Why use an IRA trust?

Andrew Sykes presents "12 Cool IRA Protection Strategies" to Pittsburgh area financial advisors on October 17, 2013

Andrew Sykes presents “12 Cool IRA Protection Strategies” to Pittsburgh area financial advisors on October 17, 2013

Qualified retirement plans, like IRAs, can have superior advantages when left to a loved one. Chief among those advantages is the ability to “stretch” distributions, which can double or triple the lifetime value to the beneficiaries.

But your plan to leave retirement assets to your beneficiaries may get tripped up in various ways. Here are a few:

Rapid depletion. Rather than carefully stretching distributions over allowable life expectancy, the beneficiary may take down all the money much sooner (perhaps right away). Rapid depletion will foreclose long-term tax deferral, and could very well mean the beneficiary pays more in taxes on the amount distributed. Early depletion can also diminish the chances that proceeds from the inherited IRA will benefit grandchildren or other heirs.

Divorce. Depending on state law, some portion of the distributions could be lost to former in-laws if a beneficiary divorces. (The “lifelong probability of a marriage ending in divorce is 40%-50%,” according to statistics cited in Wikipedia.)

Creditors. Creditors may be able to reach inherited IRAs. A ruling earlier this year in the Seventh Circuit Court of Appeals for the Seventh Circuit held that inherited IRAs do not fit the Bankruptcy Code’s exemption for “retirement funds.” Other appeals courts have held the opposite. But unless the Supreme Court overrules the Seventh Circuit’s ruling, creditor protection for inherited IRAs will depend on where your beneficiaries happen to live.

A well drafted IRA trust can mitigate the effects of these pitfalls by controlling how and when distributions are taken from the trust, and providing an additional layer of protection from the effects of divorce, creditors, and other unexpected occurrences.

Best planning tips for IRAs, 401(k)s, and other retirement plans

Here are three tips I picked up at a talk by Natalie B. Choate, a Boston lawyer and author who is nationally renowned for her expertise in retirement benefits. She addressed a packed house of financial professionals at the Financial “Four”um in Pittsburgh a few months ago.

Many of her tips were quite sophisticated or applied in rare circumstances only, so I’m including only those that apply to a wide array of retirees. These tips are aimed at qualified retirement plans such as individual retirement accounts, 401(k)s, 403(b)s, and similar plans, which have rules different from “defined benefits” pension plans.

“If you do these three things,” Ms. Choate said, “you will be 95% of the way toward happy IRA ownership.”

Take your RMDs

Starting at age 70½, most plan owners need to start taking a required minimum distribution (RMD) each year. The RMD is an amount taken from a plan based on your life expectancy and the total amount you hold in all your plans. You need to request a distribution, which is then paid to you out of your plan and is taxable.

You can defer your first year distribution until April 15 of the next year. As Ms. Choate pointed out, deferral may make sense unless it puts you in a higher tax bracket.

The penalty for not taking your distribution on time is severe: an additional tax equal to 50% of the amount you should have taken.

So you really need to take your proper RMD each year.

Fill out your beneficiary form

One of the most valuable wealth-preserving features of IRAs and similar plans is the ability of your beneficiary to stretch distributions over many years (or in the case of a surviving spouse, the ability to roll it over and make it their own).

But your beneficiaries will have these abilities only if you do one thing: put your beneficiaries’ names on your beneficiary form.

Sounds simple, and it is, but it mustn’t be neglected. Without named beneficiaries, the retirement plan administrator may require your funds to go to your estate. In that case, all funds must be paid out in five years and your beneficiaries’ wealth-preserving advantages will be lost.

Be careful with rollovers and transfers

IRS rules allow you to transfer or roll over your funds from one plan to another, such as rolling over your 401(k) funds into your own IRA when you retire.

However, you must take care to follow some strict rules.

For example, if you retire and ask for a lump sum distribution of your 401(k) plan, you have 60 days to roll it over into an IRA. If you accomplish that within the 60 days, you keep all the many tax and savings advantages that come with these retirement plans. If you miss the deadline, those advantages are lost and you will have to pay tax on your whole lump sum distribution. (A better alternative in this example is to roll over your 401(k) to an IRA with a direct “trustee-to-trustee” transfer, meaning the funds go from one bank to another without being paid to you in the interim.)

Bad things happen with rollovers and transfer, Ms. Choate reminds us, so make sure you follow the rules to the letter.

Ms. Choate’s book, Life and Death Planning for Retirement Benefits, is widely considered the “Bible” of retirement plan law. It is available for order online at http://www.ataxplan.com/.

