Why are Beneficiary Designations Important in Estate Planning? – Annapolis and Towson Estate Planning

Not having your beneficiary designations set up correctly can cause a lot of trouble after you pass away.

A designated beneficiary is named on a life insurance policy or on a financial account as the person who will receive those assets, in the event of the account holder’s death.

This person usually must file a claim with a copy of the death certificate to receive the assets.

NJ Money Help’s recent article entitled “Beneficiary designation – specific or not?” says that naming a beneficiary takes a little consideration.

When naming the beneficiaries on your accounts or insurance policies, you should always consider a primary and secondary (or contingent) beneficiary.

The owner of a policy or account can name multiple beneficiaries. The proceeds or assets can be divided among more than one primary beneficiary. Likewise, there can also be more than one secondary beneficiary.

The primary beneficiary or beneficiaries are the first ones to receive the asset. The secondary beneficiary is next in line if the primary beneficiary dies before the owner of the asset, cannot be found, or refuses to accept the asset.

Note that simply naming beneficiaries in generic terms, such as “wife,” “spouse”’ or “children,” may create legal issues, if there is a divorce or in case someone becomes disenfranchised.

It is always best to name your beneficiaries specifically and if they are minors, make certain you have designated a guardian.

Because our lives are constantly changing, you should review your life insurance policies, IRAs, 401(k)s, and any other instruments that require beneficiary designations every couple of years to make certain that everything is exactly the way you want.

Reference: NJ Money Help (Oct. 2017) “Beneficiary designation – specific or not?”

 

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What are the Big Tax Penalties to Avoid in Retirement? – Annapolis and Towson Estate Planning

Building and living off a nest egg can be a challenge. However, you can make the situation worse, if you encounter some important laws for retirement accounts.

Money Talks News’ recent article entitled “3 Tax Penalties That Can Ding Your Retirement Accounts” says make one wrong step and the federal government may want some explanations. Here are the three penalties to avoid at all costs, when contributing to or withdrawing from your retirement accounts.

Excess IRA Contribution Penalty. If you put too much away in an individual retirement account (IRA), it can cost you. The IRS says you can (i) contribute an amount of money that exceeds the applicable annual contribution limit for your IRA; or (ii) improperly roll over money into an IRA.

If you get a little too anxious to build a nest egg and make one of these mistakes, the IRS says that “excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA. The tax cannot be more than 6% of the combined value of all your IRAs as of the end of the tax year.”

The IRS has a remedy to address your mistake before any penalties are imposed. You must withdraw the excess contributions — and any income earned on those contributions — by the due date of your federal income tax return for that year.

Early Withdrawal Penalty. If you take your money out too soon from a retirement account, you will suffer another potentially costly mistake. If you withdraw money from your IRA before the age of 59½, you may be subject to paying income taxes on the money—plus an additional 10% penalty, according to the IRS. The IRS explains there are several scenarios in which you are permitted to take early IRA withdrawals without penalties, such as if you lose a job, where you can use your IRA early to pay for health insurance. The same penalties apply to early withdrawals from retirement plans like 401(k)s, although again, there are exceptions to the rule that allow you to make early withdrawals without penalty. However, note that the exceptions which let you make early retirement plan withdrawals without penalty sometimes differ from the exceptions that allow you to make early IRA withdrawals without penalty. The Coronavirus Aid, Relief, and Economic Security Act (CARES) Act of 2020 also created a one-time exception to the early-withdrawal penalty for both retirement plans and IRAs, due to the coronavirus pandemic. Therefore, coronavirus-related distributions of up to a total of $100,000 that were made in 2020 are exempt.

Missed RMD Penalty. Retirement plans are terrific because they generally let you defer paying taxes on your contributions and income gains for many years. However, at some point, the federal government will want its share of that cash. Taxpayers previously had to take required minimum distributions (RMDs) from most types of retirement accounts starting the year they turn 70½. However, the Secure Act of 2019 moved that age to 72. The consequences of failing to make RMDs still apply, and if you do not take your RMDs starting the year you turn 72, you face harsh penalties. The IRS says:

“If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.”

It is important to understand that the RMD rules do not apply to Roth IRAs. You can leave money in your Roth IRA indefinitely, but another provision of the Secure Act means your heirs must be careful if they inherit your Roth IRA.

