Is a Will Enough?
Wills, Trusts, and Your Legacy
In this webinar, Estate Planning Attorney Garrett Griffin, illustrates the differences in wills and trusts, what you can do to protect your legacy, and why it’s important to develop your estate plan with your family in mind. You don’t put together an estate plan for yourself, you do it for your loved ones.
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Video Transcript
Is a Will Enough?
Welcome to today’s webinar. I am Garrett Griffin, attorney with BFG Legal Services. Today, we are going to cover, “Is a Will Enough?” and talk about wills, trusts, and your legacy. In today’s webinar, we have a few objectives. We’re going to introduce some concepts to you about estate planning.
We want to make sure that we provide some educational topics and illustrate some of the things we have seen from a planning perspective as it relates to these documents. We also want to offer a complementary session with myself or Jason Salinardi, the other BFG Legal Services attorney.
Estate Planning Defined
When we start thinking about estate planning, we’ve got some specific definitions that we like to use. Control ultimately becomes one of the main factors. When we start to think about it, we really look at it in a couple different buckets. One of those is incapacity planning. We also look at the wealth transfer planning, and ultimately beneficiary protection plan.
It’s those three things that help us round out a full, comprehensive estate plan. A lot of times when you think about those three buckets, wealth transfer planning and beneficiary protection planning kind of go hand in hand. You’ll see that throughout some of the material today.
Types of Estate Plans
We generally have three types of estate plans—an intestate-based estate plan, a will-based plan, and a trust-based plan.
Intestate-Based
An intestate-based plan means that you have no documents in place whatsoever. Clients often think that there’s a certain default that will happen, and that is in fact true.
The difficulty is that each one of the state legislatures—being in the Kansas City metro area, we’re dealing with both laws in Kansas and Missouri—have passed an intestacy law. That means if I don’t have any of those written documents, the legislature has prescribed who those beneficiaries will be, what assets they will get, and in what percentages. Those are often inconsistent with what the client potentially might want to have happen, but without any written direction, either in a will-based plan or a trust-based plan, the default becomes those rules.
Will-Based
Ultimately, we look at, “What is a will-based plan?” Probably one of the largest misconceptions that I deal with when I sit down and talk to clients is that a lot of them think, “I have a will-based plan in place. I have my last will and testament. I’m going to avoid probate and all my wishes that I’ve set forth. Those are all going to be viable.”
The unfortunate thing is that a will-based plan does not avoid probate. In fact, the will, the last will and testament, is the document that gets admitted to the probate court and essentially starts that probate process. When we talk a little bit about probate, you can have an intestate plan or a will-based plan, and both are going to run through the probate process.
Trust-Based
So, what avoids probate? It’s our last plan, and that’s the trust-based plan. That’s where we’ll spend most of our time today. We’ll talk about the following.
- What is a trust?
- What are the flexible components of a trust?
- How do you structure the trust?
- How do you put one in place?
- What are some of the opportunities that exist within a trust-based plan?
Facts About Probate
Public
To reflect again on the dangers of probate, what happens then when we have a probate process? What are the negative connotations that surround probate? The first is that it is public. When you file the will or if you don’t have a will and it’s intestate, all the proceedings and documents that get filed, including an inventory of all the probate assets, is a public record.
Up until a few years ago, that may not have been that important, but now all the filings are online, they’re e-filed. All the records are available digitally. No longer do you have to walk down to the courthouse and potentially pull a file. Many of these things are available in electronic and digital format, so the ability for somebody to see what is going on in a probate proceeding is sometimes a bit concerning.
Complexity
There’s complexity. We live in a metropolitan area where we have multiple counties in two different states. Each of the state rules are different regarding probate. The judges in each of these counties follow some of their own set of local rules that they prescribe. The differences between the jurisdictions and counties can be somewhat difficult, and there’s some complexity involved.
Time Consuming
The time that it takes to run something through probate is also perplexing. Usually, it’s somewhere in between 12, 18 months. That’s when you don’t even have parties fighting. In non-litigation situations where things seem to be straightforward, it’s still very time-consuming. There’s difficulty in there because we’re talking about potentially getting access to the probate assets. That may be delayed based upon these times.
During that time, there’s a lot of publications that have to be done. There’s a lot of time prescriptions built into that probate process. We know that even on something simple and straightforward, there’s going to be some minimum times that we have to spend.
