The Lange Money Hour: Where Smart Money Talks
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How Should You Respond to the Election?
Jim Lange, CPA/Attorney & Nicole DeMartino
Guest: Dr. Gerry Shuster, University of Pittsburgh
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
- Introduction of Special Guest, Dr. Gerry Shuster
- The Impact of the Election on Income & Estate Taxes
- Possible Changes to Income Tax Rates
- Possible Changes to Estate Taxes
- Income Tax Planning Strategies
- Estate Planning Tips Amidst Uncertainty
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
Nicole: Hello, and welcome to The Lange Money Hour, Where Smart Money Talks. I’m your host, Nicole DeMartino, and, of course, I’m here with Jim Lange, CPA/Attorney and best-selling author of the first and second edition of Retire Secure! and now, his new book The Roth Revolution: Pay Taxes Once and Never Again, and it’s now available on www.amazon.com.
Now tonight, we actually have a surprise guest. He’s such a surprise, it was even a surprise to me when I came into the studio. Since yesterday was Election Day, Jim wanted to do a show on how taxpayers should respond to yesterday’s election. But his goal is not to do a political show discussing politics, but rather, a practical show on what listeners should be doing in terms of tax planning and estate planning, in other words, what you should be doing in response to the election. So, for our guest tonight, our surprise guest, Jim was lucky enough to find Dr. Gerry Shuster, who teaches Political Communications at the University of Pittsburgh. Gerry earned his PhD from the University of Pittsburgh, and he is regularly quoted by the media on various topics related to local, regional and national political issues and events. So, Gerry, are you there?
Gerry: Yes, I am.
Nicole: Well, welcome to the show. Thanks for joining us.
Gerry: Thank you. Thanks for the invitation to be on the show.
Nicole: Oh, absolutely.
Jim: And thanks for coming, Gerry. Gerry, right now, we are enjoying the last year of the Bush tax cuts. So, actually, we are more or less at historic lows, and income tax rates in the big scheme of things are down, although it might not seem like that to some of our listeners, and right now, there’s no estate tax for taxpayers dying in the year 2010. If there is no new legislation passed, tax rates are scheduled to go up for both middle income and wealthy taxpayers in 2011. There’s a scheduled additional healthcare surtax of 3.8% of investment income for 2013, which would mean the tax rate is going from 39% to 43.8%. Unless there is new legislation, the exemption, which is right now unlimited, is going to go to a million dollars, which could be devastating to a lot of middle income and upper income clients. What impact do you think the election is going to have on this, and could you talk about some of the processes and some of the ways that our listeners should be thinking about this?
Gerry: Well, for the immediate period, you’re dealing with when they return to session, and it’ll be very brief at best, you’re dealing with a lame duck Congress. Typically, members of Congress, especially those exiting on a more permanent basis, will not do much of anything, especially in high profile areas, two of which you have identified. So, my perception would be that at this point in time, if they haven’t dealt with those issues now, they’re not likely to until the next session of Congress shortly after the first of the year.
Jim: Okay. Can I interrupt you for one second, because I actually had a client, and as you can guess, he’s a Republican, and he is scared to death that the exiting Democrats are going to do all kinds of terrible things while they’re still in power, and they are going to stick the next administration with a lot of burdens that would not be welcome for him. Is that not a legitimate fear?
Gerry: Well, I think that would be punitive on the part of those exiting Democrats, number one, and I think the leadership of the party would do everything in its power to prevent that from occurring, because just as you heard today, Representative Boehner and the President of the United States both indicated they want to work very hard to develop a coalition of efforts, so that they can compromise on critical issues. This would almost sound a death knell that for some time to come, that kind of compromise and working jointly to try and achieve that goal would not occur, because it would be, you know, as I indicated, that would be punitive, and I can’t imagine that occurring. I’m not saying it’s impossible, but it’s not very likely.
