The rationale behind establishing an IRA may be quite simple; however, the rules for inheriting and distributing IRA benefits upon the IRA owner’s death are anything but. Therefore, understanding the rules governing IRA inheritances, for an IRA owner as well as the named beneficiary, is critical to avoid any unintended consequences, including paying higher taxes or forfeiting asset growth.
The rules governing inherited IRA assets depend upon the beneficiary’s relationship to the original IRA owner and the type of IRA that is inherited.
When the beneficiary of inherited IRA assets is a surviving spouse, the rules are simple—the spouse has the option of rolling the assets over into his or her own IRA within 60 days of taking the distribution from the decedent’s IRA. For income tax purposes, a spousal rollover of IRA benefits is not considered a distribution and therefore has no income tax consequences. On the other hand, when the beneficiary of inherited IRA assets is a non-spouse (i.e., child, grandchild, other relative, friend, etc.), the rules become quite complicated and carry various tax consequences if not followed properly.
Unlike a surviving spouse, a non-spouse beneficiary does not have the option to roll over the IRA benefits into his or her own IRA. Rather, when a non-spouse beneficiary inherits IRA assets, the beneficiary generally has three options from which to choose. Each option carries specialized rules as well as various pros and cons, which should be considered carefully when making a decision regarding distributions:
1. Take an immediate distribution.
A non-spouse beneficiary can choose to have the inherited IRA assets distributed to himself or herself immediately. Once the assets are distributed to the beneficiary, they are treated as the beneficiary’s own, and may be used or invested as the beneficiary chooses. Although taking an immediate distribution allows greater flexibility to the beneficiary, the distribution will be included in the beneficiary’s gross income and subject to ordinary state and federal income taxes. Depending on the value of the IRA assets, the amount of income taxes due on an immediate distribution in full could be significant. Despite the potential income tax consequences, it is important to note that a beneficiary who is under the age of 59½ will not be subject to the 10% penalty for early withdrawal for the distribution of assets. If a beneficiary needs immediate access to the money, taking an immediate distribution of the entire inherited IRA may be most beneficial.
2. Transfer the assets into a non-spouse inherited IRA and take RMDs.
A non-spouse beneficiary has the option of transferring the IRA assets into an inherited IRA, sometimes also known as a beneficiary distribution account. It is important that the beneficiary complete what is known as a “trustee-to-trustee transfer,” where the assets move directly and immediately from the existing IRA account to the new, inherited IRA account. Unlike the spousal IRA rollover, there is no option for a 60-day rollover when a non-spouse beneficiary inherits IRA assets. If the assets are distributed directly to the non-spouse beneficiary, the money will be taxed as ordinary income and cannot later be transferred into an inherited IRA.
An inherited IRA account remains in the name of the decedent, and although a “new” retirement account is created, the beneficiary is not able to make new contributions to the inherited IRA account. Keeping the inherited assets in an IRA account allows the assets to continue to grow on a tax-deferred basis. Thus, if a beneficiary does not have an immediate need for the money, transferring the assets to an inherited IRA may have the greatest long-term growth benefits. Notwithstanding the asset growth advantages, a beneficiary of an inherited IRA is required to withdraw a certain amount of money each year based on his or her age and life expectancy, and also other various factors (including whether there are additional beneficiaries). These required distributions generally begin in the year after the year of death and are more commonly known as “required minimum distributions” (RMDs).
3. Disclaim all or part of the assets.
A non-spouse beneficiary can choose to decline to inherit all or part of the IRA assets by executing a disclaimer. If a disclaimer is executed, the IRA assets will pass to the contingent named beneficiaries or, in the event there are no contingent beneficiaries, pursuant to the IRA provider’s contractual defaults. The decision to disclaim IRA assets is an irrevocable decision by the beneficiary, which must be made within nine months of the original IRA owner’s death and before taking possession of the assets. Before making a decision to disclaim, the beneficiary should consult with tax and estate planning professionals to consider the potential benefits and consequences of such a decision.
