Personal Wealth Law News

He Signed Into Law One of the Largest Tax Increases in History

By Robert H. Louis

And his initials are RR. No, it wasn’t Roy Rogers.

For many years, retirement account balances were exempt from federal estate tax. This was a valuable benefit, as retirement accounts grew to become a large portion of people’s wealth. During the Reagan Administration, these assets were gradually subjected to federal estate tax and are now fully taxable (with some grandfather provisions that are fading away). But retirement benefits are generally also subject to ordinary income tax (with more grandfathering and recent provisions on Roth benefits, which can be free of income tax). This means that these benefits are frequently subject both to income tax and estate tax. The combination of those two taxes can wipe out most of the value of the retirement accounts (that portion that the stock market hasn’t already wiped out). A very useful planning program from Steve Leimberg, which calculates the amount left after paying both taxes, is aptly titled “Confiscate”.

Many people, of course, will need their retirement benefits for support in retirement. But it probably makes sense to spend savings that do not generate income tax first, which means postponing the withdrawal from retirement accounts as long as possible. Withdrawals must begin shortly after reaching age 70 1/2, but the required distribution amount is small enough in early years that the account could continue to grow, at least in normal times. So, for some people, at least, there’s a good chance that amounts will remain at the participant’s death.

For those people who are married, most will be well-advised to name the surviving spouse as the beneficiary. This will avoid federal estate tax, and it’s possible that in the spouse’s remaining lifetime, the benefits will be withdrawn, taxed and spent. But in an era of second marriages, that won’t always be the favored choice: benefits may instead be divided with children from a first marriage. In this case, it may be necessary to use part of the estate tax exemption, which is $3,500,000 this year and seems likely to remain there for future years. That relieves the benefits from federal estate tax.

Another technique that has been suggested, for people with charitable interests, is to leave retirement benefits to a charitable entity. This relieves the benefits from both federal estate tax and income tax. At the death of the account owner, the balance is simply paid over immediately. There’s no need to worry about minimum required distributions. A similar technique names as the beneficiary of the retirement benefits, at the owner’s death, a charitable remainder trust. But this won’t always be the best result. Why? Because in naming a charity as the beneficiary, the ability to postpone withdrawals of taxable benefits over a long period of time is lost. Studies have been done by commentators that show the significant benefits of being able to postpone the distribution of benefits over very long periods of time (such as by naming grandchildren as the beneficiaries). Neither technique is always correct.

There is no one correct method of dealing with the problem of double taxation of retirement benefits. It is an important part of the estate planning process, and it illustrates the necessity of considering spending patterns during life as part of the estate plan. Estate planning, in this context, is the process of planning wealth transmission and its estate tax and income tax consequences during the working years and the retirement years, as well as at death

 (from the Legal Intelligencer)

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The Solution for Lawyers: AbstinenceBy Robert H. Louis 

That’s financial abstinence, of course.  The other kind, the Mrs. wouldn’t appreciate.

Perhaps you’ve checked your retirement account balance.  Neither have I, but it’s probably off a little from it’s peak in late 2007.  If history is a guide, the market will recover before the economy in general, and that could happen over the next few months.  But it’s likely that a full recovery of your retirement account will take a year or two, perhaps longer.  That’s not too serious a problem if you have many years left before retirement.  But, what to do if you’ve just reached your retirement age or will do so in a year or two?

Many financial advisors remain confident that the securities markets will recover after a year or two, but that’s little comfort if you’ve cashed out of investments and are taking withdrawals.  You will be better off if you can wait to take withdrawals from your retirement account.  And you can do that.  The Internal Revenue Code rules on minimum distributions from qualified retirement plans, such as 401(k) plans, require that distributions begin by April 1 of the year following the year in which you attain age 70 1/2.  Even then, required minimums for the first few years hover around the 4-5% rate.  This means that, at least in normal times, your account could actually continue to grow for a few years after you start taking distributions.  As an alternative, take the funds you need for retirement from non-tax-deferred accounts for as long as possible.  Since you’re withdrawing savings, much of what you take for living expenses will not be taxable income, which means that your income tax liability will fall.  Compare that to distributions from qualified plans, nearly all or all of which will be fully taxable as ordinary income.

