A morbid joke that's made its way through estate planning circles; if you're going to die, 2010 is the year to do it.Tax exemptions enacted during the Bush administration hit their peak this year, but reset - or "sunset" - to the full 2001 rate at year's end. How will your boomer clients be affected, and what can be done to mitigate the coming tax hike?
David Schlossberg is a realist. Since the day a one-year repeal of the federal estate tax was enacted in 2001, Schlossberg viewed the policy as too good to be true and unlikely to survive until its scheduled implementation in 2010. Now that 2010 has arrived, he and other advisors are already looking past the one-year estate tax hiatus, to other, more pressing estate planning and taxation issues they say warrant attention in the year ahead.
"We took the position that there will be an estate tax," explains Schlossberg, president of Assured Concepts Group, an estate and financial planning practice in East Dundee, Ill. "We never suspected the 2010 repeal would actually come to be. So accordingly, we've taken a safety-first approach with clients, where we assume there will be some sort of estate tax in 2010, and if things change, you can always go back, revisit the plan and adjust it if necessary. In the end, it's worse to over-plan than to have no plan at all."
Wealth transfer specialist Robert C. Kulle, Jr., of Heritage Capital Strategies in Oxnard, Calif., is taking a similarly conservative tact with his estate planning clients, a necessary approach, he says, in light of the uncertainty surrounding federal tax policy in 2010 and beyond. "We want to maintain some flexibility so if and when the law changes, it doesn't blow up the entire [estate] plan."
"It's standard [estate] planning for us in 2010. We're operating under the assumption that the estate tax exemption continues along the same lines [as it did in 2009]," adds Joel Javer, CFP, a principal at Sharkey, Howes & Javer advisory firm in Denver, Colo.
Heading into the New Year, the consensus among Washington watchers in the advisory community was that federal lawmakers ultimately would opt to extend 2009 estate tax parameters through 2010, then tackle comprehensive estate tax reform sometime during the course of the year. That assumption, coupled with expectations that Uncle Sam soon also will move to increase estate, income and capital gains taxes, all which have ramifications on wealth transfer strategies, is helping to shape advisors' estate planning priorities for the year ahead.
Here are several issues that the experts say deserve extra attention in 2010:
Conversion of traditional IRAs to Roth IRAs
Direct, one-step conversion of a qualified plan to a Roth IRA became reality thanks to the Pension Protection Act of 2006, allowing owners of qualified 401(k), 403(b) and 457 plans to convert their retirement accounts into Roth IRAs, without exposing conversion amounts to early withdrawal tax and without having to first convert the accounts to traditional IRAs, as required by previous law. What's more, the $100,000 adjusted gross income cap to be eligible for the conversion disappeared as of Jan. 1, creating a potentially huge one-year estate planning opportunity for high-income, high-net-worth individuals as well as people of more modest means (provided the U.S. Congress didn't repeal the provision after this issue went to press; such a move had been deemed highly unlikely). "It's one of the true gifts in the tax code for 2010," Schlossberg says.
Lifting the Roth conversion cap essentially allows IRA owners for whom wealth transfer is a top priority to pre-pay estate taxes and thus, to lower their taxable estates and avoid a "double tax whammy," he explains. The one-year window should appeal particularly to clients whose estates exceed the federal exclusion amount (which in 2009 stood at $3.5 million for an individual and $7 million for a couple), and who own qualified IRAs that they expect to transfer as part of their estates.
Instead of leaving heirs on the hook to pay both estate and income taxes on those IRAs once ownership transfers, they can convert those accounts to Roth IRAs and pay income taxes on the transfer amount upfront (in the 2010 tax year). Any subsequent growth in the converted Roth IRAs is income-tax-free, as are distributions from the accounts to those who inherited them.
Schlossberg likens the maneuver to one business partner buying out another. "Basically you're buying out your partner -- the IRS -- today for the ability to have a known, zero-percent income tax rate [on distributions from the IRA] tomorrow."
One's outlook on federal tax policy can also provide justification for converting to a Roth. If you believe, as many do, that income and estate tax rates today will be lower than they will when ownership of the IRA transfers to heirs, the conversion makes sense from a tax-efficiency standpoint. That bearish tax outlook "is why we're looking at tax-free environments such as the Roth so closely today," Schlossberg notes.
Further sweetening the deal is a one-time opportunity to spread payment of Roth conversion taxes over the 2011 and 2012 tax years, instead of paying them in lump sum. What's more, the law gives account holders what amounts to a free look -- the right to rescind a Roth conversion in the 2010 tax year. That's something to consider, he says, if the value of converted accounts plummets in the months following conversion.
Gifting and philanthropy
Many Boomer clients have put giving -- charitable and otherwise -- on hold since the financial meltdown, says Schlossberg. "There's still a deer-in-the-headlights mentality. People are hesitant to do a lot of philanthropic stuff, and hesitant to make irrevocable decisions with things like charitable trusts."
But with some measure of stability returning to the economy and people's financial portfolios, it could be time to rekindle the philanthropic spirit in 2010 by reopening discussion of charitable giving and gifting strategies, says Kulle. A window in the tax code might provide justification for doing so. The top federal marginal gift tax rate drops to 35 percent in 2010 (and as the law is currently written, 2010 only), down from 45 percent in recent years. Signs point to an increase in the rate after 2010, so this is the year to act.
Stretch IRAs and beneficiary designations
As an attractive companion to the Roth conversion opportunity, the Pension Protection Act of 2006 created a "stretch" provision that allows a non-spouse beneficiary who inherits assets in a qualified plan to transfer the balance in that plan directly to an inherited IRA, and then to elect to spread distributions from that IRA over a lifetime. Using with the stretch option allows beneficiaries to avoid a lump-sum tax burden on a large one-time distribution.
Pay close attention to IRS rules governing the non-spousal stretch provision, cautions Javer. The transfer must be executed directly from trustee to trustee, so the beneficiary never gains actual custody of the inherited funds. Also, lifetime distributions from the inherited IRA must start sometime during the year following the year of the plan holder's death.
One of the biggest potential stumbling blocks to properly exercising the stretch option is a failure to keep beneficiaries in an IRA up-to-date and consistent with the overall estate plan. Be sure IRA beneficiary designations are current, reflecting events such as divorce or death of a spouse, advises Javer. "We're finding old wills and trusts that lack the right language, or the right beneficiaries, for receipt of retirement plan funds. If beneficiaries aren't properly coordinated, there's a risk of losing the ability to stretch distributions, which can force an heir to take a lump sum distribution and pay taxes on that -- a huge mistake," but one that's easily avoidable.
Helping a client defuse such an estate planning landmine is one way to start the New Year off on the right foot.