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​Understanding the Tax Consequences of Inheriting a Roth IRA

3/28/2018

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Passing down a Roth IRA can seem like a good idea, but it doesn't always make the most sense. Before converting a traditional IRA into a Roth IRA to benefit your heirs, you should consider the tax consequences.
 
Earnings in a traditional IRA generally are not taxed until they are distributed to you. At age 70 1/2 you have to start taking distributions from a traditional IRA. Contributions to a Roth IRA are taxed, but the distributions are tax-free. You also do not have to take distributions on a Roth IRA.
 
Leaving your heirs a tax-free Roth IRA can be used as part of an estate plan.  However, in figuring out the best type of IRA to leave to your beneficiaries, you need to consider whether your beneficiary's tax rate will be higher or lower than your tax rate when you fund the IRA. In general, if your beneficiary's tax rate is higher than your tax rate, then you should leave your beneficiary a Roth IRA. Because the funds in a Roth IRA are taxed before they are put into the IRA, it makes sense to fund it when your tax rate is lower. On the other hand, if your beneficiary's tax rate is lower than your tax rate, a traditional IRA might make more sense. That way, you won't pay the taxes at your higher rate; instead, your beneficiary will pay at the lower tax rate.
 
Regardless of which IRA you pass on to your heirs, remember that your IRA is part of your taxable estate, so it can be subject to estate taxes if your estate is over the federal or Massachusetts estate tax exemption. 
 
Also bear in mind that the above is based on the tax rules as they now exist.  Future tax rules regarding inherited IRAs may change, making certain strategies more or less advantageous.    

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5 Things to Know to Reduce Your Tax on Capital Gains

3/21/2018

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Although it is often said that nothing is certain except death and taxes, the one tax you may be able to avoid or minimize most through planning is the tax on capital gains. Here's what you need to know to do such planning:
 
What is capital gain? Capital gain is the difference between the "basis" in property -- usually real estate or stocks, but also including artwork and collectibles -- and its selling price. The basis is usually the purchase price of property. So, if you purchased a house for $250,000 and sold it for $450,000 you would have $200,000 of gain ($450,000 - $250,000 = $200,000). However, the basis can be adjusted if you spend money on capital improvements. For instance, if after buying your house you spent $50,000 updating the kitchen, the basis would now be $300,000 and the gain on its sale for $450,000 would be $150,000 ($450,000 - ($250,000 + $50,000) = $150,000). Just make sure you keep good records of any capital improvements in order to prove them in the event of an audit. (The residence exclusion and the step-up in basis are discussed below.)
  1. How much is the tax? It depends, but assume 15 percent federally unless you have either very low or very high income, and whatever your state’s tax is (let’s assume 5 percent, for a total of about 20 percent). Using those assumptions, the tax on $200,000 of gain would be about $40,000. There are three exceptions. First, if you owned the property for less than a year, you would be subject to short-term capital gains tax rates, which are essentially the same rates as for income tax. Second, if your taxable income, including the capital gains, is less than $38,600 for a single person and $77,200 for a married couple (in 2018), there's no federal tax on capital gain. But beware that the capital gains will be included in the calculation and could put you over the threshold. Third, if your income is more than $425,800 for a single person and $479,000 for a married couple (in 2018), the federal capital gains tax rate is 20 percent, bringing the combined federal and assumed state rate up to just over 25 percent.
  2. The personal residence exclusion. You may exclude up to $250,000 of gain on the sale of your personal residence and if you're married you can exclude $500,000. To qualify, you (or your spouse) must have lived in and owned the house for at least two out of the five years prior to the sale. Those two years don't have to be the same. For instance, if you lived in the house from 2012 to 2014 and owned it from 2014 to 2016, but rented it out, you could still qualify for the exclusion. If you are a nursing home resident, the two-year requirement is reduced to one year.
  3. Carry-over basis. If you give property such as a family heirloom or real estate to someone else, they receive it with your basis. So, if your parents bought a vacation home many years ago for $25,000 and now its fair market value is $500,000, if they give it to you, your basis will also be $25,000. If you sell it, you'll have a gain of $475,000 and no personal residence exclusion, unless you move in for two years first. The combined state and federal tax would be $118,750.
  4. Step-up in basis. On the other hand, the basis in inherited property gets adjusted to the value on the date of death. In the example of the vacation home, if your parents passed it on to you at death rather than giving it to you during life, the basis would be adjusted to $500,000, potentially saving you $118,750 on its sale. On the other hand, depending on the size of your parents' estate, it may be subject to estate tax, which would be payable within nine months of their death, while the tax on capital gain would not be due until you sold the property, perhaps decades in the future. Some have proposed getting rid of this so-called "step-up" in basis. The reasoning is that it is regressive, benefiting people with property, and the more property they have, the more tax they save. But an argument for retaining the step-up rules is that they can save a tremendous amount of administrative hassle.  If you inherited stock from your father that he inherited from his mother, it may be impossible to establish what it was she paid for it. It's much easier to determine what it was worth at your father's death.
  5. Offsetting losses. If during the tax year you realized capital gain through the sale of property, you can offset it with capital losses.  Say, for example, you sell your home and realize a lot of gain. You could also sell some stock that has gone down in value, creating a loss that offsets some of the gain on the house sale. In some instances, you can carry over loss from one tax year to the next to offset future gains.
By understanding and considering these rules, you can save on capital gains taxes and avoid a number of possibly expensive mistakes.  Talk to your attorney or financial planner today about ways to lower or eliminate your capital gains tax.