Jim: Okay, so you don’t think that anything radical is going to happen between now…
Gerry: I think that both sides are going to work overtime: one, to get used to how, it’s a matter of they’re feeling each other out. It’s like a football game. I hate to use that analogy, but it’s a good one though, I think, that at the beginning of the game, both teams try to determine how they’re going to approach the rest of the game based on the strengths and weaknesses of each time, and I think that’s the way it’s going to go too, and I think that neither the Republicans nor the Democrats would allow a few malcontents to do that, because it just wouldn’t favor either party to allow that to occur. Moreover, the President has the option of vetoing such legislation, and whatever he feels about either of the two areas that you’ve identified, I think he would probably much prefer that to come under a new Congress.
Jim: Okay, so you’re saying that he should not worry about the lame duck session?
Gerry: Well, you know, again, it’s possible to occur, but not very likely.
Jim: No guarantees, fair enough. Okay, I’m sorry I interrupted.
Gerry: No, that’s alright.
Jim: Alright, so let’s assume, for discussion’s sake, that you’re right, at least in regards to estate taxes and income taxes, that nothing happens between now and the next session, and right now, if there is no compromise, let’s just say, for discussion’s sake, that despite all the posturing, we’re all going to work together, that the Republicans ask for something that President Obama isn’t willing to do and no compromise is made and nothing happens, then taxes go up and the estate taxes go up dramatically, can you give us some feel of what you think might happen? I know that that’s asking you to look into a crystal ball, but maybe if you can give it your best shot?
Gerry: First of all, I think that the President is going to be much more willing to take more time to evaluate those proposals no matter what level the proposals would impact. In other words, they won’t limit it and throw in a disclaimer that suggests we’re going to go for middle class and lower income levels of, in terms of how this would impact the nation, I think it’s going to be much more open that the upper level income earners would achieve the same benefits, or would accrue the same benefits, because that opens the door for even greater compromise for other issues which are far more important, at least in the overall picture, of the economy. So, in order to generate one thing, they’re going to have to give on others, and that probably is a key area, and the President has pretty much suggested he’s open for, I think, using his words, “open for consideration.”Jim: Alright, now, first of all, you said that there’s other things that are going to be more important in terms of getting the economy going, and I’m certainly not going to give you a hard time with that except that if I’m one of the listeners, and particularly, let’s say you, let’s assume, for discussion’s sake, that you have a job and you have some money, yes, I’m interested in what’s going to happen with the economy, but I’m also very interested in what is going to happen to my tax rates. And the other thing is, you seemed to indicate, and then you kind of mentioned this to me briefly on the phone today, that you thought that there might possibly not only be a continuation of the low rates we have, but possibly even lower rates, that that at least is on the table, which frankly, I have not seen before.
Gerry: I think the President and the leadership of both parties are all going to allow much more to be on the table than has been on in the past. It’s not going to be one of those situations where we’re only going to consider this, because then it frustrates the possibility of compromise. I think all good ideas have to be perceived as available, and I don’t think it’s going to be dismissed out of hand as it might have been, let’s say, a year ago this time. So, more positive action on the part of tax decreases, or, you know, in areas that are more beneficial to small business I think are going to be much more openly evaluated and consistently reacted to by experts, you know, they’re going to seek that kind of information and again, not just unilaterally knocked out of possibilities for, including in a new legislation by the new Congress.
Jim: Well, can I ask you this? I know that a number of the people who are going to be new members of the House are members of the Tea Party, and obviously not necessarily experienced in hard-nosed negotiation and compromise. Is it possible that we’re going to have a Congress and a Senate and a President that can’t compromise on things, and that it’s just not going to happen?
Gerry: Well, from time to time, that will be a real possibility, because as someone said, you have to be sometimes concerned that what you wish for, you may very well get, and now that there is a clear and definite majority, it’s a majority in numbers, but not necessarily by philosophy. So, some Tea Party members, in order to serve their constituency because they owe that constituency their election, may be much, much more conservative and not give it a thought process, but that’s something the Republicans are going to have to deal with. That’s not something that the Democrats can change, but one thing that can change is a bigger and better coalition between more moderate Republicans and the Democrats, which could then be the new coalition, and if they mean what they say what they’re talking, or the way they’re talking right now, if you build a coalition between the two parties, and there will still be splinter groups with different philosophies, but the majority will be the coalition of the Republicans and Democrats, not just the Republicans themselves. So, that could work out to be the best scenario possible, because now you’re getting all of the philosophies together, and it’s not going to be restrictive.
