Personal Wealth Law News

The San Diego Union-Tribune has been reporting for some time on the ongoing woes plaguing that city’s retirement system. A story reported on June 14, 2008 indicates that the city had hired a large law firm to look into the problems and to represent it in an investigation by the Securities and Exchange Commission. But, as it turned out, that created a conflict of interest- how could the law firm investigate the problem and at the same time defend the city in the SEC matter? Apparently, it could not, and the city sued the law firm for a very large sum of money. The case was just settled, with the law firm agreeing to return $3.25 million in fees and to forgive outstanding bills of another $1.1 million. This illustrates a couple of points: first, pension plans are important and complicated, and it’s not difficult to cause problems if you’re not sure of what you’re doing. Second, if you are a public entity and you hire someone to straighten out a problem with your pension system, that’s what they should do, not try to minimize or gloss over the problem. Even in private businesses, it makes sense to have someone, such as a law firm that knows what it’s doing, review the administration of retirement plans from time to time, to avoid lawsuits and government investigations.

Part of planning for the future is deciding where to spend the golden years, as marketing types like to call them. For those people who have an option where to live in retirement, there are the usual suspects: Florida, Arizona, North Carolina and there is the state that is one of the most popular among retirees, Pennsylvania.

By the way, the idea that you need to remain in the city where your law practice is located in order to continue to have an involvement in that practice is fast fading away. Just last week, a lawyer from a suburb of Detroit, who is suing one of my clients, called me from somewhere deep in the heart of North Carolina, from where he is able to be heavily involved in the frivolous litigation he is pursuing.

Why is Pennsylvania so popular among retirees, especially those in the neighboring states of New York, New Jersey, Delaware and Maryland? One important reason is the taxation of retirement income, such as Social Security and retirement plan distributions. There is no income tax imposed by Pennsylvania on bona fide retirement income, which is not the case in the neighboring states. If your income in retirement consists only of Social Security benefits and amounts you withdraw from a 401(k) plan, for example, your Pa. income tax will be zero. That is not the case, again for example, in New Jersey. And if you worked in New Jersey to earn a retirement benefit, New Jersey can’t reach across the river to tax it if you move to Pennsylvania, under federal law. (But here’s a caveat: Be sure to check the Pennsylvania rules to be certain that your retirement distributions qualify. Nearly all distributions after age 59 1/2 will qualify, but check the rules anyway.)

Yes, we have a sales tax, which Delaware does not have (although there are a large number of “big box” stores suspiciously close to the Pennsylvania border) and yes, we still have the state store system (again, some really good wine stores just across the border in New Jersey and Delaware, I’m told), but Pennsylvania has a big advantage in the taxation of retirement income. That, combined with reasonable property taxes and access to a world of sports, culture and recreational activities, is why Pennsylvania has one of the largest populations of retirees of any state.

Republished with permission of The Legal Intelligencer.

A new book by Alice H. Munnell and Steven Sass, titled “Working Longer: The Solution to the Retirement Income Challenge”, published by the Brookings Institution Press, makes some important points about planning for retirement. Americans, they say, need to work longer because of a contracting retirement income system, the longer lifespans now enjoyed by many of us, and the rising cost of healthcare.

The aim, they suggest, should be to move the average retirement age from 63 to 66. This will increase Social Security benefits payable, permit workers to build up larger retirement balances and reduce the period during which they must rely on retirement assets. One way of encouraging this trend might be to increase the earliest age for receiving Social Security benefits, which is now age 62.

But here’s another one, which I have suggested in earlier posts: provide income tax incentives for workers to continue working beyond age 62. For instance, for those age 62 and over, the federal income tax rate on the first $50,000 of income could be set at 10%, with a 15% rate on the next $50,000. This would surely encourage people to continue working, adding more to Social Security trust funds and delaying the payout of benefits.

Section 409A of the Internal Revenue Code was enacted in reaction to concerns about the taxation of deferred compensation, especially some of the abuses uncovered in the failure in recent years of several large corporations, including Enron. The law was enacted in 2004, but several extensions were granted of the time to amend plans and arrangements to comply with the new law. Those extensions will come to an end on December 31, 2008. This year it is still possible to make certain types of changes in deferred compensation plans and arrangements without adverse tax consequences, but there will be significant penalties assessed if compliance has not been achieved next year.

