Estate Planning

Has Your Estate Plan Outgrown You?

If you’re married, you and your spouse have estate planning documents that were prepared before 2009, and the current and projected lifetime value of your estate is less than $5.5 million, or potentially $11 million, your plan may be outdated.


A brief history of the evolution of the estate tax and the estate tax exemption will help you decide if it’s time to consult with your estate planning attorney.

Beginning in 1916, an estate tax was enacted that subjected the net value of an individual’s estate to an estate tax upon death. The net estate value, which includes life insurance proceeds and taxable lifetime gifts, has always been reduced by an exemption amount that’s used to calculate the amount of one’s estate tax liability. It was originally $50,000, fluctuated between $40,000 and $100,000 until 1977, and increased to $600,000 in 1987, $675,000 in 2001, and $1 million in 2002.

The growth of the estate tax exemption accelerated over the next eight years, jumping to $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009 before landing at $5 million in 2010. With the addition of inflation increases beginning in 2012, the current exemption is $5.43 million.

Estate Tax Reduction Strategies

If you’re married and you and your spouse have “I love you” wills where each of you leaves 100% of your assets to each other upon your death, there’s no estate tax liability when the first spouse dies. This is true regardless of the size of your estate as a result of an unlimited lifetime and estate marital deduction for transfers of assets between spouses.

The estate tax exemption is irrelevant for spouses with “I love you” wills when the first spouse dies – with one important exception. If the value of the survivor’s gross estate exceeds his/her estate tax exemption when he/she dies, his/her estate tax liability can be reduced to the extent that a particular advanced estate planning strategy is part of the couple’s estate plan.

It was common practice for many years for estate planning attorneys to include a provision in a client’s will or living trust that would shelter a portion, or potentially all, of a couple’s estate from estate taxes where the value of the combined estate exceeded the applicable estate tax exemption amount. This could be accomplished through the use of what’s alternatively referred to as an “exemption trust,” “bypass trust,” “credit shelter trust,” or “B trust” provision.

In lieu of simply leaving 100% of your estate to your spouse when you die, a bypass trust provision carves out the value of the first-to-die’s portion of a couple’s estate up to the amount of the estate tax exemption at the time of death. The assets that comprise the calculated value are used to fund a trust that’s separate from, and bypasses, the surviving spouse’s estate. The value of the trust plus any growth in the value of trust assets between the deaths of each spouse is excluded from the value of the surviving spouse’s estate provided that the trust is properly funded and maintained.

Potential Bypass Trust Obsolescence

The use of a bypass trust can result in substantial estate tax savings in situations where the value of the surviving spouse’s estate plus the value of the bypass trust exceeds the estate tax exemption amount at the time of death. The bypass trust must be established as a separate legal entity and maintained in accordance with the terms of the trust. This includes making timely and accurate income distributions from the trust to trust beneficiaries and filing of required annual fiduciary income tax returns.

With the recent escalation of the estate tax exemption from $1 million in 2002 to $5.43 million today, many bypass trust provisions have become unnecessary. This is the case where the current and projected value of a couple’s net estate during their lifetime isn’t expected to exceed the current exemption amount.

Furthermore, beginning in 2013, with the introduction of “portability” rules, unused estate tax exemptions can be transferred to surviving spouses to increase the amount of the surviving spouse’s estate exemption without the use of a bypass trust. This change enables a couple to escape tax on the value of assets equal to double the estate tax exemption, or just under $11 million, provided that an estate tax return with appropriate portability election wording is filed in a timely manner after the death of the first spouse.

Consult With an Experienced Estate Planning Attorney

It’s important to keep in mind that the use of a bypass trust provision may still be appropriate for second marriages where you want to carve out assets for children and/or the use of the “portability” provision is unavailable. Estate planning is complicated with lots of potential traps for the unwary. Consultation with an experienced estate planning attorney is highly advisable before making any changes to existing estate planning documents.

Social Security

Breadwinner Approaching Social Security Retirement Age? – File and Suspend – Part 2 of 2

Last week’s blog post introduced the “file and suspend” Social Security strategy. By implementing this strategy, a couple with a breadwinner can start a spousal benefit and suspend the breadwinner’s retirement benefits, increasing the latter’s benefits by as much as 32%, depending upon when it’s restarted. “File and suspend” is typically done when the breadwinner has reached full retirement age (“FRA”) and the younger spouse is at least age 62.

