Qualified Disclaimers can be useful tools to alter the way property passes at death, and are often used as a method to reduce transfer taxes, such federal estate tax or gift tax.

Simply stated, a qualified disclaimer is a refusal to accept a gift, bequest, devise or beneficiary designation, done in a manner which meets certain statutory requirements.

Disclaimers may be made of lifetime gifts, but that is extremely rare, and this article will focus on transfers after a transferor’s death.

A qualified disclaimer after a transferor’s death must be in writing, it must clearly identify the property which is being disclaimed, and it must be signed by the person making the disclaimer, or his or her legal representative. The written disclaimer must be delivered to the transferor’s legal representative, such as the executor of an estate, and in North Carolina to the probate court, within nine months after the transferor’s death, with the exception of a disclaimer by a minor disclaimant, which may be made within nine months after the minor disclaimant’s twenty-first birthday.

Property cannot be disclaimed after it has first been accepted by an individual. For example, if an individual accepts stock dividends, he or she cannot later disclaim the shares of stock which paid those dividends.

The disclaimed property passes as though the disclaimant had predeceased the transferor. If there is a will, it passes to the successor devisees or beneficiaries under the will, after it has been disclaimed by the primary devisee or beneficiary. If there is no will, the property must pass to the secondary heirs under state law, who would have inherited the disclaimed property if the disclaimant had predeceased the decendent.

The person making the disclaimer cannot direct that a disclaimed devise or inheritance be passed to someone else, other than the person or persons who would have received the property if the disclaimant had predeceased the transferor. For example, a will leaves property to the transferor’s brother if he survives the transferor, and if he does not survive the transferor, the will leaves the property to the transferor’s sister. The disclaimant cannot disclaim the property and direct that is passes to his or her children, instead of to the sister.

The disclaimed property passes to the successors without any tax consequences to the person making the disclaimer, provided that the disclaimer is “qualified.” That is, the qualified disclaimer is not subject to gift tax, which would have been applicable if the person making the disclaimer had accepted the property and subsequently made a gift of that property to the transferees.

Generally, a disclaimant cannot disclaim property to a trust that names the disclaimant as a beneficiary of the trust or gives the disclaimant the power to direct the further disposition of the disclaimed property. For example, if the disclaimant is also the trustee of the trust to which the disclaimed property passes because of a disclaimer, and, as Trustee, has the discretionary power to direct its further disposition then the disclaimer would not be qualified unless the disclaimant also disclaimed his discretionary power.

There is an exception for a spouse, who can be a beneficiary of a trust, but the spouse cannot have the power to further direct the disposition of the trust property after the disclaimer, unless the spouse also disclaims his or her right to direct such disposition.

It is possible to disclaim partial interests in property, but not interests which cannot be severed into separate shares at the time of the disclaimer. For example, a person may disclaim 1,000 out of a total 2,000 shares of stock in an estate, but he or she cannot accept the dividends for life and disclaim the “remainder interest” in those shares after his or her death. In that case, a “vertical” disclaimer of half the shares will work, but a “horizontal” disclaimer would not work.

If the disclaimant is the trustee of the trust into which property is disclaimed, but as trustee is given the authority to make distributions among several beneficiaries, then the disclaimant must also disclaim his or her fiduciary power to direct the disposition among those beneficiaries.

Generally, a person cannot disclaim property in order to become qualified for Federal Title XIX assistance, such as Medicaid. The person must disclose all of his or her property to qualify or to remain qualified, including any property the person has disclaimed or wishes to disclaim.

Disclaimers are very technical in nature and you should not try to disclaim property without the assistance of a qualified attorney.

Creating CRTs

Charitable Remainder Trusts can be useful tools to avoid or to postpone capital gains tax on the sale of appreciated assets, for someone who wants to make a charitable gift after the termination of the trust.  A person (the trust “grantor”) creates a trust which pays a stream of distributions each year to one or more beneficiaries (the “income beneficiary”) for life or for a term of years, after which the trust terminates and the remaining trust assets are distributed to a tax-exempt organization or organizations (the “remainder beneficiary”). Since the remainder beneficiary is a charitable organization, any capital gains which are retained in the trust are not subject to capital gains tax.   

There are two types of charitable remainder trusts, called  Charitable Remainder Annuity Trusts or CRATs and Charitable Remainder Unitrusts or CRUTs.  A CRAT pays fixed distributions to the income beneficiary based on the original value of the trust assets, whereas a CRUT adjusts the distributions each year to reflect any increases or decreases in the value of the trust assets.

Example: $1,000,000 in assets are transferred to a charitable remainder annuity trust, or CRAT. The Grantor is to receive 5% of that value, or $50,000, per year, until the trust terminates. The income beneficiary frequently is a married couple and the trust term may be for their joint lifetimes and for the lifetime of the survivor.  If the trust is funded with appreciated assets, no capital gains tax will be payable upon the sale of those assets.  If the assets are worth $1,000,000 at the time of the gift and if they are sold for that amount, assuming that they were originally acquired for $100,000, the trust would not pay income tax on the $900,000 capital gain when the assets are sold.  In addition to avoiding capital gains tax at that time, the grantor gets a charitable deduction on his or her income tax return for the value of the charitable remainder interest, calculated by Treasury actuarial tables applicable when the contribution to the trust is made.  When the trust terminates – often after the death of the second spouse to die, the remaining trust assets are paid to a tax-exempt organization or organizations (the “charitable remainder beneficiary”) as set forth in the trust agreement.

A charitable remainder “unitrust” or CRUT is similar to an annuity trust, except that the distributions are adjusted annually, to reflect any increase or decrease in the value of the trust assets.  If a 5% Unitrust was originally funded with $1,000,000 in assets, but grows in value to $1,100,000, the unitrust distributions for the following year would be 5% of the new value, or $55,000. This is different from a CRAT or annuity trust, for which the distributions would remain the same, even if the value of the trust assets increases or decreases.

Please note that the distributions from a CRT to the income beneficiary are taxable, to the extent that (a) the trust has taxable income, including capital gains, and/or (b) the trust had , in previous years, taxable income which has not been distributed to the income beneficiary.  The trust cannot avoid income tax by investing in tax-free bonds until all taxable income has first been distributed, which makes this strategy impractical.

The general rule is that a CRAT or CRUT is required to distribute at least 5% annually, but there are exceptions for certain types of unitrusts.  For example a “net income” CRUT (sometimes called a NICRUT) is not required to distribute more than its net income, and a “net income” CRUT with makeup provisions” (sometimes called a NIMCRUT) may make up income arrearages from past years (i.e., from years in which the trust was allowed to distribute less than the unitrust percentage), until the excess distributions have caught up with those arrearages. Thus a 5% NIMCRUT which earns only 1% in a given year would distribute only 1% currently and would accrue a 4% arrearage, which may be distributed only from excess income in subsequent years, i.e., income in excess of the 5% unitrust percentage.  If 7% income is earned in a subsequent calendar year, the 2% overage for that year in excess of 5% may be distributed to the income beneficiary as a make-up distribution.

There are certain types of investments which enable the trustee to have some control over the realization of taxable income of a trust, in which case the trustee may minimize taxable income in one year and maximize taxable income in another year.

Exiting CRTs

Occasionally someone creates a CRT which he or she later desires to exit. Circumstances can change over time, and sometimes there is an unanticipated major life event, which causes a change of mind.  The trust itself is irrevocable, but there are alternatives which permit an income beneficiary of a CRT to obtain a more suitable result.

Let us suppose that the spouse of the trust grantor unexpectedly dies and later the grantor remarries and wants to make the new spouse an income beneficiary. Since the original trust was irrevocable, it cannot be changed to substitute the new spouse as a replacement beneficiary.  In that case the grantor may want to exit the original trust in a manner permitted by law and to enter into a new trust agreement under which the new spouse is an income  beneficiary.

There are several alternative methods for exiting an existing charitable remainder trust:

1. Temination of a CRT.  One option is for the trustee simply to terminate the trust, in which case the trust assets must be divided between the charitable beneficiary and the income beneficiary strictly according to Treasury actuarial tables, following procedures established by the IRS. Care must be taken to avoid “self-dealing” under Code Section 4941, which could subject the trust to severe penalties.

• Sale of income interest.  Another option would be for the income beneficiary to sell the income interest in the trust to a third-party buyer. An important benefit from this alternative is that it frequently results in getting more money to the income beneficiary than would be received in a straightforward trust termination.  Please note that the income interest in a CRT is considered a capital asset for income tax purposes, and if the sale of that capital asset results in a higher price than the actuarial value of that asset under the Treasury actuarial tables, there would be a taxable capital gain for the income beneficiary.

The original CRT would continue to exist under this alternative, under the same terms and conditions, but with a different income beneficiary – but please be aware that if the original term of the trust was measured by the life of the original income beneficiary, there would be no change in the term of the trust and the original income beneficiary’s life would continue to be the measure for the remaining term of the trust. 

The proceeds received by the income beneficiary from the sale of the income interest could be contributed to a new charitable remainder trust if the Grantor so desired, with income tax benefits applicable to a new CRT, but the new trust would be scaled down in size as compared to the original trust unless additional assets were added to the new trust.  The new trust could have different beneficiaries than the original trust, such as a spouse by a second marriage or other family members.     

• CRT Rollover.  A third option could be a charitable remainder trust “rollover,” where the income beneficiary rolls over his or her income interest to a new CRT.  Initially, the new CRT would have no assets other than the right to receive unitrust distributions from the old trust, which would continue to exist.  However, an important benefit of this alternative is that the income interest from the old trust can be sold by the new CRT to a third-party buyer, and if the sale price is higher than its actuarial value under the Treasury tables, there will be no capital gains tax on the sale of that income interest, as long as the gain is retained by the trust.  The proceeds of sale could be invested by the new CRT differently than the assets of the old trust, which investment strategy may be more appropriate for the new trust.  The income beneficiary from the old trust would be the grantor of the new CRT and would get income tax benefits applicable upon the creation of a new CRT.  New beneficiaries could be named for the new trust.   

The original CRT would continue to exist and the charitable beneficiary would still receive the remainder distribution on termination of the trust under the original terms of the trust.  Please note that if remaining term of the old trust was based on the measuring life of the original income beneficiary, that same person’s life would continue to be the measuring term for the old trust, even if that person is no longer receiving the unitrust distributions from the old CRT.

• Distribution to charitable beneficiary.  Lastly, an income beneficiary who no longer needs or wants the income distributions from the CRT may want to terminate his or her trust by giving the income interest to a charitable remainder beneficiary.  If that is done, then the charitable remainder beneficiary would own both the income interest and the remainder interest, and the trust could be terminated.  A beneficiary who gives his or her income interest to a charitable organization will get a charitable deduction for giving that income interest to charity, based on the value of the income interest under the Treasury actuarial tables at the time the trust is terminated.

Charitable remainder trusts often last for one or more decades.  Although the original reasons for creating the trust were presumably valid at the time the trust was created, circumstances can change over time.  Whatever the reason for the exiting a CRT, the procedure is complicated and in some states may even require court action.  You need to consult with an experienced professional to discuss your situation and to determine the best option available for you.

Prior to the adoption of The SECURE Act of 2019, the required minimum required distributions (RMDs) for retirement accounts were based strictly on the actuarial life expectancy of the beneficiary. If the beneficiary of the retirement account was a trust, the distributions from the retirement account to the trust were based on the age of the trust’s “identifiable primary beneficiary.” If there were several identifiable beneficiaries, the RMD was based on the life expectancy of the oldest identifiable beneficiary.

The SECURE Act of 2019 changed the required minimum distributions (RMD) for retirement account beneficiaries (including identifiable beneficiaries of trusts) other than spouses, including adult children or grandchildren. The RMD has been changed from their actuarial life expectancy to 10 years (maximum), subject to exceptions. An exception is still available for beneficiaries who are “disabled” as defined by Internal Revenue Code Section 72(m)(7) or “chronically-ill” as described by Code Section 7702B(c)(2), with limited exceptions. The RMD for trusts on behalf of those beneficiaries is still based on the actuarial life expectancy of the identifiable primary beneficiary, and is not subject to the 10-year maximum payout applicable to most beneficiaries.

The Secure Act of 2019 virtually eliminated the “Stretch IRA” strategy to reduce IRA distributions by naming very young beneficiaries, but some of those benefits still exist for disabled or chronically-ill beneficiaries.

Distributions from a retirement account result in taxable income to the beneficiary or beneficiaries who receive the distributions. When a distribution is payable to a trust, the trust receives the taxable income, but the income tax liability for the distribution is passed on to the beneficiaries to whom the trust further distributes the income. Trusts are taxable entities and they file fiduciary income tax returns each year and pay income tax on any undistributed income. However, if distributions to beneficiaries are made during the year (or early in the following year, if the trust so elects on its timely-filed fiduciary income tax return), the trust can claim a “distribution deduction” on its fiduciary income tax return. That is, the trust can deduct from its taxable income the amount distributed to trust beneficiaries, and the trust issues a Schedule K-1 to the trust beneficiaries, reporting the distribution as taxable income to them. The tax laws discourage trust income from being accumulated in a trust by taxing undistributed trust income at much higher rates than the rates applicable to individuals.

The terms of some trusts require that the trusts distribute all their income to trust beneficiaries each year. These trusts are often called “simple trusts,” but insofar as retirement benefits are concerned, this type of trust can be categorized as a “Conduit Trust.”

A Conduit Trust is sometimes called a “see-through” trust, since the retirement distributions are taxable to the trust beneficiaries who end up receiving the distributions, and are not taxable to the trust.

Most of the time, overall income taxes are` reduced if a trust distributes retirement account income to the beneficiaries of a trust – because of the high tax rates applicable to trusts. However, minimizing taxes may not be the only consideration.

If the beneficiary of the IRA is a trust for a special needs beneficiary who is an “identifiable primary beneficiary,” any distributions of retirement account income from the trust to the trust beneficiary might result in too much income for the beneficiary, thereby disqualifying the beneficiary from means-tested governmental benefits, such as Medicaid.

An Accumulation Trust is an alternative to a Conduit Trust. The Accumulation Trust can be named as a beneficiary of retirement account benefits for an identifiable primary beneficiary, instead of a Conduit Trust. If the retirement income is not required to be distributed to the identifiable primary beneficiary and it may instead be retained by the trust, then the retirement account income would not cause the beneficiary to lose means-tested benefits, such as Medicaid. See Reg. Section 1.401(a)(9)-5, Q & A-7(c)(3), Example 1.

Consequently, an Accumulation Trust may be appropriate where the identifiable primary beneficiary of a trust is a special needs individual. The Accumulation Trust allows the trustee to receive the RMD from the retirement account, but does not require the trustee to distribute the RMD to the special needs beneficiary each year, thereby preserving the eligibility of the special needs beneficiary for needs-based government benefits. Instead of distributing the benefits to the beneficiary every year, which is a requirement of a Conduit Trust, the trustee of an Accumulation Trust can retain retirement benefits within the trust for future distributions to the special needs beneficiary or to the remainder beneficiaries of the special needs trust.

An Accumulation Trust which accumulates retirement distributions within the trust and does not distribute those benefits to the beneficiary must pay income tax on the accumulated income at trust tax rates, which are much higher than individual rates. However, even highly-taxed retirement account income which is accumulated within a special needs trust might be preferable to having the trust beneficiary declared ineligible for means-tested benefits, such as Medicare.

That is, if a Special Needs Trust is required to distribute to beneficiaries the required minimum distribution (RMD) from retirement accounts, the distributions would reduce the trust’s taxable income on the trust’s fiduciary income tax return, but would increase the beneficiary’s income. If the trust is an Accumulation Trust and is not required to distribute the income to the special needs beneficiary, the undistributed income is taxable to the trust itself, and it is not deemed to be taxable income of the trust beneficiary; since the income is retained by the trust, it is not considered to be the beneficiary’s income and does not disqualify the beneficiary from means-tested government benefits.

To be a valid Accumulation Trust, (a) the trust must be a valid trust under state law, (b) the trust must be irrevocable, (c) the beneficiaries must be identifiable and (d) certain documentation must be provided to the plan administrator.

As a result, even though the RMD may be taxable to the Accumulation Trust in high income tax brackets, The SECURE Act of 2019 may permit smaller RMDs from a retirement account to a trust for a disabled or chronically-ill beneficiary, in which case the amount required to be distributed to the trust will often be a smaller amount than would be applicable if the beneficiary were not disabled or chronically ill. That is, the tax detriment caused by the high fiduciary income tax rates, may be partially offset by a lower RMD from the retirement account to the trust.

If you currently have named a trust for the benefit of a disabled or chronically-ill trust beneficiary as beneficiary of your retirement account, you should review the terms of the trust with a qualified attorney, to make sure that the trust is not a Conduit Trust, which could render the trust beneficiary ineligible for means-tested government benefits, such as Medicaid.

If you have a retirement account or accounts from which you want to accumulate retirement income in trust for the possible needs of a disabled or chronically-ill beneficiary, you should consider having the retirement account payable to an Accumulation Trust for that beneficiary, instead of a Conduit Trust, which must be paid out at least annually to the beneficiary.

The economic downturn caused by COVID-19 will unfortunately be with us for the foreseeable future. There has never been a better time to try to make the best financial decisions possible. 

I have been working in the Bankruptcy Law area for over 20 years along with my paralegal, Vicki Craver. We have seen decisions made by folks, sometimes out of panic or frustration, that have led to regrettable outcomes. I can share some of those decisions with you.

Although it is sometimes difficult to know what to do in any given situation, I can point out traps to avoid regardless of the situation.  First, normally a debt relief company is not a good idea. I have seen hard working people pay large amounts of money to these organizations only to find themselves in several collection lawsuits. This is sometimes caused by someone having, for instance, 7 credit cards or other debt problems. The debt relief outfit says:  Great news! We have worked out deals with 4 of your accounts. Well, guess what happens to the other 3! Also, if you are not able to make the payments to the debt relief organization (and, of course, they keep part of your money), the other 4 that were “handled” come after you in court as well. 

Creditors are also quick to tell you not to file bankruptcy. That is a self-serving statement for them because they know that a bankruptcy filing protects you from creditors (them) and they are no longer in the driver’s seat. 

Another ‘trap’ is raiding your retirement accounts. Normally, retirement accounts are protected in bankruptcy and, therefore, safe. However, folks tend to see the 401k as a way keep their accounts current. Tragically, they deplete the retirement account and have only bought themselves a short amount of time only to be back where they started. 

When a financial crisis hits, another common trap is to use available credit card limits to keep your life together. Once again, that only results in creating an even more difficult situation down the road. To be sure, credit card companies are not concerned about you putting food on the table for your family. All they want to know is when are you going to send them more money. 

I would be happy to meet with you at no charge for the initial consultation to assess your situation and possibly help you avoid having to file bankruptcy. Please do not hesitate to contact me. It may be one of the best financial decisions you make.   

You can reach me by email at clydec@craigejenkins.com, by phone at 336-714-2561 or contact my paralegal, Vicki Craver, by email at vickic@craigejenkins.com or by phone at 336-714-2568.

By Cowles Liipfert

With less than 1% of taxpayers now being subject to federal estate tax under the new tax laws, the emphasis for tax planning for most of us has shifted from estate tax planning to income tax planning. Many people have retirement accounts of sufficient size to warrant more attention to income tax planning for those assets.

A participant’s retirement account is funded with tax-deductible contributions during his or her high earning years, presumably when he or she is in a higher income tax bracket than after retirement. By making contributions during a participant’s high-earning years, the participant not only delays the payment of taxes on the contributions, but also is likely to have lower tax rates when distributions are later made.

The participant gets tax deductions for contributions to the account, and the account builds value tax-free until distributed. Maximum funding of a retirement account during one’s working years is usually a very effective tax planning technique.

DISTRIBUTION RULES DURING OWNER’S LIFETIME

With a traditional IRA, the owner has to begin taking required minimum distributions (RMD) for the calendar year in which he or she reaches age 72, by April 1 of the following calendar year.

Prior to the adoption of the “Setting Every Community Up for Retirement Enhancement” (SECURE) Act in December 2019, the required beginning date for IRAs was April 1 of the year after which the IRA owner attained age 70½. The old rule is applicable through 2019, but not to 2020 or later years. Under the old rule, if the IRA owner’s birthday was on or before June 30, the required beginning date would be April 1 of the following calendar year, but if his or her birthday was on or after July 1, the required beginning date was one year later, also on April 1. The new rule under the SECURE Act makes April 1 of the following year after you attain age 72 as the required beginning date, no matter whether your actual birth date is in the first six months or the last six months of the year.

There is a “uniform lifetime table” whereby the RMD or required minimum distribution is determined, based on the life expectancy of the account owner and the life expectancy of a second person who is 10 years younger, but if a taxpayer is married to a spouse who is more than 10 years younger, the account owner may use a “joint and survivor table,” based on the taxpayer’s age and the actual age of the younger spouse. The Life Expectancy Factor under the uniform lifetime table for an IRA owned by for a person who is age 70, is 27.4 years; for age 80 is 18.7 years; for age 90 is 11.4 years; and for age 100 is 6.3 years. The reason those life expectancies seem so long is because they are based on the life expectancies of the second to die of two lives, using 2-life tables, based on the age of the account owner and the age of a person who is ten years younger.

Please be aware that the uniform lifetime table applies to every IRA owner (not including owners of “inherited” IRA accounts), except someone with a spouse who is more than 10 years younger. It applies to someone with an older spouse, to someone with no spouse, and to a participant who has not named a beneficiary at all for his or her retirement account. It also applies to someone who has designated his or her children, grandchildren, or others – except for a spouse who is more than 10 years younger – as beneficiaries of his or her account.

Distributions from an IRA or qualified plan before the taxpayer reaches age 59½ are ordinarily subject to a 10% early withdrawal penalty, but there are exceptions to the general rule: If the IRA owner qualifies as a first-time homebuyer, for example, he or she can withdraw up to $10,000, penalty-free, to use as a down payment or to help build a home. With the cost of higher education spiraling, people are also allowed to turn to their IRAs to help pay certain college expenses, penalty-free, from their IRAs – for tuition, books and other qualifying expenses – as long as the student (you, your spouse, your child, or your grandchild) is enrolled more than half-time at an eligible educational institution. Distributions for those purposes are not subject to the 10% early withdrawal penalty, but they are subject to regular income tax.

Early withdrawals also may be allowed penalty-free through a “Substantially Equal Periodic Payment” (SEPP) plan, with specified annual distributions for a period of five years or until the account-owner reaches age 59½, whichever comes later. Again, income tax must still be paid on the SEPP withdrawals, but no penalties. A SEPP plan is best suited to those who need a steady stream of income prior to age 59½, perhaps to compensate someone whose career has ended earlier than anticipated.

SEPP plans can be boons to those who need access to retirement funds earlier than age 59½, but starting a SEPP early – or even withdrawals for educational expenses or for a down payment on a new home – will have implications for your security later, in retirement. If you spend the money now, it will not be available when you are older. Before you embark on a SEPP plan, you should get the advice of your financial planner.

DIRECT TRANSFER FROM IRA TO CHARITY

If you are fortunate enough that you do not need your IRA distribution for living expenses, and if you are charitably inclined, you can avoid income tax by making a direct distribution from your IRA, up to $100,000/year, to a charitable organization. This is called a “Qualified Charitable Distribution” or QCD. If you file a joint income tax return and if your spouse also has an IRA, your spouse can also make a QCD of up to $100,000 from his or her IRA, which will not be taxable on your joint tax return. The gift will also reduce the value of your IRA account, thereby reducing your required minimum distributions (RMDs) in the future.

QCDs may be made only from IRAs – not from 401(k)s or other similar retirement accounts – but you can roll over funds from a 401(k) account to an IRA, then make the gift from the IRA to the charity. This takes extra time, and you must meet the deadline (usually December 31) for completing the charitable gift.

The charity to which you make the gift must be a 501(c)(3) organization, eligible to receive QCDs, but may not be (a) a private foundation, (b) a “supporting organization,” which is an exempt organization which carries out its exempt purposes by supporting other exempt organizations, or (c) a Donor-Advised Fund of “sponsoring organization,” which is a public charity which accepts and manages such funds, and from which distributions may be made to other charitable organizations, as recommended by individuals or families.

Please note that the QCD is not included in your taxable income, so you cannot claim an itemized charitable deduction for your gift on your income tax return. Otherwise, you would be getting a double benefit, i.e., (1) the distribution to charity would not be taxable income on your tax return, and (2) if it had been deductible, you would also get an itemized charitable deduction on your tax return. That would be too good to be true and is not allowed. However, you can still claim a standard deduction on your personal return – not an itemized charitable deduction – in addition to excluding the income.

Another benefit is that, since the qualified charitable distribution is not counted as part of your income, it will not be subject to the limitation to charitable deductions on your income tax return – that is, charitable deductions cannot exceed 60% of your adjusted taxable income. Consequently, it is less painful tax-wise to make large charitable contributions in this manner, for those with ample other means of support.

THREE WAYS TO MINIMIZE TAXES ON REQUIRED MINIMUM DISTRIBUTIONS

1. One simple step, if the account owner is still working after age 72, would be for him or her to continue making contributions after that age to his or her IRA or 401(k) or similar account, which would provide an income tax deduction to offset income from the required minimum distribution. For example, if a 75-year-old person has an RMD of $5,000 from his or her IRA, and if he or she contributes $7,000 to his or her 401(k) from his or her earnings, the deduction would more than offset the taxable income from the RMD. The age limit for IRA contributions – formerly 70½ – has been removed by the SECURE Act.
2. There is another exception for calculating the required minimum distribution for a taxpayer older than 72 who works for a non-profit entity or who works for a for-profit company in which he or she owns less than 5% of the company, if the employer has a 401(k) program which accepts rollovers from IRAs. In that case a taxpayer may be able to roll over his or her IRA into the company’s plan, and thereafter not be required to take required minimum distributions applicable to IRAs from that account until actual retirement from that employer. If you are still employed, you will need to inquire with your employer, to see if you can roll over your IRA to the company’s 401(k) plan and if so, whether you can defer distributions until you retire.
3. Another (more complicated) alternative, allowed by the IRS since 2014, would be to purchase a Qualified Longevity Annuity Contract (QLAC) inside your IRA. Many consider an annuity to be a poor investment for an IRA, since both annuities and IRAs are “tax shelters” – and to hold a tax shelter within a tax shelter is a redundancy and wastes the tax benefit of one of the shelters. You get the benefit of only one tax shelter when an IRA owns an annuity.

But the purchase of a QLAC within an IRA offers a different kind of tax advantage: the purchase of a QLAC is a retirement strategy in which an IRA owner can defer a portion of his or her required minimum distributions (RMDs) until a certain age (maximum limit is age 85). A QLAC is an annuity bought with a chunk of money from an IRA now, for payouts starting years later, but no later than at age 85. Money tied up in the QLAC is not counted in calculating your RMD, so the QLAC reduces your required minimum distribution (RMD). Also, it allows the value of the annuity to grow tax-free until you reach the annuity starting age, typically at age 85. Qualified longevity annuity contracts (QLACs) can be bought inside an IRA with (a) up to 25% of the IRA’s value or (b) the amount of $135,000 (in 2020) – whichever is smaller. The annuity would be paid to the annuitant or annuitants for life after the starting age, which provides a guaranteed stream of income which the annuitant or annuitants will not outlive.

The tax benefit of purchasing a QLAC is to reduce income taxes by removing money from the calculation of the required minimum distributions (RMDs) from your IRA after attaining age 72. QLACs are legal creatures created by the IRS to address the fears of many individuals as they grow older, of outliving their money. A QLAC is an investment vehicle to guarantee that some of the funds in a retirement account may be turned into a lifetime stream of income without violating the required minimum distribution rules. The annuity will be paid, no matter how long the individual lives – that is, the recipient cannot outlive the annuity payments.

Annuities provide guaranteed payments to the annuitants during their lifetimes, but at the death of the annuitant (or surviving annuitant, as the case may be) the payments stop. Consequently, an annuity itself is not a good vehicle for passing wealth to persons other than the annuitants. If an annuitant dies (or both annuitants die, if applicable) unexpectedly early, the annuity would prove to have been a poor investment, but if the annuitants outlive their actuarial life expectancies, the annuity may prove to have been a very good investment. Even though nothing would pass to the family at the death of the last surviving annuitant, the annuity payments would presumably allow the annuitant or annuitants to preserve other assets, which would pass to the annuitants’ survivors.

To prevent a total loss of premiums paid for an annuity if the annuitant or annuitants die early, the annuity (including a QLAC), may be custom-designed in some respects to meet your needs. For example, (a) a QLAC could be a joint annuity with the primary annuitant’s spouse, whereby the annuity payments continue for the lifetime of the spouse, if he or she survives, (b) the annuity may guarantee that any unused premium at the annuitant’s death will be refunded, and/or (c) the annuity payments may be adjusted for inflation. Under (b) above, if the annuitant originally paid $100,000 for an annuity, and if the annuitant died before the annuity had paid out $100,000 in total annuity payments, then the remainder of the $100,000 would be refunded.

There are negatives to owning a QLAC in your retirement account. For example, (1) if you need money sooner than originally expected, you could not get payments from the annuity in advance, and (2) your annuity would be only as secure as the company which issued the annuity – so your money would be at risk if the company became insolvent. You need to consult with your financial advisor before embarking on such a strategy.

PROS AND CONS TO ROLLING OVER IRA TO 401(k) – AND VICE-VERSA

An IRA-to-401(k) rollover offers benefits, such as (a) earlier access to the money at age 55 without penalty (as compared to age 59½ for an IRA), and without a Substantially Equal Periodic Payment Plan (SEPP) , (b) postponing required minimum distributions if still working for the employer with the 401(k) plan, and (c) in some instances, easier conversions to Roth IRAs. Also, in some states (other than North Carolina), 401(k) accounts have protections against creditors that IRAs don’t provide; in North Carolina, IRAs are protected against creditors. Also, loans are allowable from 401(k)s, whereas loans from IRAs are not allowed. Generally, you do not want to borrow against your 401(k) account, but, if you have a temporary need which can be repaid in the future, you may, as a last resort, be able to borrow from your 401(k) and to repay the loan with interest.

There are a lot of circumstances where a traditional IRA has a leg up on a 401(k) account, which is why so many people roll their 401(k) accounts into IRAs. Advantages can be wider investment selection, often lower investment costs, and looser rules for hardship withdrawals, without penalty – for reasons such as higher education expenses and first-time home purchase (limit $10,000).

DISTRIBUTIONS AFTER DEATH OF IRA OWNER/PARTICIPANT

It is very important for you to complete the beneficiary designation forms for your retirement account. Sometimes participants fail to fill in the necessary paperwork, or when they do fill in those documents, it is without professional advice. If no beneficiary is named, the default beneficiary is often the participant’s estate. Although naming an estate or trust as a beneficiary may seem logical, you’ve got to be careful. Doing so may subject an estate or trust to unexpected rules and implications, and sometimes imposes them with tax results which might seem unfair or even nonsensical.

Some rules which apply to beneficiaries of IRAs are:

1. If a spouse is the beneficiary of the owner’s IRA at the owner’s death, the spouse can “roll over” the balance in the account into his or her IRA, or into a “rollover IRA” opened by the surviving spouse, on which the spouse will be subject to similar distribution rules as an original IRA owner. That is, the RMD will be based on the joint life expectancies of the surviving spouse and an individual who is 10 years younger. If the spouse is under age 72, distributions from the rollover IRA will not be required until the spouse reaches age 72. However, the surviving spouse may take discretionary withdrawals before age 72 and can receive distributions in excess of required minimum distribution (RMD) after reaching age 72.
2. If a beneficiary is someone other than a spouse, the account may not be “rolled over” into the beneficiary’s IRA or a rollover IRA, but the IRA may be transferred to an “inherited IRA” account, which is not the same as a spousal “rollover” account. A beneficiary other than a spouse must take RMDs from the inherited IRA account starting the following calendar year, no matter what the age of the beneficiary. That is, the beneficiary of an inherited IRA cannot wait until he or she reaches age 72 before taking distributions. Since annual distributions are mandatory, there is no 10% penalty for distributions from inherited IRAs made to beneficiaries under the age of 59½. Under the old rules applicable prior to the enactment of the SECURE Act effective December 20, 2019 – an inherited IRA was subject to a one-life mortality table instead of a two-life table, and life expectancy was not recalculated as the beneficiary grew older. Under the SECURE Act applicable to accounts of participants who died on or after January 1, 2020, an inherited IRA must generally be distributed to the beneficiary over a period of no more than 10 years.
3. On a different related topic, the IRS has not issued guidelines – but there have been several private letter rulings (requiring some expense to taxpayers) – to allow spousal rollovers of qualified plans and IRA benefits when an estate or trust is the beneficiary of the account, (a) when the spouse is sole beneficiary of the estate or trust, and (b) has a general power of appointment over the trust. This can apply where there is no named beneficiary and the “default” beneficiary is the participant’s estate.

In a 2018 private letter ruling, a decedent failed to designate any post-death beneficiary and the plan was payable by default to the decedent’s estate. The decedent had no will, and under state law the estate was split among the surviving spouse and the children. The children were adults with no children of their own and all executed valid disclaimers, leaving the spouse as sole beneficiary of the estate. The IRS approved a spousal rollover in that case.

“STRETCH” IRA STRATEGY

“Stretch IRAs” have been popular for many years as a strategy for slowing down the mandatory payout of IRAs, by designating much younger beneficiaries at the owner’s death – such as grandchildren – to take advantage of their longer life expectancies (and consequently, lower required minimum distributions) than older beneficiaries. Until adoption of the SECURE Act discussed in the following paragraph, an IRA left to a beneficiary other than a spouse was payable over the life expectancy of the beneficiary. That is, if the beneficiary had an actuarial life expectancy of 30 years , the required minimum distribution (RMD) for Year 1 would be 1/30th of the account’s value, for Year 2 would be 1/29th of the account’s value, etc. If the beneficiary died before the account was closed out, his or her successor would continue, on the original beneficiary’s schedule until the account was depleted.

That tactic has been brought to a screeching halt – the SECURE Act, signed into law on December 20, 2019, and generally effective on January 1, 2020, has changed that all, by generally requiring that inherited IRAs by beneficiaries other than spouses must be paid out in no more than 10 years. That is, inherited IRAs left to much-younger beneficiaries will generally need to be paid out in 10 years, instead of over the actuarial life expectancy of the beneficiary. There are exceptions applicable to certain “eligible designated beneficiaries.” If your current estate plan includes a “stretch” IRA, you should go back and re-visit your plan, to see whether it still fits your needs, given the new 10-year payout rule.

An “eligible designated beneficiary” who is not subject to the 10-year payout requirement includes an individual who is (i) the employee, or IRA owner, (ii) a spouse of the participant, (iii) a minor child of the participant, (iv) a person who is disabled or “chronically ill,” as defined in Internal Revenue Code Section 401(a)(9)(E)(ii)(IV), or (v) any individual who is not more than 10 years younger than the participant. But upon the death of the “eligible designated beneficiary,” the 10-year rule kicks in, instead of continuing to be distributed over the remaining life expectancy of the original “eligible designated beneficiary.” When a minor beneficiary attains the age of majority applicable in his or her state (usually age 18 or 21), the 10-year rule kicks in, but a child may be treated as though he or she had not reached the age of majority, if he or she (a) has not completed a specified course of education as described under Internal Revenue Code Section 401(a)(9)-6 and is under 26 years of age, or (b) if applicable, so long as the child continues to be disabled after reaching the age of majority, see Reg. § 1.401(a)(9)-6, A-15.

The new legislation will not affect the terms of payout for original designated beneficiaries of participants who died before January 1, 2020, and it will be applicable only to accounts of participants who die on or after January 1, 2020, subject to the proviso that, instead of continuing to follow an original designated beneficiary’s minimum distribution schedule if the original designated beneficiary dies on or after January 1, 2020, the distribution schedule for any successor beneficiaries will be re-set to a 10-year payout schedule.

A POSSIBLE ALTERNATIVE WHICH SPREADS OUT RETIREMENT DISTRIBUTIONS

An alternative strategy which is still available would be to leave an IRA upon death to a charitable remainder trust (CRT), which would pay a flat percentage each year to the beneficiary or beneficiaries, either for their lifetimes or for a term not to exceed 20 years, whichever the Trust Grantor selects, following rules applicable to IRAs. A CRT is a tax shelter itself, and no income tax would be payable when the IRA was paid to the CRT, but distributions from the CRT to individual beneficiaries of the trust would be taxable to those individual beneficiaries when distributed. In the meantime, the investments inside the CRT could accrue tax-free, perhaps allowing the value of the CRT to grow. At the death of the last surviving beneficiary, the trust would terminate, and the account would be paid to a charitable beneficiary or beneficiaries, as set forth in the trust agreement for the CRT.

Because laws are changed from time to time, and because it is possible for a retirement account owner to become incapacitated, it is a good strategy for the owner to have a durable power of attorney which would be effective in the event of incapacity, specifically empowering the Agent under the durable power of attorney, on behalf of the owner, to change the beneficiaries of retirement accounts and even to create entities such as charitable remainder trusts.

SECURE ACT OF 2019

The SECURE Act was enacted in December, 2019, to expand the opportunities for individuals to increase their savings and to make administrative simplifications to the retirement system. In addition to some of the changes discussed above (moving the required beginning date to age 72 instead of age 70½, permitting deductible IRA contributions after the required beginning date for withdrawals, generally eliminating “stretch” IRAs, etc.), the SECURE Act makes it easier for small businesses to offer multiple employer plans by allowing otherwise-completely unrelated employers to join the same plan, and It also makes it easier for long-time part-time employees to participate in elective deferrals, and it allows penalty-free distributions from qualified plans and IRAs for births and adoptions. Also, penalty-free distributions are allowed from defined-benefit plans or IRAs for the birth or adoption of a child. These withdrawals may be repaid to such a retirement account.

The old rules were not repealed, but the provisions of the SECURE Act were superimposed on the old rules. Consequently, the ins-and-outs of the SECURE Act are very complicated, and there is a separate blog on our law firm’s website which discusses that Act in more detail.

By Cowles Liipfert

Donor-Advised funds are a tax-advantaged way to make gifts to charities over time. A donor-advised fund is basically an account with a public charity which has a donor-advised program and which qualifies as a “sponsoring organization.” Gifts are made to the fund, which is held in the name of the donor or in the name or names of the donor’s family members. Gifts from donors to the fund qualify as charitable deductions for income tax purposes, and distributions are made from the fund to charitable organizations over time.  Distributions from the fund do not count as additional charitable deductions for the donor, since the donor has already gotten a charitable deduction when the original gift was made to the fund.

Donor-advised funds are usually opened during the lifetimes of the donors, and distributions are made to charitable organizations which the donors select.  Since the sponsoring organization is responsible for seeing that the tax laws have been complied with, the donors make “recommendations,” and not binding directives, as to the distributions to tax-exempt organizations.  Normally those requests are honored unless the requested done does not qualify as a tax-exempt organization. Donor-advised funds may also be created, or increased at death under a will or trust agreement of the donor, often with family members of the donor to make distribution recommendations to the charitable organization after the deaths of the donors.

Donor-advised funds may be used to support  a number of public charities. They are sometimes used as alternatives to private foundations.

Private foundations are separate legal entities created by a donor or donors. They require ongoing maintenance and expense.  Also, the donors receive smaller tax benefits than they would receive with a similar gift to a donor-advised fund at a public charity.  Legally, a private foundation allows the donor or donors to retain more control over the investments, grants, and control of the entity.

Donors often prefer a donor-advised fund instead of a private foundation for convenience, reduced costs, greater tax benefits and ease of gifting, with no worries about minimum distributions or the tax issue of excise tax on net investment income, which would be applicable to a private foundation.

The donors may make a large charitable gift to the donor-advised fund, and have the gift used to make periodic distributions over time, with the donors not having to worry about compliance costs and requirements.

“Bunching” of Charitable Deductions

Under the new tax laws with higher standard deductions, donors who traditionally have made charitable gifts of several thousand dollars a year in deductible contributions now often receive reduced or no tax benefits from making their customary annual distributions.

For example, consider married donors with $120,000 annual income, who traditionally give about $5,000 per year to charitable organizations.  On their tax returns, they cannot claim medical deductions of less than 10% in 2019 (formerly 7.5% in 2017 and 2018), so often the

taxpayers would not itemize medical deductions.  They cannot deduct more than $10,000 per year in state and local taxes, and there is no longer a deduction for miscellaneous itemized deductions.  Unless they have high home mortgage interest, if they donate $5,000 to charitable organizations in 2019, their total deductions may be less than their standard deduction of $24,400 (in 2019), in which case they would receive no income tax benefit for charitable gifts  totaling $5,000. 

In the alternative, let’s consider “bunching” their contributions by the use of a donor-advised fund.  For example, they could give $50,000 to a donor-advised fund in 2019. If their itemized deductions otherwise would be $10,000 in state and local taxes and $5,000 in home mortgage interest, the gift to the donor-advised fund itemized tax deductions  would now total $65,000 ($50,000 gift to the donor-advised fund, plus $10,000 in state and local taxes and $5,000 in mortgage interest), as compared to a standard deduction of $24,400. Their income taxes for 2019 would be reduced by over $10,000, assuming they were in a 28% marginal tax bracket.

The donor-advised fund would receive $50,000 in gifts, but it would be possible to distribute from the fund only the donors’ customary $5,000 to charitable organizations, as requested by the donors.  The charities would receive their customary gifts in 2019 and the donor-advised fund would retain the remaining $45,000. In future years similar gifts could be made from the donor-advised fund each year, as directed by the donors or their family.

The donors could resume claiming a standard deduction on their subsequent income tax returns, until the fund was depleted.  If the donors died or became incapacitated, their families could continue to make charitable contributions from the fund.   

The above example illustrates moderate gifting and the effect of “bunching,” but donor-advised funds are often utilized for very large gifts, often at the death of a donor, sometimes in lieu of a private foundation.

Families With Existing Private Foundations

If the donors already have a private foundation which they find expensive and burdensome to maintain, the private foundation could distribute its assets to a donor-advised fund with a sponsoring organization.  The sponsoring organization would then be responsible for compliance with federal laws, instead of the donors or their family’s being responsible.

Multi-Generational

Another possible benefit would be to bring one’s children into the gifting process during the donors’ lifetimes.  After the donors’ deaths, the children would continue to make recommendations for charitable gifts from the donor-advised fund.

Most sponsoring organizations allow grantors or designated family members as advisors for charitable gifts for at least one generation, and some allow two generations.

Sponsoring Organizations

Most community foundations have donor-advised fund programs and sometimes other organizations such as colleges and universities maintain similar funds, where a certain percentage of contributions must go to the sponsoring organization itself, such as 50%, and the remainder can go to other charitable organizations.  

A donor who wishes to establish an ongoing philanthropic program – for themselves and/or their families – should consider establishing a donor-advised foundation as part of their ongoing gifting, and possibly establishing the habit of ongoing gifting to charities for their families.

In Winston-Salem, the Winston-Salem Foundation, Suite 200, 751 West Fourth Street, Winston-Salem, NC 27102, (336) 725-2381, can be contacted about the establishment of a donor-advised fund.  See https://www.wsfoundation.org/contact.   

Several larger cities and counties in North Carolina have large community foundations, similar to The Winston-Salem Foundation.  The North Carolina Community Foundation is a single statewide community foundation with a network of affiliate foundations across the state, which serve many rural and less-populated counties, and which can serve as a sponsoring organization for donor-advised funds in their communities.  A list of affiliated community foundations funds can be found at nccommunityfoundation.org/communities.

It is very easy to set up a donor-advised fund with a sponsoring organization.  Just contact the organization and see whether it is a sponsoring organization for donor-advised funds.  If so, they will meet with you and draft a letter whereby the organization agrees to be the sponsoring organization for your donor-advised fund, which describes the purposes for your fund, etc.  They will make it easy for you.