Tag: Estate Planning

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IRA Estate Planning Strategies In Light of the SECURE Act

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) was signed into law as part of the government’s Further Consolidated Appropriations Act of 2020. As the law’s name implies, the SECURE Act sets forth reforms to existing rules that impact retirement plans. In a partial summary, the SECURE Act promulgates the following changes to retirement plans (particularly IRAs) as follows:

– RMDs start age increased to 72 – The age at which required minimum distributions (“RMDs”) begin changed from 70½ to 72;

– No Age Limit on IRA Contributions – Contributions to traditional IRAs can now occur after the age of 70½ to match the unlimited age limit on ROTH contributions;

– Qualified Charitable Contributions (“QCD”) are offset by post-70½ Tax-Deductible IRA contributions – Without getting into the minutiae of calculations, QCDs are allowed to be made at 70 ½ instead of 72 with one caveat – the contributions no longer avoid tax recognition to the extent of cumulative post-70½ made by the taxpayer; and

– Death of the “Stretch IRA” – Prior to the SECURE Act, IRA beneficiaries were allowed, if they chose, to “stretch” RMDs from inherited IRAs over their respective lifetimes. Under the new rules per the SECURE Act, with certain exceptions, the stretch provision is now replaced with a 10-year window for completely distributing the contents of the account.

(Note: There are many more provisions of the SECURE Act that reform retirement plans and the way that they are governed and operated. For the purposes of this article, we are focusing on the provisions of the law that have significant estate planning implications. Please consult the law at https://www.congress.gov/bill/116th-congress/house-bill/1994 for more information.)

With the changes to the stretch provisions for traditional IRAs, a valued strategy that many families relied upon as part of their estate plans was essentially erased with the stroke of President Trump’s pen. Having the rug pulled out from under them seems to be apropo in this instance.

In light of the law change, many clients are now wondering what actions should be taken to ensure that the estate plans that they developed prior to the SECURE Act, are still effective. With a focus on Inherited IRAs and the dissolution of the stretch provision, we focus on the following strategies as potential estate planning strategies for revising their estate plans in the wake of the SECURE Act:

  1. Accelerating ROTH conversions and utilizing a testamentary trust to create your own inherited “stretch” IRA;
  2. Make testamentary transfers to a charitable remainder trust (“CRT”);
  3. Utilize Multi-beneficiary Trusts;
  4. Utilizing Life Insurance as an alternative to planning for passing down an IRA; and
  5. Do nothing and revise your estate plan within the framework of the new IRA rules.

The “Death of the Stretch” – A Brief Summary

Pre-SECURE Act

IRA owners are allowed to name beneficiaries for their accounts. This can be anyone – a spouse (or ex-spouse), children, parents, siblings, grandparents, friends, etc. IRA owners can also name entities as beneficiaries to their accounts too, such as charitable organizations, alma maters, houses of worship, etc. Lastly, IRA owners can name entities they create, such as a trust for the benefit of a loved one, like children or siblings. Upon death, the beneficiary has the following options available when deciding what to do with the inheritance:

– Rename the IRA as their own (this option is only available to spouses)

– Take a lump-sum distribution

– Empty the account contents within 5 yrs of the year of death

– Open a new IRA account titled in both the name of the deceased IRA owner and the beneficiary (an “Inherited IRA”) and defer taking distributions by only taking RMDs based on the life expectancy of the aforementioned beneficiary (assuming that the beneficiary is younger than the deceased IRA owner, otherwise the RMDs would be based on the deceased IRA owner). This is referred to as “stretching the IRA”.

