Today, we address what I consider to be the third aspect of a genuine wealth management program – distributions and transfers of one’s assets.  Distribution encompasses both transfers made while one is living, inter vivos transfers, and transfers made after one’s death, testamentary or postmortem transfers.

Distribution planning generally focuses on deciding how to allocate one’s assets to achieve one’s personal goals while minimizing the impact of taxes (i.e., income tax, gift tax, estate tax, alternative minimum tax, etc.) and other financial issues, both during one’s lifetime and after one’s death.  I have already written several posts and white papers that cover some of these issues, so I will simply use this post to provide a general overview of some common issues.

As always, the information provided here is general in nature and is not intended to provide advice for any specific individual.  If you need specific advice or assistance, you should contact an attorney or other professional who is experienced and knowledgeable in such matters.

One of most common distribution mistakes people make is failing to properly complete the beneficiary forms associated with their retirement plans so as to maximize the benefits such assets by avoiding the impact of taxes. In the past, by carefully considering who to designate as their beneficiaries and properly completing the beneficiary form to ensure the most effective distribution of the assets in their plan, the plan owner could effectively “stretch” the lifetime of the assets to benefit more than just the beneficiaries they designate. 

The ability to utilize the “stretch provision has been severely restricted due to recent, and ongoing, legislation in this area. This is an area of the law that is constantly undergoing change. That is why investors should always consult with an experienced attorney and/or CPA on such issues. For those who have a large balance in their pension account, it may be better to have a custom beneficiary form drafted to ensure the maximum benefit and protection for the assets within their personal account.

Another consideration regarding beneficiary forms has to do with the consolidation that has taken place within the banking and investment industries.  It is not uncommon for people to contact a bank or broker-dealer after the death of a loved one and request a distribution of a loved one’s IRA account, only to be told that the bank or broker-dealer cannot find the beneficiary form for the account.  In such instances the bank or broker-dealer will enforce the default distribution provision on the account, which are generally not in the best interests of the deceased’s heirs, as the usually result in a heavier tax impact and thus, a significant reduction in the amount of assets going to the heirs. Loss of beneficiary forms can also occur in connection with 401(k), 403(b) and 457(b).

Bottom line, owners of retirement plans should review their beneficiary forms regularly in order to verify that the custodian of a plan has the owner’s beneficiary form on file and that the forms still accurately reflects the account owner’s wishes.  There are numerous cases where the retirement account owner has divorced and remarried, but failed to change the beneficiary forms on his retirement account(s). The Supreme Court has ruled that even though it would make sense that the deceased would want to leave at least a portion of his retirement account assets to his current wife, the terms set out in a retirement account beneficiary form control distributions from said retirement account, regardless of what is stated in the deceased’s will.

Inter Vivos Distribution Planning
A common misconception about wealth distribution planning is that it has to be complicated. A common, yet simple, inter vivos wealth transfer strategy is the use of the annual gift tax exclusion amount.  This exclusion allows an individual to give a certain amount each yer to as many recipients as they wish without triggering any federal gift tax. The annual gift tax exclusion amount for 2021 is $15,000.

Married couples can maximize the benefits of the annual gift tax exclusion by each making a qualifying gift. That means for 2021, a couple with three children could give each child $30.000 annually, effectively reducing the size of a taxable estate if that is a goal.

Anyone contemplating lifetime transfers of their assets need to carefully review their personal financial situation to make sure that they can truly afford to make such transfer.  People should be careful not to “let the tax tail wag the wealth management dog.”

Another common inter vivos strategy is the use of trusts.  Some of the common inter vivos trusts include family trusts, intentionally defective grantor trust (IDGT), income-only trusts and special needs trusts.

– Family trust are typically drafted in such a way as to remove the trust’s assets from the grantor’s estates (usually a husband and a wife), but provide for ongoing management of the trust’s assets.
– IDGT trusts are drafted so that the trust’s assets are removed from the grantor’s estate, but drafted in such a way that the grantor, not the trust, is liable for any annual income tax owed by the trust, allowing the grantor to pay such taxes, providing a further reduction of the grantor taxable estate and to allow the trust’s asset to benefit from compound growth.
– Income-only trust are drafted in such as way as to remove the trust’s assets from the grantor’s estate, but to provide income to the grantor on an ongoing basis. These trusts are often used in attempting to qualify for benefit programs such as Medicaid.
– Special needs trusts (SNTs) are established to provide financial aid to injured or otherwise challenged individuals.  SNTs must be carefully drafted in order to preserve the beneficiary’s potential right to important government benefits.