Another retirement topic being discussed in today’s economic environment is the wisdom of converting a traditional IRA into a Roth IRA.  Roth IRAs have the advantage that, after a period of time, all distributions are completely free of income tax.  The cost of doing so is that the traditional IRA must be subjected to income tax at the time of conversion.  But if the values of assets are low, the cost of conversion, that is, the payment of income tax, will be lower as well.  There is an income limit that prevents many people from converting to Roth status, but that income limit will disappear next year (unless the law is changed).  The premise of this type of planning is that although you pay tax now, all of the future growth will be tax free.  That’s a strategy, but you have to consider how long you will have to experience that growth.  If you’re at or near retirement age, and you will need the IRA for retirement expenses, you might not have the time for growth that offsets the disadvantage of paying tax up front.  As with all retirement planning strategies, one size does not fit all.

(from the Legal Intelligencer)

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Criminals I Have Known

by Robert H. Louis

Not the high class kind, with a mask and a gun, but the financial type.

Much has been written about the psychology of people like Bernard Madoff, who apparently can invite people to invest with them in the knowledge that their money will eventually disappear. None of my clients dealt with Mr. Madoff, but I have met with advisors who, at a later date, were accused of having used client funds for their personal expenses. The two I have in mind presented themselves as intelligent and savvy investment advisors. I’m not sure they intended to convert funds from the outset, but it’s alleged that that was their eventual course. Both spoke knowledgeably about the market, in a way that impressed less sophisticated investors, which is just about all of us. This came to mind over the weekend. On a flight from Munich to Philadelphia, I was the third party beneficiary of a passenger who spent about three hours telling the person next to him that his advisor was the greatest and had exactly predicted the market downturn. (For the record, I have one wealthy client who, on his own, correctly anticipated the market decline and suffered no losses. I’m fairly sure that he finished high school.)

What is the lawyer’s role in dealing with investment advisors? It’s certainly not to give investment advice to the client, but it’s also not to remain silent. I have written before that these uncertain times have led many to consider investing through large organizations, because of their deep pockets and internal protective procedures. Others prefer individual or small firm guidance. In either case, it is the lawyer’s task to ensure that all of the necessary paperwork has been completed and copies given to the client. It’s important to remind the client to have regular meetings to review investment strategies and results. It’s also appropriate, if the advisor is achieving investment results that are significantly better than others are achieving, to ask how this is being done. That is, due diligence. In some cases, it might be advisable to bring in another advisor, just to review what the first one has done. I once suggested this to the board of an industry pension plan, because its advisor had done extremely well with investments no one on the board could understand, and unwitting uncovered a massive fraud and theft by the advisor. So, the lawyer is not an investment advisor, but he or she should be asking the client if steps are being taken to ensure that what is promised or advertised is in fact happening.

This is a little off the point, but my recent travels also took me to Vilnius, the capital of Lithuania, a country where the protection of rights by lawyers was, until recent years, subject to the control of an overbearing Communist regime. I had an opportunity to visit a KGB prison, where I saw cells used for torturing political opponents. The Lithuanians have opened these cells to public view, so that they will not forget the horror of living under a regime that condoned and practiced torture.

(from the Legal Intelligencer)

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Continued Planning in the Era of Estate Tax Repeal

by Robert H. Louis

At mid-February, 2010, we still have no indication of the future of estate tax legislation. There was a suggestion that it might be included in the jobs bill that could be considered by Congress soon. All that we know is that every prediction, guess and inside tip from every commentator and tax lawyer has so far proved wrong.

But there is still planning that can and should be done now. The values of business and investment assets are generally lower than they were a few years ago and that, we hope, they will be in a few more years. The interest rates used to value such interests and the rates used by the IRS to determine the gift element of transfers are both at historic lows. Those two circumstances make it important to consider planning techniques such as grantor retained annuity trusts (GRATs), which are forms of deferred gifts. In addition, because housing values are still low, it’s worthwhile to consider qualified personal residence trusts (QPRTs). Conventional wisdom suggests that QPRTs work best in a high interest environment and, all other things being equal, that’s true. But all other things aren’t equal: the continued “dip” (recession, collapse, depression?) in housing values make QPRTs a good technique even while interest rates are low.

