Effective January 1, 2020, we have a radically different law governing Inherited IRAs and retirement plans than we had in the past. The stock market seems particularly jittery and that may continue for a long time. Your own finances and family situation could change significantly between the time you draft your wills, trusts and beneficiary designations and the time of your and/or your spouse’s death.
The Elephant in the Room of Estate Planning
The elephant in the room of estate planning is uncertainty, and many traditional estate plans take a fixed in stone approach that does not account for changing circumstances. Most married IRA owners have “I love you” wills. They typically name their surviving spouse as the primary beneficiary, and then their children equally as the contingent beneficiaries. They name trusts for the grandchildren of predeceased children. Usually, the children don’t get any money until both the husband and wife die, and the grandchildren don’t get anything unless their parent died also.
Using Disclaimers to Benefit your Estate Plan
A better idea for many married couples would be to include disclaimer provisions in their plan. A disclaimer provision allows your named beneficiary to say, “I don’t want this money — give it to the next person in line.” If you include disclaimer provisions in your wills, trusts, and in the beneficiary designations of your IRAs and retirement plans, your surviving spouse has up to nine months after your death to consider how much to keep and how much to disclaim to your children. Your children would also be able to disclaim to well drafted trusts for the benefit of their own children.
I had quite a few clients pass away in 2019 with IRA and retirement plans of well over a million dollars. For many of those families, I recommended that the surviving spouse execute a disclaimer of at least a portion of the IRA — sometimes over a million dollars. Because the surviving spouse executed a valid disclaimer, that million dollars was transferred as an Inherited IRA directly to the children. The disclaimer allowed the children to defer income taxes on their Inherited IRA, and often saved the family a million dollars or more in taxes. The rules in effect in 2019 allowed the “stretch” of the Inherited IRA and the family had a great result.
The passage of the SECURE Act, effective January 1, 2020, has put a big crimp in that strategy. Now, subject to exceptions, the beneficiary of a traditional Inherited IRA must withdraw and pay taxes on that Inherited IRA within 10 years of the IRA owner’s death. One of the important exceptions is the surviving spouse.
If an IRA owner dies after January 1, 2020, there is not as much income tax incentive to disclaim IRA dollars. But in some circumstances, there is still incentive. In addition, there may be an incentive to disclaim after tax or non-IRA dollars. But again, I don’t want a reader to commit to a certain course of action when changing circumstances could make any “fixed in stone” plan less than optimal.
The point is there is a constant uncertainty surrounding what laws will be in effect when you die. You can’t control Congress, the market or many other things. Furthermore, for each type of asset, whether it is an IRA, a Roth IRA, a brokerage account, life insurance, an annuity, a house, or other asset, there might be compelling reasons for who should get what both at your death and when your spouse dies that you can’t accurately predict today. A change in circumstances could change the optimal choice of which beneficiary gets which asset.
If your estate plan includes traditional estate planning documents that “fix in stone” the distribution of your assets to your heirs, they are not likely to get the full benefit of your legacy. Better decisions regarding who should get which assets can be made after your spouse dies, when circumstances are current and clear. Furthermore, if your estate planning documents are drafted with disclaimer options like Lange’s Cascading Beneficiary Plan, the name of our plan, your surviving spouse will have nine months after your death to think about options and determine the best strategies both for themselves and the family.
These decisions can be made either with their family or, ideally, with their family and a trusted advisor who understands the enormous benefit of flexible estate planning combined with tax-savvy post-mortem estate planning. Post-mortem estate planning is when you determine a course of action based on what is best for the spouse and the family after the death of the IRA owner. Similarly, after you both die, providing your heirs (usually children) with as much flexibility as possible is also optimal. So, what can you do to give yourself and your heirs maximum flexibility?
What follows assumes a “Leave it to Beaver” family. Perhaps I am dating myself. If you don’t understand the reference, it refers to a couple who have been married once, to each other, and they only have children from their union. This means both of them have the same ultimate beneficiaries which is likely some combination of children and grandchildren. This is the old-fashioned traditional family unit (like mine).
How Do Disclaimers Work?
Disclaimers are surprisingly simple to include in your estate plan. Start by naming primary and contingent beneficiaries to your IRAs and retirement plans (and possibly most, if not all, of your other assets) according to the following hierarchy:
- your spouse,
- your child (or children equally) as the contingent beneficiary or beneficiaries,
- your grandchildren, though likely in a trust depending on their ages. There should be a separate trust for the children of each of your children.
The key concept here is disclaiming. We recommend you include disclaimer language in your wills, trusts, beneficiary designation of your IRAs and retirement plans and subject to exception, everything else too. You can’t force anyone to accept a bequest. My plan works by allowing the beneficiary of your IRA (or of any assets, if you set it up that way) to accept your IRA for him/herself, or to say, “I don’t want that IRA or I don’t want part of that IRA.” If there is a “disclaimer” of all or part of an IRA, we look to see who is next in line, or if we want to use the official term, the contingent beneficiary. The ability for the primary beneficiary to make a “partial disclaimer” adds enormous flexibility to your estate plan. This means that he or she can accept part of the asset and let the contingent beneficiary have the rest.