Reference: Money Talks News (Feb. 18, 2021) “3 Tax Penalties That Can Ding Your Retirement Accounts”

 

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Estate Planning Meets Tax Planning – Annapolis and Towson Estate Planning

Not keeping a close eye on tax implications, often costs families tens of thousands of dollars or more, according to a recent article from Forbes, “Who Gets What—A Guide To Tax-Savvy Charitable Bequests.” The smartest solution for donations or inheritances is to consider your wishes, then use a laser-focus on the tax implications to each future recipient.

After the SECURE Act destroyed the stretch IRA strategy, heirs now have to pay income taxes on the IRA they receive within ten years of your passing. An inherited Roth IRA has an advantage in that it can continue to grow for ten more years after your death, and then be withdrawn tax free. After-tax dollars and life insurance proceeds are generally not subject to income taxes. However, all of these different inheritances will have tax consequences for your beneficiary.

What if your beneficiary is a tax-exempt charity?

Charities recognized by the IRS as being tax exempt do not care what form your donation takes. They do not have to pay taxes on any donations. Bequests of traditional IRAs, Roth IRAs, after-tax dollars, or life insurance are all equally welcome.

However, your heirs will face different tax implications, depending upon the type of assets they receive.

Let’s say you want to leave $100,000 to charity after you and your spouse die. You both have traditional IRAs and some after-tax dollars. For this example, let’s say your child is in the 24% tax bracket. Most estate plans instruct charitable bequests be made from after-tax funds, which are usually in the will or given through a revocable trust. Remember, your will cannot control the disposition of the IRAs or retirement plans, unless it is the designated beneficiary.

By naming a charity as a beneficiary in a will or trust, the money will be after-tax. The charity gets $100,000.

If you leave $100,000 to the charity through a traditional IRA and/or your retirement plan beneficiary designation, the charity still gets $100,000.

If your heirs received that amount, they would have to pay taxes on it—in this example, $24,000. If they live in a state that taxes inherited IRAs or if they are in a higher tax bracket, their share of the $100,000 is even less. However, you have options.

Here is one way to accomplish this. Let’s say you leave $100,000 to charity through your IRA beneficiary designations and $100,000 to your heirs through a will or revocable trust. The charity receives $100,000 and pays no tax. Your heirs also receive $100,000 and pay no federal tax.

A simple switch of who gets what saves your heirs $24,000 in taxes. That is a welcome savings for your heirs, while the charity receives the same amount you wanted.

When considering who gets what in your estate plan, consider how the bequests are being given and what the tax implications will be. Talk with your estate planning attorney about structuring your estate plan with an eye to tax planning.

Reference: Forbes (Jan. 26, 2021) “Who Gets What—A Guide To Tax-Savvy Charitable Bequests”

 

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What Happens If Trust Not Funded – Annapolis and Towson Estate Planning Attorneys

Revocable trusts can be an effective way to avoid probate and provide for asset management, in case you become incapacitated. These revocable trusts — also known as “living” trusts — are very flexible and can achieve many other goals.

Point Verda Recorder’s recent article entitled “Don’t forget to fund your revocable trust” explains that you cannot take advantage of what the trust has to offer, if you do not place assets in it. Failing to fund the trust means that your assets may be required to go through a costly probate proceeding or be distributed to unintended recipients. This mistake can ruin your entire estate plan.

Transferring assets to the trust—which can be anything like real estate, bank accounts, or investment accounts—requires you to retitle the assets in the name of the trust.

If you place bank and investment accounts into your trust, you need to retitle them with words similar to the following: “[your name and co-trustee’s name] as Trustees of [trust name] Revocable Trust created by agreement dated [date].” An experienced estate planning attorney should be consulted.

Depending on the institution, you might be able to change the name on an existing account. If not, you will need to create a new account in the name of the trust, and then transfer the funds. The financial institution will probably require a copy of the trust, or at least of the first page and the signature page, as well as the signatures of all the trustees.

Provided you are serving as your own trustee or co-trustee, you can use your Social Security number for the trust. If you are not a trustee, the trust will have to obtain a separate tax identification number and file a separate 1041 tax return each year. You will still be taxed on all of the income, and the trust will pay no separate tax.

