EHDH Estate Planning

What Can I Do Instead of a Stretch IRA?

The idea of leaving a large inheritance to loved ones is a dream for some parents. However, without careful planning, heirs may end up with a large tax bill. When Congress passed the SECURE Act in December 2019, one of the changes was the end of the stretch IRA, as reported by Kiplinger in a recent article titled “Getting Around the Stretch IRA Block.”

Before the SECURE Act, people who inherited traditional IRAs needed to only take a minimum distribution annually, based on their own life expectancy. The money could grow tax-deferred for the rest of their lives. The tax impact was mild, because withdrawals could be spread out over many years, giving the new owner control over their taxable income. The rules were the same for an inherited Roth IRA. Distributions were based on the heirs’ life expectancy. Roth IRA heirs had the added benefit of not having to pay taxes on withdrawals, since Roth IRAs are funded with post-tax dollars.

After the SECURE Act, inherited traditional and Roth IRAs need to be emptied within ten years. Heirs can wait until the 10th year and empty the account all at once—and end up with a whopping tax bill—or take it out incrementally. However, it has to be emptied within ten years.

There are some exceptions: spouses, disabled or chronically ill individuals, or those who are not more than ten years younger than the original owner can stretch out the distribution of the IRA funds. If an underage minor inherits a traditional IRA, they can stretch it until they reach legal age. At that point, they have to withdraw all the funds in ten years—from age 18 to 28. This may not be the best time for a young person to have access to a large inheritance.

These changes have left many IRA owners looking for alternative ways to leave inheritances and find a work-around for their IRAs to protect their heirs from losing their inheritance to taxes or getting their inheritance at a young age.

For many, the solution is converting their traditional IRA to a Roth, where the IRA owner pays the taxes for their heirs. The strategy is generous and may be more tax efficient if the conversion is done during a time in retirement when the IRA owner’s income is lower, and they may be in a lower tax bracket. The average person receiving an IRA inheritance is around 50, typically peak earning years and the worst time to inherit a taxable asset.

Another way to avoid the stretch IRA is life insurance. Distributions from the IRA can be used to pay premiums on a life insurance policy, with beneficiaries receiving death benefits. The proceeds from the policy are tax-free, although the proceeds are considered part of the policy owner’s estate. With the current federal exemption at $12.06 million for individuals, the state estate tax is the only thing most people will need to worry about.

A Charitable Remainder Trust can also be used to mimic a stretch IRA. A CRT is an irrevocable split-interest trust, providing income to the grantor and designated beneficiaries for up to twenty years or the lifetime of the beneficiaries. Any remaining assets are donated to charity, which must receive at least 10% of the trust’s initial value. If the CRT is named as the IRA beneficiary, the IRA funds are distributed to the CRT upon the owner’s death and the estate gets a charitable estate tax deduction (and not an income tax deduction) for the portion expected to go to the charity. Assets grow within the charitable trust, which pays out a set percentage to beneficiaries each year. The distributions are taxable income for the beneficiaries. There are two types of CRTs: Charitable Remainder Unitrust and a Charitable Remainder Annuity Trust. An estate planning attorney will know which one is best suited for your family.

Reference: Kiplinger (March 3, 2022) “Getting Around the Stretch IRA Block”

How Does a Charitable Trust Help with Estate Planning?

Simply put, a charitable trust holds assets and distributes assets to charitable organizations. The person who creates the trust, the grantor, decides how the trust will manage and invest assets, as well as how and when donations are made, as described in the article “How a Charitable Trust Works” from yahoo! finance. An experienced estate planning attorney can help you create a charitable trust to achieve your estate planning goals and create tax-savings opportunities.

Any trust is a legal entity, legally separate from you, even if you are the grantor and a trustee. The trust owns its assets, pays taxes and requires management. The charitable trust is created with the specific goal of charitable giving, during and after your lifetime. Many people use charitable trusts to create ongoing gifts, since this type of trust grows and continues to make donations over extended periods of time.

Sometimes charitable trusts are used to manage real estate or other types of property. Let’s say you have a home you’d like to see used as a community resource after you die. A charitable trust would be set up and the home placed in it. Upon your death, the home would transfer to the charitable organization you’ve named in the trust. The terms of the trust will direct how the home is to be used. Bear in mind while this is possible, most charities prefer to receive cash or stock assets, rather than real estate.

The IRS defines a charitable trust as a non-exempt trust, where all of the unexpired interests are dedicated to one or more charitable purposes, and for which a charitable contribution deduction is allowed under a specific section of the Internal Revenue Code. The charitable trust is treated like a private foundation, unless it meets the requirements for one of the exclusions making it a public charity.

