Category Archives: Estate Planning

Check Those Beneficiary Designations

When was the last time that you checked all of your beneficiary designations? Beneficiary designations determine who gets certain financial benefits when you die. They are commonly found in workplace retirement benefits, life insurance policies, annuities, retirement accounts, pay-on-death bank accounts, and transfer-on-death investment accounts. It is important to check your beneficiary designations regularly because such designations can override your will. Otherwise, your loved ones may not know that there is a problem until it is too late.

So, how do beneficiary designations work? Let’s say that John Doe names his wife, Jane Doe, as the sole primary beneficiary of his IRA account at ABC Brokerage Company. When John dies, Jane notifies ABC Brokerage Company of John’s death. ABC Brokerage Company may request that Jane complete a simple form and send a copy of John’s death certificate. Once the appropriate documents are received, ABC Brokerage Company will retitle John’s IRA account in Jane’s name. After that, Jane can treat the account as her own. The entire process can take as little as a few days. There are no probate court proceedings involved in this scenario.

Who should you name as your beneficiaries? That depends on your wishes. Be sure to coordinate your beneficiary designations with your overall estate plan. As for beneficiaries, you can specify one or more individuals, an existing trust, a trust that will be created after your death by your will, a charity, or your estate. If you name a minor as a beneficiary, a guardian may need to be appointed to receive the assets on behalf of the beneficiary. If you name your estate as a beneficiary, the assets will need to go through the probate court process.

Check your beneficiary designations regularly! It is especially important to do so if you experience changes to your family situation.

A Few Financial Tips That Not Everyone Knows

Sometimes, little known rules can mean big money. Here are a few examples:

  1. A Roth IRA conversion is possible even after Required Minimum Distributions have started at age 70½. Just be sure to withdraw (not convert) the RMD for the year from your Traditional IRA before doing any Roth IRA conversions that year. A Roth IRA conversion is especially worth considering if you do not need all of your Traditional IRA funds to support your retirement expenses. Any funds converted into a Roth IRA will no longer have RMD requirements during your lifetime.
  2. Are you near the Social Security retirement age? Have you heard of strategies like “file and suspend” and “restricted application”? If you are married, you are entitled to a Social Security benefit based on (1) your own work record or (2) your spouse’s work record. It is possible to receive a spousal benefit while allowing your own work record benefit to grow until age 70. If any of this is news to you, do some research now!
  3. When a married couple holds community property in a community property state, 100% of the asset’s cost basis (not just one spouse’s 50% interest) gets reset at the asset’s fair market value at the death of the first spouse. This feature of the tax law can potentially save you big money on capital gains taxes. If this situation applies to you, consult a tax advisor about whether you should file an estate tax return (IRS Form 706) for the deceased spouse to document the new cost basis. You may need a valuation appraisal for real estate or closely held business interests. For publicly traded stocks or mutual funds, you can just use market trading prices.

Roth IRA Conversion – Even for High Tax Bracket People

Roth IRA conversions allow you to move pre-tax funds in a Traditional IRA into a Roth IRA. Once the funds are in a Roth IRA, you will no longer pay any income taxes on future earnings or withdrawals as long as at the time of withdrawal (1) you are at least age 59½ and (2) at least five years have passed since the conversion. The cost of a Roth IRA conversion is paying ordinary income taxes on the conversion amount in the year of conversion. Because of this tax cost, individuals in high income tax brackets are often reluctant to do a Roth IRA conversion. I believe that even those in high income tax brackets should consider Roth IRA conversions if they have excess cash outside of their retirement accounts to pay the income taxes due on conversion.

First, let’s discuss some math. Ignoring estate planning considerations, you are no better off or worse off doing a Roth IRA conversion if the following two statements are true: (1) the funds that you would use to pay the income taxes due on conversion earn the same rate of return outside of your Roth IRA as they would inside of your Roth IRA and (2) your marginal income tax rate stays the same throughout your life.

On the first point, the funds that you would use to pay the income taxes due on conversion are likely to earn a lower rate of return than your Roth IRA since the outside funds are subject to ongoing income taxes on interest, dividends, and capital gains even if you diligently invest the outside funds. Alternatively, perhaps the outside funds would just sit in a bank savings account earning minimal interest or, worse, you would simply spend the money. In any scenario, I believe the first point strongly favors a Roth IRA conversion.

The second point (marginal income tax rates) often causes high income tax bracket people to pass on the Roth IRA conversion. Lower marginal income tax rates during retirement would favor not converting to Roth today. Let’s think about this, however. The current top federal income tax rate is 35%, which is low by historical standards. Your marginal income tax rate during retirement could be higher simply because the government decides to raise income tax rates overall. Also, consider all the sources of taxable income that you might have during retirement: required minimum distributions from IRAs and 401(k)s, pension income, Social Security income, annuity payouts, interest income, and dividend income. If your mortgage is paid off by retirement and you no longer have dependents, then your deductions and exemptions could be lower too. Also, the differences in marginal income tax rates among the highest, second highest, and third highest federal tax brackets are not large.

If your estate is likely to be subject to estate taxes, then there are estate tax benefits to doing a Roth IRA conversion. By converting pre-tax funds to a Roth IRA, you remove the income taxes paid on conversion from your gross estate while creating an investment account that is free of income taxes, subject to certain rules, for your heirs.

If you have excess cash to pay the income taxes on a Roth IRA conversion, I believe the strongest argument for doing a conversion is a behavioral one. A Roth IRA conversion allows you to pay a one-time cost today (the income taxes on conversion) to save a significant amount of income taxes, most likely, during retirement. You do not have to do anything further to achieve the future payoff other than keep your Roth IRA invested and not withdraw from your Roth IRA until retirement. Think of it this way. Paying the income taxes on a Roth IRA conversion is like making a one-time contribution to your Roth IRA, except that you are not limited to $5,000 or $6,000 per year. For many people, the alternative to a Roth IRA conversion is not to diligently invest the funds outside of the Roth IRA but to simply spend the money. A Roth IRA conversion makes it less likely that you will do something unwise with the money that you would otherwise use to pay the income taxes that will be due on conversion.

Year-End Financial Checklist

Can you believe that today starts the final month of 2011? Around this time of the year, many newspapers and magazines publish articles about year-end tax planning. While year-end is certainly a good time to do tax planning, it is also a good time to take stock of your financial situation and think about broader financial issues. The following are some things that you may want to consider. I will also throw in a couple of my favorite year-end tax tips as well.

  1. Evaluate your financial goals. Is buying a house one of your goals? If so, do you know how much income and savings you need to buy a home without jeopardizing your other financial goals? What if your goal is to get out of debt? Do you know how much debt you have right now? Do you have an action plan to accomplish your goal? Do you see the pattern? Get information. Make a plan. Execute the plan.
  2. Analyze your spending and saving patterns. Different people may have different goals, but many of these goals have one thing in common. You must save money to accomplish them. Do you know your average monthly spending? Can you estimate the recurring expenses that do not occur every month or every year, such as insurance premiums, home renovation costs, and automobile purchases? Do you know what percentage of your income is being saved? If you answered “no” to any of these questions, then now is a good time to get organized.
  3. Are you missing any necessary insurance policies? Do you rent an apartment but have no renters insurance? Do you have a sizeable net worth but no personal umbrella policy?
  4. Check every beneficiary designation. Life insurance policies and retirement accounts have beneficiary designations. You can also add beneficiary designations to regular bank and investment accounts through pay-on-death or transfer-on-death provisions. Check every beneficiary designation, especially if your family situation has changed recently (e.g., getting married, having children). These beneficiary designations override any provisions in your will.
  5. Contribute to a Roth IRA if you are eligible. Contributing to a Roth IRA is an excellent way to invest for retirement. Assets in a Roth IRA grow tax-free as long as you meet certain requirements when you withdraw the funds. You can contribute to a Roth IRA as long as you have earned compensation (e.g., wages or self-employment income) and your modified adjusted gross income (“MAGI”) is below certain limits. If you are single, you can contribute up to $5,000 to a Roth IRA if your MAGI is less than $107,000. If you are married, you and your spouse can each contribute up to $5,000 to Roth IRAs if your joint MAGI is less than $169,000. The $5,000 limit increases to $6,000 for those age 50 and older. You can contribute to a Roth IRA even if you participate in a 401(k) plan at work. You can make a Roth IRA contribution for tax year 2011 any time before April 15, 2012.
  6. Consider a Roth IRA conversion. If you are in an unusually low tax bracket this year (e.g., due to a break in your career or going back to school) and you have some extra cash to invest for retirement, then consider converting some of your Traditional IRA assets into a Roth IRA. You will have to pay regular income tax on the conversion amount, but that might be a good opportunistic investment if you are temporarily in a low tax bracket. Be careful, however, that the conversion does not push you into a higher tax bracket. Also, make sure that you have cash outside of your IRA to pay the income tax due on conversion. The deadline to make a Roth IRA conversion for tax year 2011 is December 31, 2011.