Who Receives an Inherited IRA after the Beneficiary Passes?

Which estate would get the IRA when a non-spouse beneficiary inherits an IRA account but dies before the money is put in her name with no contingent beneficiaries can be complicated, says nj.com in the recent article entitled “Who gets this inherited IRA after the beneficiary dies?”

IRAs are usually transferred by a decedent through a beneficiary designation form.

As a review, a designated beneficiary is an individual who inherits an asset like the balance of an IRA after the death of the asset’s owner. The Setting Every Community Up for Retirement Enhancement (SECURE) Act has restricted the rules for designated beneficiaries for required withdrawals from inherited retirement accounts.

Under the SECURE Act, a designated beneficiary is a person named as a beneficiary on a retirement account and who does not fall into one of five categories of individuals classified as an eligible designated beneficiary. The designated beneficiary must be a living person. While estates, most trusts, and charities can inherit retirement assets, they are considered to be a non-designated beneficiary for the purposes of determining required withdrawals.

Provided there is a named beneficiary, and the named beneficiary survived the owner of the IRA account, the named beneficiary inherits the account.

The executor or administrator of the beneficiary’s estate would be entitled to open an inherited IRA for the beneficiary because the beneficiary did not have the opportunity to open it before he or she passed away.

Next is the question of who would inherit the account from the named beneficiary because she died before naming her own beneficiary.

In that instance, the financial institution’s IRA plan documents would determine the beneficiary when no one is named. These rules usually say that it goes to the spouse or the estate of the deceased beneficiary.

Reference: nj.com (June 1, 2021) “Who gets this inherited IRA after the beneficiary dies?”

Are Roth IRAs Smart for Estate Planning?

Think Advisor’s recent article entitled “Secure Act 2.0, Biden Tax Hike Plans Make Roth IRAs a Crucial Tool” says that Roth IRAs offer an great planning tool, and that the Secure Act 2.0 retirement bill (which is expected to pass) will create an even wider window for Roth IRA planning.

With President Biden’s proposed tax increases, it is wise to leverage Roth conversions and other strategies while tax rates are historically low—and the original Secure Act of 2019 made Roth IRAs particularly valuable for estate planning.

Roth Conversions and Low Tax Rates. Though tax rates for some individuals may increase under the Biden tax proposals, rates for 2021 are currently at historically low levels under the Tax Cuts and Jobs Act passed at the end of 2017. This makes Roth IRA conversions attractive. You will pay less in taxes on the conversion of the same amount than you would have prior to the 2017 tax overhaul. It can be smart to make a conversion in an amount that will let you “fill up” your current federal tax bracket.

Reduce Future RMDs. The money in a Roth IRA is not subject to RMDs. Money contributed to a Roth IRA directly and money contributed to a Roth 401(k) and later rolled over to a Roth IRA can be allowed to grow beyond age 72 (when RMDs are currently required to start). For those who do not need the money and who prefer not to pay the taxes on RMDs, Roth IRAs have this flexibility. No RMD requirement also lets the Roth account to continue to grow tax-free, so this money can be passed on to a spouse or other beneficiaries at your death.

The Securing a Strong Retirement Act, known as the Secure Act 2.0, would gradually raise the age for RMDs to start to 75 by 2032. The first step would be effective January 1, 2022, moving the starting age to 73. If passed, this provision would provide extra time for Roth conversions and Roth contributions to help retirees permanently avoid RMDs.

Tax Diversification. Roth IRAs provide tax diversification. For those with a significant amount of their retirement assets in traditional IRA and 401(k) accounts, this can be an important planning tool as you approach retirement. The ability to withdraw funds on a tax-free basis from your Roth IRA can help provide tax planning options in the face of an uncertain future regarding tax rates.