There are two main kinds of charitable trusts. One is a Charitable Remainder Trust, used mostly to make distributions to the grantor or other beneficiaries. After distributions are made, any remaining funds are donated to charity. The CRT may distribute its principal, income, or both. You could also set up a CRT to invest and manage money and distribute only earnings from the investments. A CRT can also be set up to distribute all holdings over time, eventually emptying all accounts. The CRT is typically used to distribute proceeds of investments to named beneficiaries, then distribute its principal to charity after a certain number of years.

The Charitable Lead Trust (CLT) distributes assets to charity for a defined amount of time, and at the end of the term, any remaining assets are distributed to beneficiaries. The grantor may be included as one of the trust’s beneficiaries, known as a “Reversionary Trust.”

All Charitable Trusts are irrevocable, so assets may not be taken back by the grantor. To qualify, the trust may only donate to charities recognized by the IRS.

An estate planning attorney will know how to structure the charitable trust to maximize its tax-savings potential. Depending upon how it is structured, a CT can also impact capital gains taxes.

Reference: yahoo! finance (Dec. 16, 2021) “How a Charitable Trust Works”

When Should You Use a Charitable Remainder Trust in Estate Planning?

Rising prices for investments and real estate is making owners of these assets concerned about paying exorbitant taxes amid discussions of possible changes in the near future. According to a recent article from The Street titled “Retirement Saving and Charitable Remainder Trusts,” having a strategy on hand to prepare for or even avoid these taxes is a wise move.

People who are charitably inclined may want to take a closer look at how Charitable Remainder Trusts, or CRTs, can potentially reduce taxes and provide a generous gift to worthy charities.

There are two basic types of CRTs: the Charitable Remainder UniTrust, or CRUT, and the Charitable Remainder Annuity Trust, or CRAT. In both types of trusts, the charity receives the “remainder” of the principal once the income interest ends. Income from the trust is given to a non-charity beneficiary for a certain period of time, or as in many cases, for the entire life of the beneficiary until it’s time for the remainder principal to be donated.

The key difference between the CRAT and the CRUT are how the income payment is calculated. In a CRUT with a 5% payout, the 5% is based on the value of the CRUT each and every year. Obviously that payment amount fluctuates according to the performance of the assets held by the CRUT. In a CRAT, payments are fixed based on in the initial contribution made to set up the account. Your estate planning attorney will be able to recommend the right vehicle for you and your family.

A CRT may be funded with highly appreciated assets because selling within the CRT results in no capital gains to the donor. Any proceeds may be reinvested to generate the needed income, while at the same time potentially growing the remainder asset for charity.

An administrator is hired to evaluate the trust to ensure its compliance, and the administrator’s role is to advise the trustee on the amount of the distribution annually to the beneficiary.

Since the charity is the remainder beneficiary, the grantor is not able to deduct the entire amount of the contribution to the CRT. The deduction is determined by the income payments selected and the terms of the CRT. There are software programs used to calculate the approximate deduction based on the input. The higher the income payment, the lower the deduction.

Note that if you are giving highly appreciated long-term capital gains assets, only 30% of the adjusted gross income can be given. The rest may be carried forward for five years. This should be considered when determining how much to contribute to the CRT.

The choice of CRTs lets you design a desired income stream from the trust. The taxability of the CRT is based on the types of assets used. There are four tiers, as defined by the IRS: ordinary income (which includes current year and accumulated income) and qualified dividends; capital gains; other tax-exempt income; and return of principal.

To solve the problem of choosing a charity, many prefer to use a Donor Advised Fund as a beneficiary. The DAF can be treated like a charity for tax purposes. The DAF lets you control how the account is funded and the timing of distribution of assets. The charities do not need to be named when the CRT is first created.

The CRT can be a very useful tool in estate planning for people who would be making gifts to support meaningful causes with or without tax benefits. Your estate planning attorney will be able to help you set up a CRT to work in tandem with the rest of your estate plan.

Reference: The Street (June 25, 2021) “Retirement Saving and Charitable Remainder Trusts”

Singer’s 15-Year Estate Battle Is Wrapping Up

The fighting over Brown’s estate has been going on since he died 15 years ago on Christmas Day at age 73. A series of bizarre events followed, says the Associated Press in the article “Family of James Brown settles 15-year battle over his estate.” They included photos of a woman who claimed to have been married to Brown being locked out of his home, sobbing and rattling the iron gates to his estate.

James Brown was known for his flashy performances and iconic chart-topping hits, like “I Feel Good,” “A Man’s World,” “Pappas Got a Brand-New Bag,” and many more. Unfortunately, he was plagued by drug problems and mismanaged finances, which shrank his estate.