Consumer Reports: “Legal DIY sites no match for a pro”

An article in Consumer Reports’ latest issue caught my attention this week. It evaluated whether do-it-yourself legal documents created on popular websites LegalZoom, Nolo, and Rocket Lawyer met consumers’ needs. 

The conclusion: “Using any of the three services is generally better than drafting the documents yourself without legal training or not having them at all. But unless your needs are simple — say, you want to leave your entire estate to your spouse — none of the will-writing products is likely to entirely meet your needs.” As a result, “many consumers are better off consulting a lawyer.”

You can read the entire article here.

I would add a couple of points. First, if a low price is your top priority, a legal stationery store can provide forms for a few dollars each, far below the price of the on-line sites. But the same challenges remain: will you know what provisions you need, how to write or insert them properly, and how to make the document valid with proper execution?

Second, a danger not raised by Consumer Reports is the false sense of security people may feel with documents created by some entity that gives the appearance of expertise. That sense of security may prevent consumers from seeking the advice they need. They (or more likely their families) won’t discover the pitfalls until it is too late.

What is a “self-proved” or “self-proving” will in Pennsylvania?

If you’re the executor of an estate, you want to be able to walk into the register of wills office, present the original will (along with other required materials), get sworn in, obtain the documents you need, and walk out ready to start settling the estate.

A “self-proved” or “self-proving” will is going to help.

If you are doing your estate planning now, make things easier for your executor by signing a will that is self-proved. (I will discuss how shortly.)

Background

To make a valid will in Pennsylvania, you must put it in writing and sign it at the end. If you can only make an “x” or some other mark instead of signing, two witnesses must be present and must also sign their names to the will in your presence. If you can’t sign or even make a mark, you can authorize someone else to sign for you, but again, you must have two witnesses who also sign their names to the will in your presence.

In order for the will to be accepted by the register of wills to open an estate, Pennsylvania law requires that the will be “proved by the oaths or affirmations of two competent witnesses.”

So if you had simply signed your will in front of two witnesses, those witnesses could appear at the register of wills office and swear under oath that they did indeed watch you sign that will. But what an inconvenience for the witnesses!

And what if you signed the will 30 years before you died? Will the witnesses still remember? Are they still alive? Can they be found? If not, can someone else swear that they recognize your signature on the will?

Self-proved will

A self-proved (sometimes called “self-proving”) will solves this problem.

If the will contains certain acknowledgements and affidavits, the register of wills shall accept the will without the need of witnesses to the signature.

Here is an example of an acknowledgement and affidavit that would be acceptable under Pennsylvania law:

When it won’t be accepted

There are three situations in which the register of wills would not accept a self-proved will:

1. When the validity of the will is being contested;

2. When the will is signed by mark; and

3. When the will is signed by someone else (as described above in the first paragraph under Background).

In these situations, you’ll need to have witnesses appear or submit sworn statements.

Execution

Finally, it’s important to remember that to make an effective self-proved will, the document must be executed correctly.

You’re not required to use the services of an attorney, but a qualified attorney can often help you make sure your will is drafted and executed properly.

Your legacy: what matters

How will you be remembered?

MSNBC reports the strange story of Wellington Burt, a lumber baron who at the time of his death was one of the richest men in America. Although he died in 1919, his $100 million estate is only now being distributed. His will specified that no one would receive any of his estate until 21 years after the death of his last remaining grandchild.

He is described in the story as “greedy,” “stingy,” and “tightfisted.” None of the 12 descendants who will split his fortune knew him at all. You can read the full story here:http://on.today.com/jeTSab

Contrast Burt’s story with that of another multimillionaire who died 23 years before Wellington Burt.

What do you associate with the name “Nobel?” Do you associate it with a man who was the inventor of dynamite and an armaments manufacturer, or with the highly coveted prizes for outstanding achievements in literature, peace, physics, chemistry, and medicine?

A number of years before his death, Alfred Nobel was startled to see a newspaper article reporting his death and describing him as Nobel, the “merchant of death.” The newspaper had named the wrong person, of course. It was Nobel’s brother who had died.

Still, Nobel was troubled by the way the newspaper summed up his life’s work. He later rewrote his will to leave the vast majority of his estate to a fund establishing the prizes we know so well today.

You may not have the millions of Wellington Burt or Alfred Nobel, but your will can still serve as a powerful means of establishing your legacy. As you think about what will become of your estate, consider what really matters to you and how others will remember you.