Estate Planning and the Secure Act. Roth IRAs have long been a super estate planning vehicle because there is no RMD requirement. This lets the Roth assets continue to grow tax-free for the account holder’s beneficiaries. Moreover, this tax-free status has taken on another dimension with the inherited IRA rules under the Setting Every Community Up for Retirement Enhancement (Secure) Act. The legislation eliminates the stretch IRA for inherited IRAs for most non-spousal beneficiaries. As a result, these beneficiaries have to withdraw the entire amount in an inherited IRA within 10 years of inheriting the account. Inherited Roth IRAs are also subject to the 10-year rule, but the withdrawals can be made tax-free by account beneficiaries, if the original account owner had met the 5-year rule prior to his or her death. This makes a Roth IRA an ideal estate planning tool in situations where your beneficiaries are non-spouses who do not qualify as eligible designated beneficiaries.

Reference: Think Advisor (May 11, 2021) “Secure Act 2.0, Biden Tax Hike Plans Make Roth IRAs a Crucial Tool”

What Is the Tax-Law Exception for 529 College Plans in 2021?

Grandparents might use this tactic to dramatically reduce their estate, without using any of their lifetime exemption if they meet some conditions, explains Financial Advisor’s recent article entitled “Tax Break Adds Perk To 529 College Plans.” That’s five years’ worth of the standard $15,000 annual exclusion that normally applies to 2021 gifts. Your spouse can also make the same gift.

You could give a five-year gift of $150,000 per couple and report it on a gift tax return. This uses none of your exemption. You should fund the educations of grandchildren or children, while they are young. If they end up being academic stars or athletes, scholarships can be adjusted against the 529 plan. If they choose not to go to college, you can select a new beneficiary. It is a smart way to frontload the 529 and take advantage of the tax-free growth.

Income earned in any qualified distributions from a 529 are typically not taxed, except under some states’ special rules. Non-qualified distributions are taxed and subject to a 10% penalty. Note that a 529 withdrawal to pay for health insurance or other medical expenses is a non-qualified distribution.

Many people get befuddled by filing a gift tax return. They think a tax is due. However, in fact, it is just a letter to the IRS informing them that you are using some of your lifetime exemption now.

The Tax Cuts and Jobs Act of 2017 also permitted 529 money to be used for tuition for grades K-12. Therefore, frontloading the contribution makes for potentially faster accumulation of assets in the plan, which could be helpful due to the shorter timeframe between funding and use.

There are some conditions to note in the current political climate. If a donor funds a plan with $75,000 for the benefit of an individual, that donor could not give that person any additional gifts over the five years without using their lifetime exemption (now $11.7 million per person). If that exemption amount were to be reduced, it is possible that a person will have used up their lifetime exemption and would not be able to give additional gifts above the annual exclusion without paying gift tax.

This tax break comes with another catch: if the donor dies within the five years, the balance reverts back to the deceased donor’s estate.

You should know that the downside is limited investment options. Plans are generally conservative, so you do not lose your principal. There also may be high fees and costs. The plans often impede students who apply for financial aid, though not as much as some other investment holdings.

Reference: Financial Advisor (May 3, 2021) “Tax Break Adds Perk To 529 College Plans”

What Could Proposed Estate Tax Bill Mean to You?

U.S. Sen. Bernie Sanders has released proposed legislation named “For the 99.5%” Act. If passed in its present form, the legislation would bring estate tax exemptions back to the 2009 thresholds of $3.5 million per individual and $7 million per married couple. Exemptions are currently $11.7 million and $23.4 million, as reported by Think Advisor in a recent article “Sen. Bernie Sanders Introduces Estate Tax Bill.”

Larger estates would also be subject to higher tax rates. The current 40% tax rate would be raised to 45% and taxable estates larger than $10 million would be taxed at 50%, amounts greater than $50 million at 55% and any estates valued at greater than $1 billion would be taxed at 65%.

The same rates would apply for all gift taxes, for which the threshold would be lowered to $1 million.

Sanders spoke at a Senate Budget Hearing committee, stating that his bill was designed to have the families of the “millionaire class not only not get a tax break but start paying their fair share of taxes.”

Another bill introduced by Sanders would prevent corporations from shifting profits offshore to avoid paying U.S. taxes and restoring the top corporate rate to 35%, where it has been since 2016.

In contrast, Senators John Thune, South Dakota (R) and John Kennedy, Louisiana (R), introduced legislation in early March to repeal the estate tax entirely.