Expensive
We’re concerned about the expense of probate. Because of the time that is involved, you have court filing, publication, and attorney fees. There’s going to be a personal representative or an executor who gets appointed to the probate estate. That person is also entitled to fees.
During this long period, the ability for fees to generate in a probate process becomes very expensive. Again, one of the fundamental things that we look at from a planning perspective is, “What can we do to avoid probate and what can we do to cut down on that wealth transfer to make sure that it’s as efficient as possible?”
We’re going to talk a little bit about a trust-based plan and how that does that, but there are multiple vehicles that could potentially eliminate probate. We’re going to focus on the trust today.
Dangers of Joint Tenancy
There’s also another kind of quasi-type of planning that I’ll see a lot of clients potentially engage in before they meet with me. That is joint tenancy, and that is a way that a client potentially owns property with another person.
Probably the most popular one is when husband and wife own an asset together. That’s one form of joint tenancy, but there are multiple forms that we should potentially be concerned with. There’s joint tenants with right of survivorship and tenants in common. In Missouri, we have tenancy by the entirety.
Gift Tax Consequences
There are different ways that clients can join and own these assets together, but there’s some difficulty in how that sometimes gets created. You’ll frequently see when parents will put a child on and create a joint tenancy. That is often considered as a gift.
Maybe that’s no impact from a taxation standpoint right now given the current lay of where gift and estate taxes are at, but that may not always be the case. It could produce some reporting issues or requirements that we should be concerned about.
Assets May Be Lost If Joints Tenants Run into Financial Difficulty
We’re also looking at a situation where what if, in creating this joint tenancy, I have created some potential risks in that asset that I as the original owner might have. If I take and create a joint tenancy on an asset with a child, and suddenly that child is being sued, I have now potentially exposed that asset that was mine to that creditor. I could now lose some asset protection by exposing that asset to various risks because of the tenant that I’ve joined in on that asset.
In every situation, I want to think about:
- Does it make sense?
- Does join tenancy make sense as it relates to the whole plan?
- What is the goal with this asset?
- Does that relate to the estate plan?
Proportionate Loss of Stepped-Up Basis
I’m also concerned about proportionate loss and step up in basis. When an individual passes and an asset moves in that wealth transfer at passing, the beneficiary is going to receive what’s called a step up in basis. The basis in the property is basically, “What did that person pay for the property?”
An example of that comes up when I work with a lot of farm clients. If we’re talking about a farm or a ranch, if an individual paid $1,000 an acre for that, but when they pass, it’s worth $3,000 an acre. At passing, the beneficiary’s basis adjusts. They get a step up to that fair market value of the date of death, so in this case, $3,000 an acre.
Carryover Basis
If there is a gift of that asset to the beneficiary during the owner’s lifetime, they get what’s called carryover basis. They don’t get a step up in basis at death; they get carryover. When that gift is made during the lifetime, that $1,000 basis moves over to the new owner, to that beneficiary. Now if they potentially go to sell that asset later, they’ve got a low basis. They’ve got a $1,000 basis in that asset and are potentially exposed to $2,000 an acre of capital gains.
Making those gifts and the timing of when those things happen by creating that joint tenancy, we can run into a host of potential issues. That’s not only from a gift and taxation standpoint, but a loss of step up in basis standpoint—another tax issue—and that asset protection component.
Not that joint tenancy doesn’t become part of our plan, but we really have to think about how we are setting these assets up in terms of titling, and how those things flow into our trust-based plan. We want to make sure that we’re addressing and looking at each one of these assets to make sure that we’re doing the right thing.
Comprehensive Estate Plan
Let’s look at what a comprehensive estate plan looks like and ask these questions.
- What are the various elements?
- What are the various documents?
- How are they all set up?
Revocable Living Trust
If this is a trust-based plan, we’re talking about a revocable living trust. On top of that, we’re talking about a fully funded, revocable living trust.
We’re also talking about a host of other ancillary documents that we need to make sure are part of the plan to fill in some of the holes that a trust may present. A trust does a lot. It’s a very flexible tool, but there are a few different things that the trust doesn’t handle. We need to make sure we’ve got some other components that we can use to fill in those holes.
