Inheriting an Individual Retirement Account - Part III- Trouble Spots

The last two newsletters, I discussed issues with estate planning and Individual Retirement Accounts, or IRAs. You can read more about inheriting options (here) and tax issues (here). This month, I will wrap up my three part series addressing procedural issues that trip many people up concerning IRAs.

The first issues you confront when inheriting an IRA is the Required Minimum Distribution ("RMD") and making sure that one withdraws the necessary RMD out of the IRA. The RMD is the minimum amount of money that must be withdrawn from retirement asset accounts once the IRA owner hits 70 and half. The RMD is calculated by using IRS provided actuarial tables based on life expectancy and multiplying that with the fair market value of the account. The RMD amount must be withdrawn by December 31st of each year.

The penalty for not withdrawing the RMD or withdrawing less than the required RMD is onerous. Uncle Sam will make you pay a 50% "excess accumulations tax" on the difference between 1) what should have been taken for the current tax year-your RMD- and 2) what was actually taken out in the current year. You do get a break in that you do not have to determine and withdraw the first RMD until the year after the original IRA owner died. But, if you miss that RMD, you will be stuck with the 5 year rule instead of being able to stretch out the RMDs.

Another issue that trips people up is whether the original IRA owner took an RMD in the year that they died. If the IRA owner dies very early in the year, say January, it is likely the IRA owner did not take an RMD. But, if the IRA owner dies later in the year, say over Christmas and did not take an RMD, you may not even find out that you own the account until it's already too late to take out that year's distribution. If the IRA owner was not yet age 70, or if it's a Roth IRA, then there is no year-of-death required distribution.

IRA owners should also be concerned about naming non-qualified beneficiaries. Non-qualified designated beneficiaries include estates, charities and most trusts. Qualified beneficiaries are anyone with a pulse and certain trusts drafted to accept IRA distributions. If a non-qualified designated beneficiary inherits the IRA then you would have to use the five-year rule if the IRA owner died before reached 70. But, if the IRA owner reached 70, the non-qualified beneficiary would receive an RMD based on the deceased IRA owner's theoretical life expectancy.

If you make any mistake with respect to not taking the RMD or naming qualified beneficiaries you may be taking money out of the IRA faster than it might need to be and paying more in taxes than you would if the IRA owner had not named a non-qualified beneficiary.

Improperly, titling an inherited IRA can also lead to tax issues. A qualified designated beneficiary must be named as the primary beneficiary. You must also take proper steps to make sure that the IRA is maintained in the decedent IRA owner's name. For instance, the inherited IRA must contain some kind of titling language that includes both the deceased IRA owner's name and the beneficiary's name. One example: "John Smith, deceased, traditional IRA for the benefit of Kay Smith." Such a name change does not happen automatically on the decedent's death.

Lastly, here are a couple of important dates to remember when inheriting an IRA

  • Sept. 30 of the year following the year of the IRA account owner's death. Beneficiaries to the IRA need to be identified.
  • Oct. 31 of the year following the year of the IRA account owner's death. That's the date at which the trust documents (if the trust was the named designated beneficiary) must be filed.
  • Dec. 31 of the year following the year of the IRA account owner's death. The first distribution must be made to each IRA beneficiary. Last date at which separate shares of the IRA may be created.

Inheriting an IRA is a complex issue with many tax penalties and consequences if you are not paying attention. Taking with your financial advisor, CPA or attorney is advised if you are confused about what to do.

Basics of Estate Planning: Virginia's Real Property Transfer on Death Act

A few months ago, I described the District of Columbia's new act granting the ability to an owner of real property to transfer that real property on death via a transfer on death deed (hereinafter "TOD deed"). Virginia also recently enacted a transfer on death act that is similar but not quite the same as DC's deed on death act. Both jurisdictions modeled their transfer on death deeds after the "Uniform Real Property Transfers on Death Act." Virginia and D.C. join twenty-one other jurisdictions in the United States that granted the ability to transfer real property on death via a deed on death.

In Virginia's case Uniform Real Property Transfer on Death Act; creation of a transfer on death deed, hereinafter "the Act" was signed into law on March 13th and became effective for transfers on death deeds made before, on, or after July 1, 2013, by a transferor dying on or after July 1, 2013.

Like D.C., there is a statutory form that needs to be completed that includes the legal description of the real property for the TOD deed. After acknowledging the form before a notary public, a person would pay the appropriate fees and file the TOD deed in the appropriate Virginia land record's office to be recorded.

A TOD deed cannot be revoked in a person's will, just like a life insurance policy or any other non-probate asset, nor can a testator use their will to change beneficiaries to a piece of real property that has a recorded TOD deed. A person can only revoke a TOD deed (and this is slightly different than D.C.) in the following ways, and it must be recorded:

  1. A transfer on death deed that revokes the prior transfer on death deed or part of the transfer on death deed expressly;
  2. A transfer on death deed that names a designated beneficiary that is inconsistent with the designated beneficiary in a prior transfer on death deed;
  3. An instrument of revocation that expressly revokes the transfer on death deed or part of the transfer on death deed; or
  4. An inter vivos deed that expressly revokes the transfer on death deed or part of the transfer on death deed.