More than twelve lawsuits were filed by people trying to establish claims to his assets. Courts estimates of his net worth range from $5 million to more than $100 million.

The battle was gruesome from the start, since it wasn’t just about money. Brown’s family fought over what was to happen with his body. His remains, inside a gold casket, were in a funeral home in cold storage for more than two months, until this issue was resolved.

Brown was eventually interred in Beech Island, South Carolina, at the home of one of his daughters. The family had plans to create a shrine to him, using Elvis Presley’s Graceland as a model, but the idea never became reality.

In 2020, the South Carolina Supreme Court ruled that Tommie Rae Hynie, the woman who claimed to be his wife, had never been legally married to Brown and had no claim on his estate. Justices also ordered a circuit court to proceed with probating Brown’s estate, following the directions of his estate plan.

Brown’s estate plan outlined plans for a trust to be created to use his music royalties to fund educational expenses for children in South Carolina and Georgia.

There had been a 2009 settlement plan that would have given almost half of his estate to a charitable organization, a quarter of his estate to Hynie and the rest to be divided among his adult children. That settlement was overturned in 2013, with a judge saying the settlement did not follow Brown’s wishes for most of his money to go to charity.

A professional manager had been brought in to take control of Brown’s assets from the estate’s trustees to settle his debts.

Reference: Associated Press (July 23, 2021) “Family of James Brown settles 15-year battle over his estate”

What Is a Holistic Estate Plan?

Estate planning is more than a tax strategy. It’s about creating a legacy and protecting your family for the short and long term, explains the article “Create A Holistic Estate Plan Now For Bigger Payoffs In The Future” from Forbes. The process begins with as much disclosure as possible. That means talking with your estate planning attorney about the challenges your family faces, as well as the assets to be left for loved ones.

One change to the tax code can disrupt decades of careful planning and leave people scrambling to protect loved ones. Market tumult can require assets to be sold to meet cash flow needs. Charitable contributions may also need to be reviewed and possibly changed, if the family’s asset level changes.

There are three aspects to consider when creating an estate plan: a lifetime spending strategy, a charitable legacy and bequests. All of these are impacted by taxes and need to be reviewed as a whole.

Lifetime spending strategy. These questions are centered on your goals and plans. Where do you want to live during retirement and how do you wish to live, travel and entertain? Will you stay in place and focus on charitable organizations, or travel throughout the year? It’s good to set a budget and stress-test it to see what different outcomes may arise.

A family that owns businesses or large real estate holdings may benefit from strategies, like family limited partnerships. A sale of the business to an outsider or a family member could create many different options, and all should be considered.

Charitable gift planning. Estate planning offers a way to clarify charitable giving goals and create a road map for how gifting can be transformed into a legacy. A well-planned charitable gift strategy can also minimize estate taxes and maximize the future of the gift, for both the family and the charities you favor.

A Charitable Remainder Trust is used to provide an income stream during your lifetime and reach gifting goals at the same time. One way to accomplish this is to transfer an asset, like highly appreciated stocks or bonds, into an irrevocable trust, thereby removing the asset from your taxable estate. The trustee may then sell the asset at market value and reinvest, creating a lifelong income stream for you or a beneficiary.

Leaving assets, not estate tax bills, for heirs. Families who own multiple properties in their own names or in a single LLC can lead to a lot of administrative headaches when the owners die. One simple fix is to place each property into a separate LLC, which increases the availability of strategic tax savings.

Another way to minimize estate taxes is through the use of life insurance. This is a strategy to do while you are still relatively healthy, as it becomes increasing difficult to obtain once you turn 60 or 70.

All of these strategies take knowledge and time to set up, so creating an estate plan and working through the many different strategies is best done with an experienced estate planning attorney and before any trigger events occur.

Reference: Forbes (April 6, 2021) “Create A Holistic Estate Plan Now For Bigger Payoffs In The Future”

What Qualifies as a Qualified Charitable Distribution?

Qualified charitable distributions allow individual retirement holders to divert some of their federally taxable required distributions to charity, reports a recent article “A tax break for retirees is back. Here’s how to use it–and what to avoid,” from The Washington Post. Known as QCDs, they were not a big deal until 2017, when a change in the tax law changed the number of people itemizing deductions, including charitable contributions, from 31 percent to 11 percent, according to the IRS.

Tax laws let you put tax-deductible money into “defined contribution” accounts, including IRAs, 401(k)s and 403(b)s, until you reach age 72, when you are required to start taking withdrawals—federally taxable Required Minimum Distributions–from the accounts.

