Please note that Portnoff Financial has joined with Tempus Wealth Planning and some information here may no longer be applicable. Please contact Jeremy Portnoff at 949-226-8342 (CA) or 732-226-3113 (NJ) for additional information.  We apologize for any confusion while we are in transition. 

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Estate Planning

IRA Update: March 2013

With the American Taxpayer Relief Act of 2012 that was passed in 2013, there are some new tax considerations to be aware of.

NUA planning with ATRA

NUA or Net Unrealized Appreciation has to do with employer stock within a 401k plan. NUA allows the plan participant to take the employer stock out of the plan in-kind and transfer to a taxable brokerage account while only realizing ordinary income on the original cost of the shares. The gains, or NUA is taxed at long-term capital gains (LTCG) rates but only when the shares are actually sold. See more details on NUA.

Previous to 2013, the difference between the top rate of 35% and the LTCG rate of 15% meant a 20% potential tax savings when using the NUA strategy. With the new top rate of 39.6% and 20% top capital gains rate; difference is 19.6% which is close however one must consider the 3.8% surtax on net investment income. The surtax would be applied on the income generated from the sale of shares after the distribution and thus the tax would be 23.8% which is 8.8% higher than in 2012. In other words the potential tax savings is reduced to 15.8% from 19.6%.

As an aside, almost no one will actually pay 20% capital gains because if your income is high enough to be in the 20% capital gain territory, you are probably also subject to the 3.8% surtax which is why you would pay 23.8%.

It is important to look at the potential tax savings but also important to consider that any future growth of distributed stock would no longer have the protective shell of tax deferral. Once the stock is sold, the capital gain would be realized. Any future income derived from the stock such as dividends would be taxable in the year received. Also the stretch IRA for beneficiaries would no longer be applicable to distributed NUA stock.

A key consideration: Is there significant appreciation on NUA stock and when will you need the NUA funds? If the gain on NUA is not significant, the benefit is less because it may cost a lot in having realized the ordinary income to get the NUA out at ordinary rates if there is a relatively small amount of NUA that would get the LTCG treatment. However if you are going to use the funds soon after distribution, the benefit is high because some of the money that would have been taxed at ordinary rates gets the long-term capital gains treatment instead. If holding for a long time before selling the shares, you have to evaluate whether it makes sense or not.

Roth Conversion Strategies

Roth conversion strategies need to be review and revised in light of the new tax rates. Taxpayers who are subject to the return of the 39.6% bracket obviously pay more tax and need to consider whether they want to convert at this rate. Since the Bush tax cuts for most taxpayers were made "permanent," those who converted into higher tax brackets in 2012 may want to revisit and determine if they should recharacterize and begin to reconvert over a longer period to keep their marginal tax rate lower.

Even with higher rates for high income, taxable assets are still subject to the 3.8% surtax and thus Roth conversion will help to reduce taxation on those types of funds if you were to use those funds to pay the tax on conversions. There certainly is no guarantee that congress won't come back and raise tax rates even more which is already being discussed and this should be factored into your decision to what income tax bracket you will convert to.


Planning with new estate tax threshold

With the estate tax being set at $5 million with portability and inflation adjustments means only the wealthiest will pay estate taxes, that is unless and until this level is brought back down. The Generation Skipping Tax (GST) exemption is set at $5.25 million instead of going back to $1 million. The estate tax rate went up to 40% from 35% but this is only on the amounts about the exemption.

Wealthy IRA owners may want to consider naming grandchildren as beneficiaries of IRAs to take advantage of the $5.25 million GST exemption and the stretch for the younger generation. Trusts may be necessary for grandchildren so watch the wording and the type of trust used so as to not affect the stretch and force small amounts of income to trust and estate tax rates which hit the highest bracket very quickly.

If the estate is potentially large enough, strategies to reduce the estate size such as gifting, Roth conversions, and life insurance via ILITs (Irrevocable Life Insurance Trust) should be considered. You must also consider even though there is a large federal exemption amount, some states still have their own estate tax with different thresholds such as NJ which sits at a $675,000 exemption amount.

Gifts can be given to family members who may be in lower tax brackets to help them convert their own IRAs to Roth IRAs. This can also mean gifts to parents who are in lower tax brackets. Helping a parent or even a grandparent convert their IRA to Roth means that Required Minimum Distributions cease and when you inherit, you can get a tax free stretch, or if you don't need it, have the younger generation named as beneficiaries so that they get lifetime tax free distributions.

Misc Tax Planning

  • Itemized deductions begin to phase-out at $300,000 for Married filing joint ($250,000 for single filers) up to $422,500 ($372,500 for single filers).
  • AMT exemption amount has been permanently indexed to inflation. For 2013 the amount is $80,800 ($51,900 for single filers).
  • Qualified Charitable Distributions temporarily extended for 2013.
  • In-plan Roth conversion rules have expanded.
  • Top trust tax rates starts at $11,950 which means that distributions from inherited IRAs to discretionary trusts that can retain those distributions hit the 39.6% tax rate very quickly.
  • Salary deferrals for 401k, 403b, etc, can reduce the MAGI for the 3.8% surtax however cannot reduce income for purposes of the 0.9% Medicare surtax.