As pointed out at the end of last week’s post, the “file and suspend” strategy is a viable solution for maximizing a married couple’s Social Security benefits, however, it’s not without risk. Specifically, a potential downside of using this strategy is (1) premature death of the breadwinner or (2) the couple’s premature death between age 70 and “breakeven.”

Breadwinner’s Premature Death

If the breadwinner dies between FRA, assuming this is when the strategy is implemented, and age 70, the couple will have forfeited receipt of the breadwinner’s Social Security benefits that he/she could have been receiving beginning at FRA through date of death. By doing this, the couple would have to use other resources, e.g., salary, IRA accounts, etc., to meet their financial needs.

Let’s take a look at an example. Per Exhibit 1, assuming a monthly benefit of $2,475 for the breadwinner beginning at age 66 and 2 months and annual 2% increases, there would be a cumulative loss of benefits of $117,462 for the breadwinner assuming death at age 70. This loss of benefits, however, could be offset by an increase in the surviving spouse’s benefit assuming that the breadwinner filed and suspended at age 66 and 2 months. This is due to the fact that a surviving spouse is entitled to receive the larger of his/her benefit or his/her deceased spouse’s benefit.

Per Exhibit 1, at age 70, the breadwinner’s projected annual benefit is $32,148 and the spouse’s benefit is $16,074. Assuming death of the breadwinner at age 70, the surviving spouse would be entitled to receive the larger benefit, or $32,148. Let’s further assume that the breadwinner filed and suspended at age 66 and 2 months with the goal of resuming his/her benefit beginning at age 70, however, he/she dies on his/her 70th birthday. Per Exhibit 2, the breadwinner’s annual benefit is projected to be $42,631 at age 70, or $10,483 greater than what his/her benefit would have been had the breadwinner not filed and suspended. The surviving spouse in this case would be entitled to receive $42,631 instead of $32,148. With an increased benefit of $10,483 plus annual 2% increases, it would take approximately 11 years for the surviving spouse to overcome the cumulative loss of benefits of $117,462 that the breadwinner could have received between age 66 and 2 months and age 70 had he/she not chosen to “file and suspend.”

Couple’s Premature Death Between Age 70 and “Breakeven.”

Let’s assume that our breadwinner and spouse are both healthy and the breadwinner doesn’t die before age 70. Is the use of the “file and suspend” strategy without risk? Absolutely not. Let’s also combine our couple’s cumulative projected Social Security benefits from Exhibit 1 and 2 into one spreadsheet – Exhibit 3. The three columns in orange on the left-hand side represent the cumulative results per Exhibit 1, i.e., breadwinner beginning receipt of benefits at age 66 and 2 months. The three columns in yellow on the right-hand side represent the cumulative results per Exhibit 2, i.e., the breadwinner filing and suspending at age 66 and 2 months with recommencement of benefits beginning at age 70.

Per Exhibit 3, the couple’s cumulative Social Security benefits are projected to be greater from the breadwinner’s age 66 and 2 months through age 79 assuming survival of both individuals. It isn’t until sometime during the breadwinner’s age 80 that “breakeven” occurs when the cumulative benefits using the “file and suspend” strategy are projected to exceed those without use of this strategy. Assuming survival of the breadwinner and spouse, the difference in benefits is projected to become more significant each year thereafter. What starts out as a projected difference of $10,094 ($773,091 – $762,997) at age 80 grows to $77,920 ($1,152,943 – $1,075,023) at age 85 and $152,806 ($1,572,331 – $1,419,525) at age 90.

In summary, while the “file and suspend” strategy can potentially maximize a married couple’s Social Security benefits, its success is dependent upon longevity of the breadwinner and spouse. To the extent that the breadwinner or the couple die prematurely, commencement of receipt of retirement benefits beginning at the breadwinner’s full retirement age (“FRA”) would generally be more beneficial, depending upon assumptions used.

