Article

New Horizons in Estate Planning

Steve Parrish, JD®, RICP®, CLU, ChFC®, AEP®, Co-Director Retirement Income Center and Adjunct Professor of Advanced Planning at The American College

Editor’s note: This article is an adaptation of the live webinar delivered by Steve Parrish in 2021. His comments have been edited for clarity and length.

You can read the summary article here as part of the 2nd Qtr 2021 Retirement InSight and Trends Newsletter, worth 1.0 CE when read in its entirety (after passing the online quiz.)
You may also choose to take the full length course New Horizons in Estate Planning for 1.0 hour continuing education (CE) credit.

By Steve Parrish, JD®, RICP®, CLU, ChFC®, AEP®, Co-Director Retirement Income Center and Adjunct Professor of Advanced Planning at The American College

Estate planning is typically not a top of mind for consumers. However, lately, it has been a hot topic. I was surprised earlier this month when I was watching TV, and the local news headline from the 11:00 pm anchor was, “Estate planning is more important after COVID; why you don’t want to do this alone on tonight’s 11:00 news.”

However, estate planning is very much back in vogue. Aretha Franklin and Prince died without a will, and we heard about all the problems and consequences. More recently, Tony Shay died at a very young age, again without a will.  It’s no longer a matter of just estate tax planning. It’s talking about estate planning in general.

Now, there’s more flexibility in the law. When I was in law school, there were no such things as living wills or the idea of physician-assisted suicide; none of that existed. We’ve had the effects of the pandemic when people saw these tragic things happening and nothing they could do about it. This was the wake-up call.  Then, we had the SECURE Act, the CARES act, and whatever we have on upcoming changes on the financial side. Anytime you have a change in tax law, it also affects estate planning.

I teach both law students and financial advisors about estate planning. A lot has changed. Significant changes were already occurring before the pandemic hit. But then, when people saw loved ones going into hospitals without the ability to have another speak on their behalf, it was a wake-up call.  My friends who are estate planning attorneys are besieged with appointments and requests for estate planning documents.

As financial advisors, if we do this right, we can move our trustworthy status with the public further away from mechanics and politicians and closer to doctors and accountants. In other words, building estate planning into your financial planning advisory practice really can help build that trust factor.

Eight Major Shifts or Horizons in Estate Planning 

My comments here are focused on financial advisors. What do you need to know about the new things happening in estate planning?

1. Estate planning has become more and more a part of financial and retirement planning. It used to be a separate discipline that essentially estate planning attorneys did.
2. There’s much more of a focus on longevity versus mortality. In other words, living too long, as well as dying too soon.
3. In the tax arena, it’s changed quite a bit. Now, we’re talking about required minimum distributions and inherited IRAs and income taxation when you die versus estate and Gift and generation-skipping taxes. It’s much more emphasis on the income side.
4. Life insurance for estate planning purposes was typically put in an irrevocable life insurance trust, and you were done. Now, it’s become much more of a wealth management tool.
5. End-of-life planning has become the new planning motivator. What gets clients into offices is more the issue of what happens at the end of life. A lot of that’s was sparked because of COVID-19.
6. Housing is a critical challenge and opportunity. So much of our net worth is tied up in our housing. There are new ways to release some of that equity and use it in retirement and estate planning.
7. Elder law and family law have increased importance because of what’s going on and have key aspects of integration with estate planning.
8. There are new estate planning topics and issues such as pet estate planning and digital estate planning because we need to incorporate those in our thinking.

Estate Planning is Part of the Financial Planning

It used to be when you heard the term “estate planning,” you thought of rich people and estate tax planning. That has changed quite a bit because the estate tax only currently applies to a very small elite group of typically wealthy people. When you say “estate planning” now, it’s part of that whole planning process that you do when you’re doing financial planning.

There’s now an emphasis on living versus death and estate planning. Because estate planning is not just an after-death thing anymore, it also involves living issues that receive much more attention, such as, “What happens if I have a disability or become capacitated?” Or “Is there somebody that can speak for me with a power of attorney?” Also, what about end-of-life? COVID got a lot of this going.  Do I have a say in managing my death? And now there’s a lot more opportunity to do that. And finally, the whole idea of longevity versus mortality. People are thinking about that more than just dying too soon.