Frank Clemente, executive director for Americans for Tax Fairness, said the tax plan released by President Biden during his campaign also tracked the 2009 estate tax levels that are the basis of Sanders’ bill, but because of the higher tax brackets for larger estates, his group believes the Sanders bill would raise about twice as much revenue as the Biden plan.

History teaches us that there is a long distance between the time that a bill is introduced, and many changes are made as proposed legislation makes its way through the law-making process. In this case, it can be safely said that there will be changes to the tax and estate laws, and that may be the only sure thing.

Now is a good time to review your estate plan, if these federal estate changes will have an impact on your family’s wealth. Familiarity with your current estate plan and staying in touch with your estate planning attorney, who will also be watching what Congress does in the coming months, will allow you to be prepared for changes to the tax planning aspect of your estate plan in the near or distant future.

Reference: Think Advisor (March 25, 2021) “Sen. Bernie Sanders Introduces Estate Tax Bill”

Does Your State Have an Estate or Inheritance Tax?

Did you know that Hawaii and the State of Washington have the highest estate tax rates in the nation at 20%? There are 8 states and DC that are next with a top rate of 16%. Massachusetts and Oregon have the lowest exemption levels at $1 million, and Connecticut has the highest exemption level at $7.1 million.

The Tax Foundation’s recent article entitled “Does Your State Have an Estate or Inheritance Tax?” says that of the six states with inheritance taxes, Nebraska has the highest top rate at 18%, and Maryland has the lowest top rate at 10%. All six of these states exempt spouses, and some fully or partially exempt immediate relatives.

Estate taxes are paid by the decedent’s estate, prior to asset distribution to the heirs. The tax is imposed on the overall value of the estate. Inheritance taxes are due from the recipient of a bequest and are based on the amount distributed to each beneficiary.

Most states have been steering away from estate or inheritance taxes or have upped their exemption levels because estate taxes without the federal exemption hurt a state’s competitiveness. Delaware repealed its estate tax at the start of 2018, and New Jersey finished its phase out of its estate tax at the same time. The Garden State now only imposes an inheritance tax.

Connecticut still is phasing in an increase to its estate exemption. They plan to mirror the federal exemption by 2023. However, as the exemption increases, the minimum tax rate also increases. In 2020, rates started at 10%, while the lowest rate in 2021 is 10.8%. Connecticut’s estate tax will have a flat rate of 12% by 2023.

In Vermont, they’re still phasing in an estate exemption increase. They are upping the exemption to $5 million on January 1, compared to $4.5 million in 2020.

DC has gone in the opposite direction. The District has dropped its estate tax exemption from $5.8 million to $4 million in 2021, but at the same time decreased its bottom rate from 12% to 11.2%.

Remember that the Tax Cuts and Jobs Act of 2017 raised the estate tax exclusion from $5.49 million to $11.2 million per person. This expires December 31, 2025, unless reduced sooner!

Talk to an experienced estate planning attorney about estate and inheritance taxes, and see if you need to know about either, in your state.

Reference: The Tax Foundation (Feb. 24, 2021) “Does Your State Have an Estate or Inheritance Tax?”

How Do I Use a Charitable Remainder Trust with a Large IRA?

Since the mid-1970s, saving in a tax-deferred employer-sponsored retirement plan has been a great way to save for retirement, while also deferring current income tax. Many workers put some of their paychecks into 401(k)s, which can later be transferred to a traditional Individual Retirement Account (IRA). Others save directly in IRAs.

Kiplinger’s recent article entitled “Worried about Passing Down a Big IRA? Consider a CRT” says that taking lifetime IRA distributions can give a retiree a comfortable standard of living long after he or she gets their last paycheck. Another benefit of saving in an IRA is that the investor’s children can continue to take distributions taxed as ordinary income after his or her death, until the IRA is depleted.

Saving in a tax-deferred plan and letting a non-spouse beneficiary take an extended stretch payout using a beneficiary IRA has been a significant component of leaving a legacy for families. However, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act), which went into effect on Jan. 1, 2020, eliminated this.