To these techniques should be added the value of outright gifts and other forms of gifts in trust, since the federal gift tax rate has fallen to 35% this year. And, thought should also be given to Roth IRA conversions, another subject of continued discussion now that the rules permitting such conversions have been relaxed.

We expect that the federal estate tax will return, either this year or next, and it may be that Congress will act to restrict one or more of the techniques described above. Until then, estate planners should consult with clients to review the advantages of planning right now.

(from the Legal Intelligencer)

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It isn’t Bernie Madoff or the legion of individual advisors who have adopted his business techniques. It isn’t even the US Congress.

It’s health care. It’s the cost of health care, plus the complexity of dealing with our health care/health insurance system, plus time we will spend dealing with these problems.

It is no surprise to anyone that we have a complex health care delivery system in the US. We have excellent medical care, for most of us, but at a substantial cost in money and time.  At my law firm, we have a staff of people who deal with problems that come up regarding our health insurance coverage, and a committee whose task is deciding how we will deal with the constantly-increasing cost of medical coverage.  But it didn’t strike me that this was as great a problem in retirement until I interviewed a retired partner from my firm for a PBI seminar on retirement for lawyers.  This lawyer didn’t have any particular health problems, but he said that he spent a great deal of time in retirement dealing with health insurers and Medicare.  Health care in retirement is a complex system of programs and insurance, and it can be very costly.  He added that the biggest problem of people who retire comfortably in their mid to late 60s is that they will start to run out of money in their later 70s.  They are still probably better off than most retirees, but their plans for a comfortable retirement and to have something to pass on to children and grandchildren could be frustrated by the increasing costs of health care.  And it’s possible that those costs could increase further if the Medicare and Medicaid programs are cut back. 

In the future, a component of retirement and estate planning will have to be planning for health care in retirement in ways that do not bankrupt people or result in their having nothing left to pass on to the next generation.  There’s a business opportunity here: as an adjunct to planning to have a comfortable financial retirement and nest egg to pass on, a business model is needed to provide good medical care at reasonable prices in retirement. 

(Reprinted by permission of the Legal Intelligencer)

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Unless you’re Charles Dickens, or one of the people involved in recently revealed alleged embezzlements that seem incredible.

My investment adviser suggested, or perhaps prayed, that the revelation of spectacular wrongdoing was a sign that we are coming to the bottom of the investment cycle. It’s not unlike the comment by someone, I think Warren Buffett, that when the tide goes out, you see who’s swimming naked. As always, there’s a lesson here, and it applies to everyone who has responsibility, however slight, for the care and management of money and other assets.

The lesson, fairly obvious, is that you must know where everything is, what’s being done with it and what people are charging against it. The rules of fiduciary responsibility are related in exhaustive detail in Austin Wakeman Scott’s treatise, in the Restatement of the Law of Trusts, in the Employee Retirement Income Security Act of 1974, and in numerous state laws and cases in Pennsylvania. We will shortly see the filing of many cases against Bernie Madoff and Marc Dreier, in which these principles will be cited. Between human greed, and Congress, lawyers will never go hungry.

Putting aside these spectacular examples of possible wrongdoing, the duty of care extends to many financial matters. Several of my clients have pension plans, where a third-party adviser handles investments. I am not the trustee and have no responsibility for the plans’ investments. Statements for the plans are sent to me monthly or quarterly. What is my responsibility with respect to those statements? I’m not to second-guess the investments, but perhaps there is at least a responsibility to make a cursory review of the statements. Either that, or I should either stop the statements from coming to me or advise the client that I cannot conduct any helpful review of the statements.

Here’s another example: A client has a retirement plan for which the investments are managed by one entity and the administration by another. Given the involvement of these two groups of experts, the client suggests that its office really need do nothing and has been able to supply few of the documents that it should have on hand. There’s probably nothing happening to cause concern, but I have advised the client that its responsibility is to have copies of all relevant documents, financial reports, and contracts setting forth who gets paid what for doing what. You can’t be criticized for having too much documentation of financial assets, but you can look like a great fool if you have to tell a judge, “I thought someone else was taking care of that,” or “They seemed honest.”

It’s not very likely that we will be involved in alleged embezzlements of the types reported recently, or the New Era scandal of a few years ago, or that we will meet up with the modern version Augustus Melmotte. But we will experience the need to be responsible in advising our clients on keeping good and careful records on the management of money and other assets, and this will help them from reading about themselves in newspapers or case reports.

