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 Is “Income in Respect of Decedent?” – Annapolis and Towson Estate Planning

One of the tasks required after a person’s death is to pay taxes on their entire estate and often for the last year of their life. Most people know this, but not everyone knows taxes are also due on any income received after a person has died. Known as “Income In Respect Of A Decedent” or “IRD,” this kind of income has its own tax rules and they may be complex, says Yahoo! Finance in a recent article simply titled “Income in Respect of a Decedent (IRD).”

Income in respect of a decedent is any income received after a person has died but not included in their final tax return. When the executor begins working on a decedent’s personal finances, things could become challenging, especially if the person owned a business, had many bank and investment accounts, or if they were unorganized.

What kinds of funds are considered IRDs?

  • Uncollected salary, wages, bonuses, commissions and vacation or sick pay.
  • Stock options exercised
  • Taxable distributions from retirement accounts
  • Distributions from deferred compensation
  • Bank account interest
  • Dividends and capital gains from investments
  • Accounts receivable paid to a small business owned by the decedent (cash basis only)

As a side note, this should serve as a reminder of how important it is to create and update a detailed list of financial accounts, investments and income streams for executors to work with to prevent possible losses.

How is IRD taxed? IRD is income that would have been included in the decedent’s tax returns, if they were still living but was not included in the final tax return. Where the IRD is reported depends upon who receives the income. If it is paid to the estate, it needs to be included on the fiduciary return. However, if IRD is paid directly to a beneficiary, then the beneficiary needs to include it in their own tax return.

If estate taxes are paid on the IRD, tax law does allow for an income tax deduction for estate taxes paid on the income. If the executor or beneficiaries missed the IRD, an estate planning attorney will be able to help amend tax returns to claim it.

Retirement accounts are also impacted by IRD. Required Minimum Distributions (RMDs) must be taken from IRA, 401(k) and similar accounts as owners age. The RMDs for the year a person passes are also included in their estate. The combination of estate taxes and income taxes on taxable retirement accounts can reduce the size of the estate, and therefore, inheritances. Tax law allows for the deduction of estate taxes related to amounts reported as IRD to reduce the impact of this “double taxation.”

Reference: Yahoo! Finance (Oct. 6, 2021) “Income in Respect of a Decedent (IRD)”

 

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

Make the Most of a Roth IRA, Even If You’re Not Ultra-Wealthy – Annapolis and Towson Estate Planning

While it may seem like only the ultra-wealthy benefit from a Roth IRA, this retirement tool is an excellent tax shelter that anyone can use, reports CNBC.com in the recent article “The ultra-wealthy have made full use of Roth individual retirement accounts. Here’s how you can do the same.” One of PayPal’s founders, Peter Thiel, had $5 billion in a Roth IRA as of 2019, according to a ProPublica report. It said that he used a self-directed Roth account, which allows the owner to hold alternative assets, like shares in a private company or real estate that generally cannot be placed in a regular Roth.

Traditional 401(k) plans and IRAs offer a tax break, when contributions are made. Taxes are paid upon withdrawal, which is supposed to happen only after a certain age when you have retired. By contrast, the Roth versions of the 401(k) and IRA do not have the tax break up front—you have to pay taxes on the money or assets when making contributions—but there are no taxes paid upon withdrawal, and there are no required withdrawals, as there are with traditional IRAs and 401(k)s.

You pay income taxes on the money placed into the account, and then it grows tax free. You can take it out anytime, as long as the account has been owned for at least five years and you are age 59½ or older. Self-directed Roth IRAs permit tax-free growth and untaxed distributions plus investments can be made that are not available in regular Roth accounts.

Theil had private company shares in his self-directed Roth IRA, before PayPal was a publicly traded company. He benefited from both timing and savvy investment skills.

Self-directed IRAs are generally available only through specialized custodians. Brand-name financial companies do not offer them. The custodians that hold self-directed IRAs do not manage the account or police what investments are placed into the accounts, so you will need the advice of a tax-savvy estate planning attorney to be sure you are following the rules. Note that there can also be valuation issues. The value of alternative assets is not as clear as publicly traded securities. You will need to get the value right, so you do not break any tax laws. Once assets are in the account, you can sell them and use the proceeds to purchase other instruments in the account, all under the same tax-free Roth protection.

