New Opportunities Under New Estate Tax Law – Part 2

In my last post I began a discussion of the new estate tax law and how some of the provisions my affect you.
  • Make Gifts During Your Lifetime. At death, you can leave up to $5 million in trust or outright to heirs free of estate taxes. You don’t have to wait until you die to make use of the new $5 million exemption. The new law allows you to apply that limit either during life or at death. It’s like rollover minutes for your cell phone…any of the unused $5 million gifts during your lifetime rollover at your death! This lifetime gift exemption is in addition to the annual gift tax exclusion of $13,000 per recipient. Planning point: If you are a small business owner who would like to make certain the business stays in the family, now may be an excellent time to gift some of your business ownership to children. You may get a double benefit due to timing the gift at the end of the recent Great Recession whereby business valuations are low. Then as the economy recovers the appreciation of the transferred business interests will accrue to the new owners which helps you reduce your future estate as well. And this is not just for business owners. If you have an estate that significantly exceeds the exemption amount, you may want to consider making tax free gifts to family members using assets that you believe will appreciate in value in the years ahead. This may be a disappearing opportunity since this $5 million tax free gift is set to expire. If congress takes no action, this limit will drop to $1 million on January 1, 2013.
  • Heirs receive a new tax basis for transfers at death. This is not new but is a point worth making. For example, many times people will hold a stock in which they have a low tax basis so as to avoid paying capital gains taxes if sold. If they die still holding that stock and you inherit it, you receive what’s called a stepped-up tax basis, meaning you could immediately sell it and owe no taxes. Planning point: You face a trade off in deciding whether to make transfers during your lifetime (as in my point above) versus transfers at death. The recipient of a gift during your lifetime gets your same tax basis so that a future sale would be potentially subject to capital gains taxes.
  • Lower transfer tax rates now. For gifts or death transfers in excess of the $5 million limit, the new tax rate is 35%. It is set to go to as high as 55% in 2013 if congress fails to take action otherwise. This tax rate applies to lifetime gifts or transfers at death in 2011 or 2012.   Planning point: If you have a very large estate and would consider making gifts that exceed the $5 million lifetime gift limit, you’ll likely never have a chance to do so at a lower tax rate.
Whether you feel your estate is large enough to take advantage of any of these strategies, be clear that, at a minimum, you need at least a basic estate plan which would include a will, durable power of attorney and advanced healthcare directive.


New Opportunities Under New Estate Tax Law – Part 1

It’s hard to imagine that Abraham Lincoln, Michael Jackson and Pablo Picasso have anything in common but it turns out that they do…each of them died without having a properly executed last will and testament. One was an attorney and president of the United States, one was a musician whose estate has produced over $200 million in revenue since his death and one was an artist who left a fortune in artwork and whose estate ultimately cost his heirs over $30 million to settle.

This year and next, you have an opportunity to revisit your own estate plan in light of a recently passed estate tax law that offers many opportunities for business owners, wealthy families as well as the ‘not yet wealthy’. The reason your ‘opportunity’ is time-sensitive is that this new law is set to expire December 31, 2012. Here’s a quick review of the major provisions of the new law as well as several planning strategies worth considering:
  • Up to $5 million exempt from estate taxes. The amount that you can leave a non-spouse (including a trust) without paying estate taxes is $5 million. If you are married, you can each leave $5 million for a total of $10 million. If congress doesn’t make any changes, this exemption amount will drop to $1 million beginning in 2013. Planning point: Many wills use a formula that states that the maximum amount allowed under law first goes to fill up the family trust with the balance going either outright or in trust for the surviving spouse. With this higher limit, it means that in many cases all of the assets will go to the family trust and none to the surviving spouse either outright or in the marital trust. For many families, this is an unintended consequence. Have your attorney review your documents to determine if changes are warranted.
  • Portability of Exemption Amount. If your spouse dies without using his or her full exemption amount, any unused exemption is transferred to the surviving spouse. In the old days, the unused amount was simply lost. To solve this problem under the old law, advisors would direct clients to transfer assets from the name of one spouse into the name of the other in order to ‘equalize’ their estates. This was often a challenge particularly if one spouses’ assets were largely held in a retirement account. Planning point: Theoretically, this activity of equalizing the estates between spouses is no longer necessary since the surviving spouse now ‘inherits’ the deceased spouses’ unused exemption. However, if the surviving spouse were to remarry, the exemption of the deceased spouse would be lost forever. When you review your estate documents, decide if assets need to be transferred between spouses to make certain the full exemption is available to both of you. Transfers between spouses during life or at death are not subject to either gift or estate taxes.
Next week I’ll complete my discussion of the new law and the planning opportunities it presents. Specifically we’ll look at opportunities for small business owners; families with large estates; as well as strategies for folks with smaller estates.