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Which is far better than lemonade. Here are some things that are likely to happen soon.

The new administration is still more than a month away, but there are definite ideas about what might be proposed and implemented next year. Some of those changes involve estate-planning issues. Legislation that is proposed some time next year can be made retroactively effective to Jan. 1, 2009. It seems likely that there will be legislation to fix the estate tax craziness that was enacted in 2001 ($3.5 million exemption in 2009, no tax in 2010, $1 million emption in 2011). One method of fixing the problem is to continue the tax in effect permanently at the current flat rate of 45 percent, with an exemption of $3.5 million, the 2009 amount. The problem with that solution is that it brings in a lot less revenue than the $2 million exemption in effect this year. An alternative is to leave the exemption amount at $2 million until our budget deficits fall below a trillion.

In addition to changing the estate tax exemption or the rate of tax, or both, it’s possible to affect the tax collected by changing the law on what’s included in the taxable estate. One of the largest increases in the estate tax base took place during the Reagan administration, when retirement benefits were subjected to estate tax. Some suggestions are now being heard in Washington, ideas that have been percolating for a while and that address someone’s notion of tax fairness.

One proposal that has been discussed relates to transfers of family limited partnership interests. Because these kinds of assets are not publicly traded, a practice has developed of discounting the underlying value of the partnership assets when a transfer, such as a gift, takes place. Percentage discounts are a matter of opinion, and the IRS has been concerned that these discounts are not valid in every case. We are likely to see a proposal to end these kinds of discounts, especially where the partnership assets are investment assets, as compared to an operating business.

Another technique that has been extremely popular for many years is making gifts by taking advantage of the unfortunately named Crummey powers (Crummey refers to the name of a successful litigant against the IRS). Crummey withdrawal rights, which are almost never exercised, permit gifts that are not outright transfers to come within the gift tax annual exclusion ($12,000 this year, $13,000 next year). The IRS has never liked this concept, and may use the circumstance of the large budget deficits to propose its discontinuance.

Other suggestions made include cutting back on other discounted gift techniques, such as grantor retained annuity trusts and qualified personal residence trusts. It’s possible to maintain the fiction that you haven’t raised taxes by cutting back or eliminating these techniques, since they don’t change tax rates. Many practitioners are trying to close as many transfer transactions as possible this year, to avoid greater restrictions that could affect the ability to do estate planning next year. We’re entering a time of change, and those practitioners who are knowledgeable on the opportunities created by that change will prosper in the next four years.

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Sometimes it seems that our federal tax policy is written by the Marx Brothers. Here’s a curious example.

The Pension Protection Act of 2006 added a provision regarding distributions from retirement plans to beneficiaries who were not the surviving spouse. Why is this important? Under existing law, if a participant in a qualified retirement plan died, and the participant named the surviving spouse as the beneficiary for whatever remained, there were some tax options. Although most retirement plans require that death benefits be paid out promptly after death, in a lump sum, the surviving spouse could roll over the distribution to an Individual Retirement Account and avoid immediate taxation. The spouse could instead take out distributions as needed, and be taxed when distributions were made (subject to certain minimum requirements).

But if the beneficiary were not the surviving spouse, but, instead, the participant’s children, this option wasn’t available. The children would have to take out the balance immediately, under most plans, and be taxed on it. This was a much less favorable income tax situation. So, the Pension Protection Act authorized plans to allow distributions to non-spouse beneficiaries to be transferred to IRAs and avoid immediate taxation.

Many people thought that this meant that qualified plans had to permit such rollovers. But the Treasury indicated, initially, that it was an option for plans; they didn’t have to do it. Treasury representatives asked at the time why any plan would not have such a provision, but it appeared that some employers had decided not to offer this option.

To correct this situation, a technical corrections bill was offered, which contained language making the non-spousal rollover provision mandatory. Then, the Treasury indicated that, in its opinion, the rollover provision was voluntary for the current year, but would be mandatory in future years. However, that technical corrections bill was not enacted, and the Treasury appeared to go back to its original view that the provision was voluntary.