Effects of the SECURE Act

The SECURE act changed the IRA rules by allowing the same options for taking ownership of an Inherited IRA, with the exception that:

– The timeline for emptying accounts is now 10 years instead of 5 (the “10-year rule”); and

– With respect to stretching the IRA, only certain “eligible designated beneficiaries” are allowed to stretch payments over their respective lives, which include:

Spouses

Minor Children (only until such minor reaches the age of majority, after which such minor children become “Designated Beneficiaries”, as defined below)

Beneficiaries that are not more than 10 years younger than the deceased

Disabled Persons (per Code Section 72(m)(7) 

Chronically Ill Persons (per Code Section 7702B(c)(2)

Certain Trusts  for the benefit of Eligible Designated Beneficiaries

– “Designated Beneficiaries” cannot stretch the IRA and must adhere to the 10-year rule:

Non-Spouse Beneficiaries

Certain Trusts established for the benefit of Designated Beneficiaries

Prior to the SECURE Act, many estate plans could simply rely on the IRA stretch provision as a means to allow such assets to grow while minimizing the tax impacts of the inheritance. In addition, certain vehicles such as conduit trusts were instrumental in bequeathing assets while establishing a spendthrift to help protect beneficiaries preserve the windfalls that they inherited.

With the rule changes, primarily with the modification of IRA stretch rules, clients are now concerned about the efficacy of their previously established plans, and need education, guidance, and assistance in making sure their plans are adjusted accordingly. In addition, with a strong government mandate to raise income with a view towards taxing the projected massive transfer of wealth  (estimated at $68 trillion over the next 25-30 years), smart estate planning will be key to ensure that future generations don’t lose significant wealth to potential higher tax bills.

Estate Planning Strategies

Accelerating ROTH conversions

One strategy that can be utilized that can be utilized to mitigate the adverse effects of SECURE Act Inherited IRA changes is to begin converting such traditional IRA holdings into a ROTH IRA and bequeath it outright, or name an accumulation testamentary trust as the beneficiary of the ROTH (for the benefit of the Designated Beneficiary), and through such trust, dictate tax-free distributions per the deceased owner’s wishes. The IRA owner can use the IRS life expectancy tables to create their own stretch IRA for the trust beneficiary (or beneficiaries, if applicable).

Charitable Remainder Trusts (CRT)

Another strategy for consideration involves the tax free, lump-sum distribution of Inherited IRA into an irrevocable CRT that names Designated Beneficiaries as income beneficiaries and a charitable organization as the remainder beneficiary. Conceptually, the CRT will make distributions to the beneficiaries of an IRA for up to 20 years (or the life of the beneficiary, whichever is shorter) with the remainder going to the charity named as the remainderman. There are complexities in structuring the CRT and maintaining its IRS compliance (i.e., the 10% remainder test) as well as potential drawbacks  such as (1) distributions being limited to income (principal distributions not permitted) and (2) the disinheritance of successor beneficiaries due to the mandatory payment of the trust assets to the charity upon the death of the beneficiary.

Mutli-beneficiary Trusts

Multi-beneficiary trusts can be utilized to allow Designated Beneficiaries potentially benefit from Inherited IRAs bequeathed to both them and am Eligible Designated Beneficiary, such as a Disabled or Chronically Ill Person. The structures could be in the form of (a) a bifurcated trust, where the conduit trust (and stretch portion) pays out to the Eligible Designated Beneficiary, and the accumulation trust pays out to the Designated Beneficiary under the 10-yr rule, or (b) a sequential trust, where payments are made first to the Eligible Designated Beneficiary under the stretch provisions, and then to the Designated Beneficiary under the 10-yr rule upon the death of the first beneficiary.  For example, let’s say Michael is a Chronically Ill 50 year old with a life expectancy of 15 years. His sister, Janet is 45 and is in good health. Both Michael and Janet inherit their father’s IRA of $1 million. As Michael meets the definition of an Eligible Designated Beneficiary, the IRA can name the multi-beneficiary trust for the benefit of Michael as the beneficiary and pay funds out under the stretch provision. Janet, the Designated Beneficiary can be named as a successor beneficiary to the trust, and upon Michael’s death receive payments under the 10-yr rule.