Roth IRA

Roth IRA Conversion – Analysis Paralysis? – Part 1 of 2

As is evident by the sheer number of blog posts to date about Roth IRA conversions – 33 – there’s a lot of things to consider when deciding whether a Roth IRA conversion makes sense for you. These include, but are not limited to, the following questions:

  • Should you do a Roth IRA conversion?
  • How much traditional IRA should be converted?
  • In which year(s) should a conversion be made?
  • Should you employ a multi-year conversion strategy, and, if so, what’s the best plan for you?
  • At which point during a particular year should a conversion be done?
  • Does it make sense to do multiple conversions in a single year?
  • Even though the income from a conversion in 2010 can be deferred to 2011 and 2012, should you do a conversion in 2010?
  • If you do a Roth IRA conversion in 2010, should you go with the default of reporting 50% of the conversion income on your 2011 tax returns and 50% on your 2012 returns or should you instead make an election to report 100% of your conversion income on your 2010 income tax returns?
  • Will your income tax rate be higher or lower than what it is now when you take distributions from your IRA accounts?
  • Which assets should be converted?
  • Should you set up multiple Roth IRA conversion investment accounts?
  • Is the current primary beneficiary of your traditional IRA a charity?
  • Are there retirement plans available for conversion other than active 401(k) plans?
  • What is the amount of projected income tax liability attributable to a potential conversion?
  • When will the tax liability attributable to the conversion need to be paid?
  • What sources of funds are available for payment of the tax liability?
  • Will withdrawals need to be made from the converted Roth IRA within five years of the conversion?
  • Do you have a life expectancy of five years or less with no living beneficiaries?
  • Do your itemized deductions and personal exemptions exceed your gross income such that you can convert a portion, or perhaps all, of your traditional IRA to a Roth IRA without incurring any income tax liability?
  • Do you own a rental property with a large passive activity loss carry forward that you can sell and do a Roth IRA conversion while incurring minimal or no income tax liability?
  • Is there a net operating loss that you can use to offset Roth IRA conversion income?
  • Is there a large charitable contribution available from the establishment of a charitable remainder trust that can be used to offset income from a Roth IRA conversion?
  • What is the basis of your traditional IRA, i.e., how much of your IRA has come from nondeductible IRA contributions or qualified retirement plan after-tax contributions?
  • Are you a surviving spouse in a low tax bracket who isn’t dependent on your IRA and one or more of your children are in a high income tax bracket?
  • What are the years and amounts of your projected required minimum distributions with and without a Roth IRA conversion?
  • What is the amount of projected taxable Social Security benefits that can be reduced by doing a Roth IRA conversion?
  • Do you have a SEP-IRA that can be converted to a Roth IRA?
  • Do you have a dormant 401(k) plan that can be converted?
  • How will a Roth IRA conversion affect financial aid qualification?
  • Will your Medicare Part B premium increase if you do a Roth IRA conversion?
  • If you do a Roth IRA conversion in 2010, will your Medicare Part B premium increase in more than one year?
  • What are the income tax consequences of a partial 72(t) Roth IRA conversion?
  • Should you not do a full Roth IRA conversion and instead leave funds in your traditional IRA for future nondeductible IRA contributions?

Feeling overwhelmed? Read Part 2 next week.


Two Great Roth IRA Conversion Candidates

In the two previous blog posts, I examined four scenarios where it’s possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion, and, as such, qualify as ideal Roth IRA conversion candidates.

This week’s blog presents two additional Roth IRA conversion candidates that I would classify as “great,” but not “ideal,” candidates. Both scenarios have the potential for the IRA owner or beneficiaries to end up with more assets than they would if they don’t do a conversion, however, there could be a sizeable amount of income tax liability attributable to the conversion, depending upon the situation. The two scenarios are as follows:

  1. Substantial basis in IRA
  2. Surviving spouse in low tax bracket not dependent on IRA with children in high tax bracket

Substantial Basis in IRA

Whether or not you’re considering a Roth IRA conversion, if you’re an IRA owner, it’s important to know the amount of your basis in your IRA. What does this mean? If the origin of your IRA is entirely from deductible IRA contributions or other deductible retirement plan contributions assuming your IRA was rolled over from a qualified retirement plan, such as a 401(k) plan, then your basis is $0. When you either take distributions from your IRA or do a Roth IRA conversion, 100% of your distributions or conversion amount will be taxable.

On the other hand, suppose that part or all of your IRA came from either nondeductible IRA contributions or after-tax contributions from a qualified retirement plan that was rolled over to your IRA. In this case, distributions from your IRA or Roth IRA conversions that are attributable to your nondeductible IRA contributions or qualified retirement plan after-tax contributions will be nontaxable. All prior year, as well as current year, nondeductible and after-tax contributions are required to be reported to IRS on Form 8606 – Nondeductible IRAs.