The size of the distribution depends upon the year-end retirement account balances and your age. If you had $100,000 in a retirement account last December 31 and turned 75 this year, the RMD is about $4,370. For an 80-year-old, the number would be around $5,350, and at 85, it would be $6,760.

In 2020, QCDs were of little interest because the CARES Act cancelled any RMD requirements. You could still use a QCD, but there was no tax advantage of reducing taxable income by offsetting required distributions.

In 2021, RMDs are back, and QCDs are worth doing again. To make a QCD, you ask the IRA administrator to send a check made out to a registered charity. You are permitted to donate as much as $100,000 per year. Let’s reinforce the message: the check must be made out to the charity, not to you. You also may not send the money to your own donor-advised fund.

IRAs can be used for QCDs, but not 401(k)s or 403(b)s.

You will need to keep track of the QCDs yourself. Do not expect the IRA custodian to do that for you. The retirement plan does send a tax form, the 1099-Rs, to the IRS that shows your total distributions for the year. The QCDs are subtracted from your 1099-R income by you or your tax preparer.

It sounds great, but there is a problem, created by the SECURE Act of 2019. That law let people aged 70½ and older make tax-deductible contributions to their IRAs. However, if you make a tax-deductible contribution to your IRA that you use for a QCD, it triggers a reduction in the amount of the QCD that you can deduct from your federally taxable income.

Do not make QCDs from the same IRA to which you are making tax-deductible contributions. You can set up a solo 401(k) if you are self-employed or use a SEP-IRA to make deductible contributions.  Here again, trouble lurks; do not make a QCD from a SEP-IRA in the same year you are claiming an income tax deduction for contributing to the SEP-IRA.

Reference: The Washington Post (March 18, 2021) “A tax break for retirees is back. Here’s how to use it–and what to avoid”

Can a Charity Be a Beneficiary of an Estate?

The interest in charitable giving increased in 2020 for two reasons. One was a dramatic increase in need as a result of the COVID pandemic, reports The Tax Advisor’s article “Charitable income tax deductions for trusts and estates.” The other was more pragmatic from a tax planning perspective. The CARES Act increased the amounts of charitable contributions that may be deducted from taxes by individuals and corporations.

What if a person wishes to make a donation from the assets that are held in trust? Is that still an income tax deduction? It depends.

The rules for donations from trusts are substantially different than those for charitable contribution deductions for individuals and corporations. The IRS code allows an estate or nongrantor trust to make a deduction which, if pursuant to the terms of the governing instrument, is paid for a purpose specified in Section 170(c). For trusts created on or before October 9, 1969, the IRS code expands the scope of the deduction to allow for a deduction of the gross income set aside permanently for charitable purposes.

If the trust or estate allows for payments to be made for charity, then donations from a trust are allowed and may be tax deductions. Otherwise, they cannot be deducted.

If the trust or estate allows distributions for charity, the type of asset contributed and how it was acquired by the trust or estate determines whether a tax deduction for a charitable donation is permitted. Here are some basic rules, but every situation is different and requires the guidance of an experienced estate planning attorney.

Cash donations. A trust or estate making cash donations may deduct to the extent of the lesser of the taxable income for the year or the amount of the contribution.

Noncash assets purchased by the trust/estate: If the trust or estate purchased marketable securities with income, the cost basis of the asset is considered the amount contributed from gross income. The trust or estate cannot avoid recognizing capital gain on a noncash asset that is donated, while also deducting the full value of the asset contributed. The trust or estate’s deduction is limited to the asset’s cost basis.

Noncash assets contributed to the trust/estate: If the trust or estate acquired an asset it wants to donate to charity as part of the funding of the fiduciary arrangement, no charity deduction is permitted. The asset that is part of the trust or estate’s corpus, the principal of the estate, is not gross income.

The order of charitable deductions, compared to distribution deductions, can cause a great deal of complexity in tax planning and reporting. Required distributions to noncharitable beneficiaries must be accounted for first, and the charitable deduction is not taken into account in calculating distributable net income. The recipients of the distributions do not get the benefit of the deduction. The trust or the estate does.

Charitable distributions are considered next, which may offset any remaining taxable income. Last are discretionary distributions to noncharitable beneficiaries, so these beneficiaries may receive the largest benefit from any charitable deduction.

If the trust claims a charitable deduction, it must file form 1041A for the relevant tax year, unless it meets any of the exceptions noted in the instructions in the form.

These are complex estate and tax matters, requiring the guidance of an experienced estate planning attorney for optimal results.

