are pretty complicated, so work with a qualified estate planning attorney.

Reference: Motley Fool (November 21, 2019) “What is a Step-Up in Basis?”

Will My Heirs Need to Be Ready to Pay Estate Taxes?

Estate taxes all depend on how on much a person is planning to give to heirs.

Motley Fool’s recent article asks “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?” The article tells us that retirement accounts like 401(k)s, 403(b)s, traditional and Roth IRAs and others are a part of your taxable estate.

However, unless the total assets of your estate plus any taxable gifts you’ve already given are more than the lifetime exclusion amount, your estate won’t owe estate taxes.

For 2019, this is $11,400,000, and in 2020, the exclusion will be raised to $11,580,000. If you total all of your assets’ value, only the amount in excess of the exclusion will be taxable. Therefore, if you have a $12,000,000 estate and die in 2020, only $420,000 of your assets would be subject to estate taxes.

Let’s look at another example: if your assets, including your retirement savings, total up to $5 million, your heirs won’t be required to pay any estate tax whatsoever.

However, while they may not have to pay estate taxes, remember that withdrawals from most retirement accounts (except Roth IRA accounts) will be deemed to be taxable income. Thus, estate tax or no estate tax, if your heirs are in a pretty high tax bracket, inheriting your retirement savings may increase their tax liability.

Don’t neglect to check with an estate planning attorney about your state’s estate and inheritance taxes. There are a handful of states that have their own estate taxes, and their thresholds may be lower than the IRS’s.

There are now six states with an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.

Each state sets its own inheritance tax exemption, and inheritance tax rates. However, these rates are subject to change at any time with changes to the laws in those states.

Reference: Motley Fool (November 8, 2019) “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?”

What Will New Acts of Congress Mean for Stretch IRAs?
Retirement On Calculator Showing Pensioner Retired Decision

What Will New Acts of Congress Mean for Stretch IRAs?

The SECURE and RESA acts are currently being considered in Congress. These acts may impact stretch IRAs. A stretch IRA is an estate planning strategy that extends the tax-deferred condition of an inherited IRA, when it is passed to a non-spouse beneficiary. This strategy lets the account continue tax-deferred growth over a long period of time.

If a parent doesn’t need her Required Minimum Distributions, does it make sense to do a gradual Roth IRA conversion and use the RMDs to pay taxes on the conversion? Or should the parent invest the RMDs in a brokerage account?

There are several options in this situation, according to nj.com’s recent article, “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

Congress is considering legislation with the SECURE and RESA Acts, that would eliminate the ability of children to create a stretch IRA, one that would let them to stretch distributions from the inherited IRA over their lifetimes.

Under the proposed SECURE and RESA Acts under consideration, the maximum deferral period will be 10 years. If the beneficiary is a minor, the period would be 10 years or age 21.

The best planning strategy for a parent would depend on her overall finances and what she wants for her children’s inheritance.

The conversion to a Roth may be a good planning move, depending on her tax bracket. Putting the money in a brokerage account is also an option.

A parent may also want to think about using the RMD proceeds to purchase a life insurance policy held by an irrevocable trust for the benefit of her children.

It’s best to contact an experienced estate planning attorney, so he or she can review the details of the parent’s finances and help her choose the best options for her situation.

Reference: nj.com (October 15, 2019) “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

If My Mom Wants to Give Me Her House, Is It Better to Inherit or Buy It?

Say that your mom owns a house without a mortgage, and she’d like to transfer the house to her adult son and daughter. The issue is whether it’s a better strategy to make the transfer via gift or a sale. Let’s throw in the fact that the son is a U.S. citizen, but the mom and sister are citizens of France.

Some major tax consequences need to be considered, advises nj.com in its recent post, “What happens when a non-citizen wants to transfer a home to an heir?”

First, understand that if the son, a U.S. citizen, receives a gift of money or other property from a foreign person, he may need to report these gifts on Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.

Note the difference: this an information return—not a tax return. However, there are significant penalties for not filing it. The IRS says that U.S. persons (and executors of estates of U.S. decedents) must file Form 3520 to report:

  • Certain transactions with foreign trusts;
  • Ownership of foreign trusts under the rules of Internal Revenue Code §§ 671 through 679; or
  • Receipt of certain large gifts or bequests from certain foreign persons.

As to whether a gift or a sale is better off for the adult child and his mother, consider that the children keep the parent’s cost basis on lifetime transfers of property made by the parents.

That means that if the mom’s home was purchased for $100,000 and it now has a current market value of $250,000, the cost basis of $100,000 becomes the child’s cost basis. When you sell the property, the capital gains tax on the difference between the sale price and the cost basis—$150,000—would have to be paid.

However, if the sister and brother inherit the property, they will receive a “step up” in the cost basis. Thus, if at the Mom’s death, the property is worth $250,000 and it is sold by the child for that amount, there’s no gain on which to pay a capital gains tax.

If you’re in this situation, it’s wise is to talk with an estate planning attorney to help your family with sound planning strategies. They will be able to help work out the best possible solution.

Reference: nj.com (September 24, 2019) “What happens when a non-citizen wants to transfer a home to an heir?”

Image of Sigerson Book

Request a No-Cost, No-Obligation Consultation, and Receive a Complimentary Copy of our new book: The Family Estate Planning and Elder Law Guide