The following discussion is intended to provide some helpful, basic background as to some of the legal and tax issues involved in areas practiced by the firm. It does not constitute legal advice, and you should not rely upon it as such. Rather, you should seek individual advice, due to the complex nature of the laws in this area and the individual nature of each person's situation. However, we hope you find this helpful as some background and explanation.
What is the SECURE Act's Impact on Estate Planning?
On January 1, 2020, significant changes were made to the federal laws governing retirement accounts, including 401(k) plans, traditional IRAs and ROTH IRAs. The changes may affect your estate planning because your retirement account, which may be a significant portion of the inheritance you are leaving for your beneficiaries, now must be withdrawn by your non-spouse beneficiary under new rules. The changes were included in the law that is known as the "SECURE Act." The SECURE Act contains many provisions; however, this article summarizes only some of the key aspects of the SECURE Act as they relate to estate planning. Given the significance of these changes, we urge you to review your estate planning documents with your attorney in order to determine whether the SECURE Act's distribution limitations affect your estate planning goals.
Elimination of the Stretch IRA
The most significant changes brought about by the SECURE Act, at least in terms of estate planning, is the elimination of the "Stretch IRA" option which allowed a non-spouse beneficiary to withdraw assets from an inherited IRA over his or her life expectancy. Now, those who inherit an IRA in 2020 and thereafter will have 10 years to withdraw the assets. There are a few exceptions to the 10-year withdrawal rule for spouses, disabled and chronically ill beneficiaries and minor children of the original account owner, which will be discussed below.
Prior to 2020, a beneficiary of a retirement account could "stretch out" the distributions from an inherited retirement plan over the life expectancy of the beneficiary, if that beneficiary qualified as was a "designated beneficiary." This lifetime stretch-out provided income tax free growth of the inherited retirement plan assets during the beneficiary's life, deferred the payment of income taxes paid on distributions made to the beneficiary from the retirement account for non-Roth IRAs, and protected the retirement plan assets from most of the beneficiary's creditors. The prior law permitted these advantages even for retirement plan assets left to beneficiaries in trust, as long as the trust contained certain required terms and conditions.
However, the SECURE Act has changed these rules and now most designated beneficiaries will be required to receive the entire inherited retirement account within ten years following the death of the original account owner. There is no annual required minimum distribution during these first ten years; therefore, the beneficiary could distribute the assets at any time during these ten years, even waiting until the end of the period, so long as all assets have been distributed within this period.
This is a significant change because it eliminates growth potential and with the mandatory distribution within a ten-year period, the increased withdrawals may push the beneficiary into a higher tax bracket.
The tax law provides for a few exceptions to the requirement that an inherited retirement account be withdrawn within 10 years following the death of the original account owner. If you are the surviving spouse of the original account owner or you are disabled or chronically ill, as the beneficiary of an inherited retirement account you are still permitted to take distributions over your expected lifetime. Further, if you are the minor child of the original account owner, the 10 year rule for withdrawing the retirement account does not start until you attain the age of majority. It is possible to continue to use a trust as the recipient of the retirement account for individuals who qualify for the exception to the 10-year rule; however, the trust must be specifically prepared for that purpose.
The good news is that the SECURE Act does not change the method of designating a beneficiary or beneficiaries to receive inherited retirement assets. If you have existing beneficiary designations in place, those designations are still valid. What the SECURE Act does introduce, however, is a host of new considerations that you should take into account in structuring your estate plan to take into account the distribution limitations.
Estate plans that, through the end of 2019, offered a sound approach to planning for retirement assets, may suddenly no longer provide the desired outcome. For example, some of our clients may have current plans in place that leave their retirement assets to a trust known as a "conduit trust" following the client's death. Generally, distributions of retirement plan assets to a conduit trust pass immediately from the trust to the beneficiary. Conduit trust plans were frequently utilized under the prior law because the distributions of the retirement plan would be stretched over the expected lifetime of the trust beneficiary but still retain control and creditor protection provided by the trust. However, under the SECURE Act, that same conduit trust may now result in distribution of all of the retirement plan assets to the beneficiary within 10 years of the death of the original account owner, which may not be a desired outcome. Depending on the circumstances, other planning techniques may better serve your goals.
The Positive about the SECURE ACT
One component of the SECURE Act that will affect many people during their lives is a change in the age at which a person must begin taking distributions from a retirement plan. Under the prior law, most people were required to begin taking distributions from their retirement plans or IRAs when they reached age 70½. Under the new law, the age is increased to 72. In addition, the SECURE Act removes the age cap for funding traditional IRAs, meaning that individuals over age 70½ are now eligible to make contributions to a traditional IRA. These changes may present an opportunity for people to take further advantage of the tax-deferred savings offered by retirement plans.