Life Insurance

Generally, life insurance can be used to act as an hedge against the adverse effects of the SECURE Act. By taking distributions and using part of those proceeds to pay life insurance premiums on permanent life insurance (which can be housed in an irrevocable life insurance trust, or “ILIT”) with a face amount that covers at a minimum the account size set aside for bequeathment, the IRA owner can not only gain peace of mind with the fact that the asset won’t fluctuate in value, he or she will also be pleased that such an asset is being passed on to heirs without the burden of taxes.

Keeping the Status Quo

In some situations, things might be just fine with the new rules in place. The 10 yr rule might work as an alternative to the stretch provision of the IRA, and certain alternative planning may work for clients. This due to the fact that (a) many IRA beneficiaries do not stretch their inherited funds, (b) for those that do stretch their IRAs, many exhaust their accounts within 10 years anyway, and (c) given, the size of the account, taxes, and expenses of certain strategies, the status quo is considered to be the path of least resistance.

Regardless of the strategy chosen, it makes sense to sit down with competent, licensed, and credentialed professionals to ensure that your plan contemplates all relevant variables to ensure that the strategy makes sense in light of the client’s financial goals, wishes, and financial situation.

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Life Insurance – An Honest & Down-To-Earth Q&A Session – Pt. 2

Now, Where Were We?

Hello there. Thanks so much for reading my blog. As this post is a continuation from last week’s post, if you haven’t had a chance to read it, please take a look at it here. I will now continue my “self-interview” on all things involving life insurance.

We get it. You are a big proponent of having insurance – either in the form of term and/or permanent coverage.  But how much is enough?  How does one determine how much insurance he/she needs?  How much should be in term?  How much should be permanent?

Answering such a question is highly subjective.  I mean, life insurance is such a personal purchase, and it is the most unselfish thing that you can buy for the people you love, that I often struggle with the question regarding “how much is enough” or “how much should I buy”.  That is exactly why I engage clients in planning – so I can listen to them, understand their goals, get a sense of their value system, and try to serve as a guide and resource in helping them find the right balance of protection to meet their needs.  Simply saying “7-10 times salary” doesn’t do the planning process any justice.

How much do you need?

So, in trying to answer this question I often do my best to ascertain answers to the following two financial questions: (1) how much is financially needed immediately upon your death and (2) for the foreseeable future, how much is financially needed to meet the shortfall in financial needs due to your death.  Then you add (1) and (2) together and subtract the sum of: (3) existing life insurance, (4) social security benefits (if any), and (5) any assets that you currently have in place to meet the needs of (1) and/or (2).

Immediate Needs are financial needs/wants that you want to take care of within 12 months of your death.  These items include (1) final burial costs, (2) medical bills, (3) satisfaction of joint debts, (4) fully funding of college fund for children, (5) fully funding of emergency fund for family (i.e., one year of after-tax earnings), (6) optional pay-off of major family debt like a mortgage/student loans of surviving spouse, etc., and (7) funding a “surviving spouse grief fund” (funds adequate to pay for the surviving spouse’s time off from work or change in work, as applicable).

Future needs are a little more complex and oftentimes requires a financial calculator of some sort, but I will try my best to be simple.  In looking at future needs, I take the lost financial resources (salary, retirement savings, asset accumulation, etc.) and compare that to the resources needed under the new plan (one where a financial provider is gone, but there remains to be needed for household maintenance, child care, college planning, retirement planning, etc.).  This often entails multi-stage analyses when dealing with young children (where Social Security can be contemplated), teens and college-age children, and the surviving spouse as a pre-retiree and retiree).  Those needs are then computed into an amount needed now to fund the shortfall, which is the Future Needs component of life insurance.

Next, you add the Immediate and Future Needs to arrive at the Tentative Need.  Finally, you subtract the combination of Social Security your surviving family is expected to receive, existing life insurance, and existing assets (in place for the purposes that the insurance is intended to be used for) from the Tentative Need to arrive at your Insurance Need.  This is not the easiest stuff to come up with.  Thank goodness that there are calculators on the web and trusted professionals out there that can assist you in the process.