This is a good time to review what deferred compensation plans and arrangements are now in effect, whether they need to be amended and how they will be amended. Deferred compensation can be a valuable tool for businesses to provide incentives to executives, but it’s important that the new law be satisfied.

Actually, the Warren Zevon song refers to “Lawyers, Guns and Money,” but the Internal Revenue Code can also be a dangerous weapon. Now that the campaign for president has reached the general election stage, it’s time to realize that whoever wins the election; there are massive changes in our federal tax system looming ahead. These changes will affect us and our clients in various ways. In some cases, there will be little that can be done but to accept the changes; in other situations, there may be planning that can be used to reach a better result. Here are a couple of areas where change may occur:

• Federal estate tax: This discussion has been going on for several years, with much misinformation being spread about. (Read “Wealth and Our Commonwealth” by William H. Gates and Chuck Collins for a good review of this debate.) But there will be changes in our federal estate tax system in the future because leaders in both parties agree that the tax must be revised to include only the truly wealthy, not those who bought a home in a good neighborhood. There might be relief for small businesses and farmers, but in general the tax should be one that allows people to pass on some of the fruits of their life’s work without destroying the incentive of the next generation to take part in life’s struggle.
• Federal income tax: The reductions in income tax rates that were enacted in 2001 are scheduled to phase out in a few years. One solution is to extend indefinitely, but this easy answer has to be balanced against the colossal budget deficits that have resulted, in part, from those tax reductions. The view that those budget deficits can go on forever and will somehow be resolved or will disappear as a result of future growth is now classified with bedtime stories.
• Alternative minimum tax: Whose idea was this anyway? In the past few years, we’ve had small bandages applied to this gaping wound in our tax system. Some have suggested just repealing it, which would only result in even larger budget deficits. But reducing its effect to those who are perceived as not paying a fair share of taxes, which was the original intent of the law, will require that some difficult choices be made. Doing nothing (which is a skill of both political parties): not an option.
• Social Security taxes: Someone will have to finally accept that this problem also can’t be ignored or magically wished away with private accounts, and that higher taxes will only be acceptable to a limited degree. As last week’s blog indicated, you can either increase revenues or reduce benefits; there’s no third way.

All of these problems will have to be addressed by our next president, either John or Barack. In the course of resolving them, many provisions of our tax laws will be placed on the table: taxation of life insurance, employee benefit taxation, relief for older taxpayers and those with children. Many constituencies will be contending for their interests. It’s important for all of us to know what’s happening, and to plan for change, for us and for our clients.

Republished with permission of The Legal Intelligencer.

I know it was discussed extensively over the past few years, but is it no longer front-page news because the problem has been fixed? Apparently not. It’s more likely that the nation is suffering from attention deficit disorder and can only think about high gas prices right now.

But this problem isn’t going away, nor is the Medicare problem on the verge of resolution. Both of these programs face long-term funding challenges and waiting another few years to think about them again isn’t going to make their solution any easier.

An interesting Web site is maintained by the Center for Retirement Research at Boston College, and included on the Web site is a publication called the “Social Security Fix-It Book.” There are only a certain number of possible solutions to these problems, and the center has summarized them in 52 clearly written and entertaining pages. The publication begins with basic facts about how Social Security works and then makes the following fairly simple statement: The only two ways to fix the problem are to cut benefits or increase revenues. There is no magic formula that will painlessly make Social Security financially solvent for the indefinite future.

There are a couple of ways to cut benefits:

• An across the board percentage benefits cut that affects everyone, including those now receiving benefits.
• Raising the normal retirement age for full benefits, as has already occurred.
• Freezing the purchasing power of benefits, which means that future benefit amounts would be lower than under the current law.
• Freezing the purchasing power, but to a lesser degree for lower income earners.
• Changing the cost of living adjustment for benefits.
• Doing nothing and cutting benefits all at once in 2040

And, there are a couple of ways to increase revenues:

• Increasing the payroll tax rate today.
• Raising the cap on earnings subject to Social Security taxes.
• Financing Social Security with revenues from the federal estate tax.
• Transferring Social Security’s startup costs (from benefits paid in the early years of the program) to general revenues.
• Increasing the rate of return on assets held in the Social Security Trust Fund.
• Waiting until 2040 to raise taxes.