Even if you do not use a self-directed Roth IRA, the standard Roth IRA yields many benefits. We do not know what the future tax environment will be, but tax-free withdrawals in the future, combined with high-growth assets, make the Roth IRA a good choice for retirement nest eggs.

Reference: CNBC.com (June 24, 2021) “The ultra-wealthy have made full use of Roth individual retirement accounts. Here’s how you can do the same”

 

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

What is not Covered by a Will? – Annapolis and Towson Estate Planning

A Last Will and Testament is one part of a holistic estate plan used to direct the distribution of property after a person has died.  A recent article titled “What you can’t do with a will” from Ponte Vedra Recorder explains how Wills work, and the types of property not distributed through a Will.

Wills are used to inform the probate court regarding your choice of Guardians for any minor children and the Executor of your estate. Without a Will, both of those decisions will be made by the court.  It is better to make those decisions yourself and to make them legally binding with a will.

Lacking a Will, an estate will be distributed according to the laws of the state, which creates extra expenses and sometimes, leads to life-long fights between family members.

Property distributed through a Will necessarily must be processed through a probate, a formal process involving a court.  However, some assets do not pass through probate.  Here is how non-probate assets are distributed:

Jointly Held Property. When one of the “joint tenants” dies, their interest in the property ends and the other joint tenant owns the entire property.

Property in Trust. Assets owned by a trust pass to the beneficiaries under the terms of the trust, with the guidance of the Trustee.

Life Insurance. Proceeds from life insurance policies are distributed directly to the named beneficiaries.  Whatever a Will says about life insurance proceeds does not matter—the beneficiary designation is what controls this distribution, unless there is no beneficiary designated.

Retirement Accounts. IRAs, 401(k) and similar assets pass to named beneficiaries.  In most cases, under federal law, the surviving spouse is the automatic beneficiary of a 401(k), although there are always exceptions.  The owner of an IRA may name a preferred beneficiary.

Transfer on Death (TOD) Accounts. Some investment accounts have the ability to name a designated beneficiary who receives the assets upon the death of the original owner.  They transfer outside of probate.

Here are some things that should NOT be included in your Will:

Funeral instructions might not be read until days or even weeks after death. Create a separate letter of instructions and make sure family members know where it is.

Provisions for a special needs family member need to be made separately from a Will.  A special needs trust is used to ensure that the family member can inherit assets but does not become ineligible for government benefits.  Talk to an elder law estate planning attorney about how this is best handled.

Conditions on gifts should not be addressed in a will. Certain conditions are not permitted by law.  If you want to control how and when assets are distributed, you want to create a trust. The trust can set conditions, like reaching a certain age or being fully employed, etc., for a Trustee to release funds.

Reference: Ponte Vedra Recorder (April 15, 2021) “What you can’t do with a will”

 

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

Estate, Business and Retirement Planning for the Farm Family – Annapolis and Towson Estate Planning

The family is at the center of most farms and agricultural businesses. Each family has its own history, values and goals. A good place to start the planning process is to take the time to reflect on the family and the farm history, says Ohio County Journal in the recent article “Whole Farm Planning.”

There are lessons to be learned from all generations, both from their successes and disappointments. The underlying values and goals for the entire family and each individual member need to be articulated. They usually remain unspoken and are evident only in how family members treat each other and make business decisions. Articulating and discussing values and goals makes the planning process far more efficient and effective.

An analysis of the current state of the farm needs to be done to determine the financial, physical and personnel status of the business. Is the farm being managed efficiently? Are there resources not being used? Is the farm profitable and are the employees contributing or creating losses? It is also wise to consider external influences, including environmental, technological, political, and governmental matters.

Five plans are needed. Once the family understands the business from the inside, it is time to create five plans for the family: business, retirement, estate, transition and investment plans. Note that none of these five stands alone. They must work in harmony to maintain the long-term life of the farm, and one bad plan will impact the others.

Most planning in farms concerns production processes, but more is needed. A comprehensive business plan helps create an action plan for production and operation practices, as well as the financial, marketing, personnel, and risk-management. One method is to conduct a SWOT analysis: Strengths, Weaknesses, Opportunities and Threats in each of the areas mentioned in the preceding sentence. Create a realistic picture of the entire farm, where it is going and how to get there.

