Estate Planning with Roth IRAs

As Roth usage increases, so do questions about best estate-planning practices for these accounts.

Natalie Choate, 11/11/2011

Since the "income cap" was lifted on Roth conversions in 2010, more and more clients have Roth IRAs. It's time to consider where those assets should be placed in the estate plan.

Question: I read in a financial publication that giving away a Roth IRA is "a good planning idea." Several other articles are out there about this strategy. Does it really work?
Answer: No. You cannot give away a Roth IRA. Or rather, you can do so, but giving it away would cause it to cease to be an IRA. The gift-transfer would be treated as a complete distribution of the account to the donor, followed by a gift of the proceeds to the transferee. The deemed distribution might be tax-free (if the donor meets the requirements for a "qualified distribution"), but there will be no further tax-free accumulation because the Roth ceases to exist.

A "Roth gift" strategy that does work is for a donor (typically the parent of a teenager) to open a Roth IRA for the donee (the teenager). Example: Teenager earns $5,000 in a summer job. Teenager therefore has compensation income, and if his income is low enough, he is entitled to contribute to a Roth IRA. The parent and teen can open the account together in the teen's name and the parent contributes $5,000 to it.
Both of these strategies are discussed in ¶ 5.8.06(C), "Gifts with Roth IRAs," of my book Life and Death Planning for Retirement Benefits (7th ed. 2011).

Question: "Duncan" wants to leave some of his assets to charity, some to his wife, and some to his children. He has some assets in a traditional retirement plan, some in a Roth plan, and some in outside (nonretirement) investments. Which asset should he leave to which beneficiary?

Answer: With a traditional IRA, all three of Duncan's proposed beneficiaries are considered "tax-favored" choices for income tax purposes: Children (or other young people) because of their long life expectancies (facilitating a long tax-deferred "stretch" payout), the spouse (because she can roll over to her own IRA), and charity because it is income tax-exempt. In Duncan's case, leaving the traditional plan to charity is very appealing, since the charity (unlike the wife and children) can receive these retirement plan benefits income tax-free.

With the Roth plan, the picture changes slightly. Charity is not an income tax-favored choice of beneficiary for a Roth plan. Because distributions from a Roth plan are generally income tax-free anyway, there is no advantage to leaving this asset to an income tax-exempt entity. Thus, Duncan should leave the Roth plan either to his spouse or to the children.

If federal estate taxes are a concern, there is a strong argument against making the traditional IRA payable to the children. By inheriting the traditional IRA, they would be inheriting an asset that has a built-in income tax "debt." Duncan does not get a marital or charitable deduction for leaving assets to his children; the only estate tax "shelter" there is for bequests to his children is the federal estate tax exemption. Part of that exemption is "wasted" if the children inherit an asset that they then have to pay income tax on--part of the "exempt" amount goes to the IRS. So the children should inherit either the Roth plan or the nonretirement assets; either way, they will owe no income tax on their inheritance.

We have figured out that the charity should inherit the traditional retirement, and the children should not inherit it; that leaves the Roth plan and the nonretirement assets to be divided somehow between the spouse and the children. The question is, what is the best income tax scenario for the Roth plan?
If a Roth IRA is left to the children, they can stretch it out via annual tax-free distributions over their life expectancies. That's a pretty darn good scenario.

But if the Roth plan is left to the surviving spouse, she can get an even better scenario: She can roll the inherited Roth plan over to her own Roth IRA (only the surviving spouse has this right). Then she will be able to stretch out the tax-free distributions much longer than the children possibly could: She does not have to take any minimum required distributions at all from the rollover Roth IRA during her lifetime. After her death it can be left to the children for gradual tax-free distributions over their life expectancy.

Duncan's choice is made: Leave the traditional retirement plan to the income tax-exempt charity, the Roth plan to the wife for her to roll over and keep accumulating tax-free, and the nonretirement assets to the children.

Resources: For all details regarding Roth retirement plans, including who is eligible to contribute (and how much), income tax treatment of Roth distributions, and minimum distribution requirements for Roths, see Chapter 5 of Natalie Choate's book Life and Death Planning for Retirement Benefits (7th ed. 2011).

The views expressed are the author’s.

Rollover IRAs Offer a Wide Range of Benefits

IRA assets can generally be divided among multiple beneficiaries in an estate plan.

As compared with employer-sponsored retirement accounts, a rollover IRA can provide you with the broadest range of investment choices and the greatest flexibility for distribution planning. Also, a rollover IRA can typically be operated with fewer restrictions. This brief overview highlights some of the key benefits of a rollover IRA compared with an employer-sponsored plan.

• More control: As the IRA account owner, you make the key decisions that affect management and administrative costs, overall level of service, investment direction, and asset allocation. You can develop the precise mixture of investments that best reflects your own personal risk tolerance, investment philosophy, and financial goals. You can create IRAs that access the investment expertise of any available fund complex, and can hire and fire your investment managers by buying or selling their funds. You also control account administration through your choice of IRA custodians.
• More flexibility: IRAs can be more useful in estate planning than employer-sponsored plans. IRA assets can generally be divided among multiple beneficiaries in an estate plan. Each of those beneficiaries can make use of planning structures such as the Stretch IRA concept to maintain tax-advantaged investment management during their lifetimes. Beneficiary distributions from employer-sponsored plans, in contrast, are generally taken in lump sums as cash payments. Also, except in states with explicit community property laws, IRA account holders have sole control over their beneficiary designations.

