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IRAs and 401ks . Estate Planning for Married Couples with

Stock market growth over the past several years, coupled with the passage of the Every Community Establishment for Retirement Enhancement (SECURE) Act two years ago, and a 50% reduction in the size of the federal estate tax exemption set four years ago. Now, there’s been a renewed interest in estate planning for an individual retirement account. (ira) and Internal Revenue Code Section 401k accounts (401k accounts) are owned by married couples. Married couples with significant IRA and/or 401k accounts as well as other assets need to decide whether to consider paying all or a portion of IRA and/or 401k income to a bypass trust so that the surviving spouse or To get benefits for the removal of wife. The specified portion of an IRA or 401k is derived from the surviving spouse’s taxable assets, as well as to achieve certain other non-tax purposes.

Spousal Portability Limitations of Choice

In 2013, Congress passed into law a permanent, known as portability election for assets, which passes to a surviving spouse upon the death of the first spouse. Portability allows a surviving spouse to use the deceased spouse’s unused federal estate tax exemption, thus claiming two federal estate tax exemptions. Now looking at the beneficial aspects of this 9 year old law, why does a married couple now need to consider using a bypass trust in their estate planning? There are at least five reasons:

  1. A portability election will not remove the appreciation in value of the “ported” asset from the surviving spouse’s taxable assets, while a bypass trust will remove all appreciation.
  2. The portability election will not apply (in the form of an unused estate tax exemption for at least the dying first spouse) if the surviving spouse remarries and the new spouse dies while the surviving spouse Remarriage of the spouse is irrelevant in the case of transfer of property. To bypass trust;
  3. The portability election will no longer apply for federal generation-skipping transfer (GST) tax purposes, meaning the amount that could have passed to an estate and a GST tax-exempt bypass trust, including all appreciation in its value, is now would potentially be subject to a federal transfer tax on children’s estates;
  4. Using a portability election will make the “ported” asset subject to potential lawsuits from the surviving spouse, as well as potential claims from a new spouse, while avoiding laws and claims against a surviving spouse if bypassed. Trust is exercised; And
  5. While using the portability election would result in the death of the first spouse, when the “ported” asset passed on to the surviving spouse’s death, control that could have been retained had the bypass trust been used instead.

In states that impose a separate estate or other transfer tax, a sixth reason may occur if state law does not make the same portability election as federal law.

Traditional Bypass Trusts as an Alternative

In light of the above-mentioned limitations of spousal portability choice as compared to bypass trust planning, whereby married couples divide their assets in some fashion, so that upon the death of the first spouse who dies, all or a portion of their separate assets are inherited by the survivor. To pass an estate tax-exempt trust, the latter scheme is still in operation after 2013. The question is: are bypass trusts a suitable eclipse for IRA and 401k plan income, given that, following the SECURE Act, these trusts are generally subject to the 10-year maximum payout rule, whereas IRAs and Is the lump sum payment of a 401k plan received by a surviving spouse entitled to spousal rollover treatment and, therefore, potentially more income tax deferred? Bypass trusts are also thought to: (1) be subject to the highest federal income tax rate only at levels of gross income as low as $13,550, (2) include only a $100 exemption, and (3) qualify for income tax. There is no Aadhaar step-up on death of surviving spouse.

It is a simple matter to dispatch with the last issues mentioned. The judicious use of IRC Section 678 in the drafting of a bypass trust would generally eliminate the relevance of the higher trust income tax rates, as well as the minimum exemption, as the trust is also not taxed to the extent that the surviving spouse or The wife is taxed. Section 678. What’s more, using section 678 allows the estate tax-free bypass trust to be reduced from the annual income taxes that are payable by the surviving spouse, leading to the importance of the bypass trust in estate planning for married couples. is further extended. (For more information on using Section 678 to avoid higher income tax rates on complex trusts (including choosing small business trusts), see Jim Blaise, 6-7-8: Estate Planning with Section 678 of the Internal Revenue Code (2022)). Although a full discussion of this topic is beyond the scope of this article, a conditional general testamentary power appointment (POA) can be included in the non-IRA portion of a bypass trust, the inclusion of which can often result in full or partial income tax. Aadhaar step-up for all or a portion of the valuable assets in the trust upon the death of the surviving spouse. If an income tax basis step-up for the IRA portion of the trust is also desired, the full or partial income tax base step-up upon the passing of the surviving spouse can be achieved by intentionally triggering the so-called “Delaware Tax Trap.”