As an example, I had a client recently approach me about converting his wife and his IRA accounts to Roth IRA accounts. The combined value of their IRA accounts is $98,000 with a basis arising from nondeductible IRA contributions totaling $67,000. Assuming they convert 100% of their respective IRA accounts to Roth IRA accounts, they would recognize ordinary income equal to the difference between the account values of $98,000 and their basis of $67,000, or $31,000. This is less than one-third of the total value of their IRA accounts.

Even though my clients are in a combined 45% federal and state marginal income tax bracket, resulting in income tax liability of approximately $14,000 attributable to a Roth IRA conversion, this is only 14% of the total combined value of their IRA accounts of $98,000. Taking into consideration the fact that my clients are in their early 40’s, they may never need to take distributions from their IRA accounts, they have nonretirement funds from which to pay the tax attributable to the conversion, and the stock market is currently priced well below its highs of a couple of years ago, I encouraged them to pursue a conversion of 100% of their respective traditional IRA accounts to Roth IRA accounts.

Surviving Spouse in Low Tax Bracket Not Dependent on IRA With Children in High Tax Bracket

The second great candidate for conversion of a portion, or all, of a traditional IRA to a Roth IRA is a surviving spouse who meets the following three criteria:

  1. Low tax bracket
  2. Not dependent on IRA
  3. Has one or more children who are in a high tax bracket

The goal here is to reduce, or potentially eliminate, income tax liability that the surviving spouse’s beneficiaries will incur upon inheriting a traditional IRA since they will be required to take minimum distributions each year from their inherited IRA’s. Anyone in this situation should have a multi-year income tax projection prepared to determine the amount of traditional IRA that should be converted to a Roth IRA in the current and future years while keeping the surviving spouse in a relatively low tax bracket.

While both of these scenarios are not ideal Roth IRA conversion candidates since they could result in a sizeable amount of income tax liability upon conversion, they nonetheless present great opportunities to end up with greater assets than without doing a Roth IRA conversion, especially when beneficiaries are considered.

Retirement Asset Planning Retirement Income Planning

Retirement Asset Planning – The Foundation

Last week, in Retirement Planning Risks, I discussed six risks associated with retirement planning in general. In order to understand and appreciate the value and importance of retirement income planning and its associated strategies, let’s take a closer look at retirement asset planning.

As was presented in The Retirement Planning Paradigm Shift – Part 2, the focus of retirement asset planning is on the accumulation and “spending down” of one’s assets. The accumulation phase is common to various financial planning areas, not just retirement, including house purchase planning and education planning, to name a couple. With most types of planning, you’re typically designing a plan for the purpose of accumulating funds for either (1) a single expenditure at some specified, or target, date, in the future, e.g., a down payment on a house, or (2) a series of expenditures for a limited and specified series of target dates, e.g., a four-year college education.

With all types of financial planning, there are two major stages:  (1) design, and (2) funding, or plan implementation. Similar to an architect, a financial planner, after consultation with his/her client(s), designs a financial blueprint, or plan, for achieving a particular goal, or series of goals. Assuming that the client approves the recommendations, the plan is generally funded with a single lump sum or a series of payments over a specified period of time, depending on the plan’s goals, the client’s current and projected resources, and various other factors.

With most types of financial planning, when you reach the plan’s target date, you immediately, or over a limited number of years, e.g., four in the case of college education, see the results of your plan. What distinguishes retirement asset planning from other types of planning and adds to the complexity of the plan design and funding strategy is the “spend-down” phase.

Unique to retirement asset planning, the timeframe of the “spend-down” phase is undefined. It can last for less than a year and, although it is unlikely, it can go on for as many as 60 years, depending upon when it starts and a host of many variables.

Unlike most types of financial planning where you get to see the results of your plan after reaching a specified target date, this is not the case with retirement asset planning. As a result of all of the risks discussed in last week’s post, there’s an inherent uncertainty associated with retirement asset planning. Even if you’ve done an excellent job of accumulating what appear to be sufficient assets for retirement, you generally won’t know if this is true for many years.

While retirement asset planning can provide a solid foundation for a successful retirement plan, unless it is accompanied by a customized retirement income plan at the appropriate stage in your life, there is a higher likelihood that your retirement income will fall short of your needs and that the plan, itself, may not succeed.