Do Retirement Estate Planning Your Way
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Do Retirement Estate Planning Your Way
Episode 14
Hi, I'm Addie Prewitt, a New Orleans-based estate planning and tax lawyer. I collaborate with forward-thinking clients to preserve their property and pass their legacy and prosperity to future generations.
Today we're going to be talking about newish estate planning rules for retirement accounts.
And the reason I say “newish” is because they actually came into law in 2019. But if you remember, right when they came into law we were in 2020… in the middle of a global pandemic.
I don't think retirement account rules were on a lot of people's radars, nor were they really concerned about it at that point in time. But I wanted to talk to you a little bit about what happened, what the changes were, and offer a quick illustration about them. I also wanted to offer some things you can think about doing to mitigate those changes.
Are you ready to get into high-level retirement planning? So am I.
First, let’s talk about The Secure Act.
One of the changes that you may have heard of is the Secure Act. Which basically increased the required minimum distribution age from 70 and a half to 72. Always a super weird age, in my opinion, but now the required minimum age for distribution is 72. Now you don't have to take anything out of your retirement accounts if you don't want to, until you reach age 72.
However, another thing that the Secure Act did was it got rid of what was called “the Stretch IRA”. Prior to this law going into effect, if someone died and their child inherited a retirement account from them, the child could then use their own life expectancy to decide how much they needed to take out of the account. So if you had a 38-year-old child, you had 45 years to take the amount out, as needed over that time. If you think about that, that money is growing as it's sitting in that account. So it was a great opportunity to pass wealth on to children. But unfortunately, the Secure Act did away with this “Stretch IRA.”
Now, spouses can still use some of those life expectancy rules, but generally, children, which is probably what we're most concerned with here, have to take all of the money out of the account within 10 years. Think back to that 38-year-old child: if the parent dies in 2020, they have to take everything out of the account by 2030.
We're talking about qualified retirement accounts here.
So these are like your 401ks, IRAs, and retirement accounts that you have put money into without paying tax.
This is not the Roth that we're talking about here, but instead, stuff that you've not paid the tax on that yet.
When your heirs go to pull that money out, they will owe tax.
Generally, it's going to be an ordinary income tax rate. From a tax perspective, it's considered income in respect of the decedent (IRD).
That's getting way in the weeds, probably more than most people here ever want to know. But, the problem with it is you have 10 years to pull it all out. Well, remember you're paying tax on that. You pay tax on graduated income tax rates.
Meaning, when you pull a whole lot of money out, your tax rate skyrockets.
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It really has done away with some of the traditional estate planning in this area where you could plan to take that money out over several years.
Now, there are some things you can do to not have this issue.
One is that you can spend down the IRAs. Maybe you didn't think you were gonna need the money in the IRAs. You just wanted to leave it to your kids. But now maybe you’re thinking, “I can go ahead and pay that tax now and pass them other assets that aren't going to be subject to those ordinary income tax rates.”
That's one planning technique that a lot of people are thinking of.
A lot of people, depending on the size of your family, as well as your preferences, could divide your designated beneficiaries.
Before, maybe you were just going to leave these retirement accounts to your children. But now, maybe you want to add grandchildren, for example, so that not each person has that big tax hit.
Of course, those original beneficiaries may have liked to have that money. So, that's another thing that could go wrong. So, another thing that people can do is actually convert those traditional IRAs into Roth IRAs during your lifetime.
That way you will be immediately picking up the tax.
You’d need to do it in a thoughtful way, so that you're not getting yourself into too high of a tax bracket. But when those Roth IRA funds are then passed on to your children, they don't have to worry about that big old income tax waiting for them on the other side.
Now, let’s discuss Charitable Remainder Trusts
I think this is probably where we're going to spend most of the time of this conversation, talking about what charitable remainder trusts are and what some of the benefits are.
So a charitable remainder trust is a split-interest trust. It is an irrevocable trust that you create during your lifetime. Essentially, you will name a charity as the remainder beneficiary, and then your children, let’s say, can get a stream of income for (usually) 20 years (or based on their life expectancy.) Then at the end of that term, whatever's left in the trust, passes to the charity.
So, automatically you're probably thinking, “Addie, that sounds great! I can pass all this money on to my kids!”
Let’s talk about your specific situation, and get a plan in place today!
But there are rules!
Unless you were charitably inclined, this is probably not the best way to pass generational wealth on to children. Because at the beginning, when the account is set up, the charity has to receive at least a 10% remainder interest. It can grow or decrease based on what the market does, or what the funds are invested in. But, because you have a large chunk automatically going to the charity, generally if you just gave the money outright to the kids, even with them paying the tax, they probably would at the end of the day, receive more money. But if you want to be charitable, this is a great way to make those dollars go further, so to speak.