Efficient Rollovers Require Careful Planning
One common goal of planning for a lump-sum distribution is averting unnecessary tax withholding. Under federal tax rules, any lump-sum distribution that is not transferred directly from one retirement account to another is subject to a special withholding of 20%. This withholding will apply as long as the employer's check is made out to you -- even if you plan to place equivalent cash in an IRA immediately. To avert the withholding, you must first create your rollover IRA, and then request that your employer transfer your assets directly to the custodian of that IRA.

Keep in mind that the 20% withholding is not your ultimate tax liability. If you spend the lump-sum distribution rather than reinvest it in another tax-qualified retirement account, you'll have to declare the full value of the lump sum as income and pay the full tax at filing time. In addition, the IRS generally imposes a 10% penalty tax on withdrawals taken before age 59 1/2.

Also, if you plan to roll over the entire sum, but have the check made out to you rather than your new IRA custodian, your employer will be required to withhold the 20%. In that event, you can get the 20% refunded if you complete the rollover within 60 days. You must deposit the full amount of your distribution in your new IRA, making up the withheld 20% out of other resources. When you file your tax return for the year, you can then include a request for refund of the lump-sum withholding.

If you have after-tax contributions in your employer plan, you may opt to withdraw them without penalty when you roll over your assets. However, if you wish to leave those funds in your retirement account in order to continue tax deferral, you can include them in your rollover. When you begin regular distributions from your IRA, a prorated portion will be deemed nontaxable to reimburse you for the after-tax contributions.

Potential Downsides of IRA Rollovers

While there are many advantages to consolidated IRA rollovers, there are some potential drawbacks to keep in mind. Assets greater than $1 million in an IRA may be taken to satisfy your debts in certain personal bankruptcy scenarios. Assets in an employer-sponsored plan cannot be readily taken in many circumstances. Also, you must begin taking distributions from an IRA by April 1 of the year after you reach 70 1/2 whether or not you continue working, but employer-sponsored plans do not require distributions if you continue working past that age.

Remember, the laws governing retirement assets and taxation are complex. In addition, there are many exceptions and limitations that may apply to your situation. Therefore, you should obtain qualified professional advice before taking any action.

© 2011 McGraw-Hill Financial Communications. All rights reserved.

 This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by James P Ellman, ChFC and Barry Mendelson, CFP, local members of FPA.

Four Risks to Your Retirement Future

Because younger retirees typically are planning for a time horizon of 20 years or more, it is important that their portfolios include a source of growth that is likely to exceed inflation over the long term.

As Americans live longer, the task of managing money after retirement gets more complex. A retiree in his or her mid-60s typically has a different risk profile than an individual approaching 90. It may be helpful to look at various types of risk from the vantage point of how they affect retirees at different life stages. Here are four key risks to consider.

1. Investment Risk -- Balancing risk and return takes on a different meaning for individuals as they age. A negative rate of return during the early years of retirement could leave an individual with a significantly smaller nest egg when compared with negative returns later in the retirement life cycle. Your financial advisor can help you craft an investment mix with the goal of smoothing out returns over the long term and increasing the chances that your assets will last throughout your lifetime.

2. Longevity Risk -- Withdrawing too much from a portfolio during the early years of retirement may heighten the chance of depleting your assets during your later years. For this reason, many financial advisors recommend limiting annual withdrawals to 5% or less of a portfolio's value, adjusted for inflation, to make assets last as long as possible.

3. Inflation Risk -- Because younger retirees typically are planning for a time horizon of 20 years or more, it is important that their portfolios include a source of growth that is likely to exceed inflation over the long term. To complement this potential growth, many retirees rely on more conservative investments that may generate income and help to balance risk and potential return.

4. Health Care Risk -- It is not unusual for medical costs to increase as retirees age, and it may be prudent to plan for these costs before the need is immediate. Preretirees and younger retirees may want to explore options for medical insurance that supplements Medicare, as well as long-term care insurance, to reduce the possibility of dipping into personal assets to finance illness- or accident-related expenses. Also, remember that those who retire before age 65 need to find an alternate source of medical insurance prior to becoming eligible for Medicare.

Reviewing these and other challenges associated with retirement planning with your financial advisor may increase your confidence that you have considered all scenarios. While it may not be possible to prepare for every situation, planning ahead may help you cope with financial issues that come your way.

© 2011 McGraw-Hill Financial Communications. All rights reserved.

June 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by James P Ellman, ChFC and Barry Mendelson, CFP  local members of the FPA.

Late Retirement and Minimum Distributions

The IRS offers a frustrating lack of guidance on how to tell whether someone is 'retired.' by Natalie Choate 06-09-11 |

Certain people who are still working after age 70 1/2 get to postpone the "required beginning date" for required distributions from their retirement plans. What can be frustrating is the lack of IRS guidance about how to tell whether someone is "retired."

Question: "Joe" is leaving his job this year, at age 79. He does not now own and has never owned any stock of the corporation he works for. When must he start taking distributions from the company's retirement plan? If he goes back to work for this company later, can he suspend taking those minimum distributions until he retires again?

