How Do You Stretch Out an IRA?

In 2011, it was reported that Americans held over $4.87 trillion in IRA accounts. Most of that money will be withdrawn from those IRAs to support the IRA account owners during their life time. But, some IRA account owners will pass their IRA accounts down to beneficiaries including the account owner's spouse, children or even grandchildren. One way to accomplish passing the IRA down to a beneficiary and reduce the tax burden for the beneficiary is through a Stretch IRA.

Stretch IRAs are ideal for those who do not need their entire IRA to cover their living expenses during their lifetime. Doing this also allows the owner to have their IRA used by others, potentially for several generations. Normally, an owner of an IRA must begin taking distributions on the April 1st of the year after which they reach 70 ½ years of age. At this point, owners must take at least the Required Minimum Distribution ("RMD"). Your initial RMD is calculated by taking the balance of the account on December 31 of the previous year, and dividing that amount by the number of years remaining in the owner's life expectancy as determined by a formula devised by the IRS. Your annual RMD is recalculated each year based on the balance of your account on December 31st of the previous year. Upon the death of the owner, the account will transfer to the named beneficiary of the account, or if none are named, the deceased owner's estate.

The beneficiary's options in accepting the IRA vary based on who the beneficiary is in relation to the owner (spousesi vs. others) but generally, the non-spousal beneficiary has two options. The first option is to take the entire balance of the account in a lump sum. The second is to withdraw the balance of the account over the course of five years. Either option can lead to punitive levels of taxation because RMD distributions are taxed at the beneficiary's normal income tax rates.

A third option available "stretches" the IRA distributions out to the beneficiary. By doing this, a beneficiary may extend out the length of time that funds can stay in the IRA. This continues the IRA's tax-deferred growth over a longer period allowing beneficiaries to benefit from the account for an even longer period. This option, offered by individual plans, is not named in any of the IRS code, and as such, the ability to use it depends entirely on your individual plan's rules and regulations. Should they wish to stretch out their IRA, owners must be sure to name a beneficiary. Failure to name a beneficiary will cause the account to be passed through probate and the IRA proceeds will be distributed via the IRA account owner's distribution provisions in the account owner's will or by intestacy. Distributions then may only be taken according to the lifespan of the original owner (if they were over 70 ½ at death) or within five years if they were under 70 ½. However, should a beneficiary be named, they are then able to request that the RMD's be based on that beneficiary's expected life span, instead of that of the now-deceased owner. If multiple beneficiaries, say your children, are named as IRA beneficiaries then the stretch is based on the age of oldest beneficiary.

There are two scenarios to consider when looking at stretch IRA's. The first is if your spouse is your beneficiary. A surviving spouse can roll over IRA funds into their IRA, and begin taking distributions when they hit 70 ½. The second scenario is if the beneficiary is not the spouse and was instead, for example, a grandchild, and the grandchild would take RMD distributions based on the grandchild' age. Remember, RMDs must be made in a timely fashion, or risk losing this option or facing additional tax penalties.

You may at this time be wondering why this would be worth it. The reason is that, were you to stretch the IRA like this, the grandchild would be able to supplement their income for a longer period of time (their RMD vs. 5 years). The account could optimize its tax-deferred growth. For example, imagine you are lucky enough to have an IRA account valued at $800,000 when you died this year. Let's say the designated beneficiary was born in 1990 and the IRA account averages an annual rate of return on its investments equal to 4%. First, the account would not deplete its funds until 2073. The account would distribution approximately of $3.15 million over the lifetime of the beneficiary. Not too shabby! The account would also have earned an additional $2.3 million. The account also avoids taxation in the highest income brackets for most of the life of the account, as no distribution exceeds $120,000 until 2069. Compare that if the five year distribution was taken. There, the beneficiary would not only lose the additional $2.3 million in future income, but the beneficiary could pay at the highest income tax rates each year. This would further depreciate the value of the account (to calculate this for your own circumstances, check out this calculator.

One last thing to note is that President Obama's 2016 budget proposal called for restricting the ability to stretch-out the distributions by non-spouse beneficiaries. President Obama proposed eliminating "stretch IRAs" by requiring IRAs inherited by non-spouse beneficiaries to be cashed out within 5 years of the deceased owner's date of death. His 2015 budget was defeated recently but it does provide notice that stretch IRAs have a target on its back during any tax reform discussions.

Basics of Estate Planning: How Does a Gift Plan Work Within Your Estate Plan?