A charitable remainder trust is defined as a trust which provides for specified distributions, at least annually to one or more beneficiaries. One of which is a charity for a term of years. At the end is paid over to the charity.
We used to use that Stretch IRA, so the kids could get the money out over several years. But, because of the Secure Act, people have suggested that charitable remainder trusts might be an alternative to that Stretch IRA. I do think it's a great alternative if you are charitably inclined.
If you're not so charitably inclined, though, as I said before, it's probably not going to maximize the amount of money that you transfer to your children.
One of the common ways to do this is to name your spouse in the charitable remainder trust.
You make your spouse the income beneficiary of that trust so they can take the amount out each year based on their life expectancy. Then at the end, it goes to charity. So that's a very simple way where you're providing for your spouse through this charitable remainder trust, but then at the end, it's going to charity.
If you name the trust as the life expectancy of your spouse, I think people worry or wonder what that means.
If your spouse lives for another 30 years, then they are taking the income from that trust's assets for those 30 years. Then at the end, whatever's left, goes to the named charity.
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The other side is that if the spouse only lives for three years, whatever is left in that trust goes to the charity.
So you can't do that and give it to your kids. Another thing that people do is called the “give it twice trust.” (If you Google “give it twice”, you will see Texas A&M come up right on point on this, which I think is hilarious just because Texas A&M has all that oil money. I'm a big LSU fan and they're a big rival of ours!)
But essentially what it says is, you have that IRA, you’re going to split it.
You’re going to give the children a 20-year term for the money in it, let's say a 5% of whatever's in that trust.
So, with an $800,000 trust, 5% means the kids are getting $40,000 per year. And then at the end of that 20 years, the rest goes to charity. And the reason to “give it twice” is because if the numbers work out. You're essentially giving the same amount to both your children and the charity.
So, charities love that. They get the money and the kids also have a stream of income coming in for that 20 years.
So that could be great in the sense that if the kids are fine with that extra stream of income, I mean, who's not fine with extra money, I suppose?
But the detriment to the kids could be, let's say they have some large expense (they want to pay for a wedding, want kids to go to college), they can't just go in and get extra money out of that trust. They can only get what’s allotted. Think of it as an annuity, because that's really what it is. Or think of it as a unitrust amount. But that's getting into the weeds again.
They only get the certain amount that's coming out to them every year.
The reason people like this “give it twice trust” though, is with the life expectancy. When the income term is based on the life expectancy of a person, it could be large, it could be small. Unfortunately, that's not something we can predict. If we could, this would make all of our jobs in this space a whole lot easier.
But, the good thing about the “give it twice trust” is if you have a child that you name, unfortunately, they die early, then their children can step in and take over that term for the remainder of the 20 years. So it doesn't just all go to charity. I think that's a good way to protect both your family and your charitable remainder interest.
That's a brief and very high-level overview of charitable remainder trusts. I don't think people often think about the ways that they could give to charity, especially if you think about give it twice: “I could give that same amount to my kids and to a charity.” I think people are interested in that, particularly if they don't plan on using their retirement savings. Maybe they sold a business for millions of dollars.
They just have this 401k, but they don't actually foresee the need for it.
These are really good opportunities to advance some charitable inclinations that you may have and also benefit your children.
Take Care,
Addie
Retirement Estate Planning FAQ
Q: What is a charitable remainder trust?
A: Charitable remainder trusts are defined as trusts which provide for specified distributions, at least annually to one or more beneficiaries. One of which is a charity for a term of years. At the end of that term, the remaining sum is paid over to the charity.
It is a split-interest trust or an irrevocable trust that is created during your lifetime.
Essentially, you will name a charity as the remainder beneficiary which means that at the end of designated terms, the remainder of the trust passes to the charity.
In the beginning, when the charitable remainder trust account is set up, the charity has to receive at least a 10% remainder interest.
It is common to name your spouse as the income beneficiary in the charitable remainder trust. They will then take x amount out each year based on their life expectancy. After their death, the remainder goes to charity.
Q: What did the Secure Act do?
A: It basically increased the required minimum distribution age from 70 and a half to 72. The Secure Act also eliminated the Stretch IRA.
Prior to this law going into effect, if someone died and their child inherited a retirement account from them, the child could use their own life expectancy to decide how much money they took out of the inherited retirement account.
So if you had a 38-year-old child, then, generally speaking, they had 45 years to take the given amount out, as needed over that time.
This meant that the money was growing as it was sitting in that account for those 45 years. So it was a great opportunity to pass wealth on to children.
But unfortunately, the Secure Act did away with this Stretch IRA.
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