Answer: Because Joe has never had any ownership interest in the employer, it's easy to figure out when he must start taking distributions. His "required beginning date" for distributions from his employer's retirement plan(s) is April 1 of the year following the later of the year he reaches/reached age 70 1/2 and the year he "retires." He reached age 70 1/2 several years ago, so the "later of" year is this year, the year he retires. Accordingly, 2011 is his "first distribution year," and he can take that first year's minimum required distribution anytime in 2011, or in 2012 (on or before April 1).

If he owned an interest in the employer (now or in the past), we would have to take more steps to verify that he would not be considered a "5-percent owner." A 5-percent owner, unlike other employees, is not entitled to postpone the start of minimum distributions past age 70 1/2, regardless of whether he is "retired."

Unfortunately, the plan apparently cannot suspend minimum distributions if he goes back to work for the company. The statute and regulations key the start of minimum distributions to the year the employee "retires," and there's no mention of any way to stop minimum distributions once they start. If Joe rolled his company plan benefits into an IRA, then went back to work for a different company, and rolled the IRA into his new employer's plan, that might do the trick--because he would not yet be "retired" under the new company's plan!

 Question: "Chris" is receiving deferred compensation from the company he used to work for. He is not and never has been a "5-percent owner" of that company. He is completely retired as far as I can tell, but he would like to postpone taking any minimum required distributions from the company's qualified retirement plan. He thinks he is entitled to such postponement because the nonqualified deferred compensation he is receiving is reported to the IRS on Form W-2. Because Form W-2 is reporting his income to the IRS as "wages" (W-2 is the "Wage and Tax Statement" form), he says the IRS would not regard him as "retired," therefore he is not subject to minimum required distributions yet. Is his argument valid?

Answer: "Chris" is not going to be making this decision all by himself. The plan administrator of the company retirement plan and the person who prepares Chris' federal income tax return both also have a stake in getting the right answer here.

The plan administrator of the qualified plan is responsible for making sure the plan stays "qualified." One element of qualification is complying with the minimum distribution rules. If the plan is required to distribute to Chris because he is (1) over age 70 1/2 and (2) retired, then the plan had better make the distribution or risk disqualifying the entire plan. If the plan administrator has done the necessary research and/or gotten an IRS ruling that Chris is not "retired," then Chris and the plan and Chris' return preparer can all rest easy with Chris' decision to postpone distributions.  

However, contrary to Chris' belief, there is no authority supporting the position that a person is not "retired" so long as he is receiving compensation that is reported on Form W-2. It's true that Form W-2 is used to report compensation for current services. But it is also used to report certain types of deferred compensation--and believe it or not, the IRS is aware of that fact! A Form W-2 that reports no compensation other than deferred compensation does not support the position that the individual is still working--in fact it supports the opposite conclusion, namely, that the person is retired.

We have something analogous we can look at--namely, the question of what constitutes "compensation" for services for purposes of supporting a contribution to an IRA. "Compensation" for this purpose "does not include any amount received as deferred compensation." Rev. Proc. 91-18, 1991-1 C.B. 522, recognizes that amounts reported on Form W-2 generally constitute "compensation for services" for purposes of supporting an IRA contribution, and accordingly the IRS will accept the "compensation" amount shown on Form W-2 as a "safe harbor" with respect to supporting an IRA contribution--unless the amount is also shown as deferred compensation.

Box 1

of Form W-2 ("Wages, Tips, and Other Compensation") reports the individual's total compensation for services during the year.

Box 11

of the 2010 Form W-2 ("Nonqualified Plans") reports how much of the

Box 1

amount is deferred compensation. Have a look at Chris' W-2. See whether the amount reported as total W-2 compensation for the year (Box 1) is also reported in

Box 11

. If it is, the IRS is unlikely to be fooled into thinking that Chris is not "retired."

If Chris fails to take a minimum required distribution, such failure must be reported on Form 5329 attached to his personal income tax return, with the attendant 50% penalty carried over to line 58 of the Form 1040 ("additional tax on IRAs, other qualified plans, etc."). The preparer of Chris' federal income tax return needs to consider this issue when preparing his return.

Natalie Choate practices law in Boston, specializing in estate planning for retirement benefits.


The views expressed in this article are the author's.

Three Step Retirement Planning Strategy for Couples

It's important for you and your partner to evaluate all of your portfolios at the same time to see whether the overall investment mix is well diversified.

Communication is one of the foundations of a successful relationship. It also can help you and your partner structure a solid retirement planning strategy.

Planning for two can be more complex than planning for one. It's not unusual for two individuals to have very different plans and financial resources -- for example, one may have more money set aside or may be eligible to collect retirement benefits significantly earlier than the other.

If you're part of a dual-income couple, be sure to review the following considerations.

Step One: Talk About the Future

If you and your partner expect to retire at different times or need to negotiate priorities regarding how you'll spend time and money during retirement, it's important to start talking about the future now.

First, make sure your planned retirement dates are realistic. Next, estimate your combined retirement income needs as well as the amount of money you're each likely to have accumulated by retirement. If it looks like you may be facing a shortfall, try to contribute as much as possible to your employer-sponsored retirement plan while you still can.

