An IRA is a popular vehicle to save for retirement, and it can also be a powerful estate planning tool. Some people designate a trust as beneficiary of their IRAs, but is that a good idea? The answer: possibly.
The benefit of an IRA is that your contributions can grow and compound on a tax-deferred basis for many years. The longer you leave the funds in the IRA, the greater the potential growth, because taxes aren’t taking a bite out of the account. If you don’t need to tap your IRA funds during your life — other than required minimum distributions (RMDs) — you can stretch out its benefits even longer by designating your spouse or child as beneficiary.
For traditional IRAs, you must begin taking annual RMDs by April 1 of the year following the year in which you reach age 70½ (your “required beginning date,” or RBD). The distribution amount is calculated by dividing your account balance by your remaining life expectancy.
If you name your spouse as beneficiary, he or she can transfer the funds to a spousal rollover IRA and delay distributions until his or her own RBD. If someone other than your spouse inherits your IRA, that person must take distributions even if he or she hasn’t reached age 70½ but can stretch them out over his or her own life expectancy.
If you designate multiple beneficiaries, distributions will be based on the oldest beneficiary’s — that is, the shortest — life expectancy.
One thing you shouldn’t do, unless you have a specific reason, is designate your estate as beneficiary or fail to name a beneficiary at all. Under those circumstances, the IRA must be distributed to your heirs within five years (if you die before your RBD) or over your remaining statistical life expectancy (if you die after your RBD).
Why use a trust?
One reason to name a trust as IRA beneficiary is to prevent a loved one from emptying the account too quickly and defeating your tax-deferral purposes. Another, if you have children from a previous marriage, is to ensure that they’ll benefit from an IRA you leave to your current spouse.
If you decide to use a trust, be sure it’s designed properly to meet the requirements of a “see-through” trust. Otherwise, distributions will be accelerated as if you’d failed to name a beneficiary. To qualify, the trust must be valid under state law, be irrevocable (or become irrevocable on your death) and name only identifiable individuals as beneficiaries.
In addition, the trustee must furnish the trust documentation to the IRA custodian by October 31 of the year following the year of death.
Under the right circumstances, naming a trust as IRA beneficiary can be a good strategy. However, contact us before taking action. We can help assess your circumstances and determine if this is the right move for you. Contact us at 205-345-9898.
© 2018 Covenant CPA
If most of your money is tied up in your business, retirement can be a challenge. So if you haven’t already set up a tax-advantaged retirement plan, consider doing so this year. There’s still time to set one up and make contributions that will be deductible on your 2018 tax return!
Not only are contributions tax deductible, but retirement plan funds can grow tax-deferred. If you might be subject to the 3.8% net investment income tax (NIIT), setting up and contributing to a retirement plan may be particularly beneficial because retirement plan contributions can reduce your modified adjusted gross income and thus help you reduce or avoid the NIIT.
If you have employees, they generally must be allowed to participate in the plan, provided they meet the qualification requirements. But this can help you attract and retain good employees.
And if you have 100 or fewer employees, you may be eligible for a credit for setting up a plan. The credit is for 50% of start-up costs, up to $500. Remember, credits reduce your tax liability dollar-for-dollar, unlike deductions, which only reduce the amount of income subject to tax.
3 options to consider
Many types of retirement plans are available, but here are three of the most attractive to business owners trying to build up their own retirement savings:
1. Profit-sharing plan. This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. You can make deductible 2018 contributions as late as the due date of your 2018 tax return, including extensions — provided your plan exists on Dec. 31, 2018. For 2018, the maximum contribution is $55,000, or $61,000 if you are age 50 or older and your plan includes a 401(k) arrangement.
2. Simplified Employee Pension (SEP). This is also a defined contribution plan, and it provides benefits similar to those of a profit-sharing plan. But you can establish a SEP in 2019 and still make deductible 2018 contributions as late as the due date of your 2018 income tax return, including extensions. In addition, a SEP is easy to administer. For 2018, the maximum SEP contribution is $55,000.