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​Estate Planning and Retirement Considerations for Late-in-Life Parents

3/14/2018

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Older parents are becoming more common, driven in part by changing cultural mores and advances in infertility treatment. Comedian and author Steve Martin had his first child at age 67. Singer Billy Joel just welcomed his third daughter. Janet Jackson had a child at age 50. But later-in-life parents have some special estate planning and retirement considerations.
 
The first consideration is to make sure you have an estate plan and that the estate plan is up to date. One of the most important functions of an estate plan is to name a guardian for your children in your will, and this goes double for a parent having children late in life. If you don't name someone to act as guardian, the court will choose the guardian. Because the court doesn't know your kids like you do, the person they choose may not be ideal.
 
In addition to naming a guardian, you may also want to set up a trust for your children so that your assets are set aside for them when they get older. If the child is the product of a second marriage, a trust may be particularly important. A trust can give your spouse rights, but allow someone else -- the trustee -- the power to manage the property and protect it for the next generation. If you have older children, a trust could, for example, provide for a younger child's college education and then divide the remaining amount among all the children.
 
Another consideration is retirement savings. Financial advisors generally recommend prioritizing saving for your own retirement over saving for college because students have the ability to borrow money for college while it is tougher to borrow for retirement. One advantage of being an older parent is that you may be more financially stable, making it easier to save for both. Also, if you are retired when your children go to college, they may qualify for more financial aid. Older parents should make sure they have a high level of life insurance and extend term policies to last through the college years.
 
When to take Social Security is another consideration. Children can receive benefits on a parent’s work record if the parent is receiving benefits too. To be eligible, the child must be under age 18, under age 19 but still in elementary school or high school, or over age 18 but have become mentally or physically disabled prior to age 22. Children generally receive an amount equal to one-half of the parent's primary insurance amount (PIA), up to a "family maximum" benefit. You will need to calculate whether the child's benefit makes it worth it to collect benefits early rather than wait to collect at your full retirement age or at age 70.


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What Happens to a MassHealth Recipient If the Community Spouse Dies First?

3/13/2018

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When one spouse is in a nursing home and applying for MassHealth, planning has to take into account the possibility that the spouse who is not in the nursing home (called the “community spouse”) may pass away first. This is because the community spouse’s death may make the spouse in the nursing home ineligible for MassHealth.

In order to qualify for MassHealth, a nursing home resident can have only a limited number of assets. Careful planning can allow the resident’s spouse to maintain some assets. However, if that community spouse passes away first and leaves those assets to the nursing home resident, the resident suddenly would be over MassHealth’s asset limit.

While the community spouse could write a will that disinherits the MassHealth resident, most states including Massachusetts have laws that allow spouses to claim a portion of their deceased spouse’s estate regardless of what the will says. This is called the elective or statutory share. The amount the spouse can claim varies from state to state.

A spouse can disclaim his or her elective share, but if a MassHealth recipient disclaims the inheritance or fails to take their statutory share, it is considered an uncompensated transfer of assets and the recipient may receive a period of MassHealth ineligibility. To avoid this, the community spouse will most likely need a will that addresses this issue. One option is for the community spouse to create a will that leaves the nursing home spouse a limited interest in trust considered to be worth more than the elective share.
 
A will may only address a limited amount of the community spouse’s assets, thus care and attention should be paid to the beneficiary designations on life insurance, retirement accounts, and other assets.  Lastly, a community spouse might not be the only person a nursing home resident could inherit assets from.  Other family members, even adult children who do not have children of their own, should review and possibly modify their estate plans to ensure assets are not directed to the nursing home resident.
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Every situation is different and thus all options should be explored with an attorney.

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    meet the attorneys

    Peter C. Herbst Jr
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    Areas of focus: estate planning, estate & trust administration and elder law. 
    Briana N. Nashawaty
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    Areas of focus: estate planning, estate & trust administration, and 
    elder law.

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