Step Two: Make Sure You Are Properly Diversified

Within a single portfolio, diversification involves spreading your money among different types of investment options so that any losses in one area may be offset by potential gains elsewhere.1 With two or more retirement accounts, the same theory applies. It's important for you and your partner to evaluate all of your portfolios at the same time to see whether the overall investment mix is well diversified. For example, if you and your spouse have similar investment portfolios, your overall level of risk could be higher than you realize, since a decline in one portfolio would likely be accompanied by a similar decline in the other. If that's the case, you might want to rebalance your asset allocation by shifting money that's already in your accounts to different asset classes (stock funds, bond funds, or cash investments) or by directing future contributions to the under-represented asset classes.¹

Step Three: Get on the Same Page

When laying the groundwork for a financial future that includes your significant other, ask yourselves the following questions:

•                      Do you understand each other's "financial personality"? It's never too late to have an honest discussion about financial habits and objectives. Try to look past your differences and focus on shared goals.

•                      Have you calculated how much money you are likely to need to fund a financially secure retirement? Do both of you think this amount is realistic? It's tough to work together toward a shared goal if the two of you have different ideas about what exactly that goal is.

•                      Have you consulted a financial professional? Making a date to discuss your entire range of goals may put you in a stronger position financially to survive unforeseen circumstances.

Regardless of your particular situation, a little advance planning can make the transition to retirement much more pleasant for both you and your better half.

¹Diversification and asset allocation do not ensure a profit or protect against a loss in a declining market.

© 2011 McGraw-Hill Financial Communications. All rights reserved.

May 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by James P Ellman, ChFC and Barry Mendelson, CFP,  local members of the FPA.

Estate Planning for Second Marriage

by Natalie Choate | 05-13-11

Question: My client, who has a significant 401(k) plan through his small business, is getting remarried at age 64. Following the marriage, his estate planning goal is to have his new spouse (now age 58) be named as life beneficiary of his plan benefits, entitled to receive only the minimum required distribution, with any balance remaining at the spouse's later death to pass to the client's children (currently ages 40 and 35). He wants the benefits to qualify for the marital deduction for estate tax purposes, but does not want the wife to be able to access a lump sum distribution or change the successor beneficiaries. Further complicating this, when my client dies, the business will come to an end and have to be liquidated, which involves terminating the plan. Another problem is how we can get the future wife to accept this estate plan prior to the marriage.

Answer: The plan this client wants poses a number of legal hurdles and income tax disadvantages.

Perhaps there is a need to step back from these complications and look for a better way to

accomplish his goals. The plan he has in mind would require naming a trust as beneficiary of the retirement plan. The trust would provide that the wife would receive, each year, the income of the trust's non-retirement assets (if any), plus the "greater of" the minimum required distribution from the retirement plan for that year or the "income" of the plan for such year. Upon her death, the balance of the retirement benefits

(if any are left) would pass to the client's children. This type of trust is called a "QTIP trust" (for "qualified terminable interest property"), a name derived from the Internal Revenue Code section dealing with marital deduction trusts. If the trustee withdraws from the plan in any year more than the income/minimum distribution amount, the excess would be held in the trust for later distribution to the children. While that sounds fairly straightforward, this proposed plan would have to clear numerous hurdles.

After he and his family pay hefty legal fees to prepare and implement this plan, the client might then look down from heaven some years hence to see that his children receive exactly nothing from his retirement plans and his wife received much less than she could have received if things had been done a little differently.

Here are the obstacles to success with the QTIP trust plan; a suggested alternative approach at the end of this outline avoids these problems.

Federal spousal rights. Under federal law, once he and his new wife have been married for one year, he cannot designate anyone other than his surviving spouse as beneficiary of this plan unless she consents to allow him to name someone else. So, after the one-year period, he cannot leave his 401(k) plan to a QTIP trust without his spouse's consent. (Many retirement plans don't bother with the one-year waiting period; they give the spouse this consent right immediately upon the marriage.)

This right cannot be waived in a prenuptial agreement, according to the Department of Labor. Having the spouse agree, in a prenuptial agreement, that she will later waive these benefits might work, especially if she is given a significant financial incentive to consent, but that outcome is not guaranteed.

See-through trust rules. A QTIP trust named as beneficiary of the plan would need to qualify as a "see-through trust" under the IRS' "minimum distribution trust rules" in order for the trust to obtain a "stretch" payout of the benefits over the life expectancy of the oldest trust beneficiary (the wife). If the trust does not so qualify, then the benefits will have to be distributed out of the plan or IRA and into the trust within five years after the participant's death. Thus, the trust would need to be drafted by an estate planning lawyer familiar with the tricky see-through trust rules.

Wife must receive greater of minimum distribution or income. If the trust provides that the wife will receive only the minimum required distribution, it will not qualify for the federal estate tax marital deduction. To qualify for the marital deduction, the trust needs to provide that the wife will receive, each year, at least the income of the retirement plan (which could be more or less than the minimum required distribution in any particular year), as well as the income of any other trust assets. Again, we are faced with the need for an estate planning attorney who is experienced in drafting trusts for retirement benefits.