What to do? The publication ends by asking these three questions, the answers to which will determine how to fix Social Security:

• Do we want to keep benefits about where they are now? If so, how should the burden be shared?
• Do we want to keep taxes about where they are now? If so, how do we cut benefits?
• Finally, should each generation pay about the same tax and get about the same benefits?

Republished with permission of The Legal Intelligencer.

This is what a father wrote in a will that was brought to me. It illustrates another fundamental point about estate and retirement planning.

The father had decided to make his estate planning easy. “I’ll just buy CDs in my name and in the names of each of my children. That way, when I die, each of them will have a CD now in his or her sole name.” So, to carry out this idea, the father bought one CD with Child No. 1’s name on it in addition to his, a second in the name of Child No. 2 and the father all the way up to five children. The trouble was, he forgot how much he had purchased for each child, so the amounts were uneven. One child would get $100,000, another $10,000.

But Dad planned how to solve that problem. In his will, he wrote: “If any of the CDs I bought aren’t equal among my children, I ask them to straighten it out.” What do you think happened? Wrong, they did straighten it out. In one of those unusual family situations, the children who got more recognized their obligation to the others and entered into a family settlement. Sometimes it snows in April.

It’s important to remember that a will isn’t the only document that determines how assets are distributed. Life insurance beneficiary forms, retirement plan beneficiary designations and joint title on assets are all forms of testamentary dispositions; that is, they are all wills. Most people don’t know where these forms of wills are, sometimes can’t remember what they say and usually haven’t put them together so that they understand what their estate plan is. But it’s important to do this, because not every family (and, in fact, very few) is as close and understanding as the one described above.

Republished with permission of The Legal Intelligencer.

I adapted this motto from that of Faber College (”Knowledge Is Good”), to illustrate a point about trust and estate planning. Lawyers are specially trained in the law and in legal writing for an important reason, which is so they can write documents that make sense and accomplish what they are supposed to do. But we do that so often that we sometimes forget that others aren’t trained in that way. In the trusts and estates world, we see many people trying to write documents without the necessary training.

This comes to mind because we have seen numerous advertisements lately for do-it-yourself kits for wills and incorporations. Well-known television advice givers and former counsel in high-profile murder cases are offering forms that permit people to write their own wills. Is this a good idea? No. One might think that, for all those people who don’t have any will, this is better than nothing. That sounds right, but it doesn’t seem to work out that way. We see numerous examples of wills that, because they are written without guidance, end up confusing the situation more than helping it. The real work of trust and estate planning is not the document; it’s the planning and thought that go into it.

There are similar problems that we see in “estate planning” that is done by financial planners, which often involves transferring assets to lifetime trusts to avoid the necessity of a will or probate. The idea of having your lifetime and testamentary financial wishes carried out through a kit doesn’t seem to make sense and, in the experience of many lawyers, it has created more work rather than less. And it’s not likely that the person doing the planning will come back to explain what he or she really meant. This type of planning had its genesis in a book written long ago, “How To Avoid Probate.” The theory was that probating a will was so difficult and revealed so much about a person’s private affairs, every effort should be made to arrange one’s affairs to avoid having to probate a will. That may be true in some states, but probate in Pennsylvania is easy and carried out by county officials who have streamlined the process to about half an hour. And, as for revealing to the world your estate plan and list of assets, unless you’re Marilyn Monroe or Betsy Ross, no one seems especially interested in reading your will.

There is a need, however, to assist people of modest means with estate planning. Lawyers often help with this work through the Philadelphia Bar Association, Senior Law Center and similar organizations. Do other professions offer as much pro bono assistance as lawyers? No. Despite that, there is a need for good estate planning advice for those with smaller estates, and anyone who has this expertise should consider volunteering with one of those groups.