As estate planners, we ask our clients a lot of questions and answer a lot of questions to help craft an estate plan that meets the needs of the client’s family and situation. We each have our own families and our own situations that need careful thought as well. Here are some of the thoughts that we have considered as we have created our own estate plans.
Entering the work world
As someone who recently entered the “real world,” there are many new responsibilities, including maintaining an apartment, investments, health insurance, bills and taxes. As a single adult with no dependents, an estate plan seemed unnecessary initially. However, part of my new responsibilities include being prepared for the unexpected as well. Taking the time to ensure my loved ones have a clear understanding of my wishes, in the case of an unexpected event, is another responsibility I have now. Health care proxy, power of attorney and will, here I come.
I do not have an estate plan or incapacity documents (i.e., power of attorney and health care proxy), which is not good for an estate planning attorney. I do anticipate putting a formal estate plan into place in the next year or so. For now, all of my financial accounts have transfer-on-death instructions and/or beneficiary designations, which name my parents as the primary beneficiaries and my sibling as the secondary beneficiary. I do not own real estate and do not expect to be purchasing real estate any time soon either.
It’s time for me to review my own plan. My concerns are: Are my health care proxy, durable power of attorney, will and trust up to date? Do they work with the recent changes to state and federal laws? Are the agents, executor and trustee I picked still good choices? Are all my assets titled in the name of my trust so that my estate avoids the expense and delay of probate at my death? Do my life insurance and retirement plan designations still work with my plan?
As I approach my wedding date, I am thinking about updating my transfer-on-death instructions and beneficiary designations to reflect my fiancé as the primary beneficiary and my parents as the secondary beneficiaries. My fiancé and I have discussed but do not plan to sign a prenuptial agreement as neither of us has any substantial assets or expects a substantial inheritance from our parents.
Prior to getting married, my (now) spouse and I were starting our careers as attorneys. We thought, “How can we advise clients all day long that they need an estate plan when we, ourselves, do not have one?” Despite not being married, we executed our powers of attorney, living wills, health care proxies and wills. In going through the process of drafting our own estate planning documents, we realized that we had appointed people who would not have been our default agents by law. Additionally, we realized that it was even more important for individuals who are engaged (and not married) to have these documents in place. Without them, my fiancé would have had no say in my medical or financial affairs.
Starting a family
As we begin to think about starting a family, we know it will be especially important to have proper wills in place that will allow us to appoint guardians of our minor children and provide that their distributions be held in trust, for health and education purposes, rather than given to them outright.
Young and growing family
As a parent of teenagers, I am getting my first glimpses of what my children might be like as adults. This has made me consider whether I want their inheritance to pass outright to them or remain in trust for a long or short period of time. I have also reconsidered which family members to name as guardians because I feel it is now important for them to remain in the Boston area. I have also thought about whom I would name as trustee of assets because I want someone in that role who is wise financially but can also relate to my children as they mature into adulthood.
Parent of an 18-year-old
As my daughter was preparing for college, I thought about how I would no longer be able to do things for her just because I was her mother. No longer would the doctors talk to me without her permission. No longer could I handle her financial matters. It was now time for her to take over these matters herself (even if I wasn’t sure she was 100% ready). What if she was injured and couldn’t make medical decisions for herself? What if she was too far away to take care of a financial transaction at our local bank? She needed a health care proxy and power of attorney before she headed off to college.
Parent of young adult children
My kids have graduated from college and started their careers. I have made sure they have health care proxies, durable powers of attorney and wills, that they are investing in their employer-provided 401(k) and that they understand how to think about their beneficiary designations for their retirement plans and employer-provided life insurance. I also put some money in their IRA accounts every year for which they will thank me when they are my age!