Benefits must be rolled to an IRA after the client's death. Because the 401(k) plan will

terminate at the client's death, the benefits will need to be either cashed out in a lump sum or "direct rolled" into an inherited IRA when he dies. A rollover to an inherited IRA is the only way to preserve the option of a "stretch" (life expectancy) payout at that point. That option will be available if the plan beneficiary is either the surviving spouse, the children, or a see-through trust. This option is not available if, for some reason, the trust that is named as beneficiary "flunks" the IRS' minimum distribution trust rules. There is nothing wrong with post-death beneficiary direct rollovers, but the client should be aware that this is an additional complication of his plan--one that would not arise if he rolled the benefits to an IRA prior to his death.

Booby prize: Nothing left for the children. What do you get for successfully meeting all of those challenges? If the benefits are left to a QTIP trust as contemplated by the client's proposed plan, and the wife lives to her late-80s or later, there will be nothing left for the children at the wife's death--even if the trust qualifies as a see-through trust, and even if the wife has consented to allow the trust to be named as beneficiary! That's because the client has specified that the entire minimum distribution is to be distributed to the wife each year. Minimum distributions will be based on the wife's life expectancy. Under the IRS tables, the wife's life expectancy would run out when she reaches approximately age 85. At that point the entire plan would have been distributed (and taxed) to the wife, so there would be nothing left for the children. To counteract that effect, the trust would have to provide that the wife does not receive the entire required minimum distribution; she just receives the "income" of the trust (as required by marital deduction rules). But in that case, the amount held back and retained in the trust for future distribution to the children will be taxed at trust income tax rates. A trust goes into the highest bracket (currently 35%, scheduled to rise starting in 2013) at a mere $11,800 or so of taxable income. So accumulating retirement plan distributions inside a QTIP trust for future distribution to the children comes at a very high price.

Plan sacrifices major deferral potential: By leaving benefits to a QTIP trust, the client is throwing away all of the potential deferral benefits of the spousal rollover as well as of a life expectancy payout based on his children's young ages. Thus, the plan is not only complicated in terms of its legal structure and requirements, it is very beneficial to the IRS. The client may want to consider another approach. Because of the spousal consent rule, the client is not free to leave the benefits either to his children or to a QTIP trust--the wife is the mandatory sole beneficiary (at least she will be after they are married for a year), and a prenuptial agreement waiving that right could be problematic. The client can remove this "blackmail" factor by rolling the benefits to an IRA prior to the marriage. Then the couple can agree upon a fair estate plan and disposition of the benefits via a prenuptial agreement that is clearly enforceable. (The federal spousal consent rules do not apply to IRAs.) Even if the husband continues to have future accruals under the 401(k) plan, and these become subject to spousal consent, the main bulk of the retirement plan money will have been rolled to the IRA and thus will have a "secure future."

Then, instead of leaving the benefits to a QTIP trust, the client should consider purchasing (through a trust) enough life insurance to provide everything for his wife that he wants to provide for her, while naming his children as beneficiaries of the IRA. The insurance trust would be structured to be outside the client's estate. The wife would receive the trust's income for life plus principal in an amount specified by the client (such as for health and support, or equal to a minimum dollar amount or percentage each year).

If the benefits are left outright to the children, the distributions can be spread over the children's long life expectancy. That's not possible with a QTIP trust, because the wife is the oldest beneficiary. The distributions can be taxed at the children's tax rate (normally lower than the tax rate applicable to a trust; humans don't get into the highest tax bracket until they have more than $370,000 of taxable income).

This plan costs more in terms of insurance premiums. The tax savings after the client's death should outweigh the premium cost during his life--and his children will get something from their father instead of nothing!

The views expressed in this article are the author's.

Four Tips for Tax Smart Investing

At times, you may use losses in your investment portfolio to help offset realized gains.

Savvy investors have long realized that what their investments earn after taxes is what really counts. After factoring in federal income and capital gains taxes, the alternative minimum tax (AMT), and potential state and local taxes, your investment returns in any given year may be reduced by 40% or more. Luckily, there are tools and tactics to help you manage taxes and your investments. Here are four tips to help you become a more tax-savvy investor.

Tip #1: Invest in Tax-Deferred and Tax-Free Accounts

Tax-deferred investments include company-sponsored retirement savings accounts such as traditional 401(k) and 403(b) plans and traditional individual retirement accounts (IRAs). In some cases, contributions to these accounts may be made on a pre-tax basis or may be tax deductible. More important, investment earnings compound tax-deferred until withdrawal, typically in retirement, when you may be in a lower tax bracket.

Contributions to Roth IRAs and Roth 401(k) savings plans are not deductible. Earnings that accumulate in Roth accounts can be withdrawn tax free if you are over age 59 1/2, have held the account for at least five years, and meet the requirements for a qualified distribution.

Tip #2: Manage Investments for Tax Efficiency

Tax-managed investment accounts are managed in ways that can help reduce their taxable distributions. Your investment professional can employ a combination of tactics, such as minimizing portfolio turnover, investing in stocks that do not pay dividends, and selectively selling stocks that have become less attractive at a loss to counterbalance taxable gains elsewhere in the portfolio. In years when returns on the broader market are flat or negative, investors tend to become more aware of capital gains generated by portfolio turnover, since the resulting tax liability can offset any gain or exacerbate a negative return on the investment.