Many people wish to leave a legacy behind after they pass away. For most that is leaving an inheritance to their children. But, sometimes that means providing some form of distribution to a non-profit, charity or the like. Planned giving is one method of supporting non-profits and charities through gifting of assets while also minimizing a person's taxable estate.

Donors can make gifts during life or at death as part of an estate plan (this article will focus on the later). By using after-death gift planning, individuals are able to donate highly appreciated assets and, thus reduce their taxable estate. Gifting at death allows the benefitting non-profit organization to avoid any capital gains tax to be applied to the appreciated asset. Gifting usually is focused on highly appreciated types of assets, usually stocks, bonds and charitable trusts (to name a few). In each instance, the goal for gifting is to be able to support an organization while also avoiding potentially onerous taxation on the part of the donor's estate. Donating the asset to a non-profit, removes the value of the asset from an individual's estate, lowering the estate's value. Individuals are able to leave a legacy, help both family and a non-profit at once, and gain other income tax deductions.

Should you be interested in the above advantages, and you would like to make such a bequest, the question then is, how would you do it?

This next step depends on whether the asset is a probate asset or not. When giving probate assets to an organization under a planned giving scheme, the value of the bequest may be removed from your estate. To make a gift via your will, you would add a clause in your will with the bequest, or if a will exists, draft a codicil. An example of a general bequest to a non-profit would be: "I leave $20,000 to John Doe College." Very simple and very direct.

When making more specific bequests you must ensure that you do not benefit yourself in such a way that the gift loses tax-deductible status. It is important to remember that the "yourself" under this includes more than just you, but anything that gives you a benefit, even if attenuated. An extreme example of this would be a scholarship that could only be given to future family members.

Another very popular planned gift is the gift of stock. The reason for this is that it allows individuals to avoid capital gains taxes on any appreciation because normally the sale/transfer of a stock triggers capital gains tax liability on the amount of gain over the original purchase price. In some instances this gain may be substantial. By gifting the stock to a non-profit, you are able to avoid capital gains tax from that appreciation. Further, the estate can deduct the market value at transfer in the taxable part of the estate. An additional benefit of donating stock over, for example, a cash bequest, is that if the capital gains rate is higher than your income tax rate then there would be no additional tax liability. It is important to note the transfer will not be complete until the ownership of the stock is in the organization's possession.

Too many restrictions on use of a trust's income can also cause issues for the non-profit accepting the donation. For example, if you have been following the recent news that Sweet Briar College ("SBC") in Virginia will close at the end of the school year. One of the underlying impediments with SBC closing is that the initial trusts used to establish SBC back in 1901 have restrictive provisions on what the trust funds could be used for. In SBC's case, the initial will and trust language stated the funds and land donated via the trust could only be used for a women's college. This has locked SBC into some rather difficult legal issues. SBC would like to distribute the assets from the various trusts and endowment and sell the land and use the proceeds as severance packages to the faculty, administration and staff. That means a trip to the Courthouse in an attempt to amend the trusts under the doctrine of cy-près. And, that trip won't be easy since in the last 24 hours, two lawsuits have been filed to halt the closure. The first lawsuite was filed by an SBC alumna seeking an injunction to stop the closure. The other lawsuitlawsuit was brought by the Amherst County Attorney's office claiming the decision to close SBC violates the terms of the will under which the school was founded.

Needless to say the SBC situation is not a pretty one.

You could also create a trust that allows for the benefit of your family in the short term via a charitable remainder trust, or CRT, and the non-profit in the long term. An example of this would be a trust with the income used to put your grandchildren through college using income distributions, with the principal to the non-profit upon the final grandchild's graduation. In each instance, the trust allows for the owner of the assets to dictate what assets are given, in what amounts, and with any possible limitations.

Update on the Robin Williams Estate: Maybe His Trust Needed Some More Work After All?

A few months ago, I wrote that by placing most of his estate into trust that Robin Williams was doing the "right" estate planning moves and would likely avoid any trust issues. Well, guess I was wrong on that one since Robin Williams's third wife, Susan Schneider Williams, and his children from his two prior marriages are fueding in court over a number of estate issues.

Williams had updated his trust to reflect his 2011 marriage to Schneider. But, much of the focus of the dispute is on how the estate should distribute Williams's personal effects. This would include items like his awards he won over his lifetime including an Oscar for his performance in "Good Will Hunting," six Golden Globes, two Emmys and five Grammys.

