Should I Have a Roth IRA? – Annapolis and Towson Estate Planning

Roth IRAs are powerful retirement savings tools. Account owners are allowed to take tax-free distributions in retirement and can avoid paying taxes on investment growth. There is little downside to a Roth IRA, according to a recent article “10 Reasons to Save for Retirement in a Roth IRA” from U.S. News & World Report.

Taxes are paid in advance on a Roth IRA. Therefore, if you are in a low tax bracket now and may be in a higher bracket later, or if tax rates increase, you have already paid those taxes. Another plus: all your Roth IRA funds are available to you in retirement, unlike a traditional IRA when you have to pay income tax on every withdrawal.

Roth IRA distributions taken after age 59 ½ from accounts at least five years old are tax free. Every withdrawal taken from a traditional IRA is treated like income and, like income, is subject to taxes.

When comparing the two, compare your current tax rate to what you expect your tax rate to be once you have retired. You can also save in both types of accounts in the same year, if you are not sure about future tax rates.

Roth IRA accounts also let you keep investment gains, because you don’t pay income tax on investment gains or earned interest.

Roth IRAs have greater flexibility. Traditional IRA account owners are required to take Required Minimum Distributions (RMDs) from an IRA every year after age 72. If you forget to take a distribution, there is a 50% tax penalty. You also have to pay taxes on the withdrawal. Roth IRAs have no withdrawal requirements during the lifetime of the original owner. Take what you need, when you need, if you need.

Roth IRAs are also more flexible before retirement. If you are under age 59 ½ and take an early withdrawal, it will cost you a 10% early withdrawal penalty plus income tax. Roth early withdrawals also trigger a 10% penalty and income tax, but only on the portion of the withdrawal from investment earnings.

If your goal is to leave IRA money for heirs, Roth IRAs also have advantages. A traditional IRA account requires beneficiaries to pay taxes on any money left to them in a traditional 401(k) or IRA. However, those who inherit a Roth IRA can take tax-free withdrawals. Heirs have to take withdrawals. However, the distributions are less likely to create expensive tax situations.

Retirement savers can contribute up to $6,000 in a Roth IRA in 2022. Age 50 and up? You can make an additional $1,000 catch up contribution for a total Roth IRA contribution of $7,000.

If this sounds attractive but you have been using a traditional IRA, a Roth conversion is your next step. However, you will have to pay the income taxes on the amount converted. Try to make the conversion in a year when you are in a lower tax bracket. You could also convert a small amount every year to maintain control over taxes.

Reference: U.S. News & World Report (April 11, 2022) “10 Reasons to Save for Retirement in a Roth IRA”

 

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

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

Sometimes as individuals and families increase in wealth, they want to give more to charities.

Some charitable donations may be tax deductible or be able to reduce tax liabilities. Let’s look at some suggestions if you decide you want to make charitable donations, according to WMUR’s recent article entitled “Money Matters: Considerations when making charitable gifts.”

First, it might be the time to establish a giving plan. The first step is to decide how much your family wants to give. When researching a charity, look at how the contributions will be used. Charity Navigator, a charity assessment organization, has a site to help you get started at charitynavigator.org. Each charity has a rating with additional information.

Besides annual giving, charitable giving can play a role in estate planning. Your estate planning documents can state these wishes, and sometimes, giving can reduce estate taxes. The federal government taxes wealth transfers during life and at death. Currently, these types of taxes are imposed on lifetime transfers exceeding $12.06 million per spouse at a top rate of 40%. States may also impose these types of taxes. Ask an experienced estate planning attorney about it.

To give to charity, you could include a bequest in your will or trust. Another option is to name a charity as a beneficiary on life insurance policies. Retirement plans such as IRAs, 401(k)s, and 403(b)s may also have a charity listed as beneficiary. If these plans are tax-deferred, then an advantage to using them to make charitable gifts is that a charity can get money tax-free that would otherwise be taxed.

You might also ask an estate planning attorney about a charitable lead or a charitable remainder trust.

Another option for giving is to use donor-advised funds, which gives the donor the tax benefit for making the gift all in one year but the option to make the actual gift later on.