Tip #3: Put Losses to Work

At times, you may be able to use losses in your investment portfolio to help offset realized gains. It's a good idea to evaluate your holdings periodically to assess whether an investment still offers the long-term potential you anticipated when you purchased it. Your realized losses in a given tax year must first be used to offset realized capital gains. If you have "leftover" losses, you can offset up to $3,000 against ordinary income. Any remainder can be carried forward to offset gains or income in future years.

Tip #4: Keep Good Records

Keep records of purchases, sales, distributions, and dividend reinvestments so that you can properly calculate the basis of shares you own and choose the most preferential tax treatment for shares you sell.

Keeping an eye on how taxes can affect your investments is one of the easiest ways to help enhance your returns over time. For more information about the tax aspects of investing, consult your tax professional.

The information in this article is not intended to be tax advice and should not be treated as such. You should consult with your tax advisor to discuss your personal situation before making any decisions.

© 2011 McGraw-Hill Financial Communications. All rights reserved.

March 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by James P Ellman ChFC and Barry Mendelson CFP local members of the FPA.

Estate Transfers: IRA to Beneficiary

The "stretch" or "life-expectancy-of-the-beneficiary" payout is available only to a "designated beneficiary."

 by Natalie Choate 04-08-11 |

Judging by the number of questions I get on this topic, this is one of the hottest issues out there. I've consolidated the most common questions into one typical scenario:

Question: "Yuri" died in 2010 at age 68 without having named a beneficiary for his IRA. Under the account documents for this particular IRA, the default beneficiary is Yuri's estate. He also left no will, so under the applicable intestacy laws, the estate passes half to Yuri's wife "Lara" and half to their daughter, "Tonya." The estate has no other assets. Lara, as administrator of the estate, has instructed the IRA provider to transfer Yuri's IRA in equal shares, via direct IRA-to-IRA transfer, half to Lara's own IRA and half to an "inherited IRA" payable to Tonya as beneficiary. The IRA provider refuses to do this unless an "inherited IRA" is opened in the name of the estate first. We are at an impasse. If the IRA provider insists on this condition, then the IRA will be subject to the "5-year rule." We want to instead have Lara do a spousal rollover of her half, and Tonya wants a life expectancy payout for her half. We also don't want to have to report the account as an estate asset for probate purposes. How can we resolve this dilemma?

Answer: On this one, the IRA provider is doing it right.

To back up a little bit, there is nothing wrong (in my opinion) with your goal of transferring the IRA out of the estate, intact, to the estate's two beneficiaries. Some IRA providers permit estates to do this, requiring only that the executor or administrator of the estate take control of the account and then give proper instructions for the transfer. Some IRA providers permit the transfer but have more substantial requirements--for example, the IRA provider might require an IRS ruling, legal opinion, and/or hold harmless agreements from the beneficiaries. And some IRA providers do not permit such transfers under any circumstances.

But whether or not the IRA provider permits the estate fiduciary to transfer the account out to the estate's beneficiaries, the IRA provider cannot deal with the fiduciary at all until the fiduciary has provided proper documentation to establish the fiduciary's right to give instructions with respect to this asset. Typically this means the fiduciary must (1) provide documentation of its right to deal with the account, such as a certificate of appointment from the Probate Court, and (2) sign the IRA provider's paperwork agreeing that the estate (as IRA beneficiary) is bound by the IRA provider's terms and conditions. Only once the IRA provider has this documentation can the provider begin taking orders from the estate fiduciary with respect to the deceased participant's IRA.

If the estate is going to transfer the asset out to the beneficiaries immediately, the IRA provider may or may not require the opening of an actual formal "inherited IRA account" in the name of the estate, before allowing that account to be closed as the IRA is transferred to the beneficiaries. If this step is required, the new "inherited IRA" account will be titled "Yuri IRA, payable to the estate of Yuri as beneficiary" or "Lara, administrator of the estate of Yuri, as beneficiary of Yuri." Some IRA providers might be willing to dispense with formally opening an account in the name of the estate as beneficiary, once the executor has provided evidence of its authority, written acceptance of the IRA provider's terms, and instructions for the transfer.

The transfer instructions would say in essence, "I, Lara, as administrator of the estate of your deceased IRA customer Yuri (see my certificate of appointment attached) hereby instruct you to divide the above account [i.e., Yuri's IRA] into two separate equal inherited IRAs, one titled 'Yuri, deceased, IRA, payable to Lara as successor beneficiary' and the other titled 'Yuri, deceased, IRA, payable to Tonya as beneficiary.'"

So the "good news" is that (one way or another) Lara can do these transfers. If the IRA provider she is dealing with won't allow the transfers, the account can be moved (still as an inherited IRA in the name of the estate as beneficiary) to a more cooperative IRA provider.

The bad news is that, unfortunately, Lara is misinformed about the effects of doing this transfer. Transferring the account to Lara and Tonya individually will not magically transform them into "designated beneficiaries" for minimum distribution purposes.

The "stretch" or "life-expectancy-of-the-beneficiary" payout is available only to a "designated beneficiary." A "designated beneficiary" means an individual or a qualifying "see-through trust." When Yuri died, there was no designated beneficiary on his IRA account. His estate was the default beneficiary, and (under the IRS' regulations) an estate cannot be a "designated beneficiary." Therefore the stretch or life expectancy payout method is not available for this IRA. Transferring the account out of the estate has absolutely no effect on the "applicable distribution period" for the account. It does not cause the transferees to become "designated beneficiaries" with respect to the account.