I write a column on retirement planning in Forbes. If anything in this article sounds like something you want to hear more about, you’ll see that I have an article on it.

Longevity versus Mortality

When I was young, an uncle in his early 40s was walking down the street. He suddenly clutched his chest, fell over, and died of a massive heart attack. I also have an aunt who lived well into her 90s. The challenge she had is that for over 25 years, she had dementia, which turned into full-blown Alzheimer’s. For 20 years, she didn’t even know her own kids’ names.

People now associate more with the issue of my aunt living into her nineties with Alzheimer’s than the idea of someone in their young 40s dying early. Living too long has become more pressing than dying too soon. This has been mainly seen with affluent trends in life expectancy, even with COVID last year, where mortality went worse rather than better. As far as the affluent, their life expectancy still improved. What happens when you have that conflict between dying too soon and living too long is at the client level, they worry about, “I need to have enough retirement income stream so that I can live my whole life comfortably, and I don’t know how long that is.” But, most of these individuals also would like to leave a legacy for their children or grandchildren.  Now the two are running into each other, and that’s part of the planning process.

Then, we have a challenge that has evolved over the last 10 – 15 years: life expectancy and life quality can disconnect. Longevity no longer necessarily equals the quality of life because you could be hooked up to a feeding tube or a respirator.  Suddenly people realize, “Oh, okay, living a long life does not necessarily mean leading a good life.” Then, you add in COVID-19, which caused people to realize they didn’t want to suddenly be rushed into a hospital, not have anyone speaking for them, suddenly be intubated, have a respirator, and have no say over what’s going on. This is the emphasis on longevity versus mortality.

Emphasis on Income versus Estate & Gift Tax

Where are we with the state gift and generation-skipping trust? We have an $11.7 million exemption level this year. When the tax hits, it hits big, at 40%. It’s a cliff tax.

Remember that when 2025 is over, the current law sunsets and goes back to an exemption of about half of that. That’s where we are right now. What about income tax? We’re sitting at a 37% top marginal income tax bracket, but that’s only when a couple hits about $600,000 in income. We also have a 20% maximum capital gain tax.

As far as gifts, if you make a gift for estate planning purposes, the lower of the basis or the fair market value will carry over. Any gain is going to be taxed when the donor sells it. However, if you receive it in a will, then the basis steps up.

The SECURE Act came in and significantly changed Inherited IRAs. If you inherit an IRA from someone and if you’re an adult, you’re going to have to liquidate that within ten years. It used to be that that could be stretched over your lifetime.

Because of that, people are not just assuming that when you inherit an IRA, it’s going to be stretched. Now people are asking, “What are the alternatives? Maybe life insurance? Maybe charitable remainder trusts?” So, a lot has changed.

This leads to another issue that certainly has been sparked in part because of the SECURE Act, and that’s required minimum distributions. The SECURE Act delayed the age at which you have to begin drawing down your IRAs from age 70½ to 72. They’re talking about moving it up to age 75; we’ll see. Another thing people aren’t always aware of is that they also increased the life expectancy tables. They did this late November last year, but they’re not effective until January 2022, where they’re assuming people at retirement age will live about two years longer than the tables used to assume.

Because of this, you’re now can draw down less than you had to before from your retirement savings. This means that many people will have larger balances, leading to more planning for the next generation, not just the donor or the decedent.  We’re looking more and more at Roth IRA planning and trying to get the taxes down for the beneficiary.

In addition, we have this uncertain tax environment. We know that there’s talk about increasing the top income tax bracket from 37% to 39.5%. The scary one to me is bringing capital gains rates to that amount. When you add into that the 3.8% net investment income tax (NIIT) for higher-income earners, you’re talking about over a 40% tax on potential capital gains.