Jim: Well, I hope you’re right, but I guess I have a hard time seeing somebody who was elected on a platform of eliminating Social Security, eliminating the Federal Reserve…
Gerry: But not all Republicans have that strong conservative view. Many of them are more moderate in that regard and might be more prone to deal with a coalition from the Democratic Party, realizing that what has just happened could happen to them again. Remember, we have a presidential election in just two years, so the posturing for the Presidency, as well as, remember those persons just elected yesterday are already starting to campaign today for, you know, 2012. So, they know that what happened to the Democrats can’t be repeated, and history shows us under the Reagan administration, under the Clinton administration, and frankly, even under the Bush administration, where there was so much more compromising occurring, despite the gang that came in in ’94. Once they saw life in a real light in Congress, they decided to mellow a little bit, and they were less obstructionist and a lot was accomplished.
Jim: Well, you seem to be a bit more optimistic than other people I’ve talked to in terms of reasonable compromises actually taking place, because I guess one of my concerns is if no compromise takes place, that you’re going to have these massive tax increases that are really going to affect a lot of people.
Gerry: Well, first of all, if no compromise occurs and a stalemate results, then they have just shot themselves in the foot on both sides of the aisle, and they’ve already seen the damage that has occurred from that. Both parties now have to do damage control, and I think that the Democrats realizing how much they’ve lost in terms of power, and Republicans recognizing that just because there is an ‘R’ in front of the name, by no means suggests that they’re of the same philosophy. Learn that the compromise is critical, and however that compromise comes about, is tantamount to their ticket for reelection.
Jim: Alright, well, let’s be a little more specific for the moment. President Obama has, and for a while, has stated his position and maybe that will be changing, is that he would be willing to keep the Bush tax cuts on the income tax level for taxpayers whose income is below $250,000, but he wanted people who had $250,000 or more to have a tax increase.
Gerry: Now, but that’s where he just recently noted that he’s open for reconsideration, that that would be dramatically increased. In other words, the line that’s drawn for the tax cuts would now be appreciably higher. He’s open to reviewing that.
Jim: Alright, well, let’s take the extreme. Let’s say that he says, “Okay, hey, we’ll keep all the tax cuts. Even if you make a million dollars, we’re still going to go by the rules that were in effect in 2010 before the sunset occurred.” Do you actually think that there might be a possibility of a tax decrease over and above what the current rates are?
Gerry: That’s not the way I approach it. Given what occurred yesterday, I think everything’s on the table, and I think the President understands better than anyone, as does the leadership of the Democratic Party, that certain things have to occur in order to put the party back in leadership position, and so I think that said, I am not pessimistic about the possibility of a much more conservative approach and some of the ideas of the Republicans that were thwarted over the past two years now become much more prominently considered and perhaps even incorporated in new legislation.
Nicole: Alright, gentlemen, we’re going to take a quick break. When we come back, we’ll continue this conversation, and I want to remind our listeners out there that we are live tonight, so if you have any thoughts and you want to chime in, you can give us a call at 412-333-9385. We’ll be right back in a minute with Dr. Gerry Shuster and Jim Lange on The Lange Money Hour, Where Smart Money Talks.
Nicole: Hello there, and welcome back to The Lange Money Hour, Where Smart Money Talks. This is Nicole DeMartino, and I’m here with Jim Lange and Dr. Gerry Shuster who teaches Political Communications at the University of Pittsburgh. They’re talking about yesterday’s election, and the impact it’s going to have on the taxpayers.
Jim: Gerry, we talked a little bit about changes to the income taxes, but I also want to talk about changes in the estate tax, because if you remember, for years, the federal exemption amount, meaning the amount that you were allowed to die with without having to pay any taxes, was $600,000, and then it inched its way up to $1,000,000, and then in 2009, it was up to $3.5 million. In 2010, George Steinbrenner died with a $1.5 billion interest in the New York Yankees, left it to his kids and didn’t have to pay a nickel in estate tax. In 2011, unless something is done, the exemption amount is going to go back to $1,000,000, which probably saved him roughly $500,000,000 between dying this year or dying next year if there isn’t a change. I mean, obviously, this wild, unpredictable pattern makes life pretty hard for somebody to plan. Do you think yesterday’s election has some impact, and do people have any more definition in terms of what is likely to happen with the estate tax, both in the short term and in the long run?