Will Your 401K Be Enough?

Research that was spearheaded by the Federal Reserve suggests that those pre-retirees, ages 60-62 are significantly unprepared for retirement. Here are some of the basic facts:
The median income for couples in this group is $87,700 with a median 401-k account of $149,400. If we assume a retirement income need of 85% of pre-retirement income, they’ll need about $75,500 per year plus annual increases for inflation. Social Security may provide $30,000-$35,000 of their need leaving the 401-k to make up the balance. Using a 5% withdrawal rate from the 401-k produces an additional $7,500 per year leaving an annual short-fall of $33,000-$38,000 or about 50%.
How did this happen? Americans have been under-savers for decades. Until recently, historical savings rates varied from zero to about three percent annually. In the days of old, people counted on company pension plans to provide the foundation for their retirement. But, in the eighties, companies began to abandon pension plans in favor of 401-k plans as a way to cut future costs. While 60% of this age 60-62 group has a 401-k plan, most under-contributed while many more failed to participate. Couple all of this with a decade where the stock market produced virtually no returns and you have created the perfect storm.
What’s the solution? There are no easy solutions for this group because the most important element, that being time, cannot be retrieved. However the first step is to assess the size of your problem by doing a retirement analysis. It may be that you can comfortably live on a lot less than 85% of your pre-retirement income. Other possibilities include downsizing your home to retrieve some equity that can be invested for additional cash flow. You could also tap your home equity with a reverse mortgage. Another strategy would be to use your 401-k money to buy a lifetime annuity. Based on current rates, you’d increase your cash flow by about $3,000 per year but part of this added cash flow represents a return of your principal and there will be nothing left of your 401-k for your heirs. Another choice, one that many people are making, is to simply work longer either on a full-time or part-time basis. If you fall into this age 60-62 group and would like a free retirement analysis, email me at and put ‘Retirement Analysis’ in the subject line. We’ll run a report and give you a quick assessment of strategies that might be helpful.
Lessons for the next generation: Unfortunate circumstances, lack of planning and less-than-optimal decisions have left many of the Baby Boomer generation in a difficult position regarding their retirement plans. This doesn’t have to be the case for the next generation. A few simple changes can turn a retirement nightmare into an early retirement dream:
  • Start early. Save a minimum of 10% of your gross income. If you are in your thirties and haven’t created significant savings, up this percentage to 12%-15%. If you’re just getting started and you’re in your forties, target a savings program of 15%-20%.
  • Capture the match. If your company offers to match a portion of your 401-k contributions, be sure to invest enough to capture the entire match.
  • Invest in stocks. Just because the last decade produced poor stock market results, don’t give up on the stock market. American free enterprise is alive and well and I expect the stock market to return to more normal historical returns (8%-12%) in the decades ahead.


“Christmas Comes Early” Estate Tax Roulette

Halleluiah! Halleluiah!

This chant is usually reserved for holiday cheer but estate attorneys and financial advisors throughout the land are singing this song in praise of President Obama and the Republican compromise proposal to raise the estate tax exemption to $5 million ($10 million for couples) with a maximum 35% tax rate on the balance. This is the equivalent of a full exemption for the vast majority of Americans. Had no compromise been offered, the estate tax exemption was set to drop to $1 million exposing millions of middle class Americans to a maximum of 55% taxes on a portion of their estate. That’s the good news. The bad news is that these new rules are effective only for tax years 2011 and 2012. Beyond that, we don’t know what the rules will be which continues to create uncertainty and makes long-term planning difficult.

In addition to revisions in the estate tax rules, the compromise plan will extend the Bush tax cuts for all taxpayers for a period of two years. This is great news for millions of retirees who depend on stock dividends for a portion of their retirement income. This keeps dividends taxed at the 15% federal rate rather than ordinary income which could be as high as 35%.

One of the biggest surprises in the compromise proposal is a one-year reduction in the payroll tax of 2%. If you earn $50,000, this means you’ll see an additional $1,000 in your paycheck. The payroll tax maxes out at $106,800 which would produce savings of $2,136 for every worker earning that amount or more.

Businesses will be allowed to immediately write off certain equipment purchases rather than deducting the costs over a number of years. This acceleration of tax deduction will encourage businesses, who have been postponing purchases, to buy equipment over the next two years.

What this means for the economy. The goal of the compromise measure is to further stimulate the economy which has been marred at anemic growth levels for a near record number of months. You know, this just might work. Many companies have been holding back due to uncertainty regarding taxes and regulations. Now they have a much better understanding of the playing field.

What this means for the stock market. The compromise measure should prove positive for the stock market. Both public and private corporations have ‘leaned-out’ their organizations to the point that an uptick in revenue should quickly drive up profits.

What this means for you. With the new $5 million exemption, many wills will direct all of the first spouse’s assets into a family trust and nothing outright to the surviving spouse. Use this as an opportunity to review your estate plan. Decide now what you’ll do with your payroll tax savings. Suggestions include paying on high interest debts such as credit cards; building an emergency reserve or starting an investment program. Now is a good time to review your investments and consider increasing your allocation to stocks.

The final bill must be hammered out in committee and passed by both houses but for now, all I can say is ‘Halleluiah!’

2010 IRA Deadlines

With about thirty days remaining in this calendar year, those of you with IRA accounts have a number of opportunities or responsibilities with a year-end deadline.

Required Minimum Distributions (RMD). As a result of the financial and economic crisis, congress temporarily eliminated the Required Minimum Distributions for retirement accounts for 2009 but brought it back for 2010. If you turned 70 ½ this year, you must take a minimum distribution from your IRA account by April 1, 2011. However, if you wait until then, you’ll be required to take two distributions in 2011…a year when tax rates may be higher. If you are 71 or older, you must take your required RMD by December 31st of this year or face a 50% penalty.
Convert your Traditional IRA to a Roth IRA. For 2010, congress eliminated the income limitation for converting a traditional IRA to a Roth. As a result, many people are considering doing a conversion this year. To sweeten the pot, congress passed a special rule: If you convert by December 31st, you have the option of reporting the tax on converted funds on your 2010 tax return or splitting the income between tax years 2011 and 2012. Remember, rarely is it advantageous to convert to a Roth IRA unless you have the funds to pay the tax from a source other than your IRA account. If you plan to do a conversion this year and pay the tax on your 2010 tax return, one strategy to lessen the tax bite is to accelerate several years of planned charitable donations with a contribution to a donor advised fund such as the Community Foundation of Greater Birmingham (205 327-3800). This will allow you to partially offset your taxable IRA conversion with your charitable deduction. The donor advised fund allows you to receive the deduction this year but pay the funds out to charities of your choice over future years.
Special attention for Inherited IRAs. If you inherit an IRA from anyone other than your spouse, you are required to either a) take all the money out by December 31st of the fifth year after date of death of the IRA owner or b) take distributions each year based on your life expectancy (called a ‘Stretch’ IRA). If you are part of a group of beneficiaries who inherited an IRA and you want to use the Stretch IRA strategy, your required minimum distribution is based not on your life expectancy, but on the life expectancy of the oldest member of the group. You can avoid this problem by ‘splitting’ the group inherited IRA account into individual inherited IRA accounts by December 31st of the year following the year of death of the IRA owner. This means that for IRA owners who died in 2009, you have until year-end 2010 to split the account into individual inherited IRA accounts. You must also take your first minimum distribution by December 31, 2010. Be careful to title the account properly.