The Grantor and the Trustee
The trust is like a written contract, and it is a legal relationship. Our trusts start with a grantor or between a husband and wife. We’ve got joint grantors. The grantor is going to be the one that establishes the terms of the trust. There’s also going to be a trustee, who is going to be that person that the grantor trusts with controlling all the aspects in the trust instrument itself. That’s who is going to hold all the various powers to administer the trust.
The Third Party: The Beneficiary
Ultimately, your third party is the beneficiary. Any of the assets and all the rules that are applicable to those assets, they’re put in place for those beneficiaries. Those are technically those three parties that we have to a trust—the grantor, trustee, and beneficiary.
Most of the time when clients come in and sit down to meet, they’re going to wear all three of those hats. The client is going to be the grantor; they’re creating the trust. They’re going to be the trustee, so they’re going to be the initial party in charge of all the rules and administration and hold title to those trust assets. Finally, they’re the beneficiary.
Flexible Frills
All the assets that go into the trust are going to be there for their benefit. They’re going to have the right to use those assets, income, and principle, so they’re very flexible from that standpoint when we first put these trusts in place.
If we have a husband and wife—two grantors, we’re going to have a joint trust. If we have a single person—one grantor, we’re just going to have a single trust. It’s just going to be a revocable living trust.
In that situation, we’ve got these three parties. It’s a very flexible type of thing because we’ve got the ability then for a revocable living trust, which means the grantor has the power to adjust the trust over time. If they need to go back in and change whatever provision in the trust that they need to, they have that flexibility. That’s where we get that term revocable.
It makes it a very flexible tool because the trust can ebb and flow during the client’s lifetime. If the financial circumstances or dynamics change, we can adjust the trust. We can do that over time in this vehicle.
The Dresser Drawers Example
If you think about a trust, I liken it to a set of dresser drawers. There are various provisions that we put in our trust. They are typically sorted out by various articles that are specific to times and events that might occur during that grantor’s lifetime.
There are aspects of the trust that are important when the client is potentially disabled or incapacitated, such as who then is the trustee and what assets are available to the grantor. What happens to this trust if we have a joint trust and one of our clients passes away? Now we have a surviving grantor, so what does this trust look like? What types of provisions are in place?
One of the reasons why I think a lot of clients are looking to trusts is what happens if one of our grantors passes and then the surviving spouse gets remarried? How can we protect the assets for that surviving spouse? What if they were to get divorced? Is there anything that we can put in place with regards to the trust and trust assets that would alleviate that difficulty?
What happens if the surviving spouse were to get remarried and they pass and leave a new surviving spouse? How do we ensure that the assets are going to go down to the children or other beneficiaries without being disrupted potentially by this new surviving spouse? I’m pulling out the dresser drawer for that specific situation. How do we address that, what does the trust say, and what protective components can we put in place?
Distributions to Descendants
Where we really move into the wealth transfer and where that intersects with beneficiary protection planning is determining the provisions for the beneficiary’s trust. Whether that’s children, grandchildren—whomever those beneficiaries ultimately happen to be—what are those various provisions that we have available to us?
When we sit down and talk to clients about what that distribution looks like at the end of that trust, do we distribute assets outright to those beneficiaries, do it in stages, or some type of a staggered distribution? Do we keep things in some type of a lifetime trust, and why would we do that? If we look at the various ways that assets could be distributed to beneficiaries, descendants, etc., what does that look like? We’ve three ways that we can do that.
Outright Distribution
We can do an outright distribution. It’s probably the quickest, most simple way to go about it. Let’s say we’ve got husband and wife. If they’ve got two children and each of the children are going to be treated equally—50% to each one. Once debts and expenses are taken care of for that surviving spouse, we’re going to have an outright distribution paid to those two beneficiaries, 50/50.
What that means is they’re going to get those assets and put them in their own pocket so that they become part of their personal balance sheet. They’ve got full access, no restrictions to those assets. They take title to them.
Predators, Creditors, and Divorce
The difficulty with that is that when a beneficiary assumes personal ownership of that distribution, all the risks associated with somebody in their life now get applied to those assets that they’ve inherited. Think about the various risks we assume every day. We say it’s the predators, creditors, and divorce. What about those three risks? If it’s an outright distribution, all those things are applicable and the asset, the inheritance, is exposed to those risks.
If we’ve got young beneficiaries, they may be easily manipulated, so we might have a predator situation. We could have a beneficiary that’s getting sued for some reason, and now that creditor issue is a risk toward that inheritance. What about a divorcing situation where a beneficiary is going through a divorce? We look at those situations and suddenly, the inheritance is exposed and we’re losing that beneficiary protection.