As always, please consult with a qualified tax professional and financial advisor to determine if these strategies are right for you.
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Important IRA Rulings for 2012

In Charles Grant Beech et ux. v. Commissioner, T.C. Summ. Op. 2012-74; No. 1948-11S, 7/26/12, a non-spouse beneficiary, the decedents daughter botched an inherited IRA by not doing a trustee-to-trustee transfer and the whole inherited IRA was taxable all in one year. Remember, a non-spouse beneficiary CANNOT do a (60 day) Rollover; funds must only be moved via direct (trustee-to-trustee) transfer.

In Herring v. Campbell, Administrator of Marathon Oil Company Thrift Plan, U. S. Court of Appeals for the Fifth Circuit, 8/7/12, a $300,000 pension was not inherited by the intended beneficiaries. The decedent, John Hunter named his spouse, Joyce and the primary beneficiary of his pension plan but did not name any contingent beneficiaries. Joyce predeceased John and he never updated his beneficiary form. The plan administrator followed the rules of the plan and eventually the funds were distributed to Mr. Hunter's living siblings, not his "beloved stepsons" who inherited his estate through the Will. Unfortunately for the stepsons, a Will does not cover retirement plans, the beneficiary form does.

In Seeling, U.S. Bankruptcy Court, District of Massachusetts, Western Division, Case No. 11-30957, 5/24/12, the taxpayer received a favorable ruling protecting her inherited IRA from bankruptcy. In Clark, 2012, DC WI, 109 AFTR 2d 2012-733, 1/5/12, another bankruptcy involving an inherited IRA, the bankruptcy court ruled in favor of the creditors initially however a district court later overturned the ruling in favor of the debtor. More and more of these inherited IRA bankruptcy cases seem to be coming up and it appears a precedence is being set in many states in favor of debtors.

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Inherited IRA Horror Story

In anticipation of Halloween, I thought this real client horror story from Ed Slott & Co is timely.

The beneficiary of an IRA, Casey was 17 when she inherited the IRA worth approximately $170,000 at the time. The advisor made the (unfortunately all too common) error of moving the funds into an IRA in Casey's name rather than a properly titled inherited IRA. Casey had no idea if taxes were paid or were supposed to be paid; she relied on the guidance of the advisor.

Over the last 14 years, the account was moved several times to different IRA custodians and no one ever asked how a young person had such a large IRA. Casey only took out about $20,000 in the first three years she had the account and nothing since. Fast forward to the present when she needs some money so she makes a request to the advisor for a distribution. This prompted the current advisor to ask how she had an IRA that large at such a young age which uncovered the truth; it was an inherited IRA gone wrong!

Since a non-spouse cannot do a rollover, the transfer of funds from the inherited account to her own IRA was a taxable event the value of which should have been included on her income tax return for that year. Since it has been more than 3 years, the statue of limitations for audit has passed. However in a case such as this, the funds that went into Casey's IRA was an excess contribution subject to the 6% excise penalty per year until fixed. Normally this penalty would be filed on form 5329 which is considered a separate return, and since not filed, the statue of limitations never started.

The penalty is approximately $10,200 (6% of $170,000) per year for 14 years for a total of $142,800! The excess contribution amount would actually be reduced by the net eligible IRA contribution amount for each year which would make the penalty approximately $124,620 assuming full eligibility for the maximum allowable IRA contributions going back to 1998 and assuming she never made any of her own IRA contributions during those years.

Any distribution from the IRA Casey takes will be taxable. If she takes out the excess amount of $124,620 to pay the penalty, the tax due assuming a 25% tax bracket would be $31,155 plus the 10% early distribution penalty of $12,462 for a total of $43,617. Add these up and we have a total amount due of $168,237. All is not lost however because earning on the excess contributions are not distributed and if we assume a reasonable growth rate of 5% (which is below the 6% penalty amount), then her IRA would be worth approximately $336,588 minus the $168,237 penalty leaves her with $168,351 in her IRA. There would be the other penalties such as failure to file form 5329, accuracy related penalties, and interest due on those penalties for 14 years which would further reduce her IRA.

Note that had a distribution occurred when inherited, she would have paid the tax then presumably at lower rates because she was 17 and single, avoided the 6% annual penalty, and the 10% early distribution penalty which does not apply to beneficiaries of IRAs. More importantly if the original advisor was competent and set up a properly titled inherited IRA for Casey, she could have done the stretch and would still have the IRA today and paid much less tax along the way.

Don't let this happen to you or anyone you love. If you are not already, work with an Ed Slott Trained Master Elite IRA Advisor to make sure you and your beneficiaries don't have a scary story like Casey's to tell!

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Trust Deadline for Inherited IRAs

October 31st is the deadline for trust beneficiaries of IRA owner's who died in 2011.

