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Avoid probate and protect your home, without a land trust

Picture this.  Your spouse hasn’t been sleeping well and runs into another car during his or her morning commute.  The other driver is injured in the accident and has medical bills and lost wages greatly exceeding your insurance coverage.  The lawyer for the injured driver says it was all your spouse’s fault, and they’re coming after everything you have.  Can they really take your home?

Or your spouse runs a business, and the bank required them to personally guarantee a loan.  Now, the business isn’t doing so well, and the bank is asking about other ways your spouse might come up with the money.  Is your home safe?

Or perhaps your spouse gets into trouble with their credit card spending, and bankruptcy seems like the only option for them.  You’re making enough to pay the monthly bills, including your mortgage.  But can the credit card companies really make you sell your home to cover your spouses charges?

In Illinois, the answer to both questions might be no … if you own your home as “tenants by the entirety.”

Don’t let the complicated name scare you off (and let’s just call it “entirety protection” to keep it simple).  Entirety protection is a really important protection for married couples, and one that is overlooked by many estate planning attorneys.

You don’t get entirety protection automatically.  But a new law signed last week by Governor Quinn makes it much easier to use a living trust and keep entirety protection for your home.

Why is entirety protection so important?  Well, it protects your home from claims made against either you or your spouse (but not from claims made against you both).  Without entirety protection, a creditor of your spouse could place a lien on your home and might even force you to sell your home to pay off the debt or claim.

Until now, there have been only two ways to get entirety protection:

  1. Own your home together with your spouse, where the deed includes the words “tenancy by the entirety” or “tenants by the entireties”
  2. Own your home in a land trust, where you and your spouse are the beneficiaries

But the new law allows for a third way to get entirety protection—using a traditional living trust.

The keys to entirety protection under the new law are a properly structured deed and living trust (or trusts, if you and your spouse each have your own trust).

If you already have a land trust, that’s great!  As long as your land trust states that your home is held in “tenancy by the entirety,” you don’t need to do anything.  The new law doesn’t change anything for you.

But if you’re not sure how your home is owned or whether it has entirety protection, I can tell you by taking a look at your deed and living trust or land trust.  There’s no fee for this service.  It’s my gift to you to make sure you don’t miss out on this invaluable protection for your home.

As always, I am here to help you and educate you — bringing you the latest developments in the law that affect your family.

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An estate planning lesson…from a dancing TV show?

The 10th season of Dancing With The Stars is in full swing now on ABC.  There’s even more excitement than usual around the Kabbe household because our local Olympic hero Evan Lysacek is competing!  And, yes, I do mean the whole household.  Even my husband (and law partner), Jeff, watches!

Saying that Evan is local is an understatement.  He is not only from Naperville, but he is from our neighborhood.  He went to the same elementary school and middle school as our children now attend (and he went to the high school our children will go to, but I am really trying not to think about high school yet).

Last week we began wondering how much the stars got paid to appear on the show.  I had heard rumors that some of the stars (such as this season’s Pamela Anderson) went on the show primarily to make money.  So the obvious question was, “how much?”

Well, it wasn’t even ten minutes later and Jeff had found the answer.  During Season 8, the stars earned $125,000 just for appearing on the show.  The stars could also earn up to $240,000 more by making it to the finals.  And what about winning the whole competition?  The only reward for that appears to be the mirrored ball trophy.

How do we know all of these details?  Usually reality TV shows include a pretty tight non-disclosure agreement forbidding the participants from talking about the show and their contract.  That’s why we don’t hear much about how shows like Survivor and The Bachelor are actually produced.

But Season 8 on Dancing With The Stars was different because Olympic gymnast Shawn Johnson was one of the stars.  What made Shawn different from previous competitors is that she was a minor (she was 17 when she competed, having just turned 18 in January).

Shawn’s contract with Dancing With The Stars had to be approved by a judge because minors don’t have the same ability to enter into contracts as adults.  And the second that contract was filed with the court, it became a public record.

It’s the same deal with probate.  Far from avoiding probate, having a will actually guarantees probate (with the exception of some estates under $100,000).  Your will and a complete accounting of your assets will become part of the public record.

Now, it’s unlikely that reporters from TMZ are going to be digging through your court records after you pass away like they have done with Michael Jackson’s estate.  But you may have your own reasons for wanting to keep your family, friends, and neighbors from learning the details of your assets and what gifts you made.

That’s just one of the reasons why more and more people are turning to living trusts for their estate plans:  trusts are private.

If you have only a will, I encourage you to investigate the benefits offered by a living trust.

In the meantime, don’t forget to vote for Evan on Dancing With The Stars!

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Has your plan kept up with your life?

Spring isn’t just a time for cleaning, it is also a good time to do all of the yearly maintenance tasks around your home.  Proper maintenance can save you money and protect your family.

But more than just your house needs maintenance.  You would be well advised to review your estate plan at the same time.

Many of your assets are controlled by beneficiary forms.  Typically, these will be your retirement accounts (such as IRAs, 401(a), 401(k), and 403(b) accounts), life insurance policies, and any other accounts you have with a transfer on death (TOD) or payable on death (POD) designation.

When your beneficiary forms don’t keep up with changes in your life, it can cost you — and the people you love — lots of money.

Have you, or someone you know, gone through any of these major life changes since you last checked your beneficiary forms:

  • Gotten married
  • Gotten divorced
  • Had a child
  • Lost a husband or wife

Many people automatically think to update their estate plan when they have one of these major life events.  But the beneficiary forms often slip through the cracks.

I have read several stories in the news recently about money from a retirement account or life insurance policy going to the wrong people because beneficiary forms weren’t updated.

  • If you have gotten divorced, is your ex-wife or ex-husband still the beneficiary of your life insurance?
  • If you have gotten married, are your parents or siblings still the beneficiaries on your accounts?

It can be tough to predict what life changes will make you rethink your beneficiary forms.  So put it on your calendar.  Every year, get a copy of all of your beneficiary designations and make sure they reflect the life you now lead.

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Is Your IRA in the right bucket?

The weather is getting warmer, it’s raining, and the birds are singing in the mornings.  So you know what that means…

It’s time for spring cleaning!

As we clean out the garage and do yearly upkeep on our homes, we shouldn’t neglect our estate plans.  Proper maintenance is the key to the success of your living trust.  And just like your furnace has different needs than your air conditioner — so too does your retirement account have different needs than your checking account.

Retirement accounts — IRA, 401(k), and other employer-sponsored plans — aren’t just a great way to save for your retirement.  They’re also a great way to use the power of compound interest and tax-deferred growth (or tax-free growth for a Roth account) to turn thousands into millions.

I often compare a living trust to a bucket for holding money and assets.  But take a wrong turn — by using the wrong kind of bucket — and your heirs will stand by helplessly while the IRA custodian completely pays out the IRA and closes the account.

What would your heirs end up with?  No compound interest.  No tax-deferred growth.  And a giant tax bill from Uncle Sam.

This problem is actually more common than you might think.  But before we dig into how your IRA might be broken, let’s take a look at how it’s supposed to work.

Stretch Your IRA Distributions

The IRS allows an inherited IRA account to be distributed over the life of the beneficiary.  This is called “stretch out” of distributions, or a Stretch IRA.  So if you pass away leaving your IRA to your 35 year old son, the IRS uses his life expectancy to calculate minimum distributions — not yours!

Some living trusts aren’t designed to work with retirement accounts and don’t support stretch out of any kind.  These trusts force an IRA into the Five Year Rule.  That means the IRA must be completely paid out by the end of the fifth year after the owner’s death.

But some institutions don’t even give you that long.  You may be forced to take a single distribution, paying all the taxes in a single year (say hello to the 35% tax bracket if you inherited a sizable IRA). This happened to a recent client of mine.  Her father’s IRA was distributed in one large payment because the living trust didn’t meet the IRS stretch out rules.

It makes sense that the later you pay taxes, the better off you will be. Let’s take a look at an example to see just how much better is a stretch IRA than falling under the Five Year Rule.

See the Stretch in Action

Imagine you leave a $100,000 IRA to Angela, your 30-year-old daughter or granddaughter.  Angela has a professional job, putting her squarely in the 28% income tax bracket.

Angela invests the IRA in growth mutual funds.  It’s tough to predict what the stock market will do (just look at the past two years for evidence of that).  But we will assume that, over the long term, the IRA earns a 5% annual return, adjusted for inflation.  History suggests that Angela might be able to achieve a 7% return, but let’s be conservative.

The IRA With a Lump Sum Distribution

Let’s assume that Angela received her inherited IRA from a living trust just like the one my client’s father had.  Angela receives $72,000 from the original $100,000 IRA after taxes.  If Angela invests that money and never spends a cent, she could expect to have $239,643 when she retires at 65 (under the above assumptions).

That sounds pretty good.  And keep in mind that we adjusted for inflation.  If we hadn’t, the final figure would have been much higher. So the $240k figure is in today’s money, shopping at today’s prices.

The Stretch IRA is going to have to be pretty good to beat that.  Let’s see how it does…

The IRA with Stretch Out Distributions

If Angela is able to stretch out her distributions, she won’t have to pay any taxes up front.  She will have to take small distributions each year that are required by the IRS (called Required Minimum Distributions, or RMDs).  Over the next 35 years, those distributions will add up to $190,698 after taxes.

But even after all the distributions, Angela would still have $138,423 remaining in her trust (after taxes, if she took it as a lump sum payment at age 65).

The total value of Angela’s IRA over the 35 year period is $329,121.

You read that right.  The Stretch IRA beat the lump sum distribution by almost 73%.

The lump sum distribution performed respectably, getting Angela a nearly 240% return on her investment.

But would you turn down an extra 90% profit? I didn’t think so.

Now, of course, this is just an example.  But they show the tremendous growth potential of an IRA when it remains intact and is allowed to grow for decades.