Think about how it would work. If your surviving spouse needs all the money, that is fine—he or she can keep everything you left to them. End of story. But if your spouse doesn’t need the money, or more likely doesn’t need all of the money, then he or she can disclaim either all, or again more likely, a portion of it, in favor of the next beneficiary on the list—your children. If you have two children with unique needs, one can accept the inheritance and the other can disclaim their inheritance, or a portion of their inheritance, to a trust for the benefit of their own children.
Again, I want to give the surviving spouse the option to keep, disclaim, or partially disclaim not only the IRA and retirement plan, but all other assets including Roth IRAs, after-tax dollars, life insurance, etc. I would also like to make it crystal clear that your surviving spouse, or for that matter the next named beneficiary, has the right to disclaim all or part of every asset.
In addition to having specific disclaimer language in the will, revocable trust, and all the beneficiary designations of IRAs, Roth IRAs, etc., disclaimers allow the possibility of your grandchildren inheriting IRAs or other assets even if your children are alive.
With traditional planning and traditional estate administration, your children do not get any inherited money until both you and your spouse are gone. Your grandchildren do not get anything until their parents are gone. Incorporating disclaimers into your estate plan allows your children to receive money at the first death which not only has potential tax advantages, but also can help them out while they are younger and may need it more.
Using traditional estate planning, the only way your grandchild would receive an inheritance is if the grandchild’s parent predeceases them. By using disclaimers, there is a possibility of your grandchild inheriting money while your child is still alive. That gives us the ability to name your children as trustees for the grandchildren. Disclaiming can not only reduce taxes after your death, but also get money to younger generations sooner when they have greater financial need for it.
Looking at LCBP in Conjunction With the SECURE Act
Since the passage of the SECURE Act, using the power of disclaimers will require more strategic thinking. Under the new rules that eliminated the Stretch IRA, it usually won’t make sense for your surviving spouse to disclaim a large IRA to your child. Your grown children and grandchildren will pay a steep price because they will have to withdraw everything within 10 years.
Now, let’s look at how disclaimers can work to your advantage in conjunction with the SECURE Act.
Let’s assume you die with a large IRA and the documents give your surviving spouse complete discretion as to whether she wants to keep the entire IRA, disclaim part of the IRA, or even have a portion of the IRA pass to a grandchild or grandchildren. Your spouse, presumably with the help of an attorney or the appropriate advisor, assesses her financial position. Let’s assume that she is left with more money than she requires, and her own children don’t have any need for money. Under the old law and even under the SECURE Act, it might make sense for her to disclaim a portion of the IRA to the children who would further disclaim to the grandchildren to spread some of the income among multiple beneficiaries depending on the tax circumstances of the children and grandchildren.
Perhaps the situation is different. Perhaps the kids need some money after your death. Their income is low, and they need money and your spouse wants to provide that support. In that case, she could “disclaim a portion of her IRA” and the kids could either cash in their share immediately or better yet, do it gradually over the 10-year period incurring minimal taxes.
It makes sense to do tax projections to assess the impact of different beneficiaries receiving money at various times while always keeping in mind the tax rates for the individuals involved. One point that is frequently overlooked is once one spouse dies, the survivor’s filing status changes from Married Filing Jointly to Single.
For example, let’s assume that you have a multi-million-dollar IRA and leave behind a 74 year old spouse and two adult children. Please assume if she were to accept your entire IRA, her new annual taxable income, including required minimum distributions from your IRA, would be $203,000. That income exceeds the top of the 24% bracket for a single individual and pushes her into the 32% tax bracket by $40,000. If she were to disclaim about $1,000,000 of your IRA, her annual income would then be reduced by $40,000 (to $163,000 which is the income level at the top of the 24% tax bracket for a single individual). Her annual income would be reduced by $40,000 because if she had kept that $1,000,000, based on her life expectancy factor under the new life expectancy tables (which would be approximately 25 years), she would have been required to withdraw 4% of that $1,000,000 balance.
Let’s further assume that both of your children spread their portion of the $1,000,000 distributions over ten years, and that both are in 24% tax bracket. Because your spouse disclaimed the portion of your IRA that she would never need, your family saved 8% (32% minus 24%) on $1,000,000, or $80,000.
Of course, it may be more beneficial to disclaim other assets to children or grandchildren. It is too tough to guess what the best strategy will be after the first and second death. Therefore, we recommend you consider building flexibility into your estate plan with disclaimers. Ultimately, you might be able to get the right assets to the right beneficiaries at the right time and save a ton of money on taxes.
This article originally appeared on Forbes.