Reference: The Tax Advisor (March 1, 2021) “Charitable income tax deductions for trusts and estates”

Estate Planning Meets Tax 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 don’t care what form your donation takes. They don’t 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’d 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’s 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’s 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”

What are the Benefits of a Donor Advised Fund?

Many Americans are feeling charitable these days, and with good reasons. It’s a hard time for many, and if you are financially able, making donations may help you feel you are making a difference for others during uncertain times. There are many options when making donations, and the recent article “Choosing Charity: How Donor-Advised Funds Benefit Your Contributions” from Fort Worth Magazine explains your choices.

Donor Advised Funds (DAFs) can be opened for varying amounts, that are set by the sponsoring organizations. Smaller community foundations would welcome a DAF for $5,000, for instance. DAFs can be funded with cash or other assets, but once the donation is made, the asset no longer belongs to you. However, you may be able to decide when donations are distributed, and which charities receive funding. There are no required distribution dates, so the funds could go unused for a long time, while you receive the tax write-off right away.

You may also determine the investments within the fund, level of risk and overall investment strategy.

Another good reason to use DAFs: the sponsoring organization becomes the donor of record. Therefore, DAFs are an excellent way to make anonymous contributions.

There are also DAFs that involve active involvement from an advisor, if that is of value to you.

Why is now a great time to use a Donor-Advised Fund?

Some investors have highly appreciated assets that could lead to a significant tax liability, if they were sold right now. DAF offers an alternative—rather than sell the assets and pay taxes, putting them into a DAF can achieve the following:

• You receive a tax deduction,
• There are no capital gains taxes, and
• Your chosen the charity that fully benefits from the funds.

The pandemic has left many people facing uncertainty. Therefore, now isn’t the right time for everyone to open their wallets and a DAF. However, if you are charitably-minded and in a financial position to benefit from a DAF, it is a win-win situation for all concerned.

Reference: Fort Worth Magazine (Feb. 3, 2021) “Choosing Charity: How Donor-Advised Funds Benefit Your Contributions”

How Does a Charitable Trust Work?

A charitable trust can provide an alternative to meeting your wishes for charities and your loved ones, while serving to minimize tax liabilities. There are pros and cons to consider, according to a recent article titled “Here’s how to create a charitable trust as part of an estate plan” from CNBC. Many families are considering their tax planning for the next few years, aware that the individual income tax provisions of the 2017 Tax Cuts and Jobs Act will expire after 2025.

Creating a charitable trust may work to achieve wishes for charities, as well as loved ones.

A charitable trust is a set of assets, usually liquid, that a donor signs over to or uses to create a charitable foundation. The assets are then managed by the charity for a specific period of time, with some or all of the interest the assets produce benefitting the charity.

When the period of time ends, the assets, now called the remainder, can go to heirs, or can be donated to the charity (although they are usually returned to heirs).

There are pros and cons to Charitable Remainder Trusts and Charitable Lead Trusts. Your estate planning attorney will determine which one, if any, is appropriate for you and your family.

A charitable trust allows you to give generously to an organization that has meaning to you, while providing an equally generous tax break for you and your heirs. However, to achieve this, the charitable trust must be irrevocable, so you can’t change your mind once it’s set in place.

Charitable trusts provide a way to ensure current or future distributions to you or to your loved ones, depending on your unique circumstances and goals.

A Charitable Remainder Trust, or CRT, provides an income stream either to you or to individuals you select for a set period of time, which is typically your lifetime, your spouse’s lifetime, or the lifetimes of your beneficiaries. The remaining assets are ultimately distributed to one or more charities.

By contrast, the Charitable Lead Trust (CLT) pays income to one or more charities for a set term, and the remaining assets pass to individuals, such as heirs.

For CRTs and CLTs, the annual distribution during the initial term can happen in two ways; a Unitrust (CRUT or CLUT) or an Annuity Trust (CRAT or CLAT).

In a Unitrust, the income distribution for the coming year is calculated at the end of each calendar year and it changes, as the value of the trust increases or decreases.

In an Annuity Trust, the distribution is a fixed annual distribution determined as a percentage of the initial funding value and does not change in future years.

Interest rates are a key element in determining whether to use a CLT or a CRT. Right now, with interest rates at historically low levels, a CRT yields minimal income.

The key benefits to a CRT include income tax deductions, avoidance of capital gains taxation, annual income and a wish to support nonprofit organizations.

Your estate planning attorney and a member of the development team from the charity can work together to ensure that your charitable strategy achieves your goals of supporting the charity and building your legacy.

Reference: CNBC (Dec. 22, 2020) “Here’s how to create a charitable trust as part of an estate plan”