South Florida Estate Planning Law : Florida Estate Planning Lawyer & Attorney : David Shulman Law Firm : South FL Wills & Trusts

I'm sure a lot of you are reading the headline above and thinking "Say wha?"

Let's back up.  There are (generally) two types of IRAs, which stands for Individual Retirement Arrangements (Yes, "Arrangements" and not "Accounts."  Look it up).  There is the "Traditional" IRA and the Roth "IRA".  (Also note that Roth is not written in all caps as it's not an acronym but named after the late Sen. William Roth of Delaware).

Without going into more specific detail, the contributions to a traditional IRA are generally deductible, but the distributions are taxable income when withdrawn. On the other hand, with a Roth IRA, the contributions are with after tax money, but the withdrawals are tax free.  There are other advantages to the Roth, including the fact that the owner is not required to start taking minimum distributions at the age of 70 1/2.

There are income limitations as to who can contribute to a Roth IRA, and who can convert their traditional IRA to a Roth IRA.  In 2010, the income limitation preventing wealthier individuals from converting their traditional IRA to a Roth disappears.  Anyone can convert their traditional IRA to a Roth, but they have to recognize the amount converted as taxable income.  In other words, if your traditional IRA is worth $100,000 at the time of conversion, then if you convert you will have $100,000 in additional income, subject to taxes.  There is a special rule for those that convert in 2010, allowing them to spread the taxes owed over 2 years.

I've seen numerous articles on the internet and have heard a few presentations debating who should convert their traditional IRA to a Roth and who shouldn't.  These articles state that a number of factors should be looked at before converting: (1) the person's age; (2) the person's tax bracket; (3) whether they can pay for the conversion from funds outside of the IRA; (4) how long they have until retirement; (5) whether they think they will have a higher or lower tax rate in retirement.

All of this is true, and all of those factors should be examined.  But they should be examined after everyone converts on Monday, January 4, 2010.  Why?  Because if you convert you have until October 15 of the following year (i.e. October 15, 2011) to undo it (known as a recharacterization), penalty and consequence free.  You can even do a partial recharacterization, meaning some of the IRA will stay as a converted Roth IRA and some will go back to the traditional.

The amount of income that you are required to recognize for tax purposes, is the value of the traditional IRA at the time of the conversion.  If you wait to convert, you are risking missing a substantial increase in the market.  If the market goes up, it could cost you substantially more in taxes to convert than it would have if you had not waited.  If the market goes down, or, if based upon the above factors you later decide that converting was not the best option for you, you have almost two years (if you convert in January) to change your mind.  Not only that, you can still reconvert to a Roth IRA, provided that the reconversion is not in the same year as the initial conversion and not within 30 days of the recharacterization. 

So I think everyone should convert their traditional IRA to a Roth IRA in early January of 2010, and then they should wait and see whether or not it was a good choice, because believe it or not, Congress is giving you a do-over.

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In today's (October 15, 2009) Wall Street Journal, there is an article entitled "Is There a Trap Lurking in the Language of your Will?" written by reporter Laura Sanders. The article correctly points out that many semi-wealthy couples may have a serious problem in their Wills.  By "semi-wealthy" I mean estates worth up to $4 million.  Yes, I know for most people that is "superwealthy" but bear with me.

As the article explains it, the problem is that since 2001, the lifetime exemption, that is the amount of assets one could have at death before being subject to the estate tax, has increased from $675,000 to $3,500,000.  With proper estate planning, a married couple is able to use the exemption of both spouses. What happens is that upon the death of the first spouse, the amount of the remaining exemption is set aside.  This is generally done through what is known as a "bypass" or "credit shelter" trust, but sometimes can be given to the children directly or set up in a trust for their benefit.

The problem is that when an estate planning attorney drafts the will or the trust, they do not know what the exemption will be at the time of the client's death, and they don't know how much of the exemption the client will have already used up during their lifetime. 

Estate planning attorneys draft around this problem by using formula clauses.  A Will might leave as the article states, "the full amount of the estate tax exemption to go into the bypass trust when the first spouse dies."  If the will was drafted when the exemption was $675,000; with a $3.5 million exemption, a bypass clause could potentially and unintentionally deprive the surviving spouse of the entire estate! (Assuming there are no elective share rights).

However, not all credit shelter clauses are used to have the assets go in a manner that deprives the spouse of all use of them. Often the credit shelter trust provides the surviving spouse with all of the income, plus principal for his or her health, education, support, and maintenance.  Each situation is different. 

What the article didn't mention is what I find the much more interesting scenario.  As of right now, there is no estate tax next year.  It is scheduled to expire, only to come back at a lower exemption and a higher rate in 2011. Now, I'm a firm believer that Congress will do something to prevent repeal from happening.  Most likely, they will extend the 2009 levels for another year, to, as usual, put off making any decision for as long as possible.

But let's say that they don't; and it's 2010 and there is no estate tax.  Let's also say that a person dies with a Will that leaves the "smallest pecuniary amount which, if allowed as a federal estate tax marital deduction, would result in the least possible federal estate tax being payable by reason of my death" to a marital deduction trust.  If there is no estate tax, how much is the marital deduction trust funded with?  If there is no estate tax, the smallest amount which if allowed as a federal estate tax deduction would result in the least possible federal estate tax is probably zero.  Would we have to fund bypass trusts if there is no tax?

We live in interesting times.

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The IRS has created what it calls a "new Web-based tool to help small business owners determine which tax-favored pension plan bests suits their needs and how to keep their plans in compliance."

The IRS Retirement Plan Navigator has links to "Choose a Plan," "Maintain a Plan," or "Correct a Plan."  I especially like the Plan Comparison Table, which is a chart of various plans and the rules that apply to each of them.

Although the IRS says that the purpose of the website is to help small business owners make determinations regarding their plans, I think it's a good idea for small business owners to contact an attorney who specializes in this area, as mistakes can be quite costly.

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I'm not sure how recent this is (I think that some if it is fairly new), but I have just come upon Bankrate.com's 2009 Estate Planning Guide.  It is broken down into four chapters, with an example of an article from each chapter in parenthesis:

1. Planning for Life (8 life stages of estate planning)
2. Planning Techniques (9 key estate-planning tools)
3. Planning for the future (How to split up the family willed home)
4. Estate Planning Resources.

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