In determining what amount should be term coverage vs. permanent coverage.  It’s highly subjective, but I generally recommend that families use the “temporary need for term, ongoing and changing need for permanent” approach.  For instance, let’s say that my total insurance need is $1.5 million, made up of an immediate need of $500,000 and a future need of $1 million.  However, when I drill down deeper into my future need amount, I see that $700,000 is needed to fund financial shortfalls needed only while my daughter is a child up to and through her graduation from college.  After college, there is no longer such a need.  Therefore, in this instance, structure my $1.5 million life need as $1.2 million in 15- or 20-year term, and $300,000 in permanent life coverage.  Also, as term has conversion features, I might buy $1.5 million in 20-yr term and at the end of my childcare need period, convert $300,000 of my aforementioned term insurance into permanent coverage and drop the $1.2 million term coverage.  The point is, that once the need is determined, there are many ways to go about securing it.  No one way works best for everyone.

Lastly, this analysis is representative of how I derive insurance needs with a majority of clients that I service.  It should be said and made clear that everyone’s situation is different.  With that said, it is not my aim to tell you that the approach that I described is the best way that works for you and your family.  There are many different situations – families with children who have disabilities/special needs, breadwinners with generous pensions, or a married couple with no children, but provide for parents/other loved ones, etc.  The list goes on and on, but the point to drive home is that different facts, circumstances, makeup of net worth and makeup of existing coverages impact the calculation and derivation of the amount of insurance needed (if any) as well as the structuring of such coverage (i.e., the term life vs. permanent life, or combination of the two).

Stay Tuned. There’s more to come.

Please come back next week for the final part of this discussion on Life Insurance. I hope that the information shared is helpful to you and those that you love. As always, feel free to contact me via Facebook or Twitter to ask questions or discuss the topic in more detail. Thanks!

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Life Insurance – An Honest & Down-To-Earth Q&A Session – Pt. 1

Happy New Year!

Hello everyone and Happy New Year!

Welcome back to my blog.  On the date of this post, I am dealing with the one-year anniversary of my father’s death (February 5th), mired with a myriad of emotions and nostalgia.  I had a complicated relationship with my father growing up, but as I became a father and have grown in that space, I have come to acknowledge and appreciate him more and more – even though he is no longer here. 

Without getting into too much detail, my father died unexpectedly (he was in relatively normal health for a 75-year-old) and caught my family off-guard.  Luckily, we were able to handle the financial impact and with only my mother and siblings as the surviving immediate family members, there was little to sort out by way of probate/estate.  Yes, we were lucky.

Life Insurance should be a no-brainer, right?

Yes, lucky indeed.  But what about families in different or more complex situations?  How would they deal with the sudden or unexpected death of a loved one who is a significant financial provider to the household?  The easy and almost textbook-like answer is “life insurance”.  It is general and widely accepted knowledge that many low- and middle-class families look to financial products like life insurance to help families “pick up the pieces” in the aftermath of the death (whether unexpected or not) of a loved one, especially one that served as a main income provider to the household.  However, such widely held knowledge and understanding does not translate into life insurance ownership. According to a 2017 Life Insurance Study conducted by LIMRA, the following statistics state the following – and it isn’t that positive.

The 2017 LIMRA Study (source: www.limra.com)

The Study (or other information from LIMRA) cites the following statistics:

  • 85% of families agree that they need life insurance, yet only 62% say that they actually have it.
  • 40% of households that have life insurance don’t believe that they have enough.
  • Although industry experts recommend that individuals have enough life insurance to replace 7-10 years of lost income, the average individual breadwinner, who has on average $168,000 in life insurance, falls well short of this recommended threshold with only enough life coverage to replace 3.4 to 3.5 years of lost income.
  • 34% own group life insurance vs. 32% that own private, individual life policies.
  • 71% of husbands own life insurance, while 63% of wives do.
  • 40% of Americans wish their spouse or partner had more life insurance coverage; 50% of married millenials wish that their spouse had more life insurance.