I want my kids to benefit from whatever I can pass to them, not my ex-spouse. Does my plan ensure that my kids are benefitted but that no unforeseen circumstance would result in my hard-earned money passing to my ex-spouse (or an ex-spouse of my child’s down the road)? In addition, are my kids able to handle money? They are good, hardworking and kind but I am not sure they are ready (sorry kids!).
As grandparents, we look at our grandchildren’s young lives and their need for money for education, necessities and buying a home someday. In doing our estate plan, we established a trust for the benefit of our children and grandchildren. The trust gives the trustees the discretion to distribute income and principal to both children and grandchildren with the primary purpose of providing for the education and support of our grandchildren. By having the assets held in a trust, they are protected from the creditors of both our children and grandchildren, including divorcing spouses.
Married with grandkids
It is a lucky parent who does not have to worry about paying a full college tuition for four years for each child. A relatively painless and tax efficient way for a grandparent to help out is by starting to make contributions to a 529 plan for each grandchild as soon as possible after they are born. Now that such plans can be used toward the payment of private school tuitions, they provide additional flexibility if the parents are concerned about having the resources to afford both a private school and a private college.
Families needing special planning
My sibling is in recovery from serious addictions. Although our grandparents wanted to treat my sibling equally, it was important that money not be left outright to my sibling. Our grandparents updated their estate planning documents so that my sibling’s share would be held in trust with our aunt serving as trustee. With this arrangement, my sibling has access to funds, and can use the money for worthy causes in his life, but they are restricted enough that they do not pose the same risk to his sobriety as an outright distribution may have.
There are three ways to own title to real property between two or more individuals—as tenants in common, joint tenants or tenants by the entirety. How you hold title to real property with another individual is important when it comes to your estate plan and knowing what will happen after death.
Tenants in common: Each owner has a separate interest in the property. If the type of ownership is not expressly stated in the deed, and the parties are not husband and wife, this creates ownership by tenants in common. Upon the death of an owner, his or her share passes pursuant to the deceased’s will, or if there is no will, to the deceased’s heirs via intestacy laws.
Joint tenants: A joint tenancy must be specifically declared in a deed. Upon the death of a joint tenant, his or her interest automatically passes to the surviving joint tenant. This tenancy may also be referred to as “joint tenants with right of survivorship.”
Tenants by the entirety: This type of ownership is unique to married persons. Upon the death of a spouse, the property becomes owned in full by the surviving spouse. The deed should state that ownership is by “tenants by the entirety” or between “husband and wife,” although if it is silent and the parties are legally married at the time, the ownership will be automatic. Alternatively, married persons can own property as joint tenants or tenants in common, provided it is expressly stated in the deed.
It is common for a married individual to fully provide for a spouse under his or her estate plan and to execute what is called an “I love you” will.” However, it sometimes happens that the married individual does not bequeath property for his/her spouse, often because he or she has children from a previous marriage and wants to leave family property to them. State laws generally do not favor disinheriting a spouse and may allow the surviving spouse to claim a portion of the decedent spouse’s property despite the provisions of the will. Absent a pre- or post-nuptial agreement addressing parties’ interests in each other’s property at death, “Elective Share” statutes can prevent a spouse from being disinherited under the decedent’s estate plan. A recent Massachusetts Supreme Judicial Court opinion underscores the importance of elective share statutes when individuals do not provide for a surviving spouse.
What are Elective Share statutes?
Elective share statutes generally allow a surviving spouse who has been disinherited by the deceased spouse to claim a fixed portion of the decedent’s estate (elective share), and in so doing, circumvent the decedent’s wishes. The purpose of elective share statutes is to allow a measure of financial protection to the surviving spouse, saving him or her from destitution.
Each state sets its own rules, and many states provide that the size of the elective share depends upon whether the decedent left issue (i.e., children, grandchildren) or parents. For example, New York allows a surviving spouse to claim the greater of $50,000 or 1/3 of the estate while Illinois allows a surviving spouse to claim 1/2 of the estate if the deceased did not leave issue but only 1/3 if the deceased left issue. In comparison, Massachusetts sets out a complicated matrix that depends on the degree of kinship of the other surviving relatives and the type of property left by the decedent. Some elective share statutes, such as Illinois’s, limit a surviving spouse’s claim to probate property; others, such as that of Massachusetts, include certain non-probate property, such as a decedent’s revocable trust.
Massachusetts’ Elective Share Statute
Where a decedent leaves issue, the Massachusetts elective share statute allows the surviving spouse to claim an interest in 1/3 of the deceased’s personal and real property. To the extent that the value of the 1/3 exceeds $25,000, the electing spouse will receive $25,000 outright and an interest in the remainder of the 1/3 share.
In a case decided in January 2019, Cianci v. MacGrath, SJC-12531 (Mass. Jan. 8, 2019), Massachusetts’ highest court determined the exact nature of the surviving spouse’s interest in that remainder of the 1/3 share. In this case, the decedent’s family consisted of a wife and adult children from an earlier marriage and his property consisted of three parcels of real estate. The case does not mention whether the couple had established a pre- or post-nuptial agreement, which could have determined the parties’ interests in each other’s property at death. The husband’s will made no provision for his wife and his real estate was bequeathed to his children. Not surprisingly, the wife elected against the will and then sought to force the sale of the real estate. Not surprisingly, litigation followed. The ultimate ruling was a toss-up: the Massachusetts Supreme Judicial Court determined that the wife has a life estate in the real estate subject to the 1/3 share, that she can seek division (partition) of the property to settle her share and that she is entitled to compensation for the value of her interest in any property that had already been sold.
What if you do not wish to fully provide for your spouse under your estate plan?
You should not assume that you can disinherit your spouse. If your estate plan does not provide at least as much for your spouse as your state’s elective share statute provides, your spouse could have a state-sanctioned override. You should consult with your estate planning attorney to determine your options and your spouse’s rights.
Every adult of any age should have a basic Estate Plan Toolkit: a health care proxy, a durable power of attorney, a will and a review of beneficiary designations on IRA accounts and employee benefits such as 401(k) plans and life insurance policies. Some will also benefit from setting up a revocable trust.
The most thoughtful gift you can give your young adult child this year could be the gift of planning for his or her well-being and future. Planting the seeds for good planning will bear fruit for decades to come.
How to assist your young adult child with estate planning
While you can suggest a lawyer to your adult child, you should not meet with the lawyer or communicate on your child’s behalf.
You can give your adult child the funds for all or a portion of the cost of the plan preparation. It is preferable for the adult child to pay the fee for legal services from his or her own funds.
This gift will count toward your gift tax annual exclusion amount (currently $15,000 per donee per year), but will provide benefits far into the future.
The “Queen of Soul,” legendary singer-songwriter and 18-time Grammy Award winner, Aretha Franklin, died at the age of 76 on August 16, 2018, without a will. As a consequence, the estimated $80 million estate of Ms. Franklin, who lived a deeply private life, will be put on display worldwide for all to see.
Although the revelation that Ms. Franklin died without a will has come as a surprise to most, the Queen of Soul is merely the latest celebrity to pass away without having planned her estate. Other high-profile celebrities who have died without a will include Michael Jackson, Prince, Amy Winehouse, Bob Marley, Jimi Hendrix, Sonny Bono and Kurt Cobain, among many more.
As a result, Ms. Franklin’s estate will be administered pursuant to public probate proceedings and administered in accordance with the laws of intestacy for the State of Michigan, her place of domicile. Due to her high profile and the public nature of her estate administration, Ms. Franklin’s estimated $80 million net worth is more likely to be subject to increased creditor claims and potential family conflicts.
Ultimately, like the many celebrities who passed before her, Ms. Franklin’s lack of wealth planning or estate planning may impact her estate severely. Increased creditor claims, prolonged administration expenses, hefty gift and estate taxes and legal fees will likely mean her four children will be left with much less than their fair share of their mother’s legacy.
The perils of dying without a will
End-of-life planning is a difficult topic that often seems morose, depressing and even scary to think about, but it is a critical aspect of managing one’s assets and protecting one’s family. Despite the advantages to having some type of estate planning in place, nearly sixty percent (60%) of Americans currently have no will.
Although most Americans view the perils associated with dying without a will as being relevant only for extremely high net-worth, high-profile individuals, like Aretha Franklin, such difficulties are of concern to any American adult who owns some type of property.
1. Fighting and expensive lawsuits
If the deceased person’s (decedent’s) wishes concerning how his or her estate should be distributed were never expressed in a will, then the court must rely on the state’s intestate statute to distribute the decedent’s assets.
Because state intestacy laws deal mainly in percentages and do not address individual items of personal property, family members and potential heirs often fight over who receives particular family heirlooms or other individual items of value. In addition, because probate proceedings are public record, personal family disputes are put on public display for all to see.
Ultimately, fighting among family members carries increased emotional tensions and often leads to litigation. As a result, family members and potential heirs may spend significantly more in legal fees than what it would have cost the decedent to create a proper will.
2. A court decides guardianship of minor children
Having proper estate planning documentation is of particular importance to people who have minor children. Using a will, parents can name their choice of guardians for their minor children, and courts generally uphold a parent’s nomination. But when there is no will, and both parents die intestate, the court will appoint guardians for the minor children left behind—a result no parent wants.
3. Increased fees, taxes and legal costs
Perhaps the most significant reason every American adult should have, at a minimum, a will, is that dying intestate incurs increased probate fees, taxes and legal costs. One of the goals of estate planning, or having a will, is to prevent potential disputes or problems from arising after a person has died. It is important to remember that preventing problems is usually less costly than paying to resolve them later, and is more predictable and less harrowing for the family of the decedent.
Avoiding the trend and planning for the inevitable
Just because one does not have an estimated $80 million estate or is not a high-profile public figure does not mean that dying without a will is worry-free. The perils associated with dying without any kind of estate planning are relevant to the majority of American adults, especially those with families and minor children.
An individual’s will is a roadmap for the distribution of his or her assets in a special proceeding called probate. Probate provides public notice of the decedent’s death to allow creditors to file claims against the estate. Whatever is left after payment of creditors’ claims is distributed to the beneficiaries as directed under the terms of the decedent’s will.
In the absence of a will, the particular state’s intestate succession laws direct how the assets get distributed, resulting in numerous perils beyond those mentioned above.
In many respects, employees and independent contractors seem to be not different at all. They often work at the same company, even doing similar work. However, there are very important legal and tax-related differences between being a contractor and an employee.
• The IRS provides the general rule that states that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. Whether a worker is an independent contractor or employee depends on the facts in each situation.
To help distinguish between employees and independent contractors, the IRS has set up three general criteria:
• Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does the job? If the worker can set his or her own hours and works with little or no direction or training, he or she may be an independent contractor.
• Financial Control: Does the company control how the worker is paid, whether expenses are reimbursed and who provides tools and supplies? A worker who is paid a salary, is restricted from working for others and who does not participate in company profits or losses, is probably an employee.
• Type of Relationship: A contract may indicate that an individual is an independent contractor, but that alone is not sufficient to determine the worker’s status. Businesses offering employee-type benefits generally indicates an employment relationship. If services performed are directly related to a key aspect of the company’s regular business, the worker is probably an employee.
Worker classification is extremely important, because it determines if an employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. Employment and labor laws also may not apply to independent contractors. Consequences of misclassifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes as well as any related penalties.
The IRS offers to help employers to determine the status of their workers by using Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. IRS Publication 15-A, Employer’s Supplemental Tax Guide, provides more information on this issue, as well. Lastly, Form 8919 can be used by individuals who believe an employer improperly classified them as independent contractors to calculate their share of uncollected Social Security and Medicare taxes.
Everyone needs an estate plan that takes into account their current circumstances and stage of their life. Estate planning is not a one-and-done process.
As your college-bound child prepares for the new chapter in their life, parents need to remember that they will no longer be able to assist their child with financial and medical matters by simply being the mom and dad. While you may not fully recognize that your 18-year-old is an adult, the law does.
Three documents to prepare your child for college
Single people often think they do not need an estate plan. However, because the law is not structured to benefit single people without children, it is critical that people in this position create an estate plan.
Why do single people need an estate plan?
Prenuptial agreements used to be thought of for the wealthy or famous, but are becoming increasingly popular among “ordinary” couples. Prenuptial agreements can offer certain protections and planning opportunities. In addition, unlike the inheritance protections in place for a married couple, there are none in place for an engaged couple.
Prenuptial agreements and relationship contracts
Inheritances and the engaged and separated
Newly married couples
Marriage may impact an individual’s estate plan in unanticipated ways that are worth considering. With the joining of two lives, it’s a good time for a financial review too.
Massachusetts: wills and wedding bells
Just married! It’s time for a financial check-up
Separated and divorced persons
While divorce may trigger automatic inheritance protections, the same is not true for those who are separated (but no divorce decree has been issued). During a separation and after a divorce, it’s a good time to review your beneficiary designations as well.
Inheritances and the engaged and separated
When parents of young children design their estate plans, they are likely to be focused on guardian selection and financial planning for education needs. As their children and grandchildren mature, parents and grandparents may want to turn their estate planning focus to inheritance protection from your creditors and a divorcing spouse.
Choosing a guardian for your children
Talking to your parents and grandparents about their estate plans and when to say no to an inheritance
Taking care of others in your estate plan
Regardless of your stage in life, there may be loved ones in your life that you want to make sure are taken care of.
Taking care of elderly parents in your estate plan
Wealth planning for children with special needs
Estate planning for your pets
As you can see, changes in your personal life will likely impact your estate plan. Accordingly, throughout your life, you should revisit your plan to make sure it meets your current wishes and the needs of your loved ones.
If you are lucky enough to have a woodworker in your life, like me, you have been the beneficiary of a coffee table, bed frame, dresser and other items made just for you and will be enjoying them for years to come after your woodworker’s passing.
But what about your woodworker’s tools and equipment? If your woodworker didn’t give direction as to the disposition of them, what should be done with the lumber, table saw, drum sander, hand tools and the plethora of clamps that all woodworkers accumulate?
What is what?
While your woodworker is intimately familiar with the tools and equipment in the woodshop, you may not be. Your woodworker likely has friends who are also woodworkers. You could ask these friends to help you determine which tools are valuable within the woodworking community and which tools are more generic.
In the alternative, you could reach out to a woodworker’s association in your area or the woodworking store your woodworker frequented for help in finding a professional to assist you.
What goes where?
My woodworker has spent decades acquiring tools and equipment to create beautiful pieces and would want them to find a good home. There are several options for gifts and donation of the tools and equipment:
- Family, friends and neighbors who also share a passion for woodworking
- Technical high schools or the students in their apprentice programs
- Organizations or clubs at your local high school
- Makerspace in your area
- Habitat for Humanity ReStore or similar charity
Another option would be to sell the tools and equipment, in bulk or individually, through:
- Professional estate sale
- Garage sale
- Craigslist, eBay or the like
If the overall value of your woodworker’s estate meets the federal or state estate tax filing threshold, then you should discuss valuation of the tools and equipment before any of the above actions are taken with the attorney or accountant preparing the estate tax return(s).
If you gift tools to an individual, you will need to file a gift tax return if the value of the tools and equipment given to an individual is worth more than $15,000. A valuation will be needed so contact your attorney or accountant prior to making the gift.
If you donate tools to a charity, make sure you get a donation receipt so you can deduct the donation on your income tax return. There are charitable deduction rules you will need to take into account.