Items 1 and 2 deal with the instances when the real property owner decides to change who the beneficiary is that would inherit the property on the real property owner's death. Items 3 deals with the instances when the real property owner outright revokes the TOD deed. Item 4 covers the instances when the real property owner sells or transfers the property to another person or entity thereby revoking the TOD deed.

Some other points to consider when creating a TOD deed include:

  • The capacity of the transferor, the person creating the TOD deed, in creating/revoking is the same capacity needed for a testator to draft a will.
  • There does not need to be any notice by the transferor to the beneficiaries about the TOD deed.
  • The beneficiary takes the property subject to all conveyances, encumbrances, assignments, mortgages, liens, etc.
  • If the transferor is a joint owner and is survived by one or more other joint owners with right of survivorship the property belongs to the surviving joint owners i.e. a TOD deed does not trump ownership by joint tenancy with the right of survivorship ownership.
  • Creditors of the beneficiary have no ability to attach to the real property with a TOD deed until the beneficiary becomes the owner of record of the TOD deeded real property.
  • The transferor's or designated beneficiary's eligibility for any form of public assistance may be affected.
  • A beneficiary of a transferor on death deed is liable for an allowed claim against the transferor's probate estate and statutory allowances. (See next paragraph for an explanation).
Many of the concerns I listed in the D.C.'s TOD article are also a concern in Virginia. However, the Virginia's Act does not inherently transform how real property is transferred on death in Virginia. In Virginia, real property "drops like a rock" upon the death of a real property owner. In short, that means upon the death of a Virginia real property owner, the ownership interest in the real property transfers immediately to the beneficiary. The Virginia Act is essentially formulizing the previous system for those that use TOD deeds. In D.C., barring a TOD deed, real property transfers to the control of the personal representative, who then transfers ownership to the beneficiaries. In D.C., a TOD deed removes the personal representative from the process.

It will be interesting to see how TOD deeds will impact estate planning in Virginia and D.C. It will also be interesting to see whether Maryland will enact similar legislation in the future. I will be sure to keep you in the loop if that happens.

Estate of the Month: Fugetabout It! Who Needs an Extra $30 Million?

I have described the problems with celebrity estate planning. Most of the time it is one mistake that creates one problem in a celebrity's estate. In this month's case, there are multiple issues. In fact, James Gandolfini's estate plan reads like "A How to Not Draft" an estate plan.

James Gandolfini was an actor in such movies as "Crimson Tide," "Zero Dark Thirty," and "Get Shorty," but, is best known for his role as Tony Soprano in "The Sopranos," a troubled Mafia crime boss struggling to balance the conflicting requirements of his "two families" that causes panic attacks and depression for Tony Soprano. Gandolfini died on June 19, 2013, from a heart attack in Italy.

That is where the problems begin for his estate. Gandolfini was survived by his wife Deborah Lin, thirteen year old son Michael from a prior marriage, a nine month old Liliana (Gandolfini's daughter with Lin) and his two sisters.

The Will

Mr. Gandolfini's will made numerous specific bequests of money to his assistant ($200,000), a couple of friends ($50,000 to two friends and $200,000 to another), his two nieces ($500,000 each), and his godson ($100,000). He provided an option to his son's trust to buy his condominium in New York City (valued at approximately between $4-5 million). Gandolfini owned a home in Italy that would be split between his son and daughter. Gandolfini's son would also receive all of Gandolfini's jewelry and clothes. The remainder of his estate would fall into his residuary and be divided in the following manner 30% to each of two sisters, 20% to his daughter Liliana, and 20% to his wife.

The Good

I guess the best thing that can be said about Gandolfini's estate was that he followed through on my advice last month about reviewing and updating your estate plan when life changing events occur. As you can see by his will, Gandolfini signed a new last will and testament replacing his old one on December 19, 2012 after the recent birth of his daughter. Unfortunately, after that there are no other positives to point to with respect to his estate.

Estate Tax Issues

The first issue, I see will be the estate tax problems. Leaving 80% of his estate to his sisters and his daughter, made 80% of his estate subject to federal (approximately $5.25 million exemption) and New York state ($1 million state exemption) estate taxes. There are reports that his estate will be subject to approximately $30 million in estate tax liability. Easily dwarfing the $19 million allegedly paid in Steve McNair's estate. The 20% going to his wife would be afforded the unlimited marital deduction that allows any transfer to a spouse tax-free. The unlimited marital deduction as it relates to estate tax was the underlying issue for the recent Supreme Court ruling finding DOMA Section 3 unconstitutional in Windsor v. U.S. You can read my comments pre and post-Supreme Court ruling here and here.