Imagine fully funding the retirement of your grandchildren — before they have even graduated from college.  That’s what a stretch IRA can do for your family.

Securing Your IRA Stretch Out

By now you might be thinking, “Ok, Natalia — just tell me what I should look for on my beneficiary form.”  Unfortunately, it’s not that simple.  Two things will determine whether your IRA can be stretched out or will fall under the Five Year Rule:

  1. How your beneficiary form is filled out
  2. The terms of your revocable living trust

You will probably need the help of an attorney to sort this out — particularly if your living trust is the beneficiary of your retirement account.  One wrong step could cost your children hundreds of thousands of dollars over their lifetime.

If you have a large IRA (over $100k) and are concerned about stretch out, you might consider a Retirement Plan Trust.   It works in many ways like a living trust, but it is specifically designed to meet the IRS stretch out rules for retirement accounts.

Call our office if you would like to discuss stretching out your retirement accounts or want to learn more about the Retirement Plan Trust.

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The estate tax is gone, but don’t celebrate yet

We are seven weeks into the new year and there is still no clear roadmap for the estate tax.  It’s probably not too early to think about what might happen in 2011 — a 55% estate tax with a $1 million exemption.

But what about 2010?  Should we all be celebrating the (at least temporary) demise of the estate tax?

Not so fast…

The estate tax hasn’t been removed, it has been replaced with another tax.  The new tax is the capital gains tax.

Thousands of estates will be impacted.  In fact, the chief tax counsel for the House Ways and Means Committee (the committee responsible for writing tax bills) estimates that an additional 65,400 estates will have to pay taxes in 2010 because of the elimination of the estate tax.

If that doesn’t make any sense, then let me explain the concepts of “basis” and “step up” and how they were affected by the change in laws on January 1.

If you buy an asset (for example: a house, shares of stock) and sell it later for a profit, you have to pay capital gains taxes on the profit.  The price that you paid for the asset is called the basis.

Sometimes the basis changes.  For someone dying last year, the basis of each of their assets would change (step up) to the value of the asset on the day that person passed away.

An example might make that more clear:

Appreciated Assets in 2009 (With An Estate Tax)

  • Steve buys 100 shares of Apple, Inc. stock for $5 in 1997.  His basis for each share is $5 (the total basis is $500).
  • Steve passes away in 2008.  At the time, the shares of Apple stock are valued at $100.
  • Steve’s trust leaves the shares to his daughter Kate.  Kate’s basis in the shares steps up (changes) to their value at Steve’s death — $100 (for a total basis of $10,000).
  • Kate sells the shares in 2010 for $200 each.
  • Kate has to pay capital gains taxes on a $10,000 gain (100 shares times the difference between the sale price of $200 and the basis of $100).

Here’s how that would have looked had Steve passed away under the laws as they currently stand for 2010:

Appreciated Assets in 2010 (With No Estate Tax)

  • Steve buys 100 shares of Apple, Inc. stock for $5 in 1997.  His basis for each share is $5 (the total basis is $500).
  • Steve passes away in 2010.  At the time, the shares of Apple stock are valued at $100.
  • Steve’s trust leaves the shares to his daughter Kate.  Kate’s basis in the shares does not change, but remains at $5 (for a total basis of $500).
  • Kate sells the shares in 2010 for $200 each.
  • Kate has to pay capital gains taxes on a $19,500 gain (100 shares times the difference between the sale price of $200 and the basis of $5).

Under the old estate tax system, a person could pass on assets worth $3.5 million (and for which the basis would be $3.5 million) without paying any federal taxes. Now, much smaller estates are exposed to taxes.

Congress hasn’t left us completely out in the cold, though.  In 2010 you can increase the basis of property you pass on by up to $1.3 million.  Again, let’s take a look at an example:

Using Your IRC § 1022 Basis Increase

  • An entrepreneur, Julie, starts a business with just $100,000 in seed money.
  • Julie’s business has grown to be worth $3 million when Julie passes away.
  • Julie trust leaves her business to her son, Mark.
  • Mark’s basis in the business, if he chooses to later sell his shares, can be increased to $1.4 million.  This would use the entire $1.3 million increase available to Julie.

The situation is even worse for couples.  Under the 2009 estate tax laws, all property left by the decedent to their spouse would get the setup up in basis.  Someone passing away in 2010 can only increase the basis of property left to a spouse by up to $3 million (in addition to the general basis increase of $1.3 million).

So who is at risk of additional taxes now that the estate tax is gone?  Many people could be swept up into these new taxes.  But two groups in particular should carefully consider their planning in light of the changes in the law in 2010:

  • Married couples or individuals with substantially appreciated assets or a closely-held business
  • Anyone with a net worth between about $1.5 million and $3.5 million that includes appreciated assets

If that sounds like you and your family — you’re not alone.  We could see a 1000% increase in the number of estates that owe taxes this year.  And then it’s all supposed to reset in 2011, with an estate tax at the antiquated limit of $1 million.

So this story is almost certainly not over.  Stay tuned!

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