Everything you know about estate planning is dead! That’s what I told a new client who was explaining to me exactly how much they knew about my profession.
This guy has turned into a very good client, but he definitely has the alpha personality – if you’re into DISC assessments, he is a high D.
I let him run for a bit and listened to his confident explanation about why he didn’t need this and how his plan would be so simple, that he really needed an attorney who would simply type out his vision.
You see most of my clients come to me with an existing estate plan and, like this guy, some part of them wants me to brag and show off about why my estate plan would be better than the one they currently have.
I didn’t do it during this meeting, and there are a lot of reasons why I don’t do that, but the refrain I get to is, “Everything you know about estate planning is dead!”
This potential client who would become a client who refers people in his circle to me stopped dead in his tracks. I anticipated his involuntary need to get defensive or hit back so I quickly explained, “I’m sorry for how blunt that assessment is, I’m sure it doesn’t make you feel good or reaffirm the confidence you came into the office with, but it is true nonetheless, let me explain.”
See the truth is, I’ve been saying this for some time, usually referring to the need to incorporate more than what I call a “death plan” into the fundamental structure of a plan,
But these days when I say “Everything you know about estate planning is dead” I am referring to an estate plan that was done before January 2020 and here’s why:
I’m not sure if you are aware, but we recently went through a tax revolution. Now, there’s been a lot of tax revolutions in our history.
Everything from the colonial rebellion against the Stamp and Tea Acts, to the infamous Whiskey Tax of 1791, to the 16th amendment passed by congress in 1909 to allow federal income taxation, to the Reagan-era tax cuts of the 80s.
And this past winter we saw the SECURE Act change the way estate planners and financial planners have to advise clients. Effective January 2020, the SECURE Act completely changed how I have to think about my clients’ estate and multigenerational income tax plans.
Now, you may have heard people like Ed Slott talk about the stretch IRA and how you can change your Individual Retirement Account into a Family Retirement Account.
You see, the IRS hasn’t been fans of this for years they’ve wanted to clamp down on it for a long time. In fact, many planners have anticipated the death of the stretch IRA for years.
The IRS’ hunger to collect tax on the money they have never had the chance to tax is why they require you to take required minimum distributions as you age and it’s why they have always required your beneficiaries to take required beneficiary distributions over their lifetime after they inherit your IRA.
Frankly, I expected the stretch IR to die during the Republican efforts to cut income taxes via the Tax Cut and Jobs Act of 2017, but I think it got lost in the mud of the post-election horse-trading. Long story short, the death of the stretch IRA finally came in the SECURE Act.
The SECURE Act killed your beneficiary’s ability to take distributions from your IRA over their lifetime. What the SECURE Act now requires is for a beneficiary to pay tax on their entire inherited IRA within 10 years of inheriting it unless they meet one of a few exceptions.
What does that mean and how does that impact you? Good question! Let’s break it down. First of all, it is important to understand that I am discussing the new rules for inherited IRAs.
To speak in technical terms of art for a second, inherited IRA rules apply when a non-spousal beneficiary inherits your IRA. So the rules that govern when your surviving spouse inherits your IRA are not the rules I am going to talk about here, I’ll get to those in a later episode.
Back to inherited IRAs – When your son inherits your IRA he will now have 10 years to pay income tax on the entire amount he inherits from your IRA.
So how has the SECURE Act potentially made your estate planning ineffective?
Well, the fact is a lot of estate plans have language in them that says “when my son inherits my IRA I want my trusty to only take out the required minimum distribution in a given year and nothing more.”
Under the old rules that would be fine, the IRS would have a table for your son or your daughter’s life expectancy, and a trustee could easily run the account balance by that table and come up with an amount that they need to take out each year.
The problem now with the SECURE Act is that there is no required minimum distribution. The rule just says everything has to be out by the end of the 10th year which means if you make a new law and apply it to your old estate plan, the required minimum distribution in year 1 is $0.00, in year 2 $0.00, year 3, 4, 5, 6, 7, 8, and 9 $0.00 and year 10 everything!
Take a minute to think about the age that your son or daughter might be when you pass away. They’re going to be at their highest-earning decade!
If you live to your mid-80s, your child is going to be in the peak of their careers, preparing for their own retirement, when you pass away, so if they defer deferring defer like we’ve all been conditioned to do, they are going to have a gigantic tax bill to pay on your IRA.
You know, advice from a lot of people is don’t pay any tax now pay it later, but what I have had to adjust as an estate planning and a multigenerational income tax attorney is my advice to a client to say, “Hey we need to allow for a better way for your kids to pay tax!”
Hopefully, we can structure it in a way, working with your financial advisor, so that they will pay zero tax on that inheritance. I think you now see that an estate plan that doesn’t take into account modern income tax rules is obsolete, but there are other issues.
What first comes to mind when you think of estate planning?
For most people, the answer is what I call death planning. Death planning is only considering the very end of your life when making an estate planning and not only is it a poor planning choice, it is also a poor financial choice.
Think about it – if you are going to pay an attorney thousands of dollars to put your estate plan together, wouldn’t you prefer for the thing to do some work while you are alive?
The truth of the matter is that almost any attorney can do that kind of planning, LegalZoom can probably do that kind of planning.
Frankly, that’s not where I set myself apart from things like LegalZoom or the attorney down the street. What your estate plan needs to consider are three other things: incapacity, long-term care costs, and multigenerational income tax issues.
If your trust or will doesn’t mention those things it’s out of date.
When I walk my clients through my process of putting together an estate plan I spend a majority of the time discussing items other than what they want to happen when they pass away.
Instead, I spend a vast majority of the time early on in an estate planning process walking clients through their health, their income, their kids and how well those kids get along with their parents and each other, and how the kids are going to be able to receive their assets in the most tax-efficient way.
These days I see a huge risk of the government being a 30 or 40% beneficiary of a client’s estate if they don’t do the proper income tax planning.