This week I would like to introduce Ryan Laughlin. Ryan is a tax manager in our Green Bay office who specializes in tax planning for high net worth individuals and their businesses. Ryan is a CPA, holds a law degree, and is a member of the State Bar of Wisconsin. He is an avid outdoorsman who excels at just about everything he does!
This week, Ryan reminds us that one of the most important estate planning documents we have often receives inadequate attention.
Background. Last August, we discussed the tremendous opportunities available with Roth IRA conversions. Please click here to view that post. The media, fellow practitioners, and investment advisors around the country have continued to discuss this topic at length in recent months. We still believe most clients should consider a Roth IRA conversion, but proper tax and estate planning does not end there. The same can be said for any retirement plan, though, including traditional IRAs, non-deductible IRAs, SEP IRAs, SIMPLE plans, or employee plans such as 401(k) or 403(b) plans.
Proper planning instead requires the completion and continual review of a Beneficiary Designation Form (BDF). Similar to a will or trust document, a BDF controls the ultimate disposition of your assets, in this case: the retirement plan. In fact, a BDF controls who gets the asset (and when) regardless of what your will or trust documents say. Despite this form’s importance, however, clients (or their advisors) often overlook it or fail to complete it properly.
The BDF must also be coordinated with your other estate planning documents (e.g. wills, trusts, powers of attorney, etc.). In addition, the same considerations that apply to your general estate plan apply to a BDF (e.g. taxes, special needs beneficiaries, creditor protection, multiple marriages, and blended families). Unfortunately, ignoring the BDF can have drastic implications for tax and estate planning purposes. In addition, these mistakes typically are not recognized until after death. At that time, it may be too late to cure the defects. Proper planning today, though, can generate tax savings and ensure your assets will be distributed according to your wishes.
Common pitfalls with incomplete or improper BDFs
- Acceleration of post-death benefits
- Larger than required income or estate tax payments
- Disposition of assets to unintended beneficiaries (e.g. former spouses, minor children, etc.)
- Loss of tax-deferred status (or tax-free in the case of Roth IRAs)
Income tax deferral (tax-free if Roth IRA). Many clients understand the benefits of IRAs and qualified retirement plans during life. Most notably, earnings inside the account grow tax-free until distributions occur. Retirement plans, then, offer tax-deferred growth. Roth IRAs, on the other hand, do not require distributions and thus allow for tax-free growth. These rules, though, only apply during the account owner’s life (or surviving spouse in certain cases). Following the account owner’s death, distributions must begin and the BDF controls who receives these distributions and when they occur.
Stretch IRAs. As with Roth IRA conversions, the concept of stretch IRAs receives a great deal of publicity. Simply put, a stretch IRA allows your beneficiaries to receive distributions following your death over their respective life expectancies. As a result, the account principal remains intact longer, allows for more tax-deferred (or tax-free with Roth IRAs) growth, and permits a greater wealth transfer. Obtaining the benefits of a stretch IRA, though, requires proper completion of the BDF. If the BDF is not completed properly, the account may be distributed as quickly as over 5 years following death. As a result, improper planning can lead to an acceleration of post-death benefits.
Trusts as beneficiaries. Instead of naming children or other beneficiaries as direct beneficiaries of your retirement plan, you may name a trust for their benefit as the beneficiaries. For example, clients usually form revocable living trusts as a means to avoid probate, and wish to name that trust as beneficiary of the retirement plan. This route offers additional legal protection to the individual beneficiaries. However, the BDF and trust document must meet strict federal and state requirements.
Conclusion. As you can see, the BDF plays a vital role in your overall estate plan. Any comprehensive estate or tax planning must consider the form and ensure its interaction with your goals and tax rules. Fortunately, the BDF is a very simple form that can be completed or changed easily to fit your plan. Wipfli associates can assist with this process and work with your other advisors to verify proper completion. Please contact Ryan Laughlin, Rick Taylor, or your Wipfli tax professional if you have any questions on this or any topic.