Under the terms of the various trusts Williams created, Schneider was to receive the Tiburon home and "the contents thereof," subject to certain restrictions. She would also be given enough cash or property to cover, for her lifetime, "all costs related to the residence." Unfortunately, that term of "all costs" and "cover" related to upkeep of the residence are somewhat ambiguous and will likely cause issues in trying to determine what "all costs" and "cover" really mean.

The plan also stated that that the actor's clothing, jewelry and photos taken prior to the actor and Schneider's marriage, as well as his second home in Napa, California and its contents, should go to his children. But, with owning two residences comes the issue that some personal items that should be in the Tiberon home are situated in the Napa home and vice versa.

Schneider has "claimed" she is not seeking items related to the actor's career in entertainment, but wanted items like the tux Williams wore to their wedding along with his "personal collections of knickknacks and other items that are not associated with his famous persona." Naturally, the Williams children did not like the use of the word "knickknacks" to describe their father's accumulation of graphic novels, action figures, theater masks, movie posters and other artifacts that the Williams's children regard as having been crucial fuel for his seemingly boundless creativity. Many of these items could have substantial value beyond their association with Williams.

Just yesterday, March 30th, the attorneys for both sides were arguing in court on such issues as the need to slow down the pace of the estate/trust administration and allegations of missing tangible personal property. If additional updates are needed, I will be sure to post them.

With such a short marriage before Williams's death, it is not shocking that there is not a level of trust between the two sides about what are generally considered low-tier items when you compare that to family where the members knew each other for a lifetime. Who am I kidding…this type of fight happens in those families, too!

Estate of the Month: Estate Plans? Hey, Let's Play Two!

On January 23rd, 2015, Ernie Banks, known in baseball as "Mr. Cub", passed away from a heart condition exacerbated by dementia. As with many estates of the rich and famous, there is currently a battle over his estate in Illinois.

In this case, the dispute revolves around a change to Banks's estate plan towards the end of his life. His children allege undue influence arose by Ms. Regina Rice, Banks's caretaker. The children claim that, in October 2014, Rice took advantage of Banks's dementia and influenced him into signing new estate planning documents that left her in control of his assets, cutting out his children. This estate not only includes assets already held by Mr. Banks, but also the ability to use his likeness in the future. Just think of the estate of Marvin Gaye's recent $7 million legal victory for copyright infringement by Pharrel and Robin Thicke over their song "Blurred Lines" as to the value of the baseball player synonymous with the phrase "Let's play two!"

Undue influence is generally defined as a person in a position of power using that power over another, causing them to make decisions they may not have made otherwise. Banks estate, from the outside "demonstrates" the classic case of undue influence. Here, a caretaker convinces the charge to transfer the charge's assets to the caretaker instead of Banks's children. This all occurs without the charge's family being aware.

Undue influence, which can be difficult to prove, requires several factors, including the existence and exertion of an influence, operation of that influence to overcome the mind of the testator of the will at the signing, and the execution of a will that the testator would not have signed otherwise. Another major factor supporting undue influence is the testator/charge is separated from others which allows the influencer to reduce any chance of another person preventing the undue influence.

Banks's children claim that Rice, in her position as caretaker, took advantage of Banks and convinced him to sign a will that left the estate in her control after his death. His children allegations are based on several deductions. First, in the final months of his life, Rice made it difficult for his children to directly speak to Banks. The Banks's children also claim Rice did not tell them that he was ill, or that he had signed a new will. The later claim is not surprising in the least. This argument seems to touch on the separation factor of undue influence, as the family is arguing that Rice isolated Banks from his family, kept them out of the loop, and by doing so was able to exert influence over his mind.

Second, the fact that Banks had dementia, and that this change happened so late in his life also contributes to their claim. Claims of dementia support the position that Banks's mind was able to be overcome, and that Rice did in fact accomplish that. Rice countered these claims, saying that Banks and Rice had become close, and that the will made his wishes clear. The will itself contains language saying that Banks was "'making no provisions' for his wife and children, 'nor for a lack of love and affection for them and for reasons best known by them.'"

Whatever the outcome of the case, it is clear that Banks' estate is yet another example of how messy estate planning can be. Further, estate planning discussions should not be a one-time event or a "let's have two" discussions, but, should be an on-going conversation among the family to prevent any confusion after you are gone.

iDepending on the ages of the IRA account owner and the surviving spouses, the surviving spouse could have additional option that are beyond the scope of this article.

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