Gerry: Well, in the short term, I’m not in a position to evaluate whether that’s on the Congressional agenda, you know, between now and the end of the year, or the end of their session, but I will say that there has been much discussion among members of Congress that it needs to be addressed and that’s again one of those areas where there will be compromise, because you just identified, you know, even average people can build up a very healthy heritage, and for someone to take that heritage and give such a large chunk of it to the federal government is distasteful no matter what side of the aisle you’re on.
So, it’s not just a program that supports the wealthy. Many persons need that kind of concern, and here again, that’s the trickle-down effect that I think is going to happen from much more compromising and openness, and that’s going to be seen very quickly with a new Congress. It is either going to happen, and happen early, or it’s not going to happen at all, and that could be one of the benefits, or it could be one of the areas that’s negatively impacted. I’m betting that that’s an area that’s going to be a real benefit, because the Democrats have to look at what the hot button issues are for the conservative Republicans, and if they want anything from the Republican Party with regard to healthcare and other kinds of issues, then they have to be able to give and give in an area that’s much more beneficial to the vast majority of the constituents. That, I think, is what they found out from the vote yesterday, and that was, too few people were actually feeling the direct impact from what has taken place so far, and the fear of things like this, like the estate tax and other key areas, not being addressed and dying for lack of inaction is…now, there’s a Freudian slip, huh? Dying. But, in any event, I see this as not a dead issue by any means.
Jim: Alright, well, I know in 2009, if you had asked me, “Hey, Jim, is there any chance that in 2010, there’s not going to be any estate tax, and George Steinbrenner can die with $1.5 billion interest in the Yankees and not have to pay any tax,” I used to tell people, in every estate attorney and every IRA expert I knew, said “Oh, no, they certainly have to do something, because it would be totally unreasonable to have an unlimited, no estate tax in 2010, and then have only a $1,000,000 exemption in 2011.” I mean, I don’t care which side of the aisle you sit on, that just isn’t reasonable to have the accident of the year of your death pay such an enormous difference in taxes to the government.
Gerry: There are some pundits who would take that thought process, Jim, and say that the way to avoid any action, or penalty for taking action on this, is to just let it die, and once it goes out of effect and the old rule comes back into effect, then no one can blame anyone. But once that starts to occur, there’ll be such a clamor for a return to sanity in that area that again, it goes back on the table, and what I’ve understood is the very real possibility that it would be retroactive to the end of 2010. I don’t know that that’s going to be the case, but that’s been the rumor.
Jim: Well, in fact, it’s interesting that you brought the retroactive issue up, because in early 2010, I told people, “Hey, I don’t even know what the law is today, because just because there is no federal estate tax at the moment, that doesn’t mean that later on in the year, they can’t retroactively have an estate tax, because they have done something like that in the past.” So, I guess another possibility is nothing happens in the lame duck session, which is what you said earlier, is that right?
Jim: So, you don’t think that they would do anything about this in the lame duck session, do you?
Gerry: It’s possible that they would do that, but here again, you still have the mavericks that are currently in session, and there might be some anger left over and some of the exiting members would simply say, “I’m not going to do this.” So, my recommendation would be if I were talking to a member of Congress, let it go into a new session, and then work for retroactivity, because then you’re looking at people who know that they need to compromise, and if they don’t compromise, just like other issues, then it becomes a stalemate, and the blood is on the floor for the 2012 election and nobody wants tainted with that again.
Jim: Right, and that then creates, let’s say it’s January or February 2011, and the exemption is still $1,000,000 and you’re planning your estate, that has to be a little bit nerve wracking for somebody…
Gerry: Yeah. Oh, I’m sure.
Jim: …you know, to realize, “Oh my goodness, if I die tomorrow,” and let’s simplify and assume that there isn’t a spouse involved, and the reason I said that is because I just wanted to avoid the complication of the unlimited marital deduction, but if I die with a million dollars, and like Yogi Berra says, “A million dollars isn’t worth a million dollars anymore,” then there could be a big tax, and I know that you’re going to have to leave in a few minutes…
Gerry: Just let me add one thing.