Under the new law (with a few exceptions for minors, disabled beneficiaries, or the chronically ill), a beneficiary who isn’t the IRA owner’s spouse is required to withdraw all funds from a beneficiary IRA within 10 years. Therefore, the “stretch IRA” has been eliminated.

However, there is an option for extending IRA distributions to a child beyond the 10-year limit imposed by the SECURE Act: it’s a Charitable Remainder Trust (CRT). This trust provides for distributions of a fixed percentage or fixed amount to one or more beneficiaries for life or a term of less than 20 years. The remainder of the assets will then be paid to one or more charities at the end of the trust term.

Charitable Remainder Trusts can provide that a fixed percentage of the trust assets at the time of creation will be given to the current individual beneficiaries, with the remainder being given to charity, in the case of a Charitable Remainder Annuity Trust (CRAT). There is also a Charitable Remainder Unitrust (CRUT), where the amount distributed to the individual beneficiaries will vary from year to year, based on the changing value of the trust. With both trusts, the amount of the charity’s remainder interest must be at least 10% of the value of the trust at its inception.

Implementing a CRT to extend distributions from a traditional IRA can have tax advantages and can complement the rest of a comprehensive estate plan. It can be very effective when your current beneficiary has taxable income from other sources and resources, in addition to the beneficiary IRA.  It can also be effective in protecting the IRA assets from a beneficiary’s creditors or for planning with potential marital property, while providing the beneficiary a lengthy predictable income stream.

Ask an experienced estate planning attorney, if one of these trusts might fit into your comprehensive estate plan.

Reference: Kiplinger (Feb. 8, 2021) “Worried about Passing Down a Big IRA? Consider a CRT”

When Did You Last Review Beneficiary Designation Forms?

For many people, naming beneficiaries occurs when they first set up an account, and it’s rarely given much thought after that. The Street’s recent article entitled “Secure your IRA – Review Your Beneficiary Forms Now” says that many account holders aren’t aware of how important the beneficiary document is or what the consequences would be if the information is incorrect or is misplaced. Many people are also surprised to hear that wills don’t cover these accounts because they pass outside the will and are distributed pursuant to the beneficiary designation form.

If one of these accounts does not have a designated beneficiary, it may be paid to your estate. If so, the IRS says that the account has to be fully distributed within five years if the account owner passes before their required beginning date (April 1 of the year after they turn age 72). This may create a massive tax bill for your heirs.

Get a copy of your listed beneficiaries from every institution where you have your accounts, and don’t assume they have the correct information. Review the forms and make sure all beneficiaries are named and designated not just the primary beneficiary but secondary or contingent beneficiary. It is also important tomake certain that the form states clearly their percentage of the share and that it adds up to 100%. You should review these forms at any life change, like a marriage, divorce, birth or adoption of a child, or the death of a loved one.

Note that the SECURE Act changed the rules for anyone who dies after 2019. If you don’t heed these changes, it could result in 87% of your hard-earned money to go towards taxes. For retirement accounts that are inherited after December 31, 2019, there are new rules that necessitate review of beneficiary designations:

  1. The new law created multiple “classes” of beneficiaries, and each has its own set of complex distribution rules. Make sure you understand the definition of each class of beneficiary and the effect the new rules will have on your family.
  2. Some trusts that were named as beneficiaries of IRAs or retirement plans will no longer serve their original purpose. Ask an experienced estate planning attorney to review this.
  3. The stretch IRA has been eliminated for most non-spouse beneficiaries. As such, most non-spouse beneficiaries will need to “empty” the IRA or retirement account within 10 years and they can’t “stretch” out their distributions over their lifetimes. Failure to comply is a 50% penalty of the amount not distributed and taxes due.

For many, the beneficiary form is their most important estate planning document but the most overlooked.

Reference: The Street (Dec. 28, 2020) “Secure your IRA – Review Your Beneficiary Forms Now”

When Exactly Do I Need to Update My Will?

Many people say that they’ve been meaning to update their last will and testament for years but never got around to doing it.

