By now, you have likely heard about the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) and the SECURE 2.0 Act of 2022 (part of the Consolidated Appropriations Act, 2023). These pieces of legislation were created to encourage Americans to save for retirement and provide additional rules about how retirement accounts should be treated. Among the many provisions in these pieces of legislation, one presents a unique opportunity for young adults to save for retirement.

SECURE 2.0 Act’s 529-to-Roth Rollover

Passed in 2023, the SECURE 2.0 Act provided additional provisions and opportunities to strengthen the retirement system in the United States. One of these provisions includes the ability to roll over unused funds from a 529 plan into the beneficiary’s Roth individual retirement account (IRA), up to a certain amount tax-free and without any penalties.

What Is a 529 Plan?

A 529 plan is a tax-advantaged investment account designed to hold funds to be used for a beneficiary’s (such as a child’s or grandchild’s) qualified educational expenses. After-tax money is placed into the account and grows tax-free through investing. Once the money is needed, it can be withdrawn tax-free for the qualified education expenses of the beneficiary, such as tuition and fees, most room and board expenses, books and supplies, and computers and other technology. The beneficiary can also use these funds to pay up to $10,000 toward their existing student loans. If money is withdrawn for nonqualified expenses, it is subject to income tax and a 10 percent penalty (with some exceptions).

What Happens If There Are Unused Funds?

Getting an education can be expensive, which is why many people are motivated to set up or contribute to 529 plans for their children and grandchildren. Like a standard investment account, money is put into the 529 plan with the hope that it will grow over time and result in enough money to cover some or all of the beneficiary’s educational expenses. If the cost of the beneficiary’s education is less than the amount that has been saved in the 529 account—perhaps the beneficiary has received more in scholarships than they anticipated, for example—there may be funds left over. Now, instead of withdrawing the unused money from the account and paying income tax and a penalty or trying to find a new beneficiary to which you can transfer the remaining funds, the leftover funds can be rolled over into a Roth IRA for the beneficiary.

What Is a Roth IRA?

A Roth IRA is a tax-advantaged IRA to which you contribute after-tax money to be used for your retirement. While in the account, the money grows tax-free through investing and can be withdrawn tax-free after you reach age 59 ½, as long as the account has been open for at least five years. You may be able to withdraw the funds before you have reached age 59 ½ without being subject to taxes or penalties under some exceptions.

Are There Limitations to the Rollover?

Like most things, there are some limits to rolling over unused funds from a 529 educational savings plan into a Roth IRA. Some important limitations include the following:

• There is a lifetime maximum of $35,000 that a 529 beneficiary can transfer to the Roth IRA.
• The 529 plan must have been in existence for at least 15 years.
• The Roth IRA must be in the name of the beneficiary of the 529 plan.
• You cannot transfer contributions or earnings on contributions to the 529 plan that were made within five years.
• Transfers to the Roth IRA are subject to the annual Roth IRA contribution limits.
• The rollover must be plan-to-plan or trustee-to-trustee.
• The beneficiary must have earned income to roll over funds from the 529 plan to the Roth IRA.

Some states do not use the same definition of qualified expenses for state income tax calculations. Therefore, it is important that you work with a professional to understand if there will be any state income tax consequences if you choose to roll over the funds from the 529 plan to a Roth IRA for the beneficiary.

Could This Be the Right Move for Me or My Child?

This new rollover technique allowed under the provisions of the SECURE 2.0 Act presents an additional option to consider if there are funds left over in a 529 plan after you or your child have completed their education. Instead of trying to fund a new beneficiary’s 529 plan or losing part of the money to income taxes and a 10 percent penalty, you may be able to assist your loved one in planning for their retirement. If you have questions about a 529 educational savings plan and how it may fit into your estate plan, please give us a call.

Today more young adults are living at home with their parents than at any time since the 1940s. While there are many different opinions about this trend and the cause of its recent prevalence, the primary motivation for young adults staying at home with their parents is usually related to finances.

Most adult children who still live at home have future plans to move out at some point. However, if one or both of their parents pass away prior to that time without addressing the adult child’s living situation in their estate plan, it can present legal issues.

An estate plan should be updated every 3 to 5 years. If you have an adult child who still lives at home or recently had an adult child move back in with you, it may be time to review your plan and make any necessary changes to ensure that your wishes are adequately addressed.

Almost Half of Young Adults Still Live at Home

A sign of tough economic times can be evidenced by the large number of young adults living at home with their parents.

According to a recent survey by the Harris Poll for Bloomberg, about 23 million—or 45 percent—of 18-to-29-year-olds are living with their parents.¹ That is the highest level since the post-Depression era.

Bloomberg cites economic headwinds like high inflation, the lingering effects of pandemic lockdowns, student loan debt, unaffordable home prices, and an uncertain job market as reasons why young people are staying home en masse.

The majority of those surveyed said the decision to live with Mom and Dad was motivated by the following financial reasons:

• Saving money (41 percent)
• Inability to afford to live on their own (30 percent)
• Paying down debt (19 percent)
• Recovering from emergency costs (16 percent)
• Losing their job (10 percent)

Opinions are split on the importance of parents charging rent to adult children who live with them. Around 57 percent of US adults told Newsweek that an adult child living at home should be charged rent; just 28 percent said an adult child should be allowed to live with them rent-free. A Lending Tree survey found that 73 percent of parents would charge rent to an adult child living at home.²

Boomerang Children and Estate Planning

The phenomenon of the not-so-empty-nest raises questions that should be addressed in an estate plan.

Adding an Adult Child to the Home Title

Moving back home is not always the result of a child’s money problems or financial circumstances. The second-most common reason cited in the Bloomberg poll was taking care of older family members (30 percent). Helping with family expenses (28 percent) ranked fourth.

Maybe one parent passed away and the surviving parent either does not want to live alone, requires living assistance, or is on a fixed income and needs help making ends meet. In such situations, an adult child could be added to the house’s deed as a partial owner.

• If the house is jointly owned by the surviving parent and the adult child and the joint ownership structure includes survivorship rights, then when the surviving parent dies, the house passes automatically to the adult child outside of probate.
• With a tenants-in-common ownership structure, the surviving parent’s share of the house becomes part of their estate and may need to be transferred to whomever they designate in their will through probate court.
• A life estateis another form of joint ownership in which the life tenant (the surviving parent) has the right to live in the home during their lifetime, and upon their death, the house passes to a named remainderman (here, the adult child). This option, like joint ownership, avoids probate and can be thought of as a type of beneficiary designation on real property.

Avoiding probate might be a desirable goal, but it should be weighed alongside other potential outcomes of co-ownership, such as capital gains tax if the property is later sold, gift tax that may be due because the surviving parent is gifting a partial ownership in the home, and potential creditor claims of the child’s creditors. If parents are trying to avoid probate, they may consider creating a trust to own their interest in the home, in addition to their other accounts and property, or utilizing an enhanced life estate deed or transfer-on-death (TOD) deed for their home, if their state law allows. All of these techniques can be applied to the parent’s partial interest in the home if the co-ownership is structured as a tenancy in common, or to the parent’s full ownership in the home if they