Jim: Please do.
Gerry: You know, from a political reality focus, you have to understand that yesterday’s election, if nothing else, was an election about the state of the nation. I don’t know how much more of a sledgehammer would be needed to let the politicians understand that people in the nation have not been this angry in a long, long time, and what they’re looking for is action, not partisan fighting, and that said, I think the possibility for greater opportunities to help both sides, and help all levels of income earners is far greater today than it has ever been in recent history, and I think that they’ve seen that people can get mad and, like the line from Network, they’re mad as hell and they’re not going to take it anymore, and they’ve shown that. They did it yesterday.
Jim: Well, Gerry, you have given our listeners some very good insights and, frankly, you have given me personally some good ideas, and going into the future a little bit more optimistically than I was a half an hour ago. I know when we talked earlier, you said you had a prior commitment, and I want to respect that, and I want to thank you very much for being on our show, Gerry Shuster, PhD at the University of Pittsburgh.
Gerry: Well, thank you very much. It’s been a great experience, and I would be very happy to do it again.
Jim: Alright, well, thank you again. Alright, well, what I’d like to do now is try to, let’s say, interpret into action what some of the things that Gerry has said, and let’s say I am in your position, that is, I am a listener and let’s assume, for discussion’s sake, that I am trying to work hard or maybe I’m retired and I’ve built up some retirement assets, and, you know, the election happened, and there is some uncertainty. Certainly, Gerry was optimistic that there could possibly be some tax decreases. By the way, that’s the first time I’ve heard that from anybody. I thought that the best we could do would be to maintain the current taxation level. But, what I would like to do is to talk about what can be done, both in terms of income taxes and estate taxes in what I think we all would agree is still a relatively uncertain area, and what I’d like to do is start with the income taxes.
Now, when I wrote The Roth Revolution, and we were looking at the potential increases in taxes, I analyzed what the impact of increased taxes would be for taxpayers, and came to the conclusion that Roth IRAs would be tremendously beneficial if there was a tax increase in 2011. So, one of the strategies that I talked about was well, it might be very good to do a Roth IRA conversion in 2010, and I cited five new tax laws. One, which is very powerful for employees that have 401(k) or 403(b) plans, you guys are now allowed to make a Roth IRA conversion from your traditional 401(k) to your Roth 401(k), or if you are working for a university or a hospital, you’re now allowed to make a Roth IRA conversion from your traditional 403(b) to a Roth 403(b), assuming your institution offers a Roth 401(k) or a Roth 403(b) plan.
The second thing is, I did cite tax increases that were scheduled to go up, and the other thing that we can’t ignore is that in addition to traditional income tax rates at least scheduled to be going up, in 2013, we have the healthcare surtax, which is an extra 3.8% on investment income. So, we have that. Now, of course, this is the first year that IRA owners, or anyone for that matter, with incomes of more than $100,000 can make a Roth IRA conversion, and finally, and this really comes to the heart of the matter, there is a law that, right now, says if you make a Roth IRA conversion in 2010, you could recognize half the income in 2011 and half the income in 2012. So, let’s say, for example, you had $100,000 in a traditional IRA and you made a Roth IRA conversion in 2010, under the existing law, you have a choice between recognizing that income in 2011, or recognizing half in 2011 and half in 2012.
Now, the analysis that I did earlier said that if tax rates are going to go up, rather than doing what seems natural, which is to pay the taxes later and defer the taxes, I said if taxes are going up, you’re probably better off recognizing that income in 2010. Well, if you listen to Gerry, it sounds like there’s some hope of no tax increases and possibly a tax decrease, and that would indicate it might be more prudent to recognize half the income in 2011 and half in 2012. One of the takeaways that I’m getting from all this is that we are living in extremely uncertain times, and if possible, I want to plan in such a way that no matter what happens, you’re still going to come out the best. Now, in the Roth IRA conversion area, what I would say is, since you don’t really have to make that decision of whether you’re going to recognize the income in 2010 or whether you’re going to recognize half in 2011 or half in 2012, if you get an extension on your 2010 tax return, you don’t have to decide that issue until October of 2011, and remember, you can always recharacterize, or undo, a Roth IRA conversion. So, that is a very powerful strategy. By the way, I know you’ve heard a lot about Roth IRA conversions, and I think next year I’ll lay off a little bit because you’ve heard a lot about it, but I actually think that since this is the first year, and because of the ability to defer, and because we have all these new tax laws that are favorable for Roth IRA conversions, that people really need to take this seriously, and again, we have one more session, that Nicole will mention, for the rest of the year.