Yuri died before his required beginning date, with no designated beneficiary, meaning that the applicable distribution period for his IRA is the "5-year rule." All funds must be distributed out of his IRA no later than Dec. 31, 2015. As a result of the transfer, Tonya is now the successor beneficiary of "her half" of Yuri's IRA, but she is not entitled to use the life expectancy payout method.

The only bright spot here is that, although the IRS regulations never permit a life expectancy payout for benefits payable to or through an estate, the IRS applies more lenient standards when the issue is the spousal rollover rather than the life expectancy payout. Because Lara, the surviving spouse, was entitled to half the IRA through the estate as her intestate share, the IRS might well allow her to "roll over" her half into her own IRA, thus salvaging substantial income tax deferral.

I understand that families and their advisors can be very upset when they receive this answer, because it may mean they have to incur probate costs they hoped to avoid and the daughter does not get the life expectancy payout she hoped for. These bad results are caused by Yuri's failure to do proper estate planning, not by some evil intent on the part of the IRA provider.

Resources: The following sections of Natalie Choate's book Life and Death Planning for Retirement Benefits (7th ed. 2011) provide complete discussion and citations to authority for the points discussed in this answer.

The views expressed are the authors.

Financial Issues for Long-Distance Caregivers

Financial Issues for Long-Distance Caregivers

As older friends and relatives increasingly need our help, it’s not always possible for us to move back to personally oversee their care. The same goes for younger loved ones who face sudden illness or injury that robs them of their ability to care for themselves.

How can we best be in charge when we can’t be onsite?

It takes a plan, one best made well ahead of the time when there’s a real need. In reality, caregiving issues should be part of any person’s long-term financial plan if there’s even the remotest chance that a spouse, partner, parent, child aunt or uncle, sibling or friend may end up needing our care.

However, statistics suggest that possibility may not be all that remote, particularly as Americans live longer. In a 2009 report, The National Alliance for Caregivers, in collaboration with AARP and the MetLife Foundation, reported that currently 29 percent of the U.S. adult population, or 65.7 million people, are caregivers, including 31 percent of all households. Those numbers are expected to grow due largely to the aging Baby Boomer demographic.

Where to start? A good first stop is a qualified financial planner who can look at your overall financial picture and the financial picture for your loved one. Then you can determine how much help you can offer from a money perspective, either in direct care, travel expenses or expenses for third parties offering direct assistance onsite.  It’s important to get one-to-one advice on these matters because a caregiving plan needs to fit you and the person you’re trying to help.  Here are some questions that can help you focus your thinking: 

Do you know your loved one’s care preferences? Before you even get to money issues, understand what your loved one wants. The best-case scenario is to have a conversation with that person long before they need care, but even in a transitional situation, addressing their care preferences and overall dignity is paramount. You need to make sure your loved one understands your situation too, particularly if your work, your family situation or other issues prevent you from caring for them personally. Before making a plan, understand each other. A family meeting might be a good idea so everyone understands these needs and wants.

Are their legal documents in place? Does this parent, relative or friend have a will and necessary health directives in place? Health directives name a single individual to manage all key health decisions if a patient cannot make them; a will depending on their assets and lifestyle situation – if they have kids to raise or a business to run, for example – check to see what detailed legal instructions they have in place to manage their finances or run their business if they are incapacitated. And if those plans have not been made, they need to be made immediately with the help of financial planning, tax and estate experts to fit those documents to your loved one’s needs. An individual who is ill or disabled needs to designate people whom they trust to handle health and personal finance decisions. But if they have not planned for the future of their business, that is a third and very detailed step that needs to be addressed in collaboration with other family members as well as key co-workers or executives.

Do you know their financial situation? It’s rarely easy to talk about money even in the closest relationships. But once care preferences are known, then it’s time to discuss the loved one’s own financial preparations because one of the biggest misperceptions about long-term care is that the government provides financial support for nursing or home-based care. (Outside of medical care for those who qualify under Medicare or Medicaid, it doesn’t.) A qualified financial planner can be an important mediator in this very detailed discussion, asking both sides critical questions to illuminate what financial resources are available and which ones might be needed. And keep in mind that the questions go well beyond what’s necessary to provide care – loved ones may need to address omnibus issues like real estate and estate planning but even minute lifestyle issues like making sure monthly bills get paid. Expect a very wide-ranging and detailed conversation that could take weeks, not hours.

Who should handle what? Bigger families and groups can share responsibilities, and that can make the caregiving job easier. But if you are soloing as the financial and health power of attorney, it’s important to devise ways to do remote tasks efficiently and bring in help when necessary so you can supervise effectively from afar:

•          Consider a geriatric care manager: The National Association of Professional Geriatric Care Managers [www.caremanager.org] is an organization of on-the-ground caregivers and caregiving coordinators with skills that include nursing, gerontology, social work and psychology. For caregivers with limited time to address their loved one’s day-to-day issues but who have the resources to pay for help, it might be wise to consult with experts after checking their references and qualifications.

