Do You Need a Revocable Trust or Irrevocable Trust?

There are important differences between revocable and irrevocable trusts. One of the biggest differences is the amount of control you have over assets, as explained in the article “What to Consider When Deciding Between a Revocable and Irrevocable Trust” from Kiplinger. A revocable trust is often referred to as the Swiss Army knife of estate planning because it has so many different uses. The irrevocable trust is also a multi-use tool, only different.

Trusts are legal entities that own assets like real estate, investment accounts, cars, life insurance and high value personal belongings, like jewelry or art. Ownership of the asset is transferred to the trust, typically by changing the title of ownership. The trust documents also contain directions regarding what should happen to the asset when you die.

There are three key parties to any trust: the grantor, the person creating and depositing assets into the trust; the beneficiary, who will receive the trust assets and income; and the trustee, who is in charge of the trust, files tax returns as needed and distributes assets according to the terms of the trust. One person can hold different roles. The grantor could set up a trust and also be a trustee and even the beneficiary while living. The executor of a will can also be a trustee or a successor trustee.

If the trust is revocable, the grantor has the option of amending or revoking the trust at any time. A different trustee or beneficiary can be named, and the terms of the trust may be changed. Assets can also be taken back from a revocable trust. Pre-tax retirement funds, like a 401(k) cannot be placed inside a trust, since the transfer would require the trust to become the owner of these accounts. The IRS would consider that to be a taxable withdrawal.

There isn’t much difference between owning the assets yourself and a revocable trust. Assets still count as part of your estate and are not sheltered from estate taxes or creditors. However, you have complete control of the assets and the trust. So why have one? The transition of ownership if something happens to you is easier. If you become incapacitated, a successor trustee can take over management of trust assets. This may be easier than relying on a Power of Attorney form and some believe it offers more legal authority, allowing family members to manage assets and pay bills.

In addition, assets in a trust don’t go through probate, so the transfer of property after you die to heirs is easier. If you own homes in multiple states, heirs will receive their inheritance faster than if the homes must go through probate in multiple states. Any property in your revocable trust is not in your will, so ownership and transfer status remain private.

An irrevocable trust is harder to change, as befits its name. To change an irrevocable trust while you are living takes a little more effort but is not impossible. Consent of all parties involved, including the beneficiary and trustee, must be obtained. The benefits from the irrevocable trust make the effort worthwhile. By giving up control, assets in the irrevocable trust may not be part of your taxable estate. While today’s federal estate exemption is historically high right now, it’s expected to go much lower in the future.

Reference: Kiplinger (July 14, 2021) “What to Consider When Deciding Between a Revocable and Irrevocable Trust”

What Is the Required Minimum Distribution for 2021?

There have been a number of changes to the requirements for RMDs—Required Minimum Distributions—from traditional retirement accounts, says a recent article titled “2 Essential Strategies for Taking Your RMDs” from Kiplinger. In 2019, the age for RMDs was raised from 70½ to 72. In 2020, they were waived altogether because of the pandemic. Now they’re back, and you want to know how to make good decisions about them.

Most people take the default approach, taking a lump sum of cash at the start or the end of the year. This is not the best approach. Investment markets and your own need for income are better indicators for how and when to take your RMD. If you can at all avoid it, never take an RMD from a declining market.

You can take your RMD anytime during the calendar year, from January 1 to December 31. If it’s the first time you’ve taken an RMD, you get a bonus: you can wait until April 1 of the year after your 72nd birthday. The RMD is calculated, by dividing the account balance on December 31 of the preceding year by your life expectancy factor, based on your age. You can find it in the IRS’s Uniform Lifetime Table.

2021 distributions will be bigger, and not just because of the market’s 2020 performance. Instead, distributions will be bigger because of how the accounts are designed, with RMDs becoming a larger percentage over time. It starts as a small percentage and eventually becomes the entire account, which is then depleted. Remember, the sole purpose of the RMD is to force retirees to take money out of their retirement accounts and pay taxes on the money.

Many retirees take RMDs because they need the money to live on. Here’s where money management gets tricky. It’s far easier to take smaller amounts of money at regular intervals, kind of like a paycheck, than taking a big amount once a year. We’re creatures of habit and are used to receiving income and managing it that way.

Distributions on a regular basis also fosters a better sense of how much money you have to live on, encouraging you to create and adhere to a budget.

If you don’t need the income, taking money through regular installments also has an advantage. It’s like the opposite of dollar-cost averaging. Instead of putting money into the market in small increments over time to even out market ups and downs, you’re taking money out of the market at regular intervals. You’re not cashing out at the market’s lowest point, or at the highest. And if you’re reinvesting RMDs in a taxable account, this strategy works especially well.