Kiplinger’s article entitled “12 Different Times When You Should Update Your Will” gives us a dozen times you should think about changing your last will:

  1. You’re expecting your first child. The birth or adoption of a first child is typically when many people draft their first last will. Designate a guardian for your child and who will be the trustee for any trust created for that child by the last will.
  2. You may divorce. Update your last will before you file for divorce, because once you file for divorce, you may not be permitted to modify your last will until the divorce is finalized. Doing this before you file for divorce ensures that your spouse won’t get all of your money, if you die before the divorce is final.
  3. You just divorced. After your divorce, your ex no longer has any rights to your estate (unless it’s part of the terms of the divorce). However, even if you don’t change your last will, most states have laws that invalidate any distributive provisions to your ex-spouse in that old last will. Nonetheless, update your last will as soon as you can, so your new beneficiaries are clearly identified.
  4. Your child gets married. Your current last will may speak to issues that applied when your child was a minor, so it may not address your child’s possible divorce. You may be able to ease the lack of a prenuptial agreement, by creating a trust in your last will and including post-nuptial requirements before you child can receive any estate assets.
  5. A beneficiary has issues. Last wills frequently leave money directly to a beneficiary. However, if that person has an addiction or credit issues, update your last will to include a trust that allows a trustee to only distribute funds under specific circumstances.
  6. Your executor or a beneficiary die. If your estate plan named individuals to manage your estate or receive any remaining funds, but they’re no longer alive, you should update your last will.
  7. Your child turns 18. Your current last will may designate your spouse or a parent as your executor, but years later, these people may be gone. Consider naming a younger family member to handle your estate affairs.
  8. A new tax or probate law is enacted. Congress may pass a bill that wrecks your estate plan. Review your plan with an experienced estate planning attorney every few years to see if there have been any new laws relevant to your estate planning.
  9. You come into a chunk of change. If you finally get a big lottery win or inherit money from a distant relative, update your last will so you can address the right tax planning. You also may want to change when and the amount of money you leave to certain individuals or charities.
  10. You can’t find your original last will. If you can’t locate your last will, be sure that you replace the last will with a new, original one that explicitly states it invalidated all prior last wills.
  11. You purchase property in another country or move overseas. Many countries have treaties with the U.S. that permit reciprocity of last wills. However, transferring property in one country may be delayed, if the last will must be probated in the other country first. Ask your estate planning attorney about having a different last will for each country in which you own property.
  12. Your feelings change for a family member. If there’s animosity between people named in your last will, you may want to disinherit someone. You might ask your estate planning attorney about a No Contest Clause that will disinherit the aggressive family member, if he or she attempts to question your intentions in the last will.

Reference: Kiplinger (May 26, 2020) “12 Different Times When You Should Update Your Will”

Do I Qualify as an Eligible Designated Beneficiary under the SECURE Act?

An eligible designated beneficiary (EDB) is a person included in a unique classification of retirement account beneficiaries. A person may be classified as an EDB, if they are classified as fitting into one of five categories of individuals identified in the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The bill passed in December 2019 and is effective for all inherited retirement accounts, as of the first of this year.

Investopedia’s recent article entitled “Eligible Designated Beneficiary” explains that these people get special treatment and greater flexibility to withdraw funds from their inherited accounts than other beneficiaries.

With the SECURE Act, there are now three types of beneficiaries. It is based on the individual’s connection to the original account owner, the beneficiary’s age, and his or her status as either an individual or a non-person entity. However, an EDB is always an individual. On the other hand, an EDB can’t be a trust, an estate, or a charity, which are considered not designated beneficiaries. There are five categories of individuals included in the EDB classification. These are detailed below.

In most instances, except for the exceptions below, an EDB must withdraw the balance from the inherited IRA account over the beneficiary’s life expectancy. There is optional special treatment allowed only for surviving spouses, which is explained below. When a minor child reaches the age of majority, he or she is no longer considered to be an EDB, and the 10-year rule concerning withdrawal requirements for a designated beneficiary applies.

Here are the five categories of EDBs.