Finally, the matter has been resolved in the recently enacted Worker, Retiree, and Employer Recovery Act of 2008. Non-spousal rollover provisions will be required in qualified plans. Why is this important? For those non-spouse beneficiaries, it can make a huge difference in the incidence of taxation. What should you do about it? If you are participating in a qualified retirement plan (401(k), profit-sharing, etc.), you should find out what provisions the plan has for distributions at death. If the plan has an immediate payout provision, and you have named children or others as primary or secondary beneficiaries, be sure there is an understanding of the tax options if they inherit the retirement account. This could be by way of a memorandum added to your estate-planning file, for example. This is also a good opportunity to review your beneficiary designation for your retirement benefits. Do you know where that designation is? Of course, you don’t; neither do I. But it’s an important addendum to your will, along with beneficiary designations for life insurance policies. It’s a good idea to be sure your assets go where you wish at the appropriate time.

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We are a few days away from the beginning of an era of change. There are some things to do right now.

In 2009, some changes in our federal tax system are very likely to occur, and some are already in effect.

The federal estate tax exemption will rise substantially, from $2,000,000 to $3,500,000. This is a wonderful opportunity to shelter assets from federal estate tax, which seems likely to continue at a rate of 45 percent. Taking advantage of this change might require the shifting of assets between spouses. There are several ways of doing this, depending on how willing one spouse is to transfer assets to the other. There are some planning techniques that can be used to make transfers that are effective for estate tax purposes but do not transfer control of assets.

The gift tax annual exclusion has risen from $12,000 to $13,000 per year per donee. This isn’t a dramatic change, but for those who are able to engage in gift-giving programs, it’s an increased opportunity.

Under the current law, the federal estate tax will disappear in 2010 and then come back in 2011 with higher rates and with a $1,000,000 exemption. No one thought we would get this far without this crazy law being amended, and we now have just under 12 months to fix it. So, we should look for legislation this year, and who knows what it will include. If the present trend continues in Minnesota, we might have a professional comedian in the U.S. Senate, but he’ll have a lot of competition from the amateurs.

In the area of income taxes, we can expect to see scrutiny of various deductions and exclusions. This is often a method of raising taxes without increasing rates. When someone else’s deductions or exclusions are limited, it’s called closing loopholes. For example, early in the Reagan administration, the federal estate tax was amended to include retirement benefits in the taxable estate, perhaps the biggest tax increase of all time. But rates of tax didn’t change.

Alternative minimum tax remains a problem, with Congress applying an ineffectual bandage each year rather than finding a way to solve it. One of my partners sent around an e-mail toward the end of the year to remind people to make payments of estimated state taxes, to get a federal tax deduction, but another responded that the deduction was mostly taken away by alternative minimum taxes.

As with many areas of federal law (employment law and employee benefits law being prime candidates), 2009 promises to be a year in which tax laws will change. Whether or not it’s change we can believe in, it will be change to which we must and should pay attention.

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Until very recently, few people gave much thought to the insurance of bank deposits provided by the Federal Deposit Insurance Corporation. And, it’s likely that few of us will ever have to be involved with recovering deposits from failed banks. Still… it’s a good idea to know some of the basics of FDIC coverage.

If you went into a bank in September, you saw a notice that deposits were insured up to $100,000. Based upon recent legislation, the insurance amount has been increased to $250,000, through December 31, 2009. And news reports this evening (Sunday, October 12, 2008) suggest the possibility that bank deposits might be insured without limit, again at least for a while. Wait and see.

The basic coverage is subject to expansion, providing additonal protection. One basic expansion is that the $100,000 (temporarily $250,000) limit is for each bank in which you hold accounts. Of course, the way banks are merging, there might be only one bank left soon. But, until then, having accounts at different banks is a way to get increased coverage.

You can get additional coverage by titling accounts differently. Amounts held in joint accounts, custodial accounts for minors, certain revocable accounts, irrevocable accounts and most retirement plan accounts have limits that can increase substantially the level of protection afforded by FDIC coverage. The FDIC has, on its very helpful website, a calculator you can use to determine the level of coverage for various types of accounts. Go to www.fdic.gov/edie to meet EDIE the Estimator, who can help you to determine your coverage. Or you can call the FDIC at 1-877-275-3342, although you probably won’t be the only one calling them.

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