Right now, I’ll tell you what we are doing with our existing clients. We are sending every one of our existing clients, whether they be an estate client, an assets under management client or an income tax preparation client, a book, and I know many clients are listening, so we are sending a book to everybody, and what we did was to go through our entire client list, and we tried to figure out which portions of the book and which strategies might be the most appropriate, and we actually developed note cards, and according to our knowledge, and we actually had to go through the files again to reacquaint ourselves with a lot of people, we actually put in additional note cards, but frankly, it is a strong call to action for a lot of people to do Roth IRA conversions. With, let’s say, the uncertainty in the political arena about what’s going to happen to income taxes, I think doing Roth IRA conversions is even more appropriate.
Nicole: Alright, Jim, let’s take a quick break. When we come back, do you want to talk about the estate planning? Alright, we’ll talk about estate planning. You’re listening to The Lange Money Hour, Where Smart Money Talks.
Nicole: Welcome back to The Lange Money Hour, Where Smart Money Talks. I’m Nicole DeMartino, and I’m here with Jim Lange, and we’re talking about how we should be responding to yesterday’s election. We talked about the income tax. Let’s talk about the estate tax issue for the remainder of the show, and we talked, and Dr. Shuster talked about the uncertainty and, you know, that’s a little nerve wracking for people, and if everything is uncertain, how should you plan? I mean, what is the best course of action at this point?
Jim: Well, let’s first take what Dr. Shuster said. He said that he didn’t think originally that there was going to be major tax legislation in a lame duck session. Then he said, well, maybe, because it’s an important issue. So, I don’t know if anything is going to happen before the end of the year or not, but it sounds like it’s very possible that we could go into the beginning of next year with no additional legislation, in which case, that means that if you die with more than a million dollars in your estate, and by the way, your estate does include your house, so if you have a house worth a couple of hundred thousand dollars, it’s not all that hard to get to a million dollars. If you die with more than a million dollars, you’ll be subject to federal estate tax at a pretty nasty level. So, that has to be considered one possibility. Another possibility is if that does occur, and then, at some point during the year in 2011, there will be a retroactive change to the estate tax. Now, if that happens, by the way, some people are going to challenge that, and the constitutionality of a retroactive tax might be questioned.
Now, there have been times in the past when there have been retroactive tax increases. This, in effect, would be a tax decrease. I’m not sure what’s going to happen, but we would certainly have uncertainty. Then, let’s be realistic and recognize that even within the existing administration, there has been a $3.5 million exemption, there has been an unlimited exemption, and it sounds like we might end up having a one million dollar exemption, at least for a while, as a clear possibility, and this is all within one administration and just one period, and actually not much more than two years. Is that fantastically relevant to our listeners? I would say yes, but I would say what is more relevant is not what the estate tax exemption is, or whatever they come up with in January or February or even towards the end of next year. What’s really relevant is what is the estate tax exemption going to be in the year of if you are married in the second death, that is, let’s say you’re married and you have $3,000,000 together and you leave everything to your spouse at the first death, and then at the second death, there’s still $3,000,000 around, the exemption amount at that point becomes very critical, because if it’s $3,000,000, your family’s off the hook for taxes. If it’s $1,000,000, then they’re going to have to, in effect, pay estate tax on $2,000,000. So, there is both short-term and long-term uncertainty, and I think it would be really irresponsible for me to say here’s what I think is going to happen because when I even hinted that in 2009, I would’ve never guessed that there’d be no estate tax in 2010. So, I think the best area, Nicole, to think about estate taxes is that we just don’t know what is going to happen.