Reference: Kiplinger (June 10, 2021) “2 Essential Strategies for Taking Your RMDs”

Roth IRA has a 5-Year Rule

Roth IRAs are popular for their flexibility and the simplicity of putting after-tax dollars in and not paying taxes on withdrawals during retirement. However, making the most of a Roth IRA requires paying attention to the details, according to a recent article “What is the Roth IRA 5-Year Rule?” from U.S. News & World Report.

More specifically, there are certain five-year rules that can undo all the good that comes from using a Roth, if you don’t know them. Avoid paying penalties or fees, by understanding how the Roth IRA rules work.

The Roth IRA five-year rule applies to investment earnings, and not to initial contributions. If you make withdrawals of investment earnings before the five-year time period, you’ll get hit with taxes and penalties, no matter how old you are. Many people think that once they turn 65 or 70, they can tap their Roth IRA whenever they want, but that’s not true.

Once you’ve opened and funded a Roth IRA, you’ll have to wait five years until you can start taking tax-free withdrawals of your investment earnings. The clock starts ticking on the date you open the account and make your very first contribution.

After five years, there are still certain requirements that must be met to take out earnings without a penalty. Before you can take out tax-free withdrawals, you will need to be at least 59½ or older.

That’s even if your first contribution was made the year you celebrated your 58th birthday. You’ll need to wait until age 63 before you may take qualified distributions from the account. The five-year rule applies, even if you opened the Roth IRA at age 70.

How is this time frame calculated? The IRS does it based on tax years. A tax year runs from January 1 to December 31. The deadline for contributions is the same as the deadline for filing taxes. Let’s say you funded a Roth IRA in April 2021 for the calendar year of 2020. The five-year rule begins on January 1, 2020. Apply the five-year rule, and you could begin taking withdrawals from the account on or after January 1, 2025.

What happens if you need to make withdrawals before the account hits that five-year mark? In that case, withdraw contributions to the account and not investment earnings.

If you’ve contributed money to a Roth IRA account, you can take that money out with no tax or penalty, no matter how old you are. However, make sure you meet all of the requirements. Remember that to avoid any taxes or penalties, you’ll need to leave the earnings in the account.

Reference: U.S. News & World Report (March 10, 2021) “What is the Roth IRA 5-Year Rule?”

Making a Fresh Start for 2020? Here’s Help

Some people like to start their New Year’s off with a clean slate, going through the past year’s files and tossing or shredding anything they don’t absolutely need. However, many don’t, in part because we’re not sure exactly what documents we need to keep, and which we can toss. This article from AARP Magazine provides the missing information so you can get started: “When to Keep, Shred or Scan Important Papers.”

Tax Returns. Unless you’re planning on running for office, the last three years of tax returns and supporting documents are enough. That’s the window the IRS has to audit taxpayers. But there are some exceptions: if you are self-employed or have a complex return, double that number to six years, which is how much time the IRS has to audit you, if it suspects something’s fishy.

Regardless of how you earn your income, visit MySocialSecurity.gov account before shredding to make sure that your income is being accurately recorded. Having your tax records in hand will make it easier to get any figures fixed.

As for documents regarding home ownership, keep records related until you sell the house. You can use home-improvement receipts to possibly reduce taxes at that time.

Banking and Investments. If you or your spouse might be applying for Medicaid to pay nursing home costs, you’ll need to have five years of financial records. That includes bank statements, credit card statements, and statements from brokerage or financial advisors. This is so the government can look for any asset transfers that might delay eligibility.

If that’s not the case, then you only need banking and financial statements for a year, except for those issued for income-related purposes to provide the IRS with a record of tax-related transactions. Your bank or credit card issuer may have online statements going back several years online. However, if not, download statements and save them in a password protected folder on your home computer.

Stocks and bonds purchases need to be kept for six years after filing the return reporting the sale of the security. Again, this is for the IRS.

If you have a stack of cancelled checks, shred them. Most every bank and credit union today have an electronic version of your checks.

Medical Records. These are the records you want to keep indefinitely, especially if you have had a serious illness or injury. The information may make a difference in how your physicians treat you in the future, so normal or not, hang on to the following documents: surgical reports, hospital discharge summaries and treatment plans for major illnesses. Put these in a password-protected folder in your computer or a secure cloud-based account, so they can be shared with future healthcare providers. You should also keep immunization and vaccination records. The goal is to have your own medical records and not to rely on your doctor’s office for these documents.

Maintain proof of payments to medical providers for six years, with the relevant tax return, in case the IRS questions a health care deduction.

Reference: AARP Magazine (August 5, 2019) “When to Keep, Shred or Scan Important Papers”