The Study also provides insight as to why current prospective consumers of life insurance currently do not own it:

  • 83% incorrectly think that the insurance in question in too expensive. For example, for a healthy 30-yr old, consumers estimated the cost of a $250,000 20-yr term policy to be $400/yr when in fact, such a policy only costs $150/yr.
  • This same cohort of consumers also feel that life insurance is not as important as (i.e, is subordinate to) other financial priorities, such as (a) building savings, (b) managing debt, and/or (c) saving for retirement.
  • 4 out of 10 consumers haven’t purchased life insurance not because they don’t want it, they simply don’t know how much they need and what type to buy.
  • 25% incorrectly believe that they do not qualify for life insurance at all (i.e., they believe that the underwriters would reject their case, or make the policy cost prohibitive based on a current or past health condition).
  • 50% of Millenials say that they haven’t purchased life insurance yet because – get this – they haven’t been approached by an agent to help them find the right coverage. (I have no words).

So what does this all mean? When it comes to life insurance,

  • We know that we need it, but fall short of committing resources to getting it (or getting enough of it);
  • We don’t value it properly (we don’t prioritize protecting our families as much as protecting our cars/homes);
  • It’s a lot cheaper than we think;
  • We’re shortchanging our families by having far less than the recommended amounts of coverage;
  • We wish that we owned more of it, or we wish our spouses/partners owned more of it;
  • With the advances of medicine and healthcare, it’s easier than ever to get coverage for current or past health conditions that once made it unattainable or financially out of reach; and
  • We need to deal with competent, professional, and trustworthy financial professionals to ensure that we are making informed decisions in selecting the optimal amount and type of coverage.

The “Real” Q&A on Life Insurance

Now that I have done a quick rundown on the status of life insurance in the typical American household budget, I thought I would change up my typical “chat-style” blog format and discuss life insurance in the form of an interview transcript. In addition, as the title of this entry says, I plan to provide “the real” response on these issues, and not provide “agent-speak” (the type of jargon that you would expect to hear from a life insurance sales agent – and this is not to imply that an agent would tell you something improper).

How important is life insurance to a family’s financial plan?

I firmly believe, that next to disability insurance, life insurance ranks as the #1 financial priority of a household, as no other product has the financial capability of completing  the financial plan (i.e., if you die, the death benefit is paid to fund college, retirement,  pay bills, fund emergency reserves, etc.) if you were to die.

OK.  We get that you’re passionate about life insurance.  Many working Americans already have access to coverage through the group policies that they have at work.  Isn’t that sufficient?

I’ll let you in on a dirty little industry secret – If you’re healthy, privately sourced term life insurance is CHEAPER than the group coverage that you pay for through the job! In order for group coverage to be affordable across the board, the healthy subsidize the unhealthy. Therefore, group coverage charges healthy insurance premium payers more than they otherwise would pay so that the unhealthy can obtain comparable coverage at an affordable rate. So, if you’re unhealthy or have a health condition that would be really expensive to cover, group coverage is a great deal for you. If you’re in reasonable health, you can get a private policy that beats that group coverage price over the life of the policy (group policies typically raise rates over 5-year increments).

As far as considering if group coverage is enough? I would say no simply because (a) there’s a question whether the coverage that you’re buying is portable, or that the coverage can be converted into privately-owned coverage if you leave your employer, and (b) many group plans do not allow employees to secure 7x salary (so the need isn’t being fully addressed by group coverage). Take whatever life coverage that the employer gives you for free (1-2x salary), but if you’re going to pay for any additional life insurance, price it out in the private market first.

What about Additional Death and Dismemberment Insurance (AD&D insurance)?  Do you recommend that consumers buy this coverage?