If you are placing real estate in a trust, ask an experienced estate planning attorney to make certain this is done correctly.

You should also consult with an attorney before placing life insurance or annuities into a revocable trust and talk with an experienced estate planning attorney, before naming the trust as the beneficiary of your IRAs or 401(k). This may impact your taxes.

Reference: Point Verda Recorder (Nov. 19, 2020) “Don’t forget to fund your revocable trust”

 

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What Happens If You Fail to Submit a Change of Beneficiary Form? – Annapolis and Towson Estate Planning

Wealth Advisor’s recent article entitled “I’m being denied an inheritance. Can they do that?” explains the situation where an individual, Peter, was given a CD/IRA by a friend named Paul.

Paul told Peter that he wanted him to have it, in case anything happened to him. Paul was married and did not tell his wife about this. Paul’s wife was the beneficiary of several other accounts.

Paul told Peter to sign a document before he died, and they got it notarized.

Paul died somewhat unexpectedly, and Peter took the signed and notarized beneficiary designation form to the bank to see about collecting the money.

However, the bank told Peter that there was no beneficiary designation given to them prior to Pauls’ death.

Is there anything that Peter can do?

The article explains that it is a matter of timing, and it is probably too late. That is because it looks like Paul failed to submit a written beneficiary change form to the financial institution prior to his death.

As a result, the financial institution must distribute the CD to the person or entities that otherwise would be entitled to receive it.

In most states, you can choose any IRA beneficiary you want. However, in nine community property states, you are required to name your spouse as your heir. If you want to name anyone else, your spouse must give written permission. The same laws apply, if you want to change your beneficiary designation.

The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

The only way for Peter to see the money, is if he can show that Paul intended for him to receive the asset. That bank does not want to be sued by another person, who claims they are entitled to the CD.

In this situation, it is best to speak with an experienced estate planning attorney who can examine the specifics of this type of issue.

Reference: Wealth Advisor (Nov. 24, 2020) “I’m being denied an inheritance. Can they do that?”

 

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Do I Qualify as an Eligible Designated Beneficiary under the SECURE Act? – Annapolis and Towson Estate Planning

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 cannot 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 would normally take their own required minimum distributions (RMDs).

Owner’s minor child. A child who is not 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 are not 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 is 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 are not 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”

 

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What Should I Know about Beneficiaries? – Annapolis and Towson Estate Planning

When you open almost any kind of financial account, like a bank account, life insurance, a brokerage account, or a retirement account – the institution will ask you to designate a beneficiary. You will also name beneficiaries when you create a will or other legal contracts that require you to specify someone to benefit. With some trusts, the beneficiary may even be you and your spouse while you are alive.

The beneficiary is typically a person, but it could be any number of individuals, as well as the trustee of your trust, your estate, or a charity.

When you are opening an account, many people forget to choose a beneficiary, mainly because it is not necessary to do so with many financial accounts. However, you should name your beneficiaries, because it ensures that your assets will pass to the people you intend. It also eliminates conflict and can decrease legal interference.

There are two basic types of beneficiaries: a primary beneficiary and a contingent beneficiary. A primary beneficiary (or beneficiaries) is first in line to get the distributions from your assets. You can assign different percentages of your account to this group. A contingent beneficiary will benefit, if one or more of the primary beneficiaries is unable to collect (typically upon death).

You should review the designations regularly, especially when there is a major life event, such as a death, divorce, adoption, or birth. This may change who you want to be your beneficiary.

Ask an experienced estate planning attorney to help you make certain that any language in your will, does not conflict with beneficiary designations. Beneficiary designations take precedence over your will.

You can have a minor child as a beneficiary, but a minor usually cannot hold property. Consequently, you will need to set up a structure, so the child receives the assets. You can appoint a guardian who will keep the assets in custody for the minor. You may also be able to use a trust to the same effect but with an added benefit: you can state that the assets be given to beneficiaries, only when they reach a certain age or for a certain purpose, like buying a first home or for college tuition.

With estate planning, ask an attorney to help you structure any legal documents, so they achieve your aims without creating further complications.

Reference: Bankrate (July 1, 2020) “What is a beneficiary?”