If you have significant retirement plan assets, we recommend that you review your estate plan to ensure that it disposes of those assets in the best manner for your beneficiaries taking into account the SECURE Act changes.
How Does the Tax Cuts and Jobs Act of 2017 Impact Estate and Gift Tax?
The Tax Cuts and Jobs Act ("TCJA") is now the law of the land, and most of its changes went into effect on January 1, 2018. Overall, these changes will result in fewer estates being subject to the estate and gift tax, and larger estates will be likely to owe less tax.
Before the TCJA, the first $5 million (as adjusted for inflation in years after 2011) of transferred property was exempt from estate and gift tax. For estates of decedents dying and gifts made in 2018, this "basic exclusion amount" as adjusted for inflation would have been $5.6 million, or $11.2 million for a married couple with proper planning.
Exclusion Doubled. The new law temporarily doubles the amount that can be excluded from these transfer taxes. For decedents dying and gifts made from 2018 through 2025, the TCJA doubles the base estate and gift tax exemption amount from $5 million to $10 million. Indexing for post-2011 inflation brings this amount to approximately $11.2 million per person for 2018, and $22.4 million per married couple with proper planning.
This increased exclusion amount may have a significant impact on some estate plans, while others may be unaffected. Our firm encourages everyone, and particularly higher net worth individuals, to consider the need to redraft some important documents, including wills and trusts. In addition, the new law may create additional planning opportunities for some. Due to the volume of our practice, our firm will not be conducting a review of each and every client file to determine how this law may affect each client. Current clients of the firm are welcome to contact our office to request a file review; however, note that time spent on such reviews will be billed according to the billing arrangement applicable to the individual client.
Why do I need a Will?
A Will is a document that determines how assets will be distributed at your death. Without a Will, state law determines how assets will be distributed at your death. (See "What is Intestacy?")
In a Will, you nominate your "Personal Representative." The Personal Representative is the person in charge of your estate, who notifies creditors, pays your bills and debts, collects assets, and distributes your remaining assets as set forth under your Will.
For parents of minor children, one of the most important reasons to have a Will is to nominate who you wish to act as the guardian of your children in the event of your death.
What is Intestacy?
Intestacy is what happens when you die without a valid Will. The proceedings are generally similar to probate, except that state law, not your own wishes, determine who will act on your behalf, and who will receive your property.
What is a Living Will?
A Living Will is a medical document expressing your wishes as to medical treatment when you cannot make your own decisions. Most Living Wills typically provide that if you are in an irreversible and terminally unconscious state, you do not want your life artificially prolonged. A Living Will is also usually combined, or accompanied with, a Medical Power of Attorney, giving the person you nominate the right to act on your behalf in implementing your health care wishes.
What is a Power of Attorney?
Power of Attorney is a grant of authority to another individual to act on your behalf. A Financial Power of Attorney gives another person, such as your spouse, child or trusted friend, the power to act on your behalf for almost all financial matters. For example, if you are incapacitated, the Financial Power of Attorney Agent has the power to pay your bills, deposit your checks, and manage your assets. If a person does not have a Living Trust, a Financial Power of Attorney is the main means of managing assets in the event of incapacity, absent the need for a court appointed Conservator.
What is a Trust and Why would I need one?
In the most general terms, a trust is an arrangement with a Trustee (which can be one or more individuals or corporations) holding assets for the benefit of one or more beneficiaries, managing, controlling, and distributing those assets under the powers, discretions, and specific terms of the trust instrument.
There are many advantages which can be obtained through the use of a trust, some or all of which may be relevant to your situation. Trusts can protect the assets of beneficiaries, reduce estate taxes, simplify administration and protect privacy.
As you will see from the further questions, there are a great variety of Trusts. Trusts can be revocable and established during your lifetime ("Living Trusts"); trusts can be established under your Will at your death ( "Testamentary Trusts"); and there are trusts which are established during your lifetime, principally for tax purposes, which you do not have any power to change ("Irrevocable Trusts"). There can be a variety of specialized trusts created in most of these manners, such as a Credit Shelter Trust, Marital Trust, or Generation Skipping Trust.
What is a Living Trust?