Owner’s surviving spouse. Surviving spouses get special treatment, which lets them step into the shoes of the owner and withdraw the balance from the IRA over the original owner’s life expectancy. As another option, they can roll an inherited IRA into their own IRA and take withdrawals at the point when they’d normally take their own required minimum distributions (RMDs).

Owner’s minor child. A child who isn’t yet 18 can make withdrawals from an inherited retirement account using their own life expectancy. However, when he or she turns 18, the 10-year rule for designated beneficiaries (who aren’t EDBs) applies. At that point, the child would have until December 31 of the 10th year after their 18th birthday to withdraw all funds from the inherited retirement account. A deceased retirement account owner’s minor child can get an extension, up until age 26, for the start of the 10-year rule, if he or she is pursuing a specified course of education.

An individual who is disabled. The tax code says that an individual is considered to be disabled if he or she is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long continued and indefinite duration.” A disabled person who inherits a retirement account can use their own life expectancy to calculate RMDs.

An individual who is chronically ill. The tax code states that “the term ‘chronically ill individual’ means any individual who has been certified by a licensed healthcare practitioner as—

  • being unable to perform (without substantial assistance from another individual) at least two activities of daily living for a period of at least 90 days, due to a loss of functional capacity,
  • having a level of disability similar (as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services) to the level of disability described in clause (i), or
  • requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.”

A chronically ill individual who inherits a retirement account can use their own life expectancy to determine the RMDs.

Any other person who’s less than 10 years younger than the decedent. This is a catch-all that includes certain friends and siblings (depending on age), who are identified as beneficiaries of a retirement account. This also excludes most adult children (who aren’t disabled or chronically ill) from the five categories of EDBs. A person in this category who inherits a retirement account is permitted to use their own life expectancy to calculate RMDs.

Reference: Investopedia (June 25, 2020) “Eligible Designated Beneficiary” 

Does the Stimulus Bill have an Impact on RMDs?

The Stimulus Bill gives some relief to those “who would otherwise be required to withdraw funds from these retirement accounts during the economic slowdown due to COVID-19.”

Waiving 2020 RMDs will help many people avoid a tax bill on IRA value that has disappeared. Without this relief, 2020 RMDs would be based on the account value at Dec. 31, 2019, when the Dow was around 28,000, says Think Advisor’s article entitled “Stimulus Plan Includes Temporary RMD Waiver.”

The Stimulus Bill’s RMD waiver also applies to IRA and Roth IRA beneficiaries who have 2020 RMDs.  However, the Treasury Department says that about 80% of people subject to RMDs take more than the minimum because they need the money. As a result, the RMD waiver won’t be much help to these individuals.

RMDs are also waived for IRA owners who turned 70½ in 2019 and must take their 2019 RMD by April 1. Those who ignored traditional advice about spreading their first two RMDs over two years (2019 and 2020), can now have their first two RMDs waived.

If they have already taken any part of their first RMD in 2019, that can’t be undone or waived.

As far as special rules for use of retirement funds, like previous disaster-related relief, the Stimulus Bill waives the 10% early withdrawal penalty for distributions up to $100,000 from qualified retirement accounts for coronavirus-related purposes made on or after January 1, 2020. The bill also states that “income attributable to such distributions would be subject to tax over three years, and the taxpayer may recontribute the funds to an eligible retirement plan within three years without regard to that year’s cap on contributions. Further, the provision provides flexibility for loans from certain retirement plans for coronavirus-related relief.”

The distribution is still taxable, but the tax impact can be lessened because it can be spread over three years. The funds can also be repaid within the three years.

The law also gives an exclusion for certain employer payments of student loans. This lets employers provide a student loan repayment benefit to employees on a tax-free basis. Under the provision, “an employer may contribute up to $5,250 annually toward an employee’s student loans, and such payment would be excluded from the employee’s income. The $5,250 cap applies to both the new student loan repayment benefit, as well as other educational assistance (e.g., tuition, fees, books) provided by the employer under current law.”

The provision applies to any student loan payments made by an employer for an employee after date of enactment and before Jan. 1, 2021.

Reference: Think Advisor (March 31, 2020) “Stimulus Plan Includes Temporary RMD Waiver”