A donor-advised fund is particularly useful for taxpayers who itemize deductions. This is an agreement between the donor and a host organization, which then becomes the legal owner of the assets.

You can tell the fund how to invest the contribution and how the money is disbursed. The fund controls the assets but usually will honor the donor’s requests.

Finally, you could set up a private family foundation. These are more complex but give you and your family control over the investment and distribution of the money. They work best when a significant amount of money is involved.

Reference: WMUR (Dec. 30, 2021) “Money Matters: Considerations when making charitable gifts”

 

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Is a Bypass Trust Necessary? – Annapolis and Towson Estate Planning

A bypass trust removes a designated portion of an IRA or 401(k) proceeds from the surviving spouse’s taxable estate, while also achieving several tax benefits, according to a recent article titled “New Purposes for ‘Bypass’ Trusts in Estate Planning” from Financial Advisor.

Portability became law in 2013, when Congress permanently passed the portability election for assets passing outright to the surviving spouse when the first spouse dies. This allows the survivor to benefit from the unused federal estate tax exemption of the deceased spouse, thereby claiming two estate tax exemptions. Why would a couple need a bypass trust in their estate plan?

  • The portability election does not remove appreciation in the value of the ported assets from the surviving spouse’s taxable estate. A bypass trust removes all appreciation.
  • The portability election does not apply if the surviving spouse remarries, and the new spouse predeceases the surviving spouse. Remarriage does not impact a bypass trust.
  • The portability election does not apply to federal generation skipping transfer taxes. The amount could be subject to a federal transfer tax in the heir’s estates, including any appreciation in value.
  • If the decedent had debts or liability issues, ported assets do not have the protection against claims and lawsuits offered by a bypass trust.
  • The first spouse to die loses the ability to determine where the ported assets go after the death of the surviving spouse. This is particularly important when there are children from multiple marriages and parents want to ensure their children receive an inheritance.

This strategy should be reviewed in light of the SECURE Act 10-year maximum payout rule, since the outright payment of IRA and 401(k) plan proceeds to a surviving spouse is entitled to spousal rollover treatment and generally a greater income tax deferral.

Bypass trusts are also subject to the highest federal income tax rate at levels of gross income of as low as $13,550, and they do not qualify for income tax basis step-up at the death of the surviving spouse.

However, the use of IRC Section 678 in creating the bypass trust can eliminate the high trust income tax rates and the minimum exemption, also under Section 678, so the trust is not taxed the way a surviving spouse would be. There is also the potential to include a conditional general testamentary power of appointment in the trust, which can sometimes result in income tax basis step-up for all or a portion of the appreciated assets in the trust upon the death of the surviving spouse.

Every estate planning situation is unique, and these decisions should only be made after consideration of the size of the IRA or 401(k) plan, the tax situation of the surviving spouse and the tax situation of the heirs. An experienced estate planning attorney is needed to review each situation to determine whether or not a bypass trust is the best option for the couple and the family.

Reference: Financial Advisor (Feb. 1, 2022) “New Purposes for ‘Bypass’ Trusts in Estate Planning”

 

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What Assets Should Be Considered when Planning Estate? – Annapolis and Towson Estate Planning

The numbers of Americans who have a formal estate plan is still less than 50%. This number has not changed much over the decade. However, the assets owned have become a lot more complicated, according to a recent article from CNBC titled “What happens to your digital assets and cryptocurrency when you die? Even with a will, they may be overlooked.”

Airline miles and credit card points, social media accounts and cryptocurrencies are different types of assets to be passed on to heirs. For those who do have an estate plan, the focus is probably on traditional assets, like their home, 401(k)s, IRAs and bank accounts. However, we own so much more today.

Start with an inventory. For digital assets, include photos, videos, hardware, software, devices, and websites, to name a few. Make sure someone you trust has the unlock code for your phone, laptop and desktop. Use a secure password manager or a notebook, whatever you are more comfortable with, and share the information with a trusted person.

You will also need to include what you want to happen to the digital asset. Some platforms will let owners name a legacy contact to handle the account when they die and what the owner wants to happen to the data, photos, videos, etc. Some platforms have not yet addressed this issue at all.