A trust is not a living breathing person and thus does not have a life expectancy therefore when a trust is named as a beneficiary of an IRA, the "stretch" or life expectancy payouts can be lost (or dramatically reduced) and taxes can be higher unless you plan properly. In order for the beneficiaries of the trust to get the Stretch, the trust must qualify as a "see-through" or "look-through" trust by meeting the following four provisions:

  1. The trust must be valid under State law, or would be except for that there is no corpus;
  2. Beneficiaries must be identifiable;
  3. The trust must be irrevocable at death, and;
  4. A copy of the trust (or at least a list of all trust beneficiaries, primary, contingent, and remainder) must be delivered to the custodian by October 31st of the year following the year of the IRA owner's death.

If a trust is named as a beneficiary, and qualifies as a see-through trust, the life expectancy period is still limited to the oldest trust beneficiary. Even if a trust splits off into sub trusts, the age of the oldest trust beneficiary must still be used unless each sub-trust was named as a beneficiary individually. In such a case with proper use of sub-trusts, each sub-trust beneficiary can use their own life expectancy in determining the payout period.

In it also important to understand whether the trust is a "discretionary" or "conduit" trust in determining who's age is used in determining the life expectancy factor. A conduit trust simply receives the payout from the IRA and then passes it on to the ultimate beneficiary; the funds do not stay in the trust. A discretionary trust on the other hand allows the trustee to limit distributions which means that funds can accumulate in the trust. In the case of a discretionary trust, all POTENTIAL trust beneficiaries must be considered in determining whose age is used for the life expectancy payout. For example, suppose three children are named as primary trust beneficiaries, and the contingent is the IRA owner's parent, the beneficiary's grandparent. If it is a discretionary trust, there is a possibility that the grandparent may receive some of the funds and thus must be considered a potential beneficiary which causes the young grandchildren to be stuck with the grandparent's life expectancy which, is much shorter than theirs, in determining the Stretch period.

Naming a trust as a beneficiary comes with many potential pitfalls and rules to follow. Be sure you have consulted with a properly trained IRA expert before naming a trust as a beneficiary.

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IRA Disclaimer

Remember to check your beneficiary forms and consider naming contingent beneficiaries so that disclaimer planning can be used post-death. A disclaimer allows a beneficiary the option to refuse an inheritance and let it pass to the next person in-line as if they pre-deceased the account owner. Disclaimers must be "qualified," in writing, and the funds cannot be directed to a specific person; they can only pass to the next person in line. Before executing disclaimers, be sure you understand where the funds will go. If there are multiple primary beneficiaries and a disclaimer is executed, the funds could pass to the remaining primary beneficiaries and not a contingent beneficiary depending upon the policies of the IRA custodian.

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Beneficiary Determination Date

September 30th is the beneficiary determination date for those who inherited an IRA from a person who deceased in 2011. This is the date which determines whose life expectancy is used for "stretch IRA" payments. The life expectancy used is based upon the age of the oldest "designated beneficiary." Here a summary points to know:

  • The "stretch IRA" is not a product rather it is a common term for the ability to take the Required Minimum Distributions over the beneficiary's life expectancy. This keeps the bulk of the IRA in the tax deferred wrapper of the IRA and minimizes the tax burden for the beneficiary by only requiring the minimum distributions if taxable. If the inherited IRA is a Roth IRA, then the minimum distributions would be tax free however as indicated, the bulk of the account would remain growing in the inherited Roth IRA tax free.
  • Only a living, breathing person can be a designated beneficiary and must be named on the beneficiary form. A charity, trust, or estate is does not have a life expectancy and thus the stretch can be lost or minimized if a non-person is a beneficiary. Naming an IRA beneficiary through your will results in no designated beneficiary and loss of the stretch.
  • 9/30 is the beneficiary determination date. You cannot add beneficiaries however existing beneficiaries can be paid out before this date. For example if a charity is a beneficiary the stretch can be lost because a charity does not have a life expectancy and the payout period can be limited to 5 years if the owner did not reach their Required Beginning Date (RBD) or the owner's remaining life expectancy if past the RBD. The solution would be to pay out the charity's share before the 9/30 deadline.
  • If you are the single named beneficiary, then you will be able to use your age in determining the applicable stretch period. If there are multiple beneficiaries, the age of the oldest beneficiary will be used.
  • A beneficiary named through an estate can never be a "designated beneficiary" and therefore the stretch will be limited to 5 years or the remaining life expectancy of the IRA owner.
  • When there are multiple beneficiaries, especially if one is a non-person, the accounts can be split, and thus undesirable beneficiaries effectively removed if done prior to the 9/30 date. In order for multiple individual beneficiaries to use their own life expectancy, the accounts must be split by 12/31 of the year after death.
  • There are special rules when a trust is named as a beneficiary; get professional help if this applies to you or are thinking of naming a trust as a beneficiary.
  • Inherited IRAs can be split after the 12/31 deadline however each inherited IRA owner will still be stuck with the age of the oldest beneficiaries life expectancy for calculating minimum distributions.
  • While Roth IRAs do not have lifetime Required Minimum Distributions, they do have RMDs for inherited Roth IRAs.

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