Retirement planning is a missing ingredient for many farm families. There needs to be a strategy in place for the owners, usually the parents, so they can retire at a reasonable point. This includes determining how much money each family member needs for retirement, and the farm’s obligation to retirees. Retirement age, housing and retirement accounts, if any, need to be considered. The goal is to have the farm run profitably by the next generation, so the parent’s retirement will not adversely impact the farm.

Transition planning looks at how the business can continue for many generations. This planning requires the family to look at its current situation, consider the future and create a plan to transfer the farm to the next generation. This includes not only transferring assets, but also transferring control. Those who are retiring in the future must hand over not just the farm, but their knowledge and experience to the next generation.

Estate planning is determining and putting down on paper how the farm assets, from land and buildings to livestock, equipment and debts owed to or by the farm, will be distributed. The complexity of an agricultural business requires the help of a skilled estate planning attorney who has experience working with farm families. The estate plan must work with the transition plan. Family members who are not involved with the farm also need to be addressed: how will they be treated fairly without putting the farm operation in jeopardy?

Investment planning for farm families usually takes the shape of land, machinery and livestock. Some off-farm investments may be wise, if the families wish to save for future education or retirement needs and achieve investment diversification. These instruments may include stocks, bonds, life insurance or retirement accounts. Farmers need to consider their personal risk tolerance, tax considerations and time horizons for their investments.

Reference: Ohio County Journal (Feb. 11, 2021) “Whole Farm Planning”

 

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

Tax Planning in Your Retirement Planning – Annapolis and Towson Estate Planning

Once you are retired, the only tax you will not have to pay will be—can you guess? Yes, payroll taxes. However, there are plenty of other taxes to be paid, advises Forbes in the article that answers the question “What Taxes Will I Owe In Retirement?”

People who are accustomed to having employers handle income taxes throughout their working lives, are often surprised when they learn that not working does not mean you are not paying taxes. Income is taxable, whether you are working or not. You will not have to pay into Social Security when you retire, and Medicare becomes a premium, not a deduction from your paycheck. However, there are still taxes to be paid.

Federal income taxes range from 10 to 37 percent, depending on your income bracket and marital status. Pensions, annuities, IRA withdrawals, defined benefit plans, 457 or any other pre-tax retirement accounts will generate tax liabilities.

Is any income tax-free in retirement? Withdrawals from Roth IRAs are tax free, since you paid tax on the money before it went into these accounts. The same goes for the Roth 401(k)s.

Are there taxes on Social Security? Approximately 60% of retirees will not owe federal income taxes on Social Security benefits. However, your Social Security benefits might be taxed, depending upon your retirement income. This tax also varies depending upon where you live. Some states tax Social Security benefits, others do not. Rental income and royalties are also counted as income.

Consumer taxes. Sales tax and property taxes will still need to be paid. For many people, property taxes are their highest tax expenses.

Is there a tax on Medicare? The Medicare Surtax, also known as the Unearned Income Medicare Contribution Surtax or NIIT, is a 3.8% Medicare tax that applies to income from investments and regular income above specific thresholds. For 2020, if you have MAGI (Modified Adjusted Gross Income) above $200,000 ($250,000 for married couples filing jointly), you will have to pay NIIT. This is one that most people do not know about, and can add up quickly, especially if you have great market returns and realized gains.

With good planning, you may be able to replace 100% or more of your pre-retirement income. In many cases, it may mean paying about the same amount in taxes as you did while working. If you do a good job of saving and have a large income during retirement, you will most likely end up paying at least some taxes on retirement income. It is a good problem to have, but still a problem.

All of these retirement taxes add up to quite a nice tax bite, if you are not prepared for them. This is another example of how advance tax planning can make a big difference in the quality of your retirement.

Reference: Forbes (Feb. 23, 2020) “What Taxes Will I Owe In Retirement?”

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

Should You Move Your 401(k) to A Roth? – Annapolis and Towson Estate Planning

Overhauling the retirement savings system is the subject of considerable talk in Washington these days, with the focus on how to give an immediate boost to government tax revenues. With retirement fund accounts being measured in the trillions, it is no surprise that they are being eyed.

One of the ideas being discussed, according to the article “What ‘Rothifying’ 401(k)s Would Mean for Retirees” from The Wall Street Journal, is to repeal the current structure of pretax contributions to retirement accounts and adopt a system where contributions would come only from after-tax contributions, just as Roth IRAs do now. It also has a name, “Rothification.” It could become very popular in the not too distant future.