As far as paying IRA or 401k plan income a lump-sum payment to the surviving spouse versus a bypass trust, the greater the income tax deferral loss, the question becomes whether the surviving spouse owes income tax on the IRA. While maximizing deferment or 401k income always makes economic sense, given the passing of so-called “stretch IRA” treatment to children upon the death of the surviving spouse, following the Safeguard Act. Given that the children will be in their highest income tax bracket when the surviving spouse passes away and they will now be required to add the income from an IRA or 401k plan to their peak taxable income over a maximum period of 10 years, this may actually be the case. that is, by deliberately choosing No To maximize the income tax deferment of IRA and 401k plan income after the death of the first spouse and before the passing of the surviving spouse, the overall income tax to the family will be reduced.

The after-tax math will be different in each estate-planning situation. The estate planner should be aware of: (1) the potential size of the IRA or 401k plan account upon the death of the first spouse as well as the surviving spouse, (2) the potential tax status of the surviving spouse. , both income tax and estate taxes, (3) the potential income tax situations of the couple’s children after the death of the surviving spouse, and (4) the number of children who will split the IRA or 401k plan income upon the death of the surviving spouse. And so, the amount of the IRA or 401k plan each child will receive will each be taxed over 10 years. The age of the surviving spouse would also be a relevant factor. For example, if the surviving spouse will already be at least 72 years of age when the first spouse passes away, the income tax deferred benefit from spousal rollover will not be as significant as if the surviving spouse was only 55 years old. was the year. It makes sense to pay a portion of the IRA or 401k plan proceeds in a lump sum to the bypass trust and a portion to the surviving spouse overall in either situation.

Disclaimer Use of Beneficiary Designation

Assuming that the IRA or 401k plan administrator makes it available, the use of a beneficiary designation that would allow full or partial disclaimer by a surviving spouse, in favor of a bypass trust, is an excellent estate planning tool here because of the flexibility. Will happen. The technology provides, and therefore definitely needs to be explored. Here is a sample primary beneficiary designation for a spouse’s IRA and/or 401k accounts, when full or partial disclaimer can be assumed:

“Jane Doe, provided that Jane DOE will disclaim any portion of the profits, (i) the disallowed portion shall be distributed to Jane DOE, or his successor in the trust, the trustee of a trust established under the DOE family trust agreement date __________, 2022, as amended, to be further divided and/or distributed if and as the Trustee directs, and (ii) for the purposes of interpreting the provisions of the aforesaid Trust Agreement, to be The former deceased John Doe will not be regarded as.

Because the surviving spouse cannot hold a testamentary limited or conditional ordinary POA on the declined IRA or qualified plan benefits, any disallowed gains (including reinvestment proceeds from the same) must be allocated to a separate share (or subtrust) of the bypass trust. Consider it. Allow the surviving spouse to maintain a testamentary POA on the balance of the bypass trust assets. Here’s some sample bypass trust language, starting with the Preface to the Bypass Trust article, followed by the testamentary POA language limiting the power of the non-IRA/401k portion of the trust.

Property to be held in a trust estate together with the income and principal in accordance with the provisions of this article shall be held by the trustee as a separate trust estate, and the property in the said trust estate shall during every time the period of the trust be held in two separate trusts. can be divided into. Trust “One” shall include only assets held under this Article as a result of disclaimer by the surviving spouse’s legal representative after the death of the surviving spouse, and Trust “Two” shall consist of all other assets. is formed. The assets of both Trust One and Trust Two, along with income and principal, will be held in the Trust and administered and distributed as follows:

On the death of the surviving spouse, and except as otherwise provided herein, the trustee shall distribute all assets remaining in the trust, including the principal and both accumulated and undivided income, or among the descendants of any grantor, in the trust or otherwise, and in such proportion, as shall be specified in the last will and testament (being the most recent date of execution by the surviving spouse) of the surviving spouse by the surviving spouse and which is relevant within six filed in the jurisdiction’s probate court. (6) months after the death of the surviving spouse, but if such last will and testament shall be contested within the period of six (6) months above, as may be specified in the last will and testament of the surviving spouse who is subsequently accepted for probation. The last will of the surviving spouse and the testamentary testament have expired, and specifically referring to this provision, however, except the surviving spouse, the property of the surviving spouse, of the surviving spouse creditors and creditors of the property of the surviving spouse.”

Though again a complete discussion of this topic is beyond the scope of this article, a conditional general testamentary POA can also be added to Trust Two to obtain income tax basis step-up for all or a part of the Trust. On the death of the surviving spouse. Deliberately triggering the Delaware Tax Trap Technique will not be available for disapproved IRA/401k income in Trust One, however, IRC Section 2518 qualified disclaimer rules do not allow any POA in the surviving spouse, in will or otherwise, in disapproved properties.

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