In the estate and gift arena, a lot is going on there. They’re talking about maybe moving the gift tax exemption as low as $1,000,000 and the estate tax exemption to three and a half million dollars. There’s also a discussion about what to do to shore up Social Security. There’s been the idea that you would still have a cap on taxing wages at about $140,000 or so on Social Security, but then when you make more than $400,000, they kick in the 12.5% FICA tax again. I’m not saying all these tax changes are going to happen. I am saying there’s the potential that some of those can happen, and we must factor that in.

How do you plan your estate when the tax law may be changing? A way to look at it from an estate planning standpoint is first to say, “What’s my target at the tax level? Is it estate tax and gift tax? Or is it more on the income tax side?” If your target tax level is on the estate side, we need to do ‘now strategies’ to freeze assets and leverage the higher exemption while still here. And so, there is much talk now with high net worth and ultra-high net worth clients about doing gifting to get those appreciated assets out using the $11.7 million exemption.

Planning Your Estate When Tax Laws May Change

 They’re also talking about taking away some of our toys in the estate tax planning like GRATS, so people are talking about, “Let’s beat the buzzer and set up GRATS now so that we can get all that appreciation out of the estate.” Many of the strategies we’re talking about are also trying to lower valuations so that to the extent they’re going to be taxed, they get taxed at a lower valuation.

Businesses that are in the process of being sold are trying to advance the dates on it so that they can do an installment sale and maybe pay the lower capital gains. They also do things like locking in the value instead of appreciating assets by putting them in the family limited partnership.

And finally, try to move some of the money out by putting it into an irrevocable life insurance trust (ILIT) while you still can. Use the exemption to move some of the premiums out and put them in an ILIT that’s outside of the estate. For the high net worth and the ultra-high net worth clients who are worried about the estate tax, we’re completely changing the retirement draw-down technique because they’ll need to take their taxable income first. They will draw down their IRAs because every dollar that the grantor or the decedent pays in taxes is a dollar that is not subject to the gift tax.

All of this is different than what most people have been doing. Compare and contrast. What if, as is the case with most of us, we’re looking at income tax as the primary issue? When you’re focused on income tax, you’re starting to look at things like tax characterization, and timing how you’re going to all do it. Because people are gifting out now, if income tax is the issue, maybe you want to do it by bequests rather than by gifts, because that way you get the step-up in cost basis.

There are other options like Roth conversions so that you’re spreading out the income and coming up with less of a tax burden for beneficiaries. You are figuring out how to keep your tax brackets lower so that you don’t have to pay the higher Medicare Part B premiums (IRMAA premiums) that are a penalty for making too much money or losing some of the deductibility you have for a closely held business under the qualified business interest.

What you’re trying to do is work your tax brackets. Another thing you’re trying to do is retain value rather than lower valuation. A lot of it has to do with tax bracket timing with IRAs.

A SECURE Act IRA Example

Let’s say that you had a client who turned age 70½ last year (2020). I’m using last year for a particular reason. This individual has about $2 million that they’ve built up an IRA. None of it is in a Roth. If we hadn’t had the SECURE Act and if we hadn’t had the new life expectancy tables, they would have this $2 million balance, and required minimum distributions would have to start.

If they took it out over ten years (I use a zero-interest rate to make it easy), that $2 million burns down to about 1.2 – $1.3 million ten years later because they had to take required minimum distributions (RMDs). However, along comes the SECURE Act and the CARES Act, plus these newly-revised life expectancy tables starting next year.

This 70-year-old now doesn’t have to take required minimum distributions until they turn 72, which will be this next year. In addition, the new life expectancy factors assume people will live two years longer than we thought before. Because of this, the RMD factor is smaller, so they don’t have to take out as much.

After ten years, they will have $1.4 million because of these changes. That means they have an 11% higher balance ten years down the road. Let’s say they then die. What’s the consequence to the beneficiary?

With the beneficiary, you’ve got the 10-year rule instead of the stretch IRA rule where they have to liquidate the IRA within ten years the year after the date of death. So, what does this really mean for the beneficiary? First of all, that means you’re going to be taking in money earlier, which means higher marginal tax rates. Remember that when I say beneficiary, if somebody dies in their 80s, that typically means it might be an adult kid who’s in their 50s.