However, behind this need to plug the gaps in the national budget could be a dismal scenario for workers saving for retirement.

Those U.S. savers who do save money for retirement now contribute to their IRA, SEP, and other tax-deferred accounts with money that is deducted from their taxable income. They only pay taxes on this money when they take Required Minimum Distributions (RMDs) during retirement, or after age 72. The tax deferral provides a powerful incentive to save. The Investment Company Institute reports that defined contribution plans and IRAs were valued at $18.3 trillion as of the third quarter of 2019.

With a federal deficit now at more than $1 trillion and the federal debt at $23 trillion (according to the U.S. Treasury), the money has to come from somewhere. The Treasury also estimates that it will forgo $2.4 trillion in tax revenue from the nation’s tax-deferred retirement savings over the next ten years.

With Social Security having an additional $43 trillion in underfunding, according to the 2019 report of the Social Security and Medicare trustees, government funds are going to have to come from somewhere.

Under “Rothification,” savers would make their retirement fund contributions with after-tax income, and the Treasury would get its money now, rather than waiting for current workers to retire or die.

The challenge is that people do not save as much as they need to for retirement. Many of them are depending upon Social Security to cover the lion’s share of their retirement income. Removing the tax incentive for retirement saving will discourage retirement saving.

What will that mean for estate planning? Adjusting to the changes from the SECURE Act already has estate planning lawyers reviewing estate plans for the new ten-year withdrawal requirements for IRA beneficiaries. Once the “Rothification” discussions move from talk to legislation, expect large push-back from the financial services industry, which runs these accounts, now worth $18.3 trillion.

Reference: The Wall Street Journal (February 17, 2020) “What ‘Rothifying’ 401(k)s Would Mean for Retirees”

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

What Exactly Is the Estate Tax? – Annapolis and Towson Estate Planning

In the U.S., we treat the estate tax and gift tax as a single tax system with unified limits and tax rates—but it is not very well understood by many people. The Motley Fool’s recent article entitled “What Is the Estate Tax in the United States?” gives us an overview of the U.S. estate and gift tax, including what assets are included, tax rates and exemptions in 2020.

The U.S. estate tax only impacts the wealthiest households. Let us look at why that is the case. Americans can exempt a certain amount of assets from their taxable estate—the lifetime exemption. This amount is modified every year to keep pace with inflation and according to policy modifications. This year, the lifetime exemption is $11.58 million per person. Therefore, if you are married, you and your spouse can collectively exclude twice this amount from taxation ($23.16 million). To say it another way, if you are single and die in 2020 with assets worth a total of $13 million, just $1.42 million of your estate would be taxable.

However, most Americans don’t have more than $11.58 million worth of assets when they pass away. This is why the estate tax only impacts the wealthiest households in the country. It is estimated that less than 0.1% of all estates are taxable. Therefore, 99.9% of us do not owe any federal estate taxes whatsoever at death. You should also be aware that the lifetime exemption includes taxable gifts as well. If you give $1 million to your children, for example, that counts toward your lifetime exemption. As a result, the amount of assets that could be excluded from estate taxes would be then decreased by this amount at your death.

You do not have to pay any estate or gift tax until after your death, or until you have used up your entire lifetime exemption. However, if you give any major gifts throughout the year, you might have to file a gift tax return with the IRS to monitor your giving. There is also an annual gift exclusion that lets you give up to $15,000 in gifts each year without touching your lifetime exemption. There are two key points to remember:

  • The exclusion amount is per recipient. Therefore, you can give $15,000 to as many people as you want every year, and they do not even need to be a relative; and
  • The exclusion is per donor. This means that you and your spouse (if applicable) can give $15,000 apiece to as many people as you want. If you give $30,000 to your child to help her buy their first home and you’re married, you can consider half of the gift from each spouse.

The annual gift exclusion is an effective way for you to reduce or even eliminate estate tax liability. The estate tax rate is effectively 40% on all taxable estate assets.

Finally, the following kinds of assets aren’t considered part of your taxable estate:

  • Anything left to a surviving spouse, called “the unlimited marital deduction”;
  • Any amount of money or property you leave to a charity;
  • Gifts you have given that are less than the annual exclusion for the year in which they were given; and
  • Some types of trust assets.