As we mentioned in our previous post, the effectiveness of a trust in providing wealth management advantages is based largely on the amount of control retained by the person establishing the trust, the grantor..  The more control the grantor retains over the assets while in the trust, the less protection provided.

Testamentary or Postmortem Distribution Planning
Testamentary planning basically refers to estate planning and specific distributions instructions provided in one’s will.  A common tax strategy is to add testamentary trust provisions within a will that will allow one’s heirs’ to possibly have access to such assets in certain circumstances if the trustee assents to such access, yet still provide tax benefits for the deceased’s estate.

The rules in this area have changed dramatically in the past few years, most changes providing potentially significant tax savings for an estate, thereby allowing taxpayers to pass more of their assets to their heirs. For that reason, if you have had any estate planning done in the past, you should definitely have your planning reviewed to see if such plans are still effective and/or whether changes might be advisable that make them even more effective.

A full explanation of all the changes is beyond the scope of this blog and not advisable, since the appropriate estate planning strategy for anyone depends any number or interrelated variables. Overall, the recent changes in the tax code relative to estate taxes have resulted in most people not owing any federal estate taxes upon their death. Again, less taxes means more assets to pass on to one’s heirs.

One such change that has benefited many taxpayers has been the so-called “portability” rules. The portability rules generally allow a surviving spouse to take advantage of the unused portion of her deceased spouse’s unused federal estate tax exemption.

In the past, estate planners would often recommend that a couple equalize their estates to make sure that they maximized the benefits of the federal estate tax exemption. With the new portability rules, estate equalization is no longer necessary.

A common trust strategy used with married couples is the so-called “A-B Trust” plan. In this strategy, the will directs that the executor fund one trust, the so-called “bypass trust,” with the applicable estate tax exclusion amount and place any remaining assets in a trust that qualifies for the unlimited marital deduction. The applicable estate tax exclusion amount for 2021 is $11.7 million dollars. That amount is subject to an annual adjustment based on inflation. Another reason to review your estate plan annually.

Assuming the marital trust is set-up properly, the use of the marital trust defers any potential taxation of the marital trust’s assets until the death of the surviving spouse, with any tax being based on any asset remaining in the trust that is not otherwise exempted from taxation. The terms of the “bypass trust” usually provide for distribution of the trust’s assets upon the death of the surviving spouse in accordance with whatever terms are provided, with the distribution of the trust’s principal being tax-free.

The “A-B Trust” strategy is just one testamentary distribution strategy that can be used to both achieve one’s goals while minimizing the impact of taxes. The appropriate strategy for an individual will depend on their specific situation, goals and concerns. That is why anyone considering distribution planning should only do so after consulting with an attorney, CPA, or other appropriate professional who is both experienced and knowledgeable in such matters.

When large estates are involved, postmortem distribution planning may help resolve issues that were not contemplated when the decedent originally drafted their will. Beneficiaries of large estates may find that distributions to them under a will may not be needed or may produce unwanted tax implications.

In such cases, a beneficiary may choose to disclaim a distribution. The disclaimed distribution is treated as if it were never made and is distributed in accordance with instructions in the will. Effectively disclaiming a distribution should only be done with the assistance of an experienced estate planning attorney in order to avoid potentially serious tax issues.

Disclaimers are often used when the distribution will result in other family members, who are also beneficiaries under the will, receiving the disclaimed assets.  Disclaimers, when done properly, can be a very effective tax planning and wealth management strategy. However, it is important for anyone considering a disclaimer to understand that if a beneficiary disclaims a distribution under a will, the beneficiary does not get to designate someone to receive the disclaimed distribution.

© 2013-2021 InvestSense, LLC. All rights reserved.

This article is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

The strategies discussed herein are only a general overview of some common wealth management strategies for wealth distribution and transfers.  Anyone considering engaging in wealth distribution and transfer strategies should only do after consulting with an attorney or other professional experienced and knowledgeable in such matters. This is definitely not an area for do-it-yourselfers!

Notice: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.