3. Defined benefit plan. This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum annual benefit for 2018 is generally $220,000 or 100% of average earned income for the highest three consecutive years, if less. Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit.
You can make deductible 2018 defined benefit plan contributions until your tax return due date, including extensions, provided your plan exists on Dec. 31, 2018. Be aware that employer contributions generally are required.
If the benefits of setting up a retirement plan sound good, contact us. We can provide more information and help you choose the best retirement plan for your particular situation. Call us at 205-345-9898.
© 2018 Covenant CPA
If you dream of spending your golden years in a tropical paradise, a culture-rich European city or another foreign locale, it’s important to understand the potential tax and estate planning implications. If you don’t, you could be hit with some unpleasant surprises.
Avoiding the pitfalls
If you’re a citizen of the United States, U.S. taxes will apply even after you move to another country. So if your estate is large, you might be subject to gift and estate taxes in your new country and in the United States (possibly including state taxes if you maintain a residence in a U.S. state). You also could be subject to estate taxes abroad even if your estate isn’t large enough to be subject to U.S. estate taxes. In some cases, you can claim a credit against U.S. taxes for taxes you pay to another country, but these credits aren’t always available.
One option for avoiding U.S. taxes is to relinquish your U.S. citizenship. But this strategy raises a host of legal and tax issues of its own, including potential liability for a one-time “expatriation tax.”
If you wish to purchase a home in a foreign country, you may discover that your ability to acquire property is restricted. Some countries, for example, prohibit foreigners from owning real estate that’s within a certain distance from the coast or even throughout the country. It may be possible to bypass these restrictions by using a corporation or trust to hold property, but this can create burdensome tax issues for U.S. citizens.
Finally, if you own real estate or other property in a foreign country, you may run up against unusual inheritance rules. In some countries, for example, your children have priority over your spouse, regardless of the terms of your will.
We’re here to help
If you’re considering a move overseas after you retire, discuss your plans with us before making a move. We can review your estate plan and make recommendations to help avoid tax pitfalls after you relocate. Call us at 205-345-9898 for more information.
© 2018 Covenant CPA
If you’ve done any research into employee benefits for your business recently, you may have come across a bit of alphabet soup in the form of “HSA + HDHP.” Although perhaps initially confusing, this formula represents an increasingly popular model for health care benefits — that is, offering a Health Savings Account (HSA) coupled with, as required by law, a high-deductible health plan (HDHP).
An HSA operates somewhat like a Flexible Spending Account (FSA), which employers can also offer to eligible employees. An FSA permits eligible employees to defer a pretax portion of their pay to later use to reimburse out-of-pocket medical expenses. But, unlike an FSA, an HSA is permitted to carry over unused account balances to the next year and beyond.
The most significant requirement for offering your employees an HSA is that, as mentioned, you must also cover them under an HDHP. For 2019, this means that each participant’s health insurance coverage must come with at least a $1,350 deductible for single coverage or $2,700 for family coverage. It’s okay if the HDHP doesn’t impose any deductible for preventive care (such as annual checkups), but participants can’t be eligible for Medicare benefits or claimed as a dependent on another person’s tax return.
The benefit of the high deductible requirement is that premiums for HDHPs are typically less expensive than for health plans with lower deductibles. You and your employees can use some or all of the money saved on premiums to fund their HSAs.
You and the employee combined can make pretax HSA contributions in 2019 of up to $3,500 for single coverage or $7,000 for family coverage. An account beneficiary who is age 55 or older by the end of the tax year for which the HSA contribution is made may contribute an additional $1,000.
The good news for you, the business owner: First, employer contributions are optional. Second, pretax contributions to an employee’s HSA, whether by you or the employee, are exempt from Social Security, Medicare and unemployment taxes.
Just how popular is the HSA + HDHP model? A 2018 report by the trade association America’s Health Insurance Plans found that enrollment in these plans increased by nearly 400% over the last 10 years — from about 4.5 million in 2007 to about 21.8 million in 2017. Of course, this doesn’t mean your business should blindly jump on the bandwagon. Contact us at 205-345-9898 to discuss the concept further or for other ideas regarding affordable employee benefits.
© 2018 Covenant Consulting CPA
There continues to be much uncertainty about the Affordable Care Act and how such uncertainty will impact health care costs. So it’s critical to leverage all tax-advantaged ways to fund these expenses, including HSAs, FSAs and HRAs. Here’s how to make sense of this alphabet soup of health care accounts.
If you’re covered by a qualified high-deductible health plan (HDHP), you can contribute pretax income to an employer-sponsored Health Savings Account — or make deductible contributions to an HSA you set up yourself — up to $3,450 for self-only coverage and $6,900 for family coverage for 2018. Plus, if you’re age 55 or older, you may contribute an additional $1,000.
You own the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.
Regardless of whether you have an HDHP, you can redirect pretax income to an employer-sponsored Flexible Spending Account up to an employer-determined limit — not to exceed $2,650 in 2018. The plan pays or reimburses you for qualified medical expenses.
What you don’t use by the plan year’s end, you generally lose — though your plan might allow you to roll over up to $500 to the next year. Or it might give you a grace period of two and a half months to incur expenses to use up the previous year’s contribution. If you have an HSA, your FSA is limited to funding certain “permitted” expenses.
A Health Reimbursement Account is an employer-sponsored account that reimburses you for medical expenses. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion typically can be carried forward to the next year.
There’s no government-set limit on HRA contributions. But only your employer can contribute to an HRA; employees aren’t allowed to contribute.
Maximize the benefit
If you have one of these health care accounts, it’s important to understand the applicable rules so you can get the maximum benefit from it. But tax-advantaged accounts aren’t the only way to save taxes in relation to health care. If you have questions about tax planning and health care expenses, please contact us at 205-345-9898.
© 2018 Covenant Consulting CPA
The most effective estate planning strategies often involve the use of irrevocable trusts. But what if you’re uncomfortable placing your assets beyond your control? What happens if your financial fortunes take a turn for the worse after you’ve irrevocably transferred a sizable portion of your wealth?
If your marriage is strong, a spousal lifetime access trust (SLAT) can be a viable strategy to obtain the benefits of an irrevocable trust while creating a financial backup plan.
A SLAT is an irrevocable trust that authorizes the trustee to make distributions to your spouse if a need arises. Like other irrevocable trusts, a SLAT can be designed to benefit your children, grandchildren or future generations. You can use your lifetime gift tax and generation-skipping transfer tax exemptions (currently, $11.18 million each) to shield contributions to the trust, as well as future appreciation, from transfer taxes. And the trust assets also receive some protection against claims by your beneficiaries’ creditors, including any former spouses.
The key benefit of a SLAT is that, by naming your spouse as a lifetime beneficiary, you retain indirect access to the trust assets. You can set up the trust to make distributions based on an “ascertainable standard” — such as your spouse’s health, education, maintenance or support — or you can give the trustee full discretion to distribute income or principal to your spouse.
To keep the trust assets out of your taxable estate, you must not act as trustee. You can appoint your spouse as trustee, but only if distributions are limited to an ascertainable standard. If you desire greater flexibility over distributions to your spouse, appoint an independent trustee. Also, the trust document must prohibit distributions in satisfaction of your legal support obligations.
Another critical requirement is to fund the trust with your separate property. If you use marital or community property, there’s a risk that the trust assets will end up in your spouse’s estate.
There’s a significant risk inherent in the SLAT strategy: If your spouse predeceases you, or if you and your spouse divorce, you’ll lose your indirect access to the trust assets. But there may be ways to mitigate this risk.
If you’re considering using a SLAT, contact us at 205-345-9898 to learn more about the benefits and risks of this type of trust.
© 2018 Covenant Consulting CPA
If you have a child or other family member with a disabling condition that requires long-term care or prevents (or will prevent) him or her from being able to support him- or herself, consider establishing a special needs trust (SNT). Also known as a supplemental needs trust, an SNT allows you to enhance a family member’s quality of life without jeopardizing his or her eligibility for government benefits, such as Medicaid or Supplemental Security Income (SSI).
An SNT is an irrevocable trust designed to supplement, rather than replace, government assistance. Generally, the trust is funded by someone other than the beneficiary, though in certain instances a beneficiary’s assets may be used to fund the trust.
To preserve eligibility for government benefits, the beneficiary can’t have access to the funds, and the trust must be prohibited from providing for the beneficiary’s “support.” That means it can’t be used to pay for medical care, food, clothing, shelter or anything else covered by Medicaid or SSI, such as the basic medical care provided by those programs.
But an SNT can be used to pay for virtually anything government benefits don’t cover, such as unreimbursed medical expenses, education and training, transportation (including wheelchair-accessible vehicles), insurance, computers, and modifications to the beneficiary’s home. It can also pay for “quality-of-life” needs, such as travel, entertainment, recreation and hobbies.
Careful drafting required
To ensure that an SNT doesn’t disqualify the beneficiary from government benefits, it should prohibit distributions directly to the beneficiary and prohibit the trustee from paying for any support items covered by Medicaid or SSI. Some SNTs specify the types of supplemental expenses the trust should pay; others give the trustee sole discretion over nonsupport items.
Like many trusts, most SNTs contain spendthrift language to protect the trust assets against creditors’ claims. Also, in some states, it may be necessary to include specific language providing that the trust is an SNT, that the funds are intended for only nonsupport purposes and that your intention is to preserve the beneficiary’s eligibility for government benefits. In other states, simply designing the trust as a discretionary trust may be sufficient, but it can’t hurt to include SNT spendthrift language just to be safe.
Communication is key
If you establish an SNT, communicate your plans to everyone concerned. Otherwise, well-meaning relatives or friends might inadvertently undermine your strategy by making gifts or bequests directly to the special needs person. Contact us at 205-345-9898with questions regarding an SNT.
© 2018 Covenant Consulting CPA
When you think about recent tax law changes and your business, you’re probably thinking about the new 20% pass-through deduction for qualified business income or the enhancements to depreciation-related breaks. Or you may be contemplating the reduction or elimination of certain business expense deductions. But there are also a couple of recent tax law changes that you need to be aware of if your business sponsors a 401(k) plan.
1. Plan loan repayment extension
The Tax Cuts and Jobs Act (TCJA) gives a break to 401(k) plan participants with outstanding loan balances when they leave their employers. While plan sponsors aren’t required to allow loans, many do.
Before 2018, if an employee with an outstanding plan loan left the company sponsoring the plan, he or she would have to repay the loan (or contribute the outstanding balance to an IRA or his or her new employer’s plan) within 60 days to avoid having the loan balance deemed a taxable distribution (and be subject to a 10% early distribution penalty if the employee was under age 59½).
Under the TCJA, beginning in 2018, former employees in this situation have until their tax return filing due date — including extensions — to repay the loan (or contribute the outstanding balance to an IRA or qualified retirement plan) and avoid taxes and penalties.
2. Hardship withdrawal limit increase
Beginning in 2019, the Bipartisan Budget Act (BBA) eases restrictions on employee 401(k) hardship withdrawals. Most 401(k) plans permit hardship withdrawals, though plan sponsors aren’t required to allow them. Hardship withdrawals are subject to income tax and the 10% early distribution tax penalty.
Currently, hardship withdrawals are limited to the funds employees contributed to the accounts. (Such withdrawals are allowed only if the employee has first taken a loan from the same account.)
Under the BBA, the withdrawal limit will also include accumulated employer matching contributions plus earnings on contributions. If an employee has been participating in your 401(k) for several years, this modification could add substantially to the amount of funds available for withdrawal.
Nest egg harm
These changes might sound beneficial to employees, but in the long run they could actually hurt those who take advantage of them. Most Americans aren’t saving enough for retirement, and taking longer to pay back a plan loan (and thus missing out on potential tax-deferred growth during that time) or taking larger hardship withdrawals can result in a smaller, perhaps much smaller, nest egg at retirement.
So consider educating your employees on the importance of letting their 401(k) accounts grow undisturbed and the potential negative tax consequences of loans and early withdrawals. Please contact us at 205-345-9898 if you have questions.
Some business owners — particularly those who founded their companies — may find it hard to give up control to a successor. Maybe you just can’t identify the right person internally to fill your shoes. While retirement isn’t in your immediate future, you know you must eventually step down.
One potential solution is to find an outside buyer for your company and undertake a long-term deal to gradually cede control to them. Going this route can enable a transition to proceed at a more manageable pace.
Time and capital
For privately held businesses, long-term deals typically begin with the business owner selling a minority stake to a potential buyer. This initiates a tryout period to assess the two companies’ compatibility. The parties may sign an agreement in which the minority stakeholder has the option to offer a takeover bid after a specified period.
Beyond clearing a path for your succession plan, the deal also may provide needed capital. You can use the cash infusion from selling a minority stake to fund improvements such as:
- Hiring additional staff,
- Paying down debt,
- Conducting research and development, or
- Expanding your facilities.
Any or all of these things can help grow your company’s market share and improve profitability. In turn, you’ll feel more comfortable in retirement knowing your business is doing well and in good hands.
Benefits for the buyer
You may be wondering what’s in it for the buyer. A minority-stake purchase requires less cash than a full acquisition, helping buyers avoid finding outside deal financing. It’s also less risky than a full purchase. Buyers can, for example, push for the company to achieve certain performance objectives before committing to buying it.
Integration may also be easier because buyers have time to coordinate with sellers to implement changes — an advantage when their IT, accounting or other major systems are dissimilar. In addition, in a typical M&A transaction, decisions must be made quickly. But under a long-term deal, the parties can debate and negotiate options, which may improve the arrangement for everyone.
What’s right for you
There are, of course, a wide variety of other strategies for creating and executing a succession plan. But if you’re leaning toward finding a buyer and are in no rush to complete a sale, a long-term deal might be for you. Covenant Consulting can provide further information at 205-345-9898.
Naming a minor as beneficiary of a life insurance policy or retirement plan can lead to unintended outcomes
A common estate planning mistake is to designate a minor as beneficiary — or contingent beneficiary — of a life insurance policy or retirement plan. While making your young child the beneficiary of such assets may seem like an excellent way to provide for him or her in the case of your untimely death, doing so can have significant undesirable consequences.
Not per your wishes
The first problem with designating a minor as a beneficiary is that insurance companies and financial institutions generally won’t pay large sums of money directly to a minor. What they’ll typically do in such situations is require costly court proceedings to appoint a guardian to manage the child’s inheritance. And there’s no guarantee the guardian will be someone you’d choose.
For example, let’s suppose you’re divorcing your spouse and you’ve appointed your minor children as beneficiaries. If you die while the children are still minors, a guardian for the assets will be required. The court will likely appoint their living parent — your ex-spouse — which may be inconsistent with your wishes.
Age of majority
There’s another problem with naming a minor as a beneficiary: The funds will have to be turned over to the child after he or she reaches the age of majority (18 or 21, depending on state law). Generally, that isn’t the ideal age for a child to gain unrestricted access to large sums of money.
A better strategy
Instead of naming your minor child as beneficiary of your life insurance policy or retirement plan, designate one or more trusts as beneficiaries. Then make your child a beneficiary of the trust(s). This approach provides several advantages. It:
- Avoids the need for guardianship proceedings,
- Gives you the opportunity to select the trustee who’ll be responsible for managing the assets, and
- Allows you to determine when the child will receive the funds and under what circumstances.
If you’re unsure of whom to name as beneficiary of your life insurance policy or retirement plan or would like to learn about more ways to provide for your minor children, please contact us.
© 2018 Covenant Consulting