We may have had an efficient wealth transfer because those assets move smoothly, didn’t go into probate, and beneficiaries received them and received them quickly, but now we ultimately have no beneficiary protection.
If we think about these risks—predators, creditors and divorce—from a creditor standpoint, one in three people get sued in their lifetime. That’s staggering; that’s a significant risk. I think divorce rate is somewhere between 50-60%. If you look at this again from the statistical standpoint where one in three people get sued in their lifetimes and 50-60% of people go through some form of a divorce, our beneficiaries are at risk for losing this inheritance.
Lifetime Beneficiary-Controlled Trusts
When we start to shift this thinking, what are our alternatives? Our alternatives are some form of a lifetime trust. Whether that’s an independent trustee or some form of a beneficiary-controlled trust, where the beneficiary has some limited ability to act as an administrative trustee, know that we have these tools to create ongoing trusts so we now have beneficiary protection.
No longer do we have to have assets that are exposed to these various risks. We have mechanisms and provisions in place where we can put these protective components around those assets. We can control them. If we think about that definition that we first looked at with control being one of the main components, we can control the wealth transfer and help from a beneficiary protection standpoint.
When we get into meetings, we’re truly talking about the design. We’re laying the blueprint of this estate plan. Thinking about how we make these distributions to descendants is paramount because we’re looking at how we get all the power of the trust and create a type of a trust that gives us the protection. We’re looking at the goals of the client. How can this trust truly accomplish those things?
The Most Important Step
We talked earlier about highlighting what went into a comprehensive plan and looked at the trust. It’s a fully funded, revocable living trust. Funding becomes a paramount part of the process when we go through putting a plan in place. One of the reasons why I really like working at Barber Financial Group with Bill Page is that we can truly put a fully funded plan in place. Bill, working alongside myself and the advisor, can make sure that the trust is going to be fully funded.
Looking into the Character of the Asset
So what does that mean? Effectively it means that all your financial assets—any type of a financial account that has monetary value to it, real estate, business interest, personal property from a vehicle standpoint that has a title—need to be funded into the trust. In some fashion, we’re going to go through that list of assets and look at the character of the asset. What type of an asset is this? That’s going to help drive us in making our decision of how we fund it into the trust.
Some assets, like real estate, are going to be retitled in the name of the trust. If you own it individually or as husband and wife, we’re going to transfer the ownership of that real estate to you as the trustee. When you own and hold title as the trustee, that means that the trust owns that asset. Again, we might be adjusting and retitling the ownership of the asset to the trust.
The other way that we fund the trust is we look at assets and say, “Maybe we don’t want the trust to technically own the asset or maybe it can’t, like with an IRA or a 401(k), where we don’t want a trust to own that asset while the client or participant is alive or that participant is alive.” Rather than direct ownership, we’re going to do some type of a beneficiary designation. That’s the way we’re going to link that asset to the trust.
If you think about an IRA or a 401(k), we’re going to update the beneficiary designation in some form. Whether it’s the primary or the contingent beneficiary, that trust is going to be layered in there. Your day to day checking account is another good example of something that we might typically put a beneficiary designation on.
Transfer of Death Designation
Vehicles have what’s called a TOD, which is a transfer on death designation. We’re going to put the trust on as a TOD on that vehicle title. We’re trying to ensure that all your assets are going to flow through the trust, so we’ve got to attach that to the trust somehow. Retitling or beneficiary designations are going to be the two primary ways that we do that.
Think again about what that comprehensive plan looks like and do a last will and testament. Even though you can have a will-based plan and we’re talking about a trust-based plan, part of our trust-based plan is to still have a last will and testament.
Pour-Over Will
When we have a very particular kind of last will and testament that we put in place, we call that a pour-over will. If for some reason there was an asset that either got missed—maybe it arose after the fact and didn’t get titled appropriately—or didn’t get the appropriate beneficiary designation on it, what often happens is there will be refunds from insurance checks and different things. Those refund checks are made out or payable to the estate of, and we didn’t really have any control over that funding component.
If there was any asset that ends up in the probate estate, we can still submit the pour-over will. However, the pour-over will doesn’t go through and list a bunch of individual beneficiaries. It basically says if I have assets in my probate estate, I want those assets poured over and into the trust.
Functioning as a Funnel
It acts like a funnel. It’s going to funnel those assets into the trust. The value of the assets in the probate estate is going to dictate the degree of complexity that the probate estate is going to entail. If we can keep it $40,000 and lower, we’re going to have a simplified process. We’ve got that receptacle, that vehicle, that can funnel those assets back to the trust.
The pour-over will is where you’re going to make nominations for your guardians if have you have minor kids. That is a document that typically is going to get admitted to the probate court. That is then going nominate to a judge who should become the parent of this child and act as guardian for them. That will is going to have a couple different impacts, specifically for those with minor kids. That’s where that guardianship happens.
Durable Power of Attorney
Agent to Act in Event of Grantor’s Incapacity
Then we start to think a little bit more about incapacity planning. I know if we think again about the dresser drawers of the trust, one of those drawers was incapacity planning. We can handle those situations, but that’s only for assets that happen to be in the trust at that time. If there are assets that are outside of the trust, the trust provisions don’t control those assets.
If you think about the funding that we talked about, there’s only certain assets that go into the trust initially. There are also some assets that kind of stay outside in your own personal name during that time until you pass. That beneficiary designation moves it into the trust.
If we have a situation where we become incapacitated or disabled, and we can’t handle our financial or legal affairs, we need some vehicle that can move somebody into our shoes to make those decisions. That document is the durable power of attorney.
There’s a couple different ways that that document can be effective. You may say, “I want my agent, proxy, or attorney to be able to make decisions immediately. As soon as I sign this document, they can act on my behalf, if necessary.”
Ability to Fund Trust
Another way of setting that up is what we call a springing. When the principal, the client, becomes incapacitated, that’s when that document triggers. Now, suddenly that agent, that attorney, now has the power to act.
Our durable powers of attorney are extensive, so it really allows the agent to make a multitude of decisions for the principal, for that client. Once that incapacity happens, that agent can essentially step into the shoes of the client and make those legal and financial decisions. One of those may be important because we may still have assets that for some reason are outside of the trust that need to be funded into the trust.
Non-Trust Assets
We can continue that funding process, if necessary, but we can handle all those financial and legal decisions. It may be something like needing to file a tax return, hiring an attorney, or doing some type of a contractual arrangement. I’ve now got that agent or that attorney who can step in and do that for me if I’m unable to.
Health Care Power of Attorney
Then, we’ve got incapacity planning as it relates to healthcare. When we look at healthcare, we typically will put into place three different healthcare documents. The first that I like to talk about is the healthcare power of attorney.
Similar to our durable power of attorney in terms of when incapacity happens, I’ve got an agent or a proxy who can step into my shoes. However, they’re going to be making medical decisions on my behalf instead of financial decisions. We like to create those documents separately.
I’ve seen other attorneys who have created a power of attorney document that encompasses both financial and healthcare, but I have chosen to split those in two. The reason being is that often have clients who may say, “I have this individual who I want to be the durable power of attorney and handle financial and legal decisions, but I’ve got somebody else that I want to handle medical decisions.”
They may have a nurse, doctor, or somebody in the medical profession that they want at the top of that list, so we’ve split those documents into two since we may have different people handling different responsibilities.
HIPAA Authorization
We also have a HIPAA authorization. We want to make sure that we’ve made authorization appropriately under the federal HIPAA law for anybody who is acting under the durable power of attorney or anyone who the client wants to have access to their private healthcare information.
Living Will or Healthcare Directive
Lastly, we have a living will or a healthcare directive. They kind of are synonymous with one another. That is your ability to control end of life decisions regarding your healthcare. It sets a medical threshold for that document to become effective.
If you are in a persistent vegetative state, suffered significant and irreversible brain damage, or otherwise in some type of a terminal condition, and the physician has said they are in there is no likelihood of any type of meaningful recovery, then please withhold or withdraw continued healthcare. It’s your ability to control end-of-life decisions in that way.
It’s also a way to take some of those difficult decisions off the healthcare power of attorney because that document tends to trump the healthcare power of attorney. It takes that difficult decision off that party, that agent or proxy, that is working on your behalf.