In a word, NO. Without getting into too much detail, AD&D insurance pays the insured if he/she dies or suffers a severe injury (i.e., loss of limb) as a result of an accident (not of their own doing). It costs a fraction of the cost of term coverage because you have to die or be severely injured by accident in order to be paid a benefit, which is an unlikely event. I don’t like managing risks (i.e., dying) with a product that only pays if you die under certain circumstances.

Let’s explore the Term Insurance vs. Permanent Insurance issue.  Many “financial experts say that you should “buy term and invest the difference”.  What are your  thoughts on the issue?

I have so many thoughts on this issue, but let’s start with the basics.

First of all, term life insurance is just that – life insurance that lasts for a certain “term” (i.e., annual renewable, 10-year, 15-year, 20-year, 25-year, 30-year). The insurance is designed to provide protection against “temporary financial risks”, such as covering a mortgage, funding college education needs for young children, replacing lost income in support of a household that have young children and any other financial risk that lasts for a limited period of time. As the coverage is finite, the cost of insurance is relatively low. Many term policies come are sold with “convertibility features”, which allow all or part of a term policy to be converted into a permanent policy at any time during the term period without the need for additional medical underwriting.

A permanent policy is life insurance that is conceptually permanent in nature (as long as the premiums have been paid). This is coverage that can conceptually last all of the insured’s life. This coverage is typically ideal for those who have a perpetual need for coverage, as there is a school of thought that believes that while needs for insurance change over time, they never really go away. A parent who gets life insurance for the benefit of his/her children may want to keep coverage in place to help provide for grandchildren or leave a bequest to a charitable cause. There are three general forms of permanent life insurance: (1) whole life, (2) universal life, and (3) variable universal life.

Permanent life insurance also has a “built-in savings component” that allows for the accumulation of cash value to grow within the policy. Depending on the type of permanent policy, the growth of the aforementioned cash value is attributed to guaranteed interest rates and possible mutual life dividends (whole life), general interest rates (universal life), and the performance of mutual fund sub-accounts (variable universal life). Due to the perpetual nature of the coverage and the cash value growth component, the cost of permanent insurance is significantly higher than comparable term insurance.

Some proponents are in favor of permanent coverage because they desire to have “something to show for their money” in the event that time comes to pass and the insured doesn’t die. One can access the cash value (potentially tax-free pursuant to Internal Revenue Code Section 7702) for a myriad of purposes, which we will discuss later. Term insurance, while cheaper, is sometimes viewed as a “zero-sum game”, where insurance company takes all of your premiums if you outlive the term of the policy.

Now getting to the “perm vs. term” debate. “Buy term and invest the difference” is, excuse my french, pure BS. Why? Because no one actually does it. I mean, it sounds good in theory and the numbers look nice on a spreadsheet, but it is simply not done in reality. So, where does that leave my thoughts on the issue? I believe that most clients will benefit from a combination of term and permanent life insurance – owning term life insurance to cover temporary life insurance needs (i.e., covering a mortgage, providing protection for young children, etc.) and have some permanent coverage for “ever-changing needs”, or for alternative strategies (which I will discuss in a future post).

To Be Continued

This will conclude Part 1 of our “Real” Life Insurance Discussion. Stay tuned for the discussion next week, where I will discuss the different ways life insurance can be used (and should not be used) as part of a comprehensive financial plan. Thanks again for bearing with me, and feel free to seek me out on Facebook or Twitter to provide comments or feedback. Thanks.

Disclaimer/Disclosure

As I am a licensed life, health, disability, and long-term care insurance agent, I want to once again reiterate that the views that I express are mine alone – not that of any firm that I am affiliated with. In addition, my commentary is for information-sharing purposes only, and should not be considered financial, tax or legal advice. As always, any financial decision should be made with adequate information and, if possible and desired, the assistance of a licensed, competent and professional advisor that is unbiased and holds your financial interests above his or her own.

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