Republished with permission of The Legal Intelligencer.

Or does it seem that just about everyone in America is planning to retire in the next few years? If you watch television or read magazines of almost any kind, you will see constant stories about impending retirement: Are people ready for retirement; What can they do now to get ready; etc.

Of course, not everyone is retiring during the next decade. After all, there are still law firm associates. But the large cohort called the Baby Boomer Generation is approaching retirement and, just as in other times in the history of that generation, it will treat the circumstances it is facing as the most important in the nation’s history.

There are varying views as to what retirement will be like for the Baby Boomers and what effect it will have on the rest of society. Many reports in the popular media suggest a need for more saving and investing. But there have been scholarly studies suggesting that those about to retire are well prepared for it. Are they both right, or both wrong?

A study, to be published later this year in The Journal of Investing, was recently concluded by three individuals connected with Barclays Global Investors, and it provides some valuable insights on the status of retirement preparation and on the effects of changes in elements of that preparation.

The authors describe several ways of measuring the state of retirement preparation, including income replacement rates and comprehensive wealth analysis. They note several disturbing trends: the disappearance of defined benefit pension plans, the decline in personal saving rates and the large proportion of wealth represented by home equity. Not surprisingly, the result is to reduce the stability of retirement security for many people.

Given the long-term insecurity of government transfer programs and the importance of reducing dependence on home equity, the authors suggest several techniques for improving preparation for retirement. These include finding ways, such as automatic enrollment and default contribution rates in retirement plans to increase retirement saving and improving the investment choices made for retirement funds through lifecycle and targeted retirement strategies. Finally, the authors stress the importance of individuals taking a more active role in improving their retirement security. This is certainly the key point: Retirement security is the individual’s responsibility and problem. It is not a societal problem, as to which the individual can expect a societal solution. It’s up to the individual to ensure a comfortable retirement, even in the face of cutbacks in government programs.

Republished with permission of The Legal Intelligencer.

“And she cruised through the hamburger stand, now.” The philosophers Brian Wilson and Mike Love remind us of the perils of giving children too much too soon, in “Fun, Fun, Fun (’Til Her Daddy Takes the T-Bird Away).”

This is a theme common in literature going back centuries, at least to King Lear, and it’s something that remains a significant issue for families at the present day, with the creation of so much wealth all over the world. But one of the reasons why people strive to accomplish something during their lives is to be able to pass it on to the next generation and to spare children the struggles that parents might have had in achieving success. How to resolve this dilemma?

Unhappily, one solution, which is seen all too often, is to do nothing, hoping that, “The kids will work it out after I’m gone.” That usually doesn’t work and leads to generations of conflict and unhappiness. Some clients have chosen to limit how much their children will receive, to ensure that they are educated and prepared for whatever they choose to do in life, but not given so much that they lose interest in working. Another solution, which is quite common, is to place assets in trust, during life or at death, so that children and grandchildren have to wait to receive their inheritances, and perhaps receive them in installments at different ages.

For example, distribution might be made in thirds, at ages 35, 40 and 45. We often tell clients that the first installment paid might be largely wasted, because the recipient will want that little red Ferrari or condo in St. Bart’s, but that by the time of the second and third installments, the need to spend might have been satisfied. Sometimes, not always.

Here’s another planning idea, which is becoming more popular with both parents and grandparents. The payment of an inheritance might be contingent on achieving certain goals, such as finishing college, getting married and having children, perhaps in that order. A promise might be made to put aside funds for education whenever a grandchild or great-grandchild is born. There is, of course, a risk in this, in that the children and grandchildren might feel that their lives are being manipulated from the grave by dangling money in front of them. An extreme version of this idea was seen in the will of Leona Helmsley, who required that her grandchildren visit her tomb each year in order to continue receiving trust income.

The risk that too much money will become a burden rather than a source of happiness is not a reason to stop striving or to give all of one’s money to charity. But it illustrates an important point: The accumulation of wealth is only half the battle. The other half is to plan so that the accumulated wealth can have a positive effect on future generations, as a source of strength and opportunity rather than an excuse to do nothing.

Republished with permission of The Legal Intelligencer.