The estate tax issue is further compounded by language in the will that calls for the shares to be divvied up after all the taxes are paid. This means Lin's 20% share will only be determined after all of the taxes have been paid, debts paid off and estate administrative costs have been determined. An estimated estate tax bill of $30 million reduces the residuary to approximately $40 million, instead of $70 million. Doing the math that means Lin will likely receive $8 million instead of $14+ million, or even $65 million.

Another issue is that estate taxes are due 9 months after the death of Gandolfini and that will likely mean the estate will have to liquidate assets to pay the $30 million tax bill.

It would have been better to give all the money to his wife and use the unlimited marital tax deduction, trusts and portability to attempt to minimize any estate taxes.

Poor Long-Term Estate Planning for his Family

The second issue is the way Gandolfini's will treats his children in very different ways. Gandolfini provides his daughter 20% of his residuary - perhaps as much as $8 million and half of an Italian villa. But, he only gives his son's trust the option to buy Gandolfini's NYC condominium and half a share of a house in Italy. If his son's trust doesn't exercise that option, the condominium will fall into the residuary and be divided up among his sisters, daughter and wife. There are reports that Gandolfini named his son the beneficiary of a $7 million dollar life insurance policy. But, by the way the will is stated, if Gandolfini's son wants to retain ownership of the condo, Gandolfini's son (or likely trustee of his son's trust) is essentially forced to use the insurance proceeds to buy the condominium or never own the home. I am not sure as a trustee or an advisor to a trustee I would agree to spending $3-5 million on a NYC condo that would consume a good portion of the life insurance death benefits

Gandolfini might provide for his son in another manner in addition to the life insurance policy. Perhaps Gandolfini is distributing other non-probate assets, like an IRA or other transferred-on-death account to his son. Only a review of the estate tax filings may provide further information if this is happening.

Moreover, his daughter's share of the estate is simply delayed until she is 21 years old and lacks any type of long-term trust provisions. The daughter's money could be subject to any creditors she might incur. Or, even more likely, she could blow through the money when she receives it at 21 years of age. Putting his daughter's money in even a simple trust could have protected the assets for 20 years and possible beyond.

Devising a solution to creating an effective estate plan is tougher since he has children from multiple relationships. But setting up most of the money to go to his wife (thereby pushing any estate tax issue down the road to his wife's passing) and then letting any assets pass through to his daughter and son on his wife's death via Q-TIP trust would be better use of his estate.

Poor Use of Specific Bequests

While it is commendable that Gandolfini provides approximately $1.6 million in specific bequests to various people, those specific bequests need to be fulfilled before the other heirs can receive their money. In this case, it appears his estate will be able to easily accommodate those bequests. But, if his estate was insolvent or worth considerably less than the reported $70 million, those specific bequests would consume a portion of the money that should go to his wife, sisters and daughter.

Even for people of more modest means that want to make specific bequest in their will or trust, while it is certainly allowable, the amounts given away should be in proportion to the overall financial picture of the estate. In other words, someone with a modest estate shouldn't be giving away large amounts of cash that could cause issues for the estate after that person has passed away.

Poor Planning Related to Foreign Owned Real Property

The next issue is the house in Italy. Most European countries have strict provisions related to inheritance. Italian inheritance laws dictate how the property will be left to Gandolfini's heirs. In this instance, his children are automatically given half and Lin receives a quarter of the Italian property. Under Italian law, Gandolfini only has the right to give away the last quarter. Let's not even get into the added friction of the cost of upkeep that will be required for the Italian property that will come at the expense of the other beneficiaries.

It would have been better for Gandolfini to have a separate will drafted by Italian counsel to dictate where the Italian real property would go and to avoid any potential problems an overseas asset might inflict on the estate. I am looking at you George Clooney with your Italian villa on Lake Como.

Allowing a Non-Estate Planner to Draft the Plan/Named Personal Representatives

The last issue and the one that likely drives all the other problems with Gandolfini's will, is that the will was drafted by Gandolfini's entertainment lawyer. We all remember what happened with Whitney Houston's estate when she let her entertainment lawyer draft her estate plan, right? She has the dubious claim to be the only celebrity with 2 estates of the month (click here for Houston's 2nd estate of the month entry) for my newsletter.

Anyway, Gandolfini's estate plan is even worse than Whitney's. Gandolfini's will appoints his attorney as co-personal representative of Gandolfini's estate. See Page 12 of Gandolfini's will.

Naturally, it is a conflict of interest when the attorney drafting a will appoints him or herself as the personal representative. But, that conflict can be waived, which Gandolfini did. See page 17 of Gandolfini's will. Thus, not only will Gandolfini's estate plan likely pay $30 million dollars in estate taxes, and treats children unequally, but Gandolfini's attorney will get an enormous fee to oversee the estate as these errors are addressed.

Unsurprisingly, Gandolfini's attorney states that this was entirely Gandolfini's intention. Wouldn't you if your client's estate was about be reduced by almost half because of poor planning and poor legal advice? In my view, there are way too many mistakes costing Gandolfini's loved ones millions of dollars to say that was his intention.

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