•          Take full advantage of the Internet: Older relatives tend to trust traditional means of paying bills, but automatic bill pay and other online financial tools provide an extraordinary benefit for caregivers or relatives charged with managing someone else’s finances. By gathering all bills that need to be paid and programming in their payment dates, there’s little or no risk that any regular bills will be paid late. Automatic bill payment should be one of the first decisions made if an elderly relative establishes a joint checking account with a caregiver or whoever holds their financial power of attorney. Also, if a relative wants to continue a regular savings or investment plan while they are incapacitated, those payments can be made as well. Most important – once those automatic transactions are set up, all the security codes and passwords must be kept in a safe place for both to access.

•          Set up a home maintenance schedule: If the relative is hoping to return to the home or if it must be sold at a later date to pay bills or to settle the estate, it must be maintained to assure its value at the time it needs to be reoccupied or sold.

•          Develop a paperwork system: the sheer amount of paperwork associated with caring for a sick or disabled person can shake the most organized individual. A trained financial expert can help you set up a system for collecting and sorting all the medical and care-based paperwork that will accumulate during your loved one’s care. This is a particular priority for those who are managing this situation remotely. If the house is unoccupied, it’s also important that there is a way to keep mail secure to avoid identity theft – buy a shredder for all mailed materials that don’t need to be filed. Also ask your loved one for permission to pull their credit reports annually so you can confirm all accounts are current and they haven’t been targeted by identity thieves.

What if I need to move? Never say never – this is the reality of a caregiver’s life. Particularly as loved ones get to the end stage of their lives or suffer emergencies and other setbacks, supervising caregivers need to plan for anything. The need to relocate, even temporarily, should always stay in the back of your mind, and the best time to coordinate with family and employers is always before the need arises.

February 2011 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by  Jim Ellman, ChFC and Barry Mendelson, CFP,  local members of FPA.

Jim Ellman, ChFC & Barry Mendelson, CFP®

Jim@JustPlans-Etc.com            Barry@JustPlans-Etc.com

1399 Ygnacio Valley Road #24, Walnut Creek, CA  94598

925.988.0330  http://www.justplans-etc.com/

Ways to Control What You’ll Spend on a Funeral

It doesn’t matter whether a loved one dies suddenly or with warning – funeral costs can be daunting. According to the National Funeral Directors Association, which bills itself as the world’s leading funeral service association, the average cost of an adult funeral in 2010 stood at $7,755, and that amount doesn’t include the price of a gravesite, monuments or flowers – not even the cost of an obituary.

As with most money issues, planning almost always saves money. But particularly with the subject of death, planning can reduce or eliminate a huge source of worry, anguish and conflict among loved ones. So while death is never easy to talk about, it makes considerable financial and personal sense to talk about funeral issues with loved ones before anyone actually needs to. Here are some key questions to ask:

What do you and your loved ones really want? It makes sense to talk with your parents, your spouse or partner or your children about what your wishes and theirs are for your funeral. Of course, many people ask this question without any real warning and deservedly get an answer with a dismissive wave or a flippant remark. But this needs to be a real conversation. There’s real value in talking about exact wishes and even more value in putting those thoughts on paper for formal inclusion with wills and powers of attorney (more on that below). There are many interlocking issues that come into play in this discussion – religion, relationships, and of course, money. Whether the discussion is face-to-face or within a family meeting, detailed discussion and note-taking is the first important step to making sure your wishes or the wishes of a loved one are recorded and followed.

Consider the alternatives: One of the biggest stories in the funeral industry in the last 25 years has been the growth in cremation as a more affordable and acceptable alternative to traditional burial. On average, cremation can cut the price of a traditional funeral by half or more. According to the Cremation Association of North America (CANA), in 1985, nearly 15 percent of deaths resulted in cremation, but by 2007, that number stood at 34.3 percent. By 2025, CANA expects cremations to reach more than half of all funeral services performed. Also, many individuals now consider donating their bodies to science for the study of disease or organ donation, often at little or no cost whatsoever. This allows friends and families to focus spending on a memorial or other financial needs. To investigate this option, the official terminology is “willed body program,” and many universities with medical schools have them.

Do a cost comparison: It’s not the easiest decision, but if it’s your funeral or the funeral for a loved one, it makes sense to plan ahead and to shop smart. A trusted funeral director will follow state guidelines on price lists and answer your questions thoughtfully. Keep in mind that many states do not require you to buy big-ticket items like coffins from the funeral director, and in some cases, expensive processes like embalming are not even required. It makes sense to visit the website of whatever state agency supervises funeral directors where you live to get an overview of what you may or may not be required to pay for at a funeral home and other alternatives that might save you money. You will also have an outlet for any complaints should they arise. Another good resource is the U.S. Federal Trade Commission’s website  which describes the 1984 Funeral Rule that has defined disclosure, pricing and other consumer rights in the funeral industry for the past three decades.

Make funeral planning part of overall end-of-life planning: Whether death comes suddenly or after an extended disability or illness, adults of any age should have proper asset planning and documents in place designating their wishes for their estate, their families and yes, the way they want to say goodbye. It makes sense to consult an expert financial planning professional as well as tax and estate experts to coordinate both financial and end-of-life planning in a way that fits the individual. Commonly, that means having finances in place and a legally written will and specific health, financial and family directives exist to guide survivors through the funeral and beyond.

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November 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Jim Ellman, ChFC and Barry Mendelson, CFP® , local members of the FPA.