Jim: Alright, so, now the question is, well, let’s assume that you have the standard wills, and I’d like to talk for a minute about what the standard wills are, and what they say, and let me tell you what the problem is and let me tell you the extreme problem that you have with uncertainty, and then, eventually, we’re going to get to the solution to the problem. Alright, so let’s say that you’ve seen an attorney and that your estate is, or at least at one point, was more than $600,000 and you have the standard what are called A/B wills. And here’s what the standard A/B will says: if you die, you take the exemption equivalent amount, and that amount, rather than going to your spouse, goes into a trust. The terms of this trust are pretty standard, although there are a few variations, but it’s basically your spouse gets the income from the trust, your spouse gets the right to invade principle for health maintenance and support, and at the second death, that is, after both spouses are gone, the money in that trust goes to the children equally, and the whole point of this trust is to have the money that’s in the trust not be in the estate of the second to die. So, let’s say, for discussion’s sake, that we go back to what the 2009 rate was, which was $3.5 million, and let’s say you have a $7,000,000 estate and you died. Basically, what the language of that trust said was $3.5 million went to the trust, the other $3.5 million went to the spouse outright, let’s for get about growth, at the second death, the trust wasn’t in the second estate, the amount that went to the spouse was but there’s a $3.5 million exemption, there’s no estate tax and by implementing that trust, we save the family over a million dollars.
And that’s all well and good, but let’s say that you’re saying, “Gee, Jim, I don’t have a $7,000,000 estate. I have a whole lot less. What would happen if I died with that type of language?” Well, the language doesn’t say $3.5 million into a trust. It doesn’t say a million into the trust. In fact, literally, the language is so difficult that really no one knows what it means except if you’re in this field, and what it really means is, and it’s kind of legalistic language, the maximum amount after taking into account the unlimited marital deduction, blah blah blah, what they really mean is you take the exemption amount. So again, in 2009, it was $3.5 million. In 2010, by the way, it’s unlimited, meaning that according to many attorneys the way they read that, is that all of the money would not go to the surviving spouse, but would go to the trust. Now, if you’re the surviving spouse, are you happy with that situation where instead of you inheriting money, all that money’s going to a trust? And let’s say it’s even worse. Let’s say you don’t even have a $7,000,000 or even a $3.5 million estate. Let’s say you have a million, or two million, or less than a million dollar estate. If you have that type of standard will, what’s going to happen is all the money goes to the trust, and that leaves how much money to the surviving spouse, Nicole?
Jim: Do you think that that spouse is going to be happy with that?
Nicole: No, I don’t think that that’s going to cut it.
Jim: I call that the cruelest trap of all, and that is almost inevitably going to happen to a lot of people. Now, right now, the exemption amount is $1,000,000, or it will revert to $1,000,000 unless something happens between now and 2011. If that happens, we might actually need that trust to save estate taxes, because then a lot more people are going to potentially be subject to estate tax. So, on the one hand, you have the value of not wanting to under provide for the surviving spouse. On the other hand, you don’t want to pay estate taxes. Then there are some other options and possibilities. Sometimes, what you might want to do after the first death is to leave a portion, maybe $100,000 each, for example, to each child at the first death. So, let’s say that you have a $2,000,000 estate or even a smaller estate, and you don’t want the kids to have to wait until they’re sixty before they enjoy any inheritance which might be their age at the second death. You might want a certain amount of money to go to each child at the first death. Another possibility: let’s say that you have some grandchildren, and you are interested in helping them out, perhaps with their education, perhaps with just some spending money, perhaps money for down payment on a home, or money even in a trust for their benefit, and if that money is IRA or Roth IRAs, I go to great lengths to talk about the enormous benefits of the stretch IRA and the stretch Roth IRA if you name grandchildren as beneficiaries. So, it might be possible that you might want to name some grandchildren as beneficiaries.
So now, we have, let’s say, four plausible options or choices for estate planning. One, we have the surviving spouse themselves, and by the way, before I move on, I’m going to tell you I’ve been doing this estate planning and I’ve been in business for thirty years now as a CPA and twenty-five as an attorney, and what I have found, almost universally for what I would call the “Leave it to Beaver” family, the “Leave it to Beaver” family being original husband, original wife and then same kids. In other words, not kids from his marriage, kids from her marriage, but kids from our marriage. People like that, I have found universally say, “Jim, the most important thing is to provide for my spouse after I am gone.” That’s the most important thing, and I hear that more than taxes, more than kids, more than anything else, the most important thing is to take care of my spouse. But, with these traditional wills, or traditional trusts, we aren’t doing that. We are first funding this trust, the purpose of which is to save estate tax at the second death, which might end up being not just not helpful, but it might actually be extremely restrictive to the surviving spouse, and it happens all the time.