Consult your tax advisor before implementing these strategies.

Strategies for Avoiding Probate at Death

My associates and I were recently working through a complex multimillion dollar estate planning case where the client owned real estate in multiple states. One of the central topics of discussion was how the probate process would work under the current will which we were in the process of revising. Probate is the court supervised process of transferring one’s property at death to his or her rightful heirs. The costs of probating an estate varies according to state law and based on case complexity but can easily be three to seven percent or more of the probate estate. Not all assets go through probate and, with proper planning, probate can be avoided altogether. That’s exactly what we are doing with this client. Since the family has real estate in more than one state, their current will would have required probate in each state that they owned real estate adding to the costs and complexity of settling their estate. In addition to fees, the probate process results in making public some of what was private information. That’s because the filing documents are part of the public record which may include listing of assets and beneficiaries. Finally, the probate process typically takes a minimum of six months and can take several years.

Here are three ways that you can avoid probate:

Create a Revocable Living Trust. With a revocable living trust, you establish a trust and move all of your probate assets into the trust. You can act as your own trustee but designate a successor trustee should you become incompetent or die. This sounds more complicated than it is, for once it’s set up it’s easy to maintain.
Own property as Joint Tenancy with Right of Survivorship. A good example would be to own your home with your spouse under this form of title. At death, your interest in your home automatically passes to your spouse by title rather than going through probate. Some states use a slightly different version known as Tenancy by the Entirety and community property states such as California use Community Property with Right of Survivorship.
Name beneficiaries to your retirement accounts, bank accounts and life insurance. I’ve run into lots of cases where someone named their estate as the beneficiary of their life insurance. This not only subjects the assets to potential probate fees but also potential creditors. For bank accounts and brokerage accounts, you can use a ‘Payable on Death’ designation to direct who gets your account assets at death.

Take a moment to review your own estate situation. If you own property in more than one state or you put a high value on privacy of your financial affairs, consider the revocable living trust. If your estate is simple and will not be subject to estate taxes, the strategies above may simplify the transfer process and greatly reduce the time required to get your assets to your heirs at your death. Care must be taken in executing a plan for avoiding probate for there are many potential pitfalls and tax traps so your best strategy is to seek the advice of a professional experienced in estate planning.

“Retirement for the Ages- Part III”

Last week I began a discussion about retirement strategies for those of you who are in your sixties and can see the light at the end of the retirement tunnel. Some of you may have discovered that the light is actually an oncoming train! I began with the importance of figuring out just how much money you will need by using a simple retirement financial calculator at the Resource Center at; click on ‘Links’; then ‘Retirement Planning Calculator’. Strategies for creating a comfortable retirement included continuing to work on a full or part-time basis and downsizing your lifestyle. Here are a few additional strategies:

  • Focus on debt elimination. One of the best ways to approach retirement planning is to pay off all your debts including your home mortgage. Start by writing down every loan you have; how much you owe; what your monthly payment is; and what your interest rate is. Use one page per loan. Shuffle your pages so that the loan with the highest interest rate is on top. Use any ‘extra’ money to accelerate the payoff on this loan while paying the minimum payment on all other loans. When the top loan is paid off, take its payments plus your ‘extra’ payments and apply to the next loan. Continue this process until you are debt free. The ‘mathematics’ of this strategy will detonate your debt in a few short years.
  • Review all insurance coverage. When you add up all of the premiums that you pay for all of the various types of insurance coverage you own, it can easily add up to 15% – 30% of your after tax retirement income. Commit to reviewing every insurance policy you own with the goal of cutting premiums 50%. In some cases you’ll discover you are paying for coverage that you no longer need. In other cases, by shopping around, you find more competitive pricing. Finally, consider raising your deductibles (property & casualty insurance and health insurance) or lengthening the waiting period (long-term care insurance) before benefits begin. For this exercise, you may need help. See my next recommendation.
  • Get professional help. If all of this seems overwhelming, consider meeting with a qualified financial advisor. They are trained to help you work through these complex issues. For a list of fee-only certified financial planners in your area, visit
  • Reorient your investments. As a pre-retiree, it’s time to take a fresh look at all of your investments. What was appropriate during your accumulation years may need to be repositioned with a more income-oriented slant. For example, our pre-retiree portfolios are dominated by Blue Chip dividend-paying stocks instead of more growth-oriented stocks. And while the current interest rates on bonds is anemic, consider what your target allocation to bonds should be as interest rates ‘normalize’ over the next few years.
  • Create additional income sources. A great time to launch a small start-up business is while you’re still working. Most people have something they are passionate about outside their job. Do you have a hobby that you could turn into a source of income?

Next week, I’ll brainstorm with you ideas for creating additional sources of income without having to get a second job.

Retirement for the Ages – Part 2

Last week, I began a discussion about retirement planning for those of you in your twenties, thirties, forties and fifties. This week I’ll address the special challenges of those in their 60’s for whom retirement is just around the corner. If you fall into this category, it is vital that you clearly understand where you are now financially compared to where you need to be at retirement. Sticking your head in the proverbial sand is not considered a viable solution. Start by getting an estimate of how much money you’ll need to support your retirement years by visiting the Resource Center at; click on ‘Links’; then ‘Retirement Planning Calculator’. Once you have this number that represents your required capital need, you may discover that you’ll need to reduce it since it will likely be larger than you can realistically accumulate in the time you have left. Here are a few strategies to consider:

Keep on working. There’s an awful lot to be said for continuing to work beyond ‘normal’ retirement age. By the way, who decided what ‘normal’ retirement age was? In the days before pensions, families lived together and everyone contributed according to their ability for their entire lives. Being productive during your mature years keeps you mentally alert and physically active and can extend life by years or decades. My father, at age 91, continues to work five days a week. Financially, he could have quit decades ago but there is no doubt that his productive lifestyle has benefited him as well as whose he interacts with on a daily basis. If you like what you do, consider continuing to work as long as you are able and are enjoying yourself. I recently worked with a physician client who loved his medical practice but hated being on call several evenings a week. He worked out a deal with his fellow partners to reduce his income so the money could go to younger physicians who were happy to take his call for extra money. I have another client who certainly could retire right now but who I am encouraging to continue working on a consulting or project basis. Why? Because he loves the work; his bosses love him and he definitely wants to stay active. However, he would like to step down from the 40-plus hour requirement of his current circumstances. What arrangement might you work out with your employer? You might be surprised at their flexibility. You’ll never know unless you ask.
Downsize your lifestyle. Most of us have created a lifestyle way beyond what is needed for a comfortable retirement. Step back and take a fresh look at all the things you could do to reduce your lifestyle expenses. Could you sell your home and buy one that is smaller, newer, and had lower maintenance costs? Could you move to an area of town or region of the country where housing costs are lower? Look at all the ways you spend money and consider what is truly necessary for you to enjoy your retirement years. Stay tuned for an upcoming column on a concept I call, Zero-Based Budgeting…a strategy for re-framing your required lifestyle.

Next week, I’ll complete this discussion of retirement strategies for pre-retirees.