So now they’re in a higher marginal tax bracket. That also means that they’re going to have more taxable income that might decrease their business deduction, increase their Medicare Part B premiums, increase or make them subject to the 3.8% net investment income tax. All these threshold taxes suddenly kick in because mom and dad gave them an IRA.

This also means they’ll have less tax-deferred growth because they will be taking it out over ten years, depending on who they are. What do you do about it from a planning standpoint?

Just because they can put off taking required minimum distributions to 72, and it won’t be as much, does that mean they want to? So, is it wait or not wait to take your RMDs? Maybe they want to spread some of that out.

Also, review trust language. Because the deal was that we as estate planners did all kinds of interesting things with trusts for people that were going to have inherited IRAs.  The trouble is that some of these clients are sitting out there saying, “If there’s any IRA left when I die, is the remainder paid to my beneficiaries from a trust that is to pay out the required minimum distribution?” However, the required minimum distribution for the IRA is no longer over a lifetime.  Now, the required minimum distribution is the last month of 10 years after the person dies.

You don’t have to amortize or pay the money out over ten years.  You could pay it on the very last day of ten years. So, suddenly this trust that was supposed to be helping beneficiaries, they might not get a dime until ten years after mom and dad die. That sounds to me like an opportunity to find out if your errors and omission insurance really works. Those trusts have to be looked at and probably redone.

That’s also an opportunity to look at beneficiary language because what many people are doing is now making sure their spouse is the beneficiary of the IRA because they can stretch it and then make the contingent beneficiary the kids.  You want to factor in the tax impact on the beneficiaries because they’ll probably be adults. So, you don’t just plan for the owner; you plan for the beneficiaries and their tax situation.

So, what do you do? First, instead of putting as much of that money as you can into a traditional IRA, make it a Roth IRA. Do some Roth conversions so that the beneficiaries don’t have to pay tax on it. Look at alternatives like life insurance. I am getting many inquiries and interest in life insurance instead of using the stretch IRA since they were taken away. It’s a tax-free, known bequest. Also, using annuities, using charitable remainder trusts. This gives you an idea of why estate planning has changed so much in the tax area.

What About End-of-Life Planning as the New Motivator?

People are starting to think about the events before they die, not necessarily after they die. What’s going on? You have all these medical advancements to maintain people’s lives even if the quality of life is gone. Recall the high-profile cases of Karen Ann Quinlan and Terri Schiavo. Then add in Alzheimer’s, which is statistically the largest cause of people going into long-term care facilities. We also had a long-term care crisis.

When I say crisis, I mean in terms of people not being prepared for it. The insurance industry had struggled with basically undershooting on premiums. This has caused some skepticism as to whether they’ve got that together.

You also have liberalized state laws, meaning that you didn’t have a call on your end-of-life planning before. That was the doctor’s decision. Now, you can have much more liberal powers of attorneys for who’s making decisions for you. You can have a living will or advanced directive. You can have a living will, or a Physician Ordered Life-Sustaining Treatment (POLST). It’s a fluorescent sheet of paper that is on the orders in the hospital that states you said, “Do not resuscitate.” Even in eight states, you can have physician-assisted suicide.

And so, all these other pre-planning things like organ donation and disposition of remains are available. Well, COVID just made it more of an issue where people said, “Whoa, I didn’t realize that these things can happen; I want to have some control over it.” In my opinion, this is what is bringing people into attorney’s offices.

Housing Considerations and Planning

For so many people, the net worth in their house is their primary asset.

For the average American, then their net worth is $170,000. If you subtract the house,  then it’s at $27,000. Let’s be honest; a house is not a good investment. It’s a place you sleep and enjoy and raise your kids and all that. But it is very subject to local markets. We know it can go up and down. Tight now, it’s hot. What’s going to happen a year from now?

What do you do to free some of that up when it comes time from an estate planning standpoint? Well, one of the things I just did less than a month ago was an article in my Forbes column that says, “Your residence in many ways is your retirement.”  As you think about retirement, you’re also thinking about, “I’m not going to be here forever; what happens when I’m gone?” So, here are some of the considerations that are new, that are driving both these retirement and estate planning issues.