If an online business generates income, what do you want to happen to the business? If you want the business to continue, who will own the business, who will run the business and receive the income? All of this has to be made clear and documented properly.

Failing to create a digital asset plan puts those assets at risk. For cryptocurrency and nonfungible tokens (NFTs), this has become a routine problem. Unlike traditional financial accounts, there are no paper statements, and your executor cannot simply contact the institution with a death certificate and a Power of Attorney and move funds.

Another often overlooked part of an estate are pets. Assets cannot be left directly to pets. However, most states allow pet trusts, where owners can fund a trust and designate a trustee and a caretaker. Make sure to fund the account once it has been created, so your beloved companion will be cared for as you want. An informal agreement is not enforceable, and your pet may end up in a shelter or abandoned.

Sentimental possessions also need to be planned for. Your great-grandmother’s soup tureen may be available for $20 on eBay, but it is not the same as the one she actually used and taught her daughter and her granddaughter how to use. The same goes for more valuable items, like jewelry or artwork. Identifying who gets what while you are living, can help prevent family quarrels when you are gone. In some families, there will be quarrels unless the items are in the will. Another option: distribute these items while you are living.

If you can, it is also a good idea and a gift to your loved ones to write down what you want in the way of a funeral or memorial service. Do they want to be buried, or cremated? Do they want a religious service in a house of worship, or a simple graveside service?

If you are among those who have a will, you probably need it to be reviewed. If you do not have a will or a comprehensive estate plan, you should meet with an experienced estate planning attorney to address distribution of assets, planning for incapacity and preparing for the often overlooked aspects of your life. You will have the comfort of expressing your wishes and your loved ones will be grateful.

Reference: CNBC (Jan. 18, 2022) “What happens to your digital assets and cryptocurrency when you die? Even with a will, they may be overlooked”

 

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What’s the Best Way to Mess Up Estate Plan? – Annapolis and Towson Estate Planning

Forbes’ recent article entitled “5 Ways People Mess Up Their Estate Plan” describes the most common mistakes people make that wreak havoc with their estate plans.

Giving money to an individual during life, but not changing their will. Cash gifts in a will are common. However, the will often is not changed. When the will gets probated, the individual named still gets the gift (or an additional gift). No one—including the probate court knows the gift was satisfied during life. As a result, a person may get double.

Not enough assets to fund their trust. If you created a trust years ago, and your overall assets have decreased in value, you should be certain there are sufficient assets going into your trust to pay all the gifts. Some people create elaborate estate plans to give cash gifts to friends and family and create trusts for others. However, if you do not have enough money in your trust to pay for all of these gifts, some people will get short changed, or get nothing at all.

Assuming all assets pass under the will. Some people think they have enough money to satisfy all the gifts in their will because they total up all their assets and arrive at a large enough amount. However, not all the assets will come into the will. Probate assets pass from the deceased person’s name to their estate and get distributed according to the will. However, non-probate assets pass outside the will to someone else, often by beneficiary designation or joint ownership. Understand the difference so you know how much money will actually be in the estate to be distributed in accordance with the will.  Do not forget to deduct debts, expenses and taxes.

Adding a joint owner. If you want someone to have an asset when you die, like real estate, you can add them as a joint owner. However, if your will is dependent on that asset coming into your estate to pay other people (or to pay debts, expenses or taxes), there could be an issue after you die. Adding joint owners often leads to will contests and prolonged court battles. Talk to an experienced estate planning attorney.

Changing beneficiary designations. Changing your beneficiary on a life insurance policy could present another issue. The policy may have been payable to your trust to pay bequests, shelter monies from estate taxes, or pay estate taxes. If it is paid to someone else, your planning could be down the drain. Likewise, if you have a retirement account that was supposed to be payable to an individual and you change the beneficiary to your trust, there could be adverse income tax consequences.

Talk to your estate planning attorney and review your estate plan, your assets and your beneficiary designations. Do not make these common mistakes!