A "Living Trust" or "Revocable Trust" is a trust which you establish during your lifetime (unlike a Testamentary Trust, which is established through your Will). You retain complete control over a Living Trust during your lifetime, with the power to utilize assets or change the document however you wish. A Living Trust may be the primary estate planning document. A Living Trust is signed to create this arrangement, which can be used to manage your assets, then manage your assets for the benefit of your spouse, children or other beneficiaries.
What are the Advantages of a Living Trust?
A Living Trust offers two primary advantages from a Will because either method can be used to create Credit Shelter, Marital and Generation Skipping Trusts. The first advantage is that a Living Trust is established during your lifetime, and as such, it allows for management of your assets in the event of incapacity. Most individuals name themselves as the initial Trustees of their own trust, and nominate successor Trustees to serve when they cannot act. In the event of incapacity, this successor Trustee would manage the assets in the trust as provided in the trust, typically making payments and managing assets for your benefit and maintenance.
The other advantage of a Living Trust is that, assuming your assets are transferred into the trust prior to death, your estate will avoid being subject to a probate administration. Probate is the court proceeding to file a Will and appoint a Personal Representative. The probate procedure has certain deadlines and time periods that must be complied with before completing an estate, and may incur additional legal costs. Also, any Will filed in probate becomes a matter of public record, while a Living Trust does not become public record.
What is a Testamentary Trust?
A Testamentary Trust is a Trust arrangement which is provided for in your Will, which does not become effective until your death. The Will will usually be subject to probate, and all the Trust provisions therein become a matter of public record that anyone can examine. It also does not provide for any management of assets during your lifetime. Other than these limitations, a Testamentary Trust can provide for the same benefits available to Trusts created under a Living Trust agreement.
What is involved in Funding a Living Trust?
After creating a Living Trust, the next step is to fund it. This means transferring title of assets to the trust. For example, after creating a Living Trust for a married couple with a home, a brokerage account, and a life insurance policy, we would prepare a deed to transfer the home into the Living Trust, assist the clients to transfer the brokerage account into the name of the Living Trust and name the Trust as the beneficiary of the life insurance policy. This is necessary to avoid a probate administration. The time and effort necessary to fund a Living Trust thus can vary greatly depending on the nature and extent of your assets.
What is a Credit Shelter or Bypass Trust?
A Credit Shelter or Bypass Trust, also referred to as a " Decedent's Trust", or "Trust B" (you will hear the term A-B Trust to describe this arrangement), is a means of using a Trust arrangement for a married couple to reduce estate taxes upon the surviving spouse's death, by establishing this separate trust at the first spouse's death.
When a married couple knows or anticipates that their combined assets may exceed the exempt amount on the survivor's death, establishing a Credit Shelter Trust should be considered.
What is a Marital Trust or a QTIP?
A Marital Trust or a QTIP ("Qualified Terminable Interest Property") Trust is a trust which qualifies for the estate tax marital deduction, but rather than distributing assets outright to a surviving spouse, it holds the assets in a trust providing the spouse with at least the income for his/her lifetime, and which can benefit no other person during the spouse's lifetime. However, at the spouse's death, the remaining trust assets are distributed as the first spouse to die sets forth.
There is a deduction from the estate tax for all assets passing to a spouse. These assets can pass outright or in certain specifically limited trust arrangements. The Marital QTIP Trust is the most popular arrangement and requires all income be
paid to the surviving spouse, but allows the original transferor to set forth in the trust how the remaining trust assets will be distributed when the spouse dies.
The basic concept of the Marital QTIP is to provide for a spouse while protecting the original transferor's assets. For instance, a husband who had been previously married may establish such a trust under the Living Trust for his wife of a second marriage. The trust could be set up with a bank or other corporate trustee, paying the wife all income during her lifetime, and any other amounts for which the husband gives the Trustee discretion. Upon the wife's death, the remaining trust assets would pass to the husband's children from his first marriage, so that the husband could be assured that his wife was provided for, but that his children were protected as well.
There are some other technical reasons to create a Marital Trust, one of which is to allow maximum use of the Generation Skipping Transfer Tax Exemption, if General Skipping Trusts are to be created.
What is Continuing Trust?
A Continuing Trust for a beneficiary represents any situation where you wish to delay outright distribution of an asset. For instance, if you have minor children, then you may wish to provide that if something happened to you, they will not receive their inheritance outright until age 25 or 30. Until the child attains the stated ages, the assets will be held in a trust for the child's benefit, with the Trustee paying any necessary or appropriate expenses, but not allowing the child to waste or dissipate the assets.