 

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Social Security and Medicare and the Impact on Retiree Taxes – Annapolis and Towson Estate Planning

A 70% increase in Medicare premiums to $559 was a complete surprise to a woman who became a single taxpayer when her husband died. She felt like she was being punished for being a widow, she said in a recent article titled “Retirees, Beware These Tax Torpedoes” from Barron’s. With a 2018 modified adjusted gross income of $163,414, a combination of required minimum distributions, Social Security and her husband’s pensions, she went from being in the third-highest Medicare bracket into the second highest Medicare bracket. All it took was $414 dollars to exceed the $163,000 limit.

This is not the only tax trap awaiting unwary retirees. Lower- and middle-income taxpayers get hit by what is commonly referred to as “tax torpedoes,” as rising income during retirement triggers new taxes. That includes Social Security income, which is taxed after reaching a certain limit. The resulting marginal tax rate—as high as 40.8%—is made worse by a Medicare surtax of 0.9% on couples with taxable income exceeding $250,000. Capital gains taxes also increase, as income rises.

It may be too late to make changes for this tax-filing year, even with a three-month extension to July 15. However, there are a few steps that retirees can take to avoid or minimize these taxes for next year. The simplest one: delay spending from one year to the next and be extra careful about taking funds from after-tax accounts.

What hurts most is if you are on the borderline of a bracket. Just one wrong move, like selling a stock or taking a distribution, puts you into the next bracket. You need to plan carefully.

One thing that will not be a concern for 2020 taxes: required minimum distributions. While many retirees get pushed into tax traps because of taking large RMDs, the emergency legislation passed in response to the coronavirus crisis (the CARES Act) eliminated RMDs for this year.

However, the RMDs will be back in 2021, so now is a good time to start thinking about how to avoid any of the typical tax torpedoes. RMDs used to start at age 70½; the SECURE Act changed that to 72.

If you do not need the money from an RMD in 2021, one workaround is to take it as a qualified charitable distribution. That avoids triggering higher taxes or higher future Medicare premiums. The administrator of the tax-deferred account needs to be instructed to make a donation directly to a charity.

An even better strategy: take steps long before Medicare income limits or tax torpedoes hit. If you can, live on after-tax savings, Roth IRA accounts or inherited money. Spend that money first, before tapping into tax-deferred accounts. You can then take advantage of being in a lower tax bracket to convert money from tax-deferred money to convert to Roth IRAs.

Another story of a tax hit that was avoided: a man with an income of about $80,000 prepared to take $4,000 from a tax-deferred account for a vacation. The couple’s normal top tax bracket was 12%, but they hit the income limit on Social Security taxes. The $4,000 in additional income would have caused $3,400 in Social Security income to be taxed, making his marginal tax rate 22.2% instead of 12%. With the help of a good advisor, the couple instead took $3,000 from a Roth IRA and sold a stock position for $1,000, where there were practically no capital gains generated.

Incomes at all levels can be hit by these tax and Medicare torpedoes. A skilled advisor can help protect your retirement and Social Security funds.

Reference: Barron’s (July 6, 2020) “Retirees, Beware These Tax Torpedoes”

 

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Coronavirus Makes Estate and Tax Planning an Urgent Task – Annapolis and Towson Estate Planning

The Covid-19 pandemic has brought estate planning front and center to many people who would otherwise dismiss it as something they would get to at some point in the future, says the article “Estate and Life Insurance Considerations During the Covid-19 Pandemic” from Bloomberg Tax. Many do not have a frame of reference to address the medical, legal, financial, and insurance questions that now need to be addressed promptly. They have never experienced anything like today’s world. The time to get your affairs in order is now.

What will happen if we get sick? Will we recover? Who will take care of us and make legal decisions for us? What if a family member is in an assisted living facility and is incapacitated? All of these “what if” questions are now pressing concerns. Now is the time to review all legal, insurance and financial plans, and take into consideration two new laws: the SECURE Act and the CARES Act.

An experienced estate planning attorney who focuses in estate planning will save you an immense amount of money. Bargain hunters be careful: a small mistake or oversight in an estate plan can lead to expensive consequences. A competent legal professional is the best investment.