Reference: The Motley Fool (Jan. 25, 2020) “What Is the Estate Tax in the United States?”

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

Am I Better Off Investing Earlier in My IRA? – Annapolis and Towson Estate Planning

Remember that you are able to make an IRA contribution for a given year anytime between January 1 and the tax-filing deadline of the following year (usually April 15). That means that you can make a 2020 IRA contribution between Jan’ 1, 2020, and April 15, 2021. However, do not wait. Why not?

Vanguard’s recent article entitled “IRA contributions: The earlier, the better” notes that you invest to earn money, and the amount of money you earn depends primarily on three factors—two you can control.

  1. Investment performance. There is no way to control investment performance and all investing involves risk. The main cause of risk is market movement, which impacts your investment earnings.
  2. The amount you invest. You earn your money with compounding, when your investment earnings make their own earnings. If you contribute more, you have more money to generate earnings. That means you have more earnings to generate additional earnings. You can control the amount you invest, provided you keep within the annual IRA contribution limit.
  3. Your investment timing. If you wait until April to make an IRA contribution, you have missed 15 months of compounding, so if you have the financial flexibility to decide when you contribute to your IRA, do it ASAP.

As an illustration, let us imagine that you invest $5,500 in your IRA each year for 30 years, and your average annual return is 4%. In Situation A, you make a lump-sum investment every January, and your end balance is $323,967. That includes $158,967 in earnings. In Situation B, you make a lump-sum investment every April and your end balance is $308,467. That includes $143,467 in earnings, which is $15,500 less than you would earn in the first scenario. In each situation, you are contributing a total of $165,000 to your IRA over the span of 30 years.

This illustration shows some what-if scenarios that are not always possible to do in real life. For instance, you may not be able to invest the same amount each year or have to skip a few years. However, you should make small steps toward saving 12%–15% of your gross income (including employer contributions) every year. If you do not have the financial flexibility to make a lump-sum investment in your IRA—in January or April (or in any other month as a matter of fact), try to set up recurring automatic bank transfers. If you make bi-weekly contributions over the course of 30 years (for a total contribution of $165,000) and earn a 4% average annual return, the end balance is smaller than Situation A but larger than Situation B.

However, remember that you can’t contribute more than you’ve earned for the year.

Reference: Vanguard (Jan. 21, 2020) “IRA contributions: The earlier, the better”

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

How Do I Incorporate My Business into My Estate Planning? – Annapolis and Towson Estate Planning

When people think about estate planning, many just think about their personal property and their children’s future. If you have a successful business, you may want to think about having it continue after you retire or pass away.

Forbes’ recent article entitled “Why Business Owners Should Think About Estate Planning Sooner Than Later” says that many business owners believe that estate planning and getting their affairs in order happens when they are older. While that’s true for the most part, it is only because that is the stage of life when many people begin pondering their mortality and worrying about what will happen next or what will happen when they are gone. The day-to-day concerns and running of a business is also more than enough to worry about, let alone adding one’s mortality to the worry list at the earlier stages in your life.

Business continuity is the biggest concern for entrepreneurs. This can be a touchy subject, both personally and professionally, so it is better to have this addressed while you are in charge, rather than leaving the company’s future in the hands of others who are emotionally invested in you or in your work. One option is to create a living trust and will to put in place parameters that a trustee can carry out. With these names and decisions in place, you will avoid a lot of stress and conflict for those you leave behind.

Let them be upset with you, rather than with each other. This will give them a higher probability of working things out amicably at your death. The smart move is to create a business succession plan that names successor trustees to be in charge of operating the business, if you become incapacitated or die.

A power of attorney document will nominate a fiduciary agent to act on your behalf, if you become incapacitated, but you should also ask your estate planning attorney about creating a trust to provide for the seamless transition of your business at your death to your successor trustees. The transfer of the company to your trust will avoid the hassle of probate and will ensure that your business assets are passed on to your chosen beneficiaries. Timely planning will also preserve your business assets, as advanced tax planning strategies might be implemented to establish specific trusts to minimize the estate tax.

Estate planning may not be on tomorrow’s to do list for young entrepreneurs and business owners. Nonetheless, it is vital to plan for all that life may bring.

Reference: Forbes (Dec. 30, 2019) “Why Business Owners Should Think About Estate Planning Sooner Than Later”

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