Reference: Forbes (Oct. 26, 2021) “5 Ways People Mess Up Their Estate Plan”

 

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What Happens If I Take a Bigger RMD? – Annapolis and Towson Estate Planning

Once you celebrate your 72nd birthday, the IRS requires you to take a minimum amount from IRAs or other tax-deferred retirement accounts. Most people take the minimum, says a recent article from Kiplinger titled “Should You Take an Extra Big RMD This Year?” However, taking the minimum is not always the right strategy.

Looking at the broader picture might lead you to go bigger with your RMDs. For example, Bill and Betty are ages 75 and 71. Bill has an IRA worth $850,000. Their retirement income consists of a pension totaling $34,000, dividends of $8,000 and combined Social Security benefits of $77,000. Bob’s 2021 IRA RMD is $37,118. Using the standard deduction of $28,100 (for a married couple where both are over age 65 plus a $300 charitable contribution deduction), their taxable income is $116,468. Federal taxes are $16,560.

Bill and Betty could recognize another $65,000 of ordinary income from his IRA before they land in the 24% tax bracket. In 2022, Betty will have to start taking RMDs on her IRA—did we mention that her IRA is worth $1.5 million?—which will bump them into the 24% tax bracket. Bill should take another $64,000 from his IRA, filing up the 22% ordinary income bracket and reducing his RMD for 2022.

Another example: Alan Smithers is 81 and remarried ten years after his first wife passed. His IRA is worth $1.3 million, and his daughter is the beneficiary. His IRA RMD is $66,000 and he intends to be generous with charity this year, using about $30,000 for a Qualified Charitable Distribution (QCS). Based on a projection of his 2021 tax return, Alan could take another $22,000 from his IRA, taxable at 12%. His daughter Daphne is 51, has a high income and significant assets. He should consider filling up his own 12% marginal ordinary income bracket, because when Daphne starts taking her own beneficiary distributions, she will be facing high taxes.

Here is what you need to consider when making RMD decisions:

Your tax bracket. How much more income can you realize while staying within your current tax bracket? Taxpayers in the 10-12% brackets should be extra careful of maxing out on ordinary income.

Your income. What does 2022 look like for your income? Will there be other sources of income, such as an inherited IRA, spouse’s IRA RMD, or annuity income to be considered?

Beneficiaries. How does your own tax rate compare with the tax rates of your beneficiaries? If you have a large IRA and your children have high incomes, could an inheritance push them into a higher tax bracket?

Medicare Premiums. Increases in income can lead to higher Medicare Part B and D premiums in coming years, so also keep that in mind.

It is best to take the broader view when planning for RMDs and taxes. A short-sighted approach could end up being more costly for you and your heirs.

Reference: Kiplinger (Nov. 23, 2021) “Should You Take an Extra Big RMD This Year?”

 

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How Much can You Inherit and Not Pay Taxes? – Annapolis and Towson Estate Planning

Even with the new proposed rules from Biden’s lowered exemption, estates under $6 million will not have to worry about federal estate taxes for a few years—although state estate tax exemptions may be lower. However, what about inheritances and what about inherited IRAs? This is explored in a recent article titled “Minimizing Taxes When You Inherit Money” from Kiplinger.

If you inherit an IRA from a parent, taxes on required withdrawals could leave you with a far smaller legacy than you anticipated. For many couples, IRAs are the largest assets passed to the next generation. In some cases they may be worth more than the family home. Americans held more than $13 trillion in IRAs in the second quarter of 2021. Many of you reading this are likely to inherit an IRA.

Before the SECURE Act changed how IRAs are distributed, people who inherited IRAs and other tax-deferred accounts transferred their assets into a beneficiary IRA account and took withdrawals over their life expectancy. This allowed money to continue to grow tax free for decades. Withdrawals were taxed as ordinary income.

The SECURE Act made it mandatory for anyone who inherited an IRA (with some exceptions) to decide between two options: take the money in a lump sum and lose a huge part of it to taxes or transfer the money to an inherited or beneficiary IRA and deplete it within ten years of the date of death of the original owner.

The exceptions are a surviving spouse, who may roll the money into their own IRA and allow it to grow, tax deferred, until they reach age 72, when they need to start taking Required Minimum Distributions (RMDs). If the IRA was a Roth, there are no RMDs, and any withdrawals are tax free. The surviving spouse can also transfer money into an inherited IRA and take distributions on their life expectancy.

If you are not eligible for the exceptions, any IRA you inherit will come with a big tax bill. If the inherited IRA is a Roth, you still have to empty it out in ten years. However, there are no taxes due as long as the Roth was funded at least five years before the original owner died.

Rushing to cash out an inherited IRA will slash the value of the IRA significantly because of the taxes due on the IRA. You might find yourself bumped up into a higher tax bracket. It is generally better to transfer the money to an inherited IRA to spread distributions out over a ten-year period.

The rules do not require you to empty the account in any particular order. Therefore, you could conceivably wait ten years and then empty the account. However, you will then have a huge tax bill.

Other assets are less constrained, at least as far as taxes go. Real estate and investment accounts benefit from the step-up in cost basis. Let us say your mother paid $50 for a share of stock and it was worth $250 on the day she died. Your “basis” would be $250. If you sell the stock immediately, you will not owe any taxes. If you hold onto to it, you will only owe taxes (or claim a loss) on the difference between $250 and the sale price. Proposals to curb the step-up have been bandied about for years. However, to date they have not succeeded.

The step-up in basis also applies to the family home and other inherited property. If you keep inherited investments or property, you will owe taxes on the difference between the value of the assets on the day of the original owner’s death and the day you sell.

Estate planning and tax planning should go hand-in-hand. If you are expecting a significant inheritance, a conversation with aging parents may be helpful to protect the family’s assets and preclude any expensive surprises.

Reference: Kiplinger (Oct. 29, 2021) “Minimizing Taxes When You Inherit Money”

 

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

What Do I Do with Estate Plan after Divorce? – Annapolis and Towson Estate Planning

If you forget to update your will after a divorce, you risk your assets being distributed to your ex-spouse when you pass away.

Investopedia’s recent article “Here’s what you need to remove and add to your will when your marriage is over,” says that many states have laws that, after a divorce, automatically revoke gifts to a former spouse listed in a will. There are states that also revoke gifts to family members of a former spouse. If you are in a state that has such a law, gifts to former stepchildren would also be revoked after your divorce.

Most married people leave everything in their will to their surviving spouse. If that is the way that your will currently reads, be certain that you change your ex as a beneficiary and add a new beneficiary. Remember that many types of assets are passed outside of a will, such as life insurance, 401k’s and other investments. Therefore, you must change the beneficiary designation on those documents.

Property Transfers. Update your will for any property gained or lost during the divorce. If you have assets that are specifically identified in your will, be sure to update them for any changes that may have happened because of the divorce.

The Executor of your Will. If your ex-spouse is named in your will as your executor, you should change this.

A Guardian for Minor Children. If you have children with your ex-spouse, you will want to update your will to appoint a guardian, if you and your ex-spouse pass expectantly at the same time. If you die, your children will likely be raised by your ex-spouse.

The Best Way to Change Your Will After Divorce. It is easy: tear up your old will (literally) and begin again because you probably left everything or almost everything to your spouse in your original will. Just because you are legally married until a judge signs a divorce decree, you can still modify your will or estate plan at any time. Ask an estate planning attorney because there are some actions you cannot take until the divorce is final.

Can an Ex Challenge Your Will? An ex-spouse or even ex-de facto partner can challenge the will of a former spouse or partner. Whether the challenge will be successful will depend on the court’s interpretation of a number of factors.

Reference: Investopedia (Sep. 14, 2021) “Here’s what you need to remove and add to your will when your marriage is over”

 

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What a Will Won’t Accomplish – Annapolis and Towson Estate Planning

Everyone needs a will. A last will and testament is how an executor is named to manage your estate, how a guardian is named to care for any minor children and how you give directions for distribution of property. However, not all property passes via your will. You will want to know what a will can and cannot do, as well as how assets are distributed outside of a will. This was the topic of “The Legal Limits of Your Will” from AARP Magazine.

Retirement and Pension Accounts

The beneficiaries named on retirement accounts, including 401(k)s, pensions, and IRAs, receive these assets directly. Some states have laws about requiring spouses to receive some or all assets. However, if you do not keep these beneficiary names updated, the wrong person may receive the asset, like it or not. Do not expect anyone to willingly give up a surprise windfall. If a primary beneficiary has died and no contingency beneficiary was named, the recipient may also be determined by default terms, which may not be what you have in mind.

Life Insurance Policies.

The beneficiary designations on an insurance policy determine who will receive proceeds upon your death. Laws vary by state, so check with an estate planning attorney to learn what would happen if you died without updating life insurance policies. A simpler strategy is to create a list of all of your financial accounts, determine how they are distributed and update names as necessary.

Note there are exceptions to all rules. If your divorce agreement includes a provision naming your ex as the sole beneficiary, you may not have an option to make a change.

Financial Accounts

Adding another person to your bank account through various means—Payable on Death (POD), Transfer on Death (TOD), or Joint Tenancy with Right of Survivorship (JTWROS)—may generally override a will, but may not be acceptable for all accounts, or to all financial institutions. There are unanticipated consequences of transferring assets this way, including the simplest: once transferred, assets are immediately vulnerable to creditors, divorce proceedings, etc.

Trusts

Trusts are used in estate planning to remove assets from a personal estate and place them in safekeeping for beneficiaries. Once the assets are properly transferred into the trust, their distribution and use are defined by the trust document. The flexibility and variety of trusts makes this a key estate planning tool, regardless of the value of the assets in the estate.

Reference: AARP Magazine (Sep. 29, 2021) “The Legal Limits of Your Will”

 

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Before They’re Gone—Estate Planning Strategies – Annapolis and Towson Estate Planning

As Congress continues to hammer out the details on impending legislation, there are certain laws still in effect concerning estate planning. The article “Last Call for SLATs, GTRATs, and the Use of the Enhanced Gift Tax Exemption?” from Mondaq says now is the time to review and update your estate plan, just in case any beneficial strategies may disappear by year’s end.

Here are the top five estate planning items to consider:

Expect Exemptions to Take a Dive. Estate, gift, and generation-skipping transfer tax exemptions are $11.7 million per person and are now scheduled to increase by an inflationary indexed amount through 2025. Even if there are no legislative changes, on January 1, 2026, this number drops to $5 million, indexed for inflation. Under proposed legislation, it will revert to $6,020,000 and will continue to be indexed for inflation. This is a “use it or lose it” exemption.

Married Couples Have Options Different Than Solos. Married persons who do not want to gift large amounts to descendants have the option to gift the exemption amount to their spouse using a SLAT—Spousal Lifetime Access Trust. The spouses can both create these trusts for each other, but the IRS is watching, so certain precautions must be taken. The trusts should not be identical in nature and should not be created at the same time to avoid application of the “reciprocal trust” doctrine, which would render both trusts moot. Under proposed legislation, SLATs will be includable in your estate at death, but SLATs created and funded before the legislation is enacted will be grandfathered in. If this is something of interest, do not delay.

GRATs and other Grantor Trusts May be Gone. They simply will not be of any use, since proposed legislation has them includable in your estate at death. Existing GRATs and other grantor trusts will be grandfathered in from the new rules. Again, if this is of interest, the time to act is now.

IRA Rules May Change. People who own Individual Retirement Accounts with values above $10 million, combined with income of more than $450,000, may not be able to make contributions to traditional IRAs, Roth IRAs, and defined contribution plans under the proposed legislation. Individuals with large IRA balances may be required to withdraw funds from retirement plans, regardless of age. A minimum distribution may be an amount equal to 50% of the amount by which the combined IRA value is higher than the $10 million threshold.

Rules Change for Singles Too. A single person who does not want to make a large gift and lose control and access may create and gift an exemption amount to a trust in a jurisdiction with “domestic asset protection trust” legislation and still be a beneficiary of such a trust. This trust must be fully funded before the new legislation is enacted, since once the law passes, such a trust will be includable in the person’s estate. Check with your estate planning attorney to see if your state allows this strategy.

Reference: Mondaq (Sep. 24. 2021) “Last Call for SLATs, GTRATs, and the Use of the Enhanced Gift Tax Exemption?”

 

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