So, we have these four options, and one, again, which I’m going to say is my favorite option, which is the surviving spouse. Now, please understand, that is not the option most of the standard A/B will type estate plans, where the first option is the trust, and again, whether you call that trust the Unified Credit Trust, the Exemption Equivalent Trust, the Uniform Shelter Credit Trust, the Exemption Trust, it’s basically the same thing that gives income to spouse right to invade principle for health maintenance and support, and at the second death it goes to the kids. That’s not what I want as the primary beneficiary. I want the surviving spouse as the primary beneficiary. However, I still want that trust as an option, and particularly, if the exemption amount is going to be $1,000,000, I’m very interested in having that as an option because at the same time, while the primary goal is to protect the surviving spouse, we don’t want to be stupid about estate taxes, and if we can figure out a way to provide for the surviving spouse and avoid paying estate taxes, I think that that would be a preferable goal. Again, with children, most people, I think, would want some money going to a child, but only if there was more than enough for the surviving spouse. We didn’t talk about it with Gerry, but what about investment alternatives? Nicole, do you see certain investments in the future, or do you think that there’s going to be a lot of fluctuation and a lot of volatility?
Nicole: A lot of volatility.
Jim: A lot of volatility, so basically then, if, let’s say, whether it’s your parents or my mom or many of the listeners out there, we don’t know how much we’re going to have when we die.
Jim: The other thing is, we don’t know who’s going to die first. And I will freely tell you this. I’ve been in business for thirty years and we’ve done a lot of projections, and just about every projection we ever did was wrong, and by that, I mean some assumption that we made, or something that we thought was going to happen, didn’t happen. I’ll give you a couple of examples. We always thought that he was the one who was going to die first, and it turns out that she died first. So, the planning had to be changed. In the last ten years, frankly, I thought that people were going to die with bigger portfolios, but the market’s pretty much been in the crapper for the last ten years and people are not dying with big portfolios. Another thing is, sometimes long-term care is a crapshoot. We don’t know if people are going to be wiped out by long-term care, and even the fear of long-term care makes people want to have total control of their assets. So how do you combine all these issues where we have, more or less, four good choices? We have the surviving spouse as the first choice, or one choice. We have the B Trust, again, income to spouse, right to invade principle for health maintenance and support, for the second choice.
The third choice we have is children equally, and the fourth choice is a well-drafted trust for grandchildren. By the way—no sex, drugs and rock and roll for the grandchildren of my clients. That money is for education, health maintenance and support, down payment for a home or seed money for a business. Sorry, guys! Alright, so let’s assume those are the four choices, and let’s also assume that we have this “Leave it to Beaver” marriage, and basically, your kids are the same as your spouse’s kids, and your grandchildren are the same as your spouse’s grandchildren, and let’s assume that you’ve been married for a long time, and let’s also assume that you trust your spouse, which is a big assumption.
What I would recommend in that situation and particularly in the light of all this uncertainty is that you draft your wills and trusts and estate plans in such a way to give the surviving spouse all four of the options that I mentioned, and you let them pick which options, or combination of options, are appropriate, not now, but you do it after the time of the first death. We call that disclaimer wills. It is all over the literature. It has been quoted in Jane Bryant Quinn, Kiplinger’s, Wall Street Journal, I did an article for Financial Planning magazine, again it was also in the book Retire Secure, endorsed by Charles Schwab, Jane Bryant Quinn, Ed Slott and a whole slew of about sixty other experts. It’s a really powerful, flexible estate plan that I think people should do, particularly right now in today’s uncertain times.Nicole: Alright, Jim, I’m giving you the one-minute mark. We are going to close the show. You’ve been listening to the Lange Money Hour, Where Smart Money Talks.
James Lange, CPA/Attorney
Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans. Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.
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