Here is an example of what can go wrong: A person names two minor children—under age 18—as beneficiaries on their IRA account, life insurance policy or bank account. The person dies. Minors are not permitted to hold title to assets. Minors in New York are considered wards of the court in need of protection and court supervision. Therefore, in this state, the result of the beneficiary designation means that a special Surrogate’s Court proceeding will need to occur to have a pecuniary guardian appointed for the minors, even if the applicant is their custodial guardian.

Another “what if?” is the support for a disabled or special needs beneficiary who may be receiving government support. If the parents are gone, who will care for their disabled child? What if there are not enough assets in the estate to provide supplemental financial support, in addition to the government benefits? Life insurance can be used to fund a special needs trust to ensure that their child will not be dependent upon family or friends to care for their needs. However, if there is no special needs trust in place, an inheritance may put the child’s government support in jeopardy.

Here are the core estate planning documents to be prepared:

  • Last Will and Testament
  • Revocable Living Trust
  • Durable General Power of Attorney
  • Health Care Declaration

The SECURE Act changed the rules regarding inherited IRAs. With the exception of a surviving spouse and a few other exempt individuals, the required minimum distributions must be taken within a ten- year time period. This causes an additional income tax liability for future generations. There are strategies to reduce the impact, but they require advance planning with the help of an estate planning attorney.

Reference: Bloomberg Tax (June 18, 2020) “Estate and Life Insurance Considerations During the Covid-19 Pandemic”

 

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Five Top Reasons to Add Beneficiaries to Investment Accounts – Annapolis and Towson Estate Planning

One way to show loved ones that you care, is by having an estate plan and communicating your wishes to them clearly, notes the article “Why You Should Add Beneficiaries to Your Investment Accounts Now” from The Street. That includes adding beneficiaries to your retirement and investment accounts. This simple step will help save heirs time, money and emotional stress at a time when they are likely to be overwhelmed with grief and paperwork.

They will retain more of your estate and get it faster too. When beneficiaries are assigned to investment and retirement accounts, the assets pass directly to them. If there are no beneficiaries, the asset may have to go through probate, the legal process of settling an estate when someone dies.

Probating an estate usually involves going to court, which is something your beneficiaries would probably prefer not to deal with during a challenging time. A typical probate case could last a year, sometimes longer, depending on where you live. During this time, your beneficiaries are not able to access their inheritance. Going to court also means court fees, attorney fees, lost time, and additional stress.

Let us not leave out how much of a bite probate can take out of your estate. Depending on its complexity, probate can consume anywhere from 0.5% to 5% of the estate.

Removes one stress for loved ones. Having assets transfer directly to beneficiaries lessens what can be an intense burden for heirs, while they are grieving. Once the account provider is notified of the death of the account holder, the provider typically notifies beneficiaries. The beneficiaries have to provide the correct documentation, like a death certificate, but that is a whole lot easier than going through probate. Obtaining death certificates is usually part of the executor’s responsibility and does not cost very much.

Beneficiary designations override your last will and testament. By law, a beneficiary designation determines who receives assets, regardless of what is in your will. That is why it is so important to make sure your beneficiary designations are up to date. What happens if you neglect to update your beneficiaries on a life insurance policy purchased when your children were young? For instance, what if you are divorced from their father, but you forget to replace him as the policy beneficiary? In that case, your ex-spouse will receive the policy proceeds, no matter how many years you have been divorced.

It is easy and relatively painless. Updating or establishing beneficiaries is one of the easiest parts of estate planning. Start by making a list of your accounts, which you should have anyway and contact the account custodian to find out who is listed as a beneficiary. If no one has been named, get directions on how to establish the beneficiary designation and if possible, name a secondary beneficiary.

If you have an IRA or a 401(k), your account will typically offer a beneficiary form within the account. If you have investment accounts, you will need to request a form from the custodian.

Special rules for retirement account beneficiaries. There are rules about leaving retirement plan assets to a spouse, so if you want to leave those assets to children or grandchildren, your spouse will have to sign off on that, with a waiver. Depending upon where you live, a spouse may be entitled to half of the assets in an IRA, even if other beneficiaries are listed, unless there is written consent.

Reference: The Street (June 12, 2020) “Why You Should Add Beneficiaries to Your Investment Accounts Now”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys