Medicaid for Long-Term Care: The Time to Plan is … Today

By: Colin B. May, Esquire

The good news is that we are living longer, healthier lives in this country. Advances in modern medicine and a better overall understanding of health has meant that the average life expectancy for a male is 76.04 and the average life expectancy for a female is 80.99.[1]  The bad news is, and I’ll quote myself here, “we are living longer, healthier lives in this country.” What do I mean? Living longer means that as we age the likelihood of needing some form of long-term care increases. In fact, around half of all aging Americans will require some form of long-term care in their lifetime. To be frank, long-term care is expensive: the average cost for assisted living in a facility is $46,485 per year, the cost of a home health aide is $53,768 and a semi-private room in  a nursing home amounts to $119,720 per year, equating to $328.00 per day.[2] With the high likelihood and cost of care, the question is not if we should plan for our own long-term care, but how we should go about doing this.

Approaches to Long-Term Care: The Big Three

Anytime I discuss long-term care with my clients, I begin by explaining that there are fundamentally three main approaches to long-term care planning. The first is to self-insure. This means that we pay as we go out of our own assets. If we look at the projected costs of long-term care and our own assets this may be a viable approach for some, but remains the least popular option for obvious reasons. The second approach is to utilize some form of long-term care insurance or some form of hybrid product that combines life insurance with long-term care coverage. The downside to this approach is that true, standalone long-term care insurance can be expensive and difficult to qualify for medically. With regard to hybrid life insurance policies, while these tend to be less expensive than true standalone long-term care insurance, the amount of long-term care coverage is often capped at the policy limit for the plan. Though these strategies have been effective in the past, they are not appropriate or feasible for every situation.  The limitations of these first two approaches lead many to explore the third option, which is putting oneself in a better position to qualify for Medicaid to pay for the cost of long-term care while ensuring that some (or many) assets are preserved and protected for their families. However, there are strict rules and regulations that we must adhere to if we plan on utilizing Medicaid to pay for long-term care.

What Exactly is Medicaid?

Medicaid rules are a complicated patchwork of state and federal regulations. In general, Medicaid consists of two types which have similarities but are treated differently at the administrative level: traditional Medicaid and Medicaid long-term care. Traditional Medicaid is a joint federal and state program available to pay the healthcare costs for those who are financially needy. Medicaid long-term care is also needs-based, but is designed to provide care specifically for long-term care costs often associated with aging. Oftentimes with planning, we are utilizing legal strategies to put ourselves into the position to qualify for Medicaid Long-Term Care. Proper and timely Medicaid Long-Term Care planning can mean that we receive the benefit of long-term care coverage while preserving our lifesavings for our family.

Medicaid Rules

As mentioned before, the rules surrounding Medicaid Long-Term Care can be complicated. I will not be exploring all of the particular rules in detail, but I will identify some of the key provisions we have to be sensitive toward in Medicaid Planning.

Asset Limitations: For an applicant, Medicaid Long-Term Care requires that we are both physically qualified, meaning that an applicant has a need for skilled nursing care and that they are financially qualified. In terms of financial qualification, Medicaid allows an applicant to have just $2,400 in non-exempt resources to their name. Fortunately, this limitation does not include specific items like the applicant’s primary residence, one vehicle, and a prepaid burial trust, among other small exclusions. However, while Medicaid will permit an applicant to keep their primary residence, the Medicaid state agency is able to place a lien against the residence at the time the applicant passes away through a process known as Medical Assistance Estate Recovery. There is a common misconception that a nursing home will take an applicant’s house, or require the applicant to sell their home prior to entering into the facility. While some applicants may decide that selling the residence to pay for care is an option, Medicaid does not require this. However, if an applicant retains ownership of the home while they are receiving care, the Pennsylvania Medicaid agency may later place a lien against the home for the cost of care after the applicant (and their surviving spouse) passes away. For many families, the Medicaid Lien placed against a recipient’s prior residence may overwhelm what the can family can pay, or is willing to pay, and instead allow the home to default to be sold by the state agency.

Community Spouse Resource Allowance: If a married applicant applies for Medicaid Long-Term Care, the state agency will allow the healthy spouse (referred to as the “Community Spouse”) to retain assets of approximately $123,000.00. This is known as the “Community Spouse Resource Allowance” or “CSRA.” In addition to the applicant spouse’s resource allowance, this hard and fast limitation is the maximum that Medicaid Long-Term Care will permit a couple to have before they are eligible for Medicaid.

Five-Year Lookback: With these resource limitations in mind, the obvious strategy would be to simply transfer assets during our lifetime to our loved ones to more quickly qualify for Medicaid. However, Medicaid knows that people do this and have placed what is known as a 5-year lookback to uncompensated asset transfers. This 5-year lookback starts from the day of application (when the applicant was otherwise qualified) and looks back a five-year period from that date to determine if any uncompensated transfer of assets has occurred. In the event that assets were transferred within this period of time, Medicaid will apply what is known as a penalty period.

Transfer Penalty and Penalty Period: There is a common misconception to conflate the five-year lookback period with the penalty period to assume that disqualification from Medicaid will be five years. However, the penalty period is calculated by looking at the total value of uncompensated transfers within the past five years leading up to application and dividing this number by the average daily cost of nursing-level care. For example, if we assume that an individual made a gift of $150,000.00 to a child and then sought to apply for Medicaid within a five year period, the penalty period would be $150,000.00/$328.00 [the daily cost of care] to be a disqualification of 457 days – well over a year of disqualification. While disqualified, an applicant must find a way to either stay out of nursing care (not a viable approach for many), to “cure” the gift by having the children give the gift back to the applicant, or to pay out of pocket for these expenses.

The Importance of Timely Medicaid Planning

If we assess that Medicaid planning for long-term care is the right approach for our family, time is of the essence. What we must do in order to maximize the potential benefit is to make transfers that are squarely outside of the 5-year period. In other words, in order to make qualifying transfers, we must be reasonably confident that we will not need nursing level care within a five-year period. How can we know this? The short answer is that we cannot. There will always be the risk that the need for extensive long-term care will arise sooner than we ever expect. Nonetheless, the likelihood of needing long-term care is significantly lower at a younger and healthier age which allows us to hedge against this risk by planning early.

The age to start thinking about Medicaid planning is not when we are in our late 70s, 80s or 90s when the likelihood of needing long-term care within a five-year period is higher, but rather, in our 50s, 60s, and in some cases, early 70s when the likelihood is much lower. In fact, there is no reason that we could not begin exploring long-term care planning at even younger ages when we may be more likely to qualify for long term care insurance or hybrid products.

What Type of Medicaid Planning Approach is Right for Me?

There is no simple answer to this question. If we decide that the most reasonable strategy is to rely on Medicaid and protect assets for our family, the most comprehensive approach is to transfer assets to a qualified Medicaid Trust that ensures that assets transferred are not considered an available resource to the applicant. To be clear, transfers to a Medicaid-compliant Trust does not avoid the five-year lookback period; so timely creation and funding of such a trust is still a key consideration. Other approaches may include strategic transfers of certain assets such as the primary residence or certain accounts, or transfers to a healthy spouse to maximize the CSRA if we plan on later applying for Medicaid. As these rules are indeed complex, what may be right for you and your family will always involve an in-depth exploration of your specific needs and goals with an estate planning attorney.

The element that is within your control is time. The sooner you have the opportunity to explore your options, the better. Keep in mind that likelihood of needing long-term care does not get better with time, it is always in your best interest to start having these discussions sooner rather than later.

 

Disclaimer: This article is merely a conversational summary of a complex area of law. No person should rely upon the contents of this article for making any decisions, and instead you are instructed to consult with your legal and tax advisors. 


[1]. Social Security Administration Actuarial Life Table, https://www.ssa.gov/oact/STATS/table4c6.html.

Attention Millionaires – New Gift Tax Regulation Encourages Trust Creation for Your Family: 6 year window confirmed to make large gifts to avoid 40% federal estate tax, even if the estate tax exemption falls again after 2025.

By: Mark T. Coulter, Esquire

The title to this article is intended to be exclusionary; most of us don’t have millions of dollars in our estate, so this article would be irrelevant. For families who do have an estate worth four million dollars ($4MM) or more, there has been a recent change in the tax laws which merits discussion and consideration of your planning.

Wealthy people tend to have at least a loose understanding of the federal estate and gift tax system. In 2012, the Estate/Gift tax exemption (the amount that can be given to beneficiaries free of this tax) was increased to $5MM, adjusted annually for inflation. A husband and wife could together give over $10MM at death to their children with just a little bit of estate planning to take full advantage of the exemption for each of them.

The Estate Tax and the Gift Tax in the U.S. are a coupled tax, meaning that the system is designed so that the tax will apply equally to a person who gives away their wealth during their lifetime, dies with wealth, or a combination of the two. The first “X” dollars (the exclusion amount) is not subject to tax, while the amount in excess of the exclusion amount is taxed either during lifetime (gift tax) or upon death (estate tax).

Two years ago, the Tax Cuts and Jobs Act (TCJA) was the largest overhaul of the tax code in the last 30 years. President Trump signed the new law December 22, 2017, after it was approved by the republican-controlled Senate and House of Representatives on December 20, 2017.  As tumultuous as the country may be, either political party having such complete control in the near future seems unlikely, providing a welcome sense of stability to the law.

The TCJA included a temporary increase in the estate tax exemption to $11.2MM in 2018, which will increase for inflation, but will revert to $5MM (indexed for inflation) as of 1/1/2026 absent congressional action to modify the sunset provisions. Thus, for the next few years, a deceased person could leave $11.2MM to their children without incurring the 40% federal estate tax, and a married couple, with both deceased, could leave $22.4MM with planning in place to take advantage of this system.

That’s great if you are dead, but what about the living? Most of us have a relatively ambiguous expiration date, so we don’t know if we are going to die before 2026. A savvy person might wish to take advantage of the $11.2MM exclusion now to “lock in” their access to this temporarily enhanced tax shelter. If, however, that tax shelter is going to disappear in 2026, does that mean that they have locked-in a taxable event? Uncertainty existed regarding the impact of gifts made in 2018-2025 relying on the engorged gift tax exemption when a person dies after 2025 with a reduced exemption amount ($5MM or whatever Congress may do).

The Treasury has, after a year of public comment on proposed regulations, issued final regulations to remove that uncertainty. In TD 9884, 84 FR 64995, published in the Federal Register on 11/26/2019, the Treasury has implemented a regulation which will “ensure that the estate of a decedent is not inappropriately taxed with respect to gifts that were sheltered from gift tax by the increased [exclusion] when made.”

For example, assume a single person has wealth of $9MM. If that person dies in 2020, there is no estate tax due, based on the $11.2MM exclusion. If that person dies in 2026, with a gift/estate tax exclusion closer to $6MM (after inflation adjustments to the $5MM base exclusion), then approximately $3MM remains exposed to estate tax at 40%, or roughly $1.2MM in tax. If that person instead made a gift of the $9MM to a trust for his family in 2020 (covered by the $11.2MM exclusion amount) but dies in 2026 (with a $6MM lifetime gift/estate tax exclusion in effect), do they still get the benefit of the former larger exemption? The new Regulations resolve this ambiguity with a “Yes.” The regulation does not directly revive the old exclusion amount, but does permit the taxpayer to take the benefit of the enhanced exclusion to the amount to which the taxpayer relied upon it in making lifetime gifts.

The regulation also confirms that for surviving spouses who file an estate tax return for 2018-2025 upon the death of their spouse to attempt to preserve the estate/gift tax exclusion of their deceased spouse (sometimes referred to as “portability”), the enhanced exclusion amount of the deceased spouse remains enhanced even after the current exclusion reverts back to $5MM.

Obviously, the devil is in the details. The question of how to best take advantage of the temporary gifting exclusion enhancement requires assessment of a number of factors. To cite just a few of these factors:

  • How much to gift, and how much to retain?
  • Which assets should be used?
  • Who should be current/future beneficiaries of a gift?
  • Whether to gift outright or likely to a protected trust?
  • How much access to retain?
  • How much authority to make future changes is retained, and by whom?
  • What parties will have control versus beneficial interest in the gift?
  • What are the likely tax benefits and tax risks?

 

One strategy likely to see more action in light of this regulation is the use of a Spousal Lifetime Access Trust (SLAT) or Family Lifetime Access Trust (FLAT). A SLAT/FLAT can provide the tax benefits of an irrevocable trust (i.e. the assets are out of your estate prior to death) while still providing reasonable family access to the trust assets through a spouse or children (for example). This can protect not only the value of the assets transferred to the trust, but also the future growth of the assets. A well designed trust can further insulate the assets from risks which may arise in your family, including marital disruptions, creditors, incapacity, uninsured medical expenses, lawsuits, and more. In addition, such a trust can be designed so that income taxes on the trust assets remain payable by the trust creator (known as a Grantor trust) at their own individual tax rates, permitting the assets in trust to grow without diminution by income tax burdens.

Long story short: For clients with estates worth upwards of $4MM dollars, it might be time to review the potential estate tax liabilities your family could face under current law as well as the known future of estate tax law, and decide if taking steps towards locking in the level of certainty provided under the new regulations makes sense before the enhanced exclusion amount disappears. As always, we invite you to contact us if you would like to schedule a complimentary consultation to review your own personal situation.

Disclaimer: This article is merely a conversational summary of a complex area of law. No person should rely upon the contents of this article for making any decisions, and instead you are instructed to consult with your legal and tax advisors. 

Can’t I Just Write My Own Will?

By: Mark T. Coulter, Esquire

Pennsylvania is perhaps the easiest state in the U.S. for people who want to create their own “legal” Last Will and Testament. All that the law requires here is that your Will be in writing, signed at the end, and reflect your intention to dispose of assets at your death. So anyone should be able to do that, right?

A Recent Example

There is a big difference, however, between a Will being “legal” and a Will being “good”.  A recent case I dealt with brought this issue back to the surface to highlight the difference. A married couple without children (we can call them Bill and Mary Smith) were going on a trip by airplane, and elected to write their own Will, which in essence provided:

“If Bill Smith and Mary Smith are both deceased at the same time, we give our house at 121 Main Street and all of our bank assets to Mary’s niece Susan Jones and her nephew John Jones. Michael Smith, brother of Bill, is in charge of carrying out these instructions.”

They signed and dated the document at the bottom. Fortunately, they successfully survived their flight, and indeed lived for several more years. Mary died a few year ago, and Bill passed away recently. At death there was a checking account, a small stock account, a home at 200 Maple Lane, and the contents of the home. How does the estate work? Sure, we all understand what they said, but how does it really work?

The first question is whether they even have a Will. It’s a close call whether or not this note jotted on a piece of notebook paper qualifies as a Will, but let’s say it does for our exercise.

Is the Will relevant? Bill and Mary seemingly signed the Will in contemplation of the risk of dying together if their plane went down, thus the reference to “deceased at the same time.” If they don’t die together, but instead several years apart, does the Will even apply? If not, this condition-based Will is disregarded, and instead the family has to go through intestacy proceedings in court to administer the estate to whomever are the next of kin (technically, his legal “intestate heirs at law”).

Whose next of kin? Bill died owning all of the assets after Mary’s death, so any assets not covered by the Will go to Bill’s family (in this case, to his brother Michael), not Mary’s family.

Is the Will complete? Bill and Mary didn’t say who gets the stock account, or the personal property located in the home, for example. As we often see with self-created Wills, the document is likely incomplete, again leading the family to go through intestacy proceedings in court to administer the estate to whomever are the next of kin.

Even worse, this process (and not getting everything) disappoints Susan and John, who now hire an attorney to represent them and litigate in court whether it should be inferred that they should get the stock instead of Michael. That means that Bill’s estate also needs to hire an attorney to represent the Executor. Now the family can fight it out in court for a couple of years.

Who gets the house? The Will referred to their residence they owned at the time the Will was written. Bill doesn’t own that home any longer, since he moved to a smaller home after his wife passed away, so that gift referencing the old home is invalid. Instead, since the Will doesn’t otherwise provide for the new home on 200 Maple Lane, the family has to go through intestacy proceedings in court to administer the estate to whomever are Bill’s next of kin.

Who is in charge? While the “Will” puts Michael in charge of the instructions in the document, it does not name an over-all Executor. As we’ve seen, the Will doesn’t cover everything. Instead, it is back to court to determine who should serve as the full Executor.

Such a simple situation, and yet so many problems arose. I’m sure that Bill and Mary were proud of the money and time they saved doing their own quick Will, and took comfort in thinking they had been responsible adults. Instead, they left their families disappointed and facing delay, expenses, loss and struggle to resolve their estate.

Hidden Problems in Do-It-Yourself Wills

The above real-world example doesn’t even address some of the other issues that arise with “do it yourself” estate planning. It is not surprising that people don’t spot the problems with their own Wills because it isn’t a part of their daily world. Some of the hidden questions that don’t get asked or answered may include:

  • How will my unique personal goals be realized?
  • What if there are handwritten changes to a Will?
  • What if there are more assets that are discovered later?
  • Who pays the death-taxes on assets received through a Will or other beneficiary designation?
  • What happens if a beneficiary is already deceased?
  • What if there is “form” language in the document that is contrary to the true plan?
  • What if there is legalese (or Latin) used in a generic form which isn’t understood or which changes how the Will works?
  • What if there is a prior Will which does (or doesn’t) conflict with the new one?
  • What if the document uses the wrong title for a fiduciary (such as naming an Agent or Power of Attorney instead of an Executor)?
  • What does a beneficiary get if an asset described in the Will is gone? Or has changed (new bank account, different car, etc.)
  • What if some part of the Will is ambiguous or unclear?
  • What is some part of the Will is illegible, or destroyed?
  • If there is debt, such as a car loan, who has to pay for that?
  • What happens if someone contests the Will?
  • Will my Executor need to purchase a Surety Bond before serving?
  • What if the Will is inconsistent with a prenuptial agreement? With other beneficiary designation? With joint-ownership on the asset title?
  • What if a beneficiary is a minor?
  • What if a beneficiary is incapacitated, or is receiving governmental benefits?
  • How do we prove the Will was actually signed by the right person?
  • How do we prove the person was of sound mind, and not pressured?
  • What if a beneficiary gets a divorce, or gets sued; are they protected?

These are but a few of the issues that estate planning professionals consider when helping clients with a Will, a trust, or other planning strategies. Sure, you can do it yourself, or use some generic fill-in-the-blank form created by some stranger for some other stranger, but that doesn’t make it a good idea. I can make my own penicillin from a moldy cantaloupe rind, but I don’t.

We Can Help You

Sometimes in life it is just worth it to get things done right. When we are talking about your final gift of everything you have left in this world to the people you care about the most, I suggest that spending the time, effort and money to get it done right makes obvious sense.

If you don’t have a current estate plan, or are wondering whether your planning is adequate to take care of your unique needs, we encourage you to take advantage of our standing offer of a free initial consultation with one of our estate planning attorneys to discuss your goals and concerns, and to review the various strategies available to protect you and your loved ones. You can call our office, contact us through our website, send us an email, or even (for this part) send us your own handwritten note.

Can’t I Just Write My Own Will?

Pennsylvania is perhaps the easiest state in the U.S. for people who want to create their own “legal” Last Will and Testament. All that the law requires here is that your Will be in writing, signed at the end, and reflect your intention to dispose of assets at your death. So anyone should be able to do that, right?

A Recent Example

There is a big difference, however, between a Will being “legal” and a Will being “good”.  A recent case I dealt with brought this issue back to the surface to highlight the difference. A married couple without children (we can call them Bill and Mary Smith) were going on a trip by airplane, and elected to write their own Will, which in essence provided:

“If Bill Smith and Mary Smith are both deceased at the same time, we give our house at 121 Main Street and all of our bank assets to Mary’s niece Susan Jones and her nephew John Jones. Michael Smith, brother of Bill, is in charge of carrying out these instructions.”

They signed and dated the document at the bottom. Fortunately, they successfully survived their flight, and indeed lived for several more years. Mary died a few year ago, and Bill passed away recently. At death there was a checking account, a small stock account, a home at 200 Maple Lane, and the contents of the home. How does the estate work? Sure, we all understand what they said, but how does it really work?

The first question is whether they even have a Will. It’s a close call whether or not this note jotted on a piece of notebook paper qualifies as a Will, but let’s say it does for our exercise.

Is the Will relevant? Bill and Mary seemingly signed the Will in contemplation of the risk of dying together if their plane went down, thus the reference to “deceased at the same time.” If they don’t die together, but instead several years apart, does the Will even apply? If not, this condition-based Will is disregarded, and instead the family has to go through intestacy proceedings in court to administer the estate to whomever are the next of kin (technically, his legal “intestate heirs at law”).

Whose next of kin? Bill died owning all of the assets after Mary’s death, so any assets not covered by the Will go to Bill’s family (in this case, to his brother Michael), not Mary’s family.

Is the Will complete? Bill and Mary didn’t say who gets the stock account, or the personal property located in the home, for example. As we often see with self-created Wills, the document is likely incomplete, again leading the family to go through intestacy proceedings in court to administer the estate to whomever are the next of kin.

Even worse, this process (and not getting everything) disappoints Susan and John, who now hire an attorney to represent them and litigate in court whether it should be inferred that they should get the stock instead of Michael. That means that Bill’s estate also needs to hire an attorney to represent the Executor. Now the family can fight it out in court for a couple of years.

Who gets the house? The Will referred to their residence they owned at the time the Will was written. Bill doesn’t own that home any longer, since he moved to a smaller home after his wife passed away, so that gift referencing the old home is invalid. Instead, since the Will doesn’t otherwise provide for the new home on 200 Maple Lane, the family has to go through intestacy proceedings in court to administer the estate to whomever are Bill’s next of kin.

Who is in charge? While the “Will” puts Michael in charge of the instructions in the document, it does not name an over-all Executor. As we’ve seen, the Will doesn’t cover everything. Instead, it is back to court to determine who should serve as the full Executor.

Such a simple situation, and yet so many problems arose. I’m sure that Bill and Mary were proud of the money and time they saved doing their own quick Will, and took comfort in thinking they had been responsible adults. Instead, they left their families disappointed and facing delay, expenses, loss and struggle to resolve their estate.

Hidden Problems in Do-It-Yourself Wills

The above real-world example doesn’t even address some of the other issues that arise with “do it yourself” estate planning. It is not surprising that people don’t spot the problems with their own Wills because it isn’t a part of their daily world. Some of the hidden questions that don’t get asked or answered may include:

  • How will my unique personal goals be realized?
  • What if there are handwritten changes to a Will?
  • What if there are more assets that are discovered later?
  • Who pays the death-taxes on assets received through a Will or other beneficiary designation?
  • What happens if a beneficiary is already deceased?
  • What if there is “form” language in the document that is contrary to the true plan?
  • What if there is legalese (or Latin) used in a generic form which isn’t understood or which changes how the Will works?
  • What if there is a prior Will which does (or doesn’t) conflict with the new one?
  • What if the document uses the wrong title for a fiduciary (such as naming an Agent or Power of Attorney instead of an Executor)?
  • What does a beneficiary get if an asset described in the Will is gone? Or has changed (new bank account, different car, etc.)
  • What if some part of the Will is ambiguous or unclear?
  • What is some part of the Will is illegible, or destroyed?
  • If there is debt, such as a car loan, who has to pay for that?
  • What happens if someone contests the Will?
  • Will my Executor need to purchase a Surety Bond before serving?
  • What if the Will is inconsistent with a prenuptial agreement? With other beneficiary designation? With joint-ownership on the asset title?
  • What if a beneficiary is a minor?
  • What if a beneficiary is incapacitated, or is receiving governmental benefits?
  • How do we prove the Will was actually signed by the right person?
  • How do we prove the person was of sound mind, and not pressured?
  • What if a beneficiary gets a divorce, or gets sued; are they protected?

These are but a few of the issues that estate planning professionals consider when helping clients with a Will, a trust, or other planning strategies. Sure, you can do it yourself, or use some generic fill-in-the-blank form created by some stranger for some other stranger, but that doesn’t make it a good idea. I can make my own penicillin from a moldy cantaloupe rind, but I don’t.

We Can Help You

Sometimes in life it is just worth it to get things done right. When we are talking about your final gift of everything you have left in this world to the people you care about the most, I suggest that spending the time, effort and money to get it done right makes obvious sense.

If you don’t have a current estate plan, or are wondering whether your planning is adequate to take care of your unique needs, we encourage you to take advantage of our standing offer of a free initial consultation with one of our estate planning attorneys to discuss your goals and concerns, and to review the various strategies available to protect you and your loved ones. You can call our office, contact us through our website, send us an email, or even (for this part) send us your own handwritten note.

 

Disclaimer: This article is merely a conversational summary of a complex area of law. No person should rely upon the contents of this article for making any decisions, and instead you are instructed to consult with your legal and tax advisors. 

Still Time To Capture Extra Social Security Benefits

index-photo[1]Caution: The Loophole is Closing Soon!

Many of my clients receive Social Security checks each month, and very few (i.e. none) feel that those checks are too large. If you knew that you could increase the size of your Social Security check by taking advantage of a loop-hole when you started your benefits, you would probably wouldn’t want to overlook that. Many people, however, have done just that, and failed to maximize their benefits for the rest of their retirement. The loophole in the law which permits such an increase, however, is about to be closed by a change in the law. For married clients considering when to start their Social Security benefits, it is definitely time for a close look. If you have already started to receive benefits, there may technically be a solution, but you probably won’t like it.

When Congress passed the Senior Citizens Freedom to Work Act in 2000, it was intended to let retirees delay receipt of their Social Security check and continue working in order to increase the later size of their benefit. Clever financial professionals discovered that there were fully legal strategies which could exploit the lackadaisical way the law was drafted in order to increase a married couple’s benefits. With the “lightning speed” at which our government works, after only 15 years, that mistake is being fixed. On October 30, 2015, the Senate passed an approved House bill to eliminate these strategies (Bipartisan Budget Act of 2015), but delayed implementation for six months and grandfathered in people already exploiting the technique. President Obama signed the new law on November 2, 2015.

The strategy being eliminated involves the “file and suspend” and the “restricted application” elections, which made it possible for one spouse to file for Social Security benefits, but delay their right to get monthly checks. During the suspension of benefits, they continue to accrue the annual increase in Social Security benefits at 8% per year. How many investments earn a guaranteed 8%? In the meantime, the non-filing spouse elects to receive spousal benefits under the earnings record of the spouse who filed. This gets a stream of income coming into the house, while letting the main benefit continue to grow for a few more years. This would also increase the size of the “survivor’s benefit” if the suspended spouse later dies. Ask anyone who has been retired for a while if they wish they had started with a larger base benefit. The longer we live, the more we wish we hadn’t been in such a hurry to get that check.

The purpose of this article is not to educate you on the intricacies of this strategy, so I’m not going to run examples here. There are a wealth of articles already published in magazines and on the internet on the issue. (Just search “Social Security file and suspend”). AARP has good information, and economist Laurence Kotlikoff has written extensively for PBS and NPR on the issue. Instead, the two points I want to make are:

  1. There is a current strategy that may increase net income for couples in their 60’s who haven’t yet elected Social Security benefits but are eligible to do so; and
  2. That strategy is going away unless you take advantage of it in the next 4 months.

If you are already obtaining benefits, the full use of this strategy might require you to repay benefits received to-date from other savings, and effectively hit restart on your benefits. The numbers can be attractive, but many people just don’t like the thought of giving back the money they already received. (I told you that you wouldn’t like it.)

For all of you who may be eligible for Social Security benefits but haven’t started taking them yet, I heartily encourage you to get some advice on this issue ASAP. Don’t just “wing it”, and don’t put it off. Talk to your financial advisor, or give us a call to set up a time to come in an talk with an expert about how the system works, and how you can best game the system. When in doubt, I’d err on the side of asking some questions.

Feel free to give us a call if you’d like to schedule a time to sit down and talk with a professional about these issues, or any other planning issues on your mind.

Retirement Account Beneficiaries: How the Tax Rules Change

puzzledollarWhen considering the manner in which beneficiary designations are set forth for tax-deferred retirement accounts (IRA’s, 401(k)s, and 403(b)s), several factors need to be considered; including simplicity, tax considerations, and beneficiary protections. This article may frequently refer to IRA accounts, but the core rules are the same for 401(k)s and 403(b)s.

Basic Concepts during the Owner’s Lifetime

To speak in broad generalities, if these tax-qualified retirement accounts are funded with “pre-tax” money, as in a traditional IRA, most people understand that the money can’t be taken out without penalty prior to age 59 1/2, and must start to be taken out no later than 70 1/2 with at least annual Required Minimum Distributions (RMDs) to the owner thereafter. The RMD is calculated based upon the balance in the account on December 31 of the preceding year, divided by your life expectancy under IRS tables (Publication 590). The older you get, the greater the percentage you must withdraw. In the meantime, the money grows tax-deferred. As it is distributed, it is taxed as ordinary income.

The Roth versions of these accounts remove the RMD requirement for the original account owner, so the money can continue to grow tax-deferred. Roth accounts can also be distributed tax-free so long as the rules are met (such as a minimum 5 years holding period, and distributions after age 59 1/2).

There are more subtleties to this discussion, but this is a sufficient backdrop for the focus of this article, which is how the accounts are handled after the original account owner dies.

Surviving Spouse as Beneficiary

If there is a surviving spouse of the original account owner named as beneficiary, he or she has two options. A surviving spouse can direct the account to be treated as a spousal rollover, or instead as an inherited account. A spousal rollover lets the surviving spouse treat the account as though it was their own account all along. This means it continues to be tax-deferred, can be accessed without penalty after 59 1/2, and RMDs must begin at 70 1/2. While this is the most common approach, it can present a problem for younger spouses who might need access to the money before 59 1/2.

In those cases, such as where a surviving spouse hasn’t hit 59 1/2, a spouse may desire to elect it as an inherited account, which can be accessed anytime without penalty (which is nice), but the account will be subject to annual RMDs each year after the account owner’s death, based on the surviving spouse’s life expectancy, whether the RMDs are needed or wanted (not as nice). There are also options to use the deceased spouse’s life expectancy in the calculation of an Inherited IRA instead, which may be helpful if the surviving spouse is older than the original account owner. Finally, if the IRA owner died prior to age 70 1/2, the surviving spouse can elect to take the entire balance out, at once or in pieces, at any time or times over the next five years, and pay income tax (if a Traditional account, not a Roth) upon those distributions. Using this alternative, after 5 years the money must all be taken, taxes due must be paid, and the tax-deferral stops.

Under any method, Traditional accounts are taxed as income when distributed, and Roth’s are generally free of income tax.

Non-Spousal Beneficiary

When the surviving spouse is not the beneficiary, the only option is an Inherited IRA. In these cases, the question of how the schedule for when RMDs must be taken from Traditional IRA accounts becomes a little more complex, depending on the beneficiary.

It is important to note that for even a Roth account, a non-spouse beneficiary must take at least annual RMDs based upon life expectancy or otherwise as discussed below. The Roth rule about “no RMD necessary” does not apply to Inherited Roth accounts.

An individual named as beneficiary, such as a child or sibling, can spread the RMDs out over his or her lifetime, using the same type of life-expectancy calculation as the original account owner would use, however, since the beneficiary is (usually) younger than the original owner, the RMD calculated is smaller. This means that the amount which remains growing tax-deferred remains larger for a longer period. This is often called the “stretch” of a retirement account.

The beneficiary can access the money more quickly if they desire, but no matter what else happens it has to be taken out no later than by the end of their life expectancy using the RMD calculation. If the beneficiary passes away after inheriting an IRA, the account will pass to his or her named beneficiaries, but the RMD calculation on any remaining balance will continue to be based upon the life expectancy table as though the original beneficiary hadn’t died. The RMD is not re-calculated to accommodate the age of the next new beneficiary.

As an alternative, if the original account owner died when younger than 70 1/2, the individual beneficiary can elect to take the entire balance out, at once or in pieces, at any time or times over the next five years, and pay income tax (if a Traditional account, not a Roth) upon those distributions. Using this alternative, after 5 years the money must all be taken, taxes due must be paid, and the tax-deferral stops.

If your beneficiary is your probate estate, or a charity, or a trust not designed to accommodate retirement accounts, the distribution rules are less flexible.  Such beneficiaries are not considered qualifying “designated beneficiaries” for calculating a lifetime stretch. This makes sense, because these beneficiaries don’t have a “lifetime”.  Such non-designated beneficiaries may continue the account owner’s RMD schedule if the account owner was required to take RMDs (i.e. over 70 1/2), or else they must use the option of taking the entire account out within 5 years and pay income tax (if a Traditional account, not a Roth) upon those distributions. As with individual beneficiaries using this 5-year alternative, after 5 years the money must all be taken, taxes due must be paid, and the tax-deferral stops. Note that there are some “fixes” which may be accomplished to mitigate these rules if an estate or trust is named when an intended individual beneficiary would be better served if they can get the “designated beneficiary” treatment, however it is better to get the designations correct initially.

Finally, if your beneficiary is a trust which is specifically drafted to accommodate retirement accounts, you can get the best of both worlds. A trust can qualify for the “stretch” treatment of the IRAs, permitting a lifetime of tax deferral. The question then becomes “Whose lifetime?”. If a trust can take the RMDs from the account and not give them to the ultimate trust beneficiary (i.e. it can accumulate the RMDs inside the trust from year to year), then the “lifetime” is that of the oldest possible trust beneficiary. Thus, if your children are the trust beneficiary, but upon their death it would go to their children, but if their children are all dead it would go to your brother, then your brother is the oldest potential beneficiary, and his life expectancy is used.

We instead often draft a trust which doesn’t “accumulate”, or hold the RMDs, but instead pays them as income to the beneficiary each year. This is sometimes called a “conduit” or “see-through” trust, because the trust passes the retirement account distributions annually to a beneficiary the IRS can predict, or “see”, and lets us then use that individual’s age for calculating the RMD schedule. In the example above (children, grandchildren, then brother), the life expectancy of your oldest child at your death would determine the available tax-deferral stretch and RMD schedule.

In many families with several children, the children are relatively close in age, and everyone is satisfied to use the age of the oldest of the children to calculate the RMD stretch. Sometimes, however, when the children are widely separated (such as a second marriage, or the “surprise” child), it is worth the extra effort to let each child use their own separate ages to calculate the RMD schedule. This can be achieved by a little more attention to the beneficiary designation, identifying each separate trust share of the children as a separate beneficiary.

For example, assume a trust is a “see-though” trust which pays the RMD to the children each year. The children are aged 50, 48 and 30 when their parent dies. The parent has named the trust as the primary beneficiary upon his or her death. The trust would ordinarily separate the account into three pieces for each of the children or their trust share, and each child would thereafter have their own account. Each account, however, would have to calculate annual RMDs based upon the age-at-death of the oldest child who was 50. That life expectancy is about 34 years according to the IRS, so each beneficiary has to take 1/34th out the first year after death, 1/33rd the second year, 1/32nd the third year, and so on. That schedule is set at the time of death. That schedule is fine for the older children, but the 30 year old has an IRS life expectancy of 53 years. Instead of having an RMD of 1/34th, they might want to reduce the RMD (and lengthen the period of available stretch) so that they only have to take 1/53rd the first year, 1/52nd the second, etc. To achieve this goal, we modify the IRA beneficiary designation from just “The Smith Trust dated 1/1/2015” to reflect instead “1/3 to Child A’s Separate Share of the Smith Trust dated 1/1/2015, 1/3 to Child B’s Separate Share of the Smith Trust dated 1/1/2015, and 1/3 to Child C’s Separate Share of the Smith Trust dated 1/1/2015.”  Now there are three separate beneficiaries of the IRA, and each trust share can use its beneficiary’s age to set the stretch.

So Why Name A Trust as Beneficiary?

While naming a trust or trust shares as beneficiary requires a little more work up front, it can provide significant protection to the beneficiaries from a variety of risks, such as;

Legal Capacity: If you name a minor as a beneficiary, or if your beneficiary dies and the account passes from them to a minor, that child can’t take title to property. Instead, a Guardian may need to be appointed by the court to oversee the asset until the child attains age 18, at which time the youngster has complete access to spend the money any way she desires.

Creditors: While your retirement accounts are very secure against creditors for you and your spouse under federal and most state laws, the rules change when these accounts become inherited accounts. The U.S. Supreme Court ruled in 2015 that such assets are not entitled to the asset protection given to “retirement funds” under federal law. Thus, they are exposed to any current or future claims against the beneficiary, such as debts, liens, lawsuit judgments, foreclosure deficiencies, bankruptcy, etc. If a trust is designed to protect a beneficiary against such risks, then it makes sense to wrap this protection around the retirement assets as well.

Long Term Care: If a beneficiary has an inherited retirement account, he will usually be ineligible for government assistance with long-term nursing care stays until that account is entirely depleted. A trust can be designed to shelter this account, taking it “off the books” for consideration by the government in applications for such benefits so that the money stays with the family to cover needs for which the government won’t provide.

Children with Special Needs: If a member of the family has a disability which permits them to obtain government benefits, receipt of an inheritance outside of a proper trust, including inherited retirement accounts, can disqualify them from their important benefits.

Imprudence: Individuals who inherit retirement accounts can do whatever they want with the funds. We see inexperienced beneficiaries spending the money too quickly, rather than saving it for their future security. Even worse, many an inattentive beneficiary has elected to have the entire account distributed to them following a death, and they are very surprised by the large income tax bill they face on the entire account the following April 15th.  Often, they no longer have funds available to pay the tax at that time, and problems ensue. If we create a trust to protect a beneficiary from his own financial inexperience, whether for just a while or for their entire lifetime, it often makes sense to include the retirement assets within the scope of this protection.

In a nutshell, if you are protecting family members with a trust after your death, if often makes sense to take the little extra effort to extend this protection to the retirement assets they will obtain as well.

Income Taxation of Retirement Accounts in Trusts

The distributions from inherited Traditional retirement accounts are treated as income, and are income tax-free when they come from Roth retirement accounts. Some questions emerge about how taxation may be different with a trust involved. Provided that the trust income, including the retirement account distributions, is being paid to the trust beneficiary, the trust itself has no tax liability. Instead the trust is merely a conduit, and just the income (including payments from retirement accounts) ends up on the beneficiary’s tax return. In these usual cases, the trust files an informational Form 1041 to tell the IRS what the beneficiary received, so that the IRS knows where to look for that income. The beneficiary receives a K-1 to tell them what income to report on their own return.

In some cases, however, we don’t want the income going right to the beneficiary. What if they are being hounded by creditors, or applying for governmental benefits, and that income would just be subject to claims from such outsiders? In those cases, the selected Trustee of the trust might elect to retain the income inside of the trust instead, in order to provide further protection. In such cases, the IRS then considers the income to be taxable to the trust, and the trust pays tax on the income. Trusts with retained income are subject to a similar “tiered” income tax rate structure, but the tiers are compressed.

For example, a single individual sees their income tax rates increase from 10% to 39.5% as their income increase in tiers (roughly, 15% marginal rate at $9,000; 25% marginal rate at $37,000, 28% marginal rate at $89,000, 33% marginal rate at 186,000, and the maximum 39.5% rate after $406,000). A trust with retained income hits the 25% marginal rate at only $2,500, 28% at 5,800, 33% at $8,900, and hits the maximum 39.6% rate at $12,500. Thus, the same rates are used, but smaller amounts cushion between tiers. For this reason, income is usually paid to the beneficiary, because it will see lower tax rates. When a beneficiary is in jeopardy, however, it is often better to pay a bit more in taxes and have the remaining income be protected than to distribute the income to the beneficiary to save taxes but then lose the balance to a creditor. Many trust designs give us flexibility to pass income when appropriate, and retain income (and pay tax through the trust) when necessary.

Notably, to the extent income is retained in the trust (and taxes paid), it is added to principal, and when thereafter distributed at an appropriate time, it is not again taxed.

Conclusion

The question of how to designate the beneficiaries, both primary and contingent, on your tax-qualified retirement accounts clearly requires you to weigh and balance a number of factors, including simplicity, taxes and protection. Please consult with your financial, tax and/or legal counsel for specific guidance regarding how these strategies should be employed in your unique case, because everyone has his or her own set of needs, goals and circumstances.

If you would like more information regarding these issues, please feel free to contact us for a complimentary consultation.


Note: the information included above is obviously general in nature, and should not be relied upon by any individual or entity for their specific circumstances. Contact us or another attorney or professional advisor for advice regarding your unique situation .

Are Your Beneficiary Designations A Disaster?

Senior_Couple_Together[1]For many families, life insurance and retirement accounts are the largest assets which pass to beneficiaries following a death. Despite this fact, people often don’t pay much attention to the way beneficiaries are designated on these assets. This relaxed attitude can destroy an otherwise successful estate plan, because such “beneficiary designated” assets often do not pass under the terms of a Will or Trust.

Someone may have spent a lot of time and money constructing a  written estate plan to govern the assets passing to beneficiaries, and providing protection for the beneficiaries under the written plan. When the names written in on a life insurance form or retirement account beneficiary designation aren’t coordinated with the underlying plan, problems ensue. Just a few examples of problems we have seen include:

  • The worker who wasn’t married when she was hired, and forgot to add her spouse or children as beneficiaries under her employer sponsored life insurance, resulting in the need to probate the benefit;
  • The husband who named his wife as the primary beneficiary on his 401k, and their two children as contingent beneficiaries, but forgot to update the form when they had a third child. The wife died first, and when the husband died, the third child was excluded from the benefit;
  • The well-meaning uncle who named his nephew with Down’s Syndrome as a beneficiary of his life insurance, resulting in a loss of governmental benefits which the child was receiving unless the family completes an expensive court process to create a semi-effective trust to preserve the benefits;
  • The father who named his wife a 50% beneficiary of his life insurance, and each of his two young children 25% beneficiaries. The children were minors when their father died, and could not take title to assets. The mother had to hire an attorney to have the court appoint a guardian to oversee the children’s money until they turn 18. The judge appointed a local attorney who will make all decisions until then (with annual fees charged for oversight, investment management and distribution decisions), and at age 18 the kids can do whatever they want with the money; and
  • The mother who named her oldest child as beneficiary of her IRA, “knowing” that he would “do the right thing” and share the money with his siblings. You can guess what happened there.  Not only did her son want to keep the money, but further he was informed by his tax advisor that if he did give it to the others, he would get hit with income tax obligations and potential gift tax issues..

Beneficiary designation forms, while seemingly easy to complete, are very important. Properly considering your beneficiary designations is critical. Don’t just throw names on the form, and do not take the advice of clerical staff at a financial institution. They often don’t really know the ramifications of what they say. Talk to your attorney, and if necessary have the attorney help with completing the forms. Just because the form only gives you a line or two for beneficiaries doesn’t mean you have to fit your information into that space. You can usually attach a separate letter of instruction if you need to be accurate and complete.

Under no circumstances should you name a minor or a person with special needs as a beneficiary. These beneficiaries should have a trust, or at least a custodian under the Pennsylvania Uniform Gifts to Minors Act, therefore avoiding a court appointed guardian.

Life insurance and retirement account assets are important and valuable. Give the process of setting up the beneficiary designations the respect and attention it deserves in order to see that your family gets the benefit of your hard work.

How Can You Plan for the Unknown?

Everyone has a plan, at least in their own mind, for how they would like to see their assets handled after they are gone. For many, that involves benefiting their children or grandchildren, while others might include community or charitable organizations.

In most of these plans, however, the structure is based upon the current circumstances of the beneficiaries, and the current nature of the assets. Such plans fail to take into consideration the fact that the estate plan may not work to aid the beneficiaries until many years from now.  Suppose that you have a vacation house that you know your daughter loves to enjoy with her family, while you have a business interest that you intend to pass to your son who works with you in the business.  The assets are of roughly equal value, and you have prepared a Will which leaves the house to your daughter, and the business to your son, and then splits the remaining assets equally.

Now, let’s fast-forward 15 years.  What has happened to the value of the house? Has it skyrocketed from surrounding development, or perhaps dropped in value due to maintenance issue or decline in the neighborhood generally?  Is the business still viable, or have you perhaps already sold your interest to your son? Maybe the business has expanded and grown substantially in value?  Has your daughter moved with her family and relocated to an area where she no longer can reasonably use the vacation home, or has your son taken his own career in a different direction such that taking over the business doesn’t really factor into his own plans?  The only thing we are certain will stay the same in our lives is the presence of constant change.

When planning for assets with significant value, it is important to keep plans flexible in order to provide the ability to address changes in goals, value, and other circumstances over time.  For example, the above plan might be better served to incorporate the ability to permit the respective children to select the designated assets as a portion of their share of the estate, while allowing the assets to instead be sold and the value distributed equally through the estate if no so selected.  If the son still wanted the business, and the daughter still wanted the vacation home, they would have first rights at those, however if interests or values had changed then the plan would still provide for each to get a fair treatment under the estate.

Harold Wilson said “He who rejects change is the architect of decay. The only human institution which rejects progress is the cemetery.”  A good estate plan can go a long way to providing contemporary protection for your family despite the change our lives may bring. This can permit us to embrace the inevitable change in life while maintaining the peace of mind that comes from knowing we have taken care of our family.