Qualified Retirement Plans
Those were the documents that rounded out the comprehensive estate plan, but we’d be remiss if we didn’t address a paramount asset that is running through most of our plans. Qualified retirement plans, 401(k)s, and IRAs are predominantly what we’re talking about here. IRAs might mean traditional or potentially ROTH. With the character of those assets and how they run through these estate plans, there is some significant impact.
Provisions of the SECURE Act
We’ll talk about the SECURE Act provisions that were passed right at the end of 2019 and became effective January 1, 2020. An important thing to note when we talk about these qualified retirement plans is that the beneficiary designation is going to control. No matter what your trust says, it’s the beneficiary designation on the retirement asset that’s going to control. If you have your spouse as the primary and your individual children as the contingent, and your spouse pre-deceases you, those individual beneficiaries control rather than the terms of the trust.
If we want the trust to be effective and control any type of the retirement plan distribution, we’ve got to make sure that somewhere on those qualified plans, on the beneficiary designations, that we have the trust listed appropriately. Let’s look at how we protect these vehicles and do tax mitigation.
At the end of the year, we were dealt with the SECURE Act. There were some positives to the provisions of the SECURE Act from a planned participant aspect. However, that has much less impact on how we’re planning from the estate planning standpoint.
What is most important in the days of what I call planning in isolation—when you come in to see the estate planning attorney—is that you’re not involving your investment advisor, your CPA. I think those days are gone. If you’re wanting to get an appropriate plan in place that looks at asset protection and tax mitigation and minimization, you have to coordinate all these people together.
Barber’s Four-Pillar Approach
That’s what’s great about Barber and their four-pillar approach: investments, insurance, tax planning, and estate planning. All those are key. They’re important, interrelated, and all the parties need to be working together to make sure that the plan is the most effective.
A Stretch IRA
With these key provisions in the SECURE Act, the ability to stretch an IRA has been eliminated. Prior to January 1, 2020, with appropriate planning, whether that was trust-based planning or even individual beneficiary designations, we could get a stretch IRA. Many of you probably have heard of that, but basically what it means is that the beneficiary would use their own life expectancy to stretch the required minimum distributions, those required minimum distributions. A beneficiary may have 30, 40, 50 years of life expectancy to stretch that.
What that required was these small RMDs. If they’re from a traditional IRA, meaning that the tax hasn’t been paid yet, the impact is minor. We have these small distributions that might go on for 30, 40, 50 years, so the income tax impact to the beneficiary was minimal. We were trying to get that stretched out by using conduit provisions in the trust, which was one of the best practices and what we were doing.
What the SECURE Act basically said is that we’re not going to have that ability anymore. By the end of the 10th year from the participant’s death, all the assets have to be distributed out of that IRA. So, what does that mean? Now we don’t have small, incremental distributions; we have large chunks of the IRA being distributed out.
Conduit Provisions
With Conduit provisions, we’re potentially going to lose some asset production. We’re certainly probably going to have some higher income taxes because again, not small distributions that are maybe just being layered on top of regular incomes. We now have these large distributions coming out of the IRA within that 10-year period, and that’s going to create additional income tax.
There are some exceptions to that rule with spouses, minor children until the child becomes of age, a beneficiary who is 10 years or less younger. There is some flexibility there; there’s not quite as stringent rules. However, most of the time when we’re talking about those IRA assets moving from parent to child, the SECURE Act is going to be an impact.
There’s a little bit of flexibility that the SECURE Act has given us, and that is that it didn’t really prescribe the way the RMDs or the distributions have to happen. It just says that they all have to happen by the end of the 10th year. We can have an all, up-front distribution, a level distribution over a 10-year period, or have it all along the back end. The individual is at least going to have some flexibility in terms of potentially doing some planning for when that potential impact comes.
Three Categories of Beneficiaries
How do we mitigate maybe some of this impact? If we look at the category of beneficiaries in terms of where that SECURE Act is going to apply, we have a couple different ones.
Eligible Designated Beneficiary
We’ve got those eligible designated beneficiaries, where we are going to use life expectancy payout. However, most of the time, that’s only going to apply to the spouse. There are a few other exceptions, but usually only the spouse can use life expectancy.
Designated Beneficiary
If we’re using a qualified trust, which what we’re mainly talking about in our situation, we’re going to be limited to a 10-year period as that designated beneficiary.
Beneficiary Who Is Not a “Designated Beneficiary”
If you’ve got something like an estate or a non-qualifying trust, those are going to be non-designated beneficiaries. We’re going to get stuck with a five-year payout. That’s potentially an even worse scenario and result in that case. But, for the most part, we’re concerned about this 10-year payout and what it means.
I talked a little bit about the conduit trust language that we’ve tended to use as a best practice to get that stretch IRA concept that was available prior to the passage of the act. These conduit provisions force the trustee.
Inherited IRA
The trust has this inherited IRA, where the distribution comes out of the IRA and lands in the trust. The trustee has no discretion whether to hold or accumulate any of those distributions and is forced to pay that distribution out to the beneficiary.
So, what’s our result? We could benefit if the beneficiary is in a tax bracket where the income tax is lessened by paying that out. The problem, though, is we then lose all our asset protection. All the protective components that we maybe have built into the trust are suddenly gone.
We’re put in the position where we’re asking if tax mitigation and asset protections are our goals. We’re forced to weigh out those provisions, but those conduit provisions do not give the trustee any discretion to hold those distributions in trust. Those have to come out.
Why Is the Conduit Provision a Problem?
We’ve talked a little bit about what that problem looks like because now we’re looking at the beneficiary situation. What is the impact? We’re probably going to lose asset protection because the tax play may control and so that distribution is going to come out.
The Big Decision
We have to start thinking about some of the other things that we could potentially do. For purposes of the trust and how the trust is designed, one of the things that we may want to put in place are accumulation provisions. We take the conduit provision out because we are no longer worried about the stretch IRA and stringing this out.
Let’s try to put some flexibility into the trust. Let’s give the trustee some discretion to do some planning. Look at the current situation when those IRAs are distributed to the trust on what they may or may not want to do.
- What does the trust say and what did the client want to have happen?
- What were their goals?
- What’s going on in the beneficiary’s life that we may need to make an adjustment?
- Is the beneficiary getting sued? Are they going through a divorce or are in a high-risk profession where there may be some likelihood that they are in the crosshairs from a lawsuit standpoint?
Best Practices
I think best practices have potentially made a shift. Instead of conduit provisions, do we put accumulation provisions in? No longer is the trustee forced to distribute an IRA withdrawal. Instead, they have the discretion to accumulate it and hold it inside of the trust.
What is the tax impact at the time that the distribution potentially could be made? Is it going to increase taxes to the beneficiary? We don’t know now, but if we have conduit provisions, the trustee will be forced to distribute that asset out.
If we have accumulation provisions in the trust, at least the trustee now has some discretion. They may still say that the best play is income tax mitigation and minimization and make the distribution. But, they also have the discretion to say no. Whatever’s going on in the beneficiary’s lifetime at this point could be contradicting what they want to do, so they accumulate. They might pay a little bit higher tax, but they’re going to preserve that wealth and protect that beneficiary from whatever may be going on at that time.
How do we view what are now best practices? Is that something different from conduit versus accumulation? It needs to be part of the discussion regarding how we make this and protect the client’s plan. We need to get the most wealth transfer and do it in an efficient manner.
We’re stuck in this dichotomy of, “Do we want asset protection? Do we want tax mitigation?” We don’t know what that happens to be because we’re not presented with the scenario yet. What we maybe try to build is the flexibility, at least for the trustee, to make those decisions.
Looking through a Different Lens
The SECURE Act is an impact. The inherited IRA world and how that relates and flows into a trust has been flipped it on its head. We have to look at this from a little bit of a different lens.
There are some other aspects to look at regarding the assets flowing into the trust. What is the characterization and what is the character of the assets that are flowing through the trust? Can we minimize what that IRA or other qualified retirement plan distributions as it rolls through the plan?
We’re looking at that because it’s a big issue right now. There is a significant amount of wealth that is tied up in qualified retirement plans. For many Barber clients that are pre-and post-retirees, that often represents a significant portion of net worth. It is a decision that becomes important as we plan for and design the trust and various elements.
Looking After Your Loved Ones
Estate planning is not something that you do for yourself; it is something that you do for your loved ones. It is an important aspect. I hope this has been helpful so that you can make some decisions and think about how it will impact your goals, concerns, and things you want to have happen.
If you have questions about your estate plan, we can help. Give us a call at 913-393-1000 or schedule a complimentary consultation below to get started today.
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Investment advisory services offered through Barber Financial Group, Inc., an SEC Registered Investment Adviser.
The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.