Sometimes parents have concerns about specific children and their patterns of behavior, such as drug use or a wasteful nature, and wish to benefit the children without allowing them free access to do whatever they want with the money. Similarly, parents and grandparents may have concerns about minor children and the effect a substantial inheritance can have on their work ethic and motivation. Alternately, you may wish to limit certain amounts set aside for children, grandchildren, or other beneficiaries to specific purposes, such as education.
Continuing trusts can be set up under your Living Trust, and often uses a third party Trustee, such as a trusted family friend or corporate Trustee, to act as Trustee for the beneficiaries. You can establish these trusts however you see fit, with the provisions and restrictions you feel are appropriate. These range from a simple trust provision to delay outright distribution
to a minor until he/she reaches age 25, or there might be a trust for grandchildren established only to pay for their education. On the other hand, you could have very elaborate incentive trusts, whereby children or grandchildren only receive distributions to the extent they are working productively for themselves or society, and/or to the extent they are not abusing drugs or alcohol. These trusts can terminate at specific points, or they can continue for the beneficiaries' lifetimes.
What is a Generation Skipping Trust?
A Generation Skipping Trust is a continuing trust established for a child or other beneficiary which is intended to last for the beneficiary's lifetime. Such a trust would typically be established under an individual's or couple's Living Trust.
It should be noted that there is some confusing terminology as to Generation Skipping Trusts, or GST's. The "Skipping" does not mean that the child for whom the trust is held does not benefit from the trust. It is possible to give a child almost complete control and benefit from such a trust, but rather, the Skipping refers to the fact that the trust will not be subject to estate tax at the child's death.
As discussed above, there are various reasons for establishing a continuing trust, which could include a trust lasting the beneficiary's entire lifetime, to protect the beneficiary from himself/herself, and to reserve assets for specific use. However, even where parents feel completely comfortable with their children receiving their inheritance outright, the Generation Skipping Trust offers advantages to the children and their descendants.
For example, a Generation Skipping Trust could be established for the benefit of a couple's child, rather than outright distribution. The child could act as her own Trustee, manage the trust assets, and distribute to herself whatever assets she felt was necessary. At her death, the assets could be distributed as she set forth in her Will. Effectively, she has almost as much control as she would have had she received the assets outright.
The advantages are that these assets would not be taxed in the child's estate at her death because of the trust arrangement. The basic rationale is similar to that of a Credit Shelter Trust.
The Generation Skipping Trust also aids in keeping the child's inheritance separate from her husband, so that it will not be commingled, and possibly subject to division in the event of divorce. It may also offer protection from creditors.
The flexibility of such an arrangement is that if a child does very well on his/her own, establishing this separate trust can save a great deal of estate taxes, as indicated above, and yet, if a child has greater need of the assets, he/she can use as much as needed during his/her lifetime.
What is an Irrevocable Trust?
An Irrevocable Trust normally refers to a trust established during your lifetime, principally for estate tax purposes, which you give up all or almost all control. Because of the nature of the estate tax, one of the ways to reduce it is to make certain gifts during your lifetime which will exclude assets from taxation at death, but to do so, you must not only give up the assets but most rights to direct or control the assets. Typically, an Irrevocable Trust represents an advanced estate planning technique to consider when estate taxes still appear to be an issue after establishing a Credit Shelter arrangement. Technically, after the transferor dies, many of the other arrangements discussed above, such as a Credit Shelter Trust, Marital Trust or Generation Skipping Trust, also become Irrevocable Trusts at that time.
Common Irrevocable Trusts include an Irrevocable Life Insurance Trust (ILIT), a Qualified Personal Residence Trust (QPRT) and a Charitable Remainder Trust (CRT).
What is an Irrevocable Life Insurance Trust or ILIT?
An Irrevocable Life Insurance Trust is a separate Irrevocable Trust established to hold life insurance in such fashion that it will not be subject to estate taxation on the death of the insured. When an individual faces a taxable estate, acquiring a life insurance within an Irrevocable Life Insurance Trust can provide for your beneficiaries without being taxed in your estate. Additionally, if an individual's estate is comprised of non-liquid assets, establishing such a trust and purchasing life insurance provides a means of paying the estate taxes without forcing sale of the illiquid assets.
What is the estate and gift tax?
The estate and gift tax is a system of taxing the transfer of assets from an individual, whether during his/her lifetime or at death.
An estate tax is imposed on all assets owned by an individual at the time of his/her death, and includes not only those assets owned outright, but those held in almost any form of ownership in which the individual has any control, interest or benefit.
The federal estate and gift tax exemption has changed several times over recent years, and its future is uncertain. We recommend maintaining regular contact with professional advisors in order to determine current law and how each individual might be affected.
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