First of all, we have the estate and local tax deduction issue that is now limited to $10,000. That has caused many people in high-tax states to be angry. Then along comes a pandemic, and they realize they can work remotely. And they’re starting to say, “Should I be a snowbird?” or “Should I move?” to other states to avoid the limitations on state and local taxes.

In general, consumers are carrying more debt, including mortgages, credit cards, and student loans. Mortgage debt is the key driver of this trend. And compared to the decade ago, fewer homeowners own their homes outright. So, you’ve got this line between economically challenged people from an estate planning and retirement planning standpoint to those who have opportunities.

What do you do from a planning standpoint? First, we have some tools available to us that we didn’t always have – reverse mortgages. Despite the things you hear about them in the silly commercials on them in the middle of the night, reverse mortgages are a very powerful planning tool in retirement. They can help you augment the money you’re taking from your savings on a tax-favored basis. When used correctly, you can leave a more significant legacy to your family.

Home equity conversion mortgages (HECMs) have become a way of freeing up some of the illiquidity in your home equity. You can access that home equity as a line of credit. You could take it as tenure payments, where it’s paid out in a monthly amount, as long as you stay in the house. It can be used to replace your conventional mortgage. If you buy a new home, you can use a HECM for Purchase to have no mortgage payments in retirement.

You could essentially gift a fast-appreciating residence to your kids and still be able to live there, or maybe do it through a sale-leaseback. It used to be that Medicaid planning was considered somehow unethical, but that has changed because the government, the states all recognize that we need some flexibility in Medicaid planning.

There are things like long-term care and annuity products that are qualified through state partnerships which can provide dollars beyond the $2,000 that you can keep in assets and the $2,000 a month in income and still qualify for Medicaid. These are tools that can help improve the quality of life for somebody on Medicaid.

Can you use techniques like the Miller Trust? This is where essentially you take 401k assets, put them in a Miller Trust, and that’ll help pay for a cell phone or better clothes, etc., and still qualify for Medicaid. From an estate planning standpoint, the Medicaid planning question for so many of your clients may be this situation.

Should we use the family inheritance now or later if you have a loved one who is elderly and will need your financial help in securing a decent residence for their golden years? One way you could do it is by taking some of the money out of your pocket and helping them. Another way is helping them qualify for Medicaid; however, then the state has a call on any inheritance before you do. The question is, should I let the government go ahead and fund a lot of this a while my mom or grandfather or whoever is alive and then have that come out of the inheritance? Or should I go ahead and pay for it? This gives you some new flexibility from a housing consideration standpoint.

Key Takeaways

1. Build estate planning into your retirement or financial planning practice because it is an integral part of today’s financial planning process.
2. This includes asking end-of-life questions in your fact-finding such as, “How do you feel about if you were unable to represent yourself financially, or as far as health decisions, who would you want to do that?”
3. Consider, if you’re not already there, broadening the scope of planning to include long-term care, Medicaid, digital assets, pets, etc., and not just, “Let me show you how to improve your portfolio.”
4. There are many ways to embrace technology. Be aware that some of the broker-dealers have things like vaults for electronically holding onto some of these documents. Consider some of the things being done with genealogy and search engines today where people are using some of these tools to make sure that no surprise beneficiary will contest something. A lot of that is now being caught with technology. Be a part of the solution.
5. Be a trusted advisor regarding proposed legislation. I’ve seen advisors who just get in camp with a client and say, “Yeah, that president’s doing the wrong thing, so we should ignore that.” No, be a trusted advisor, whether they think there’s going to be a tax change or not. They need to plan for the possibility of it. Leverage your professional relationships because I realize I’ve talked about a lot of legal stuff. The more you can work with centers of influence, the better you’re going to do.

New Horizons in Estate Planning – Steve Parrish

About Steve Parrish, JD®, RICP®, CLU, ChFC®, AEP®, Co-Director Retirement Income Center and Adjunct Professor of Advanced Planning at The American College

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©2021, Steve Parrish, JD®, RICP®, CLU, ChFC®, AEP®, Co-Director Retirement Income Center and Adjunct Professor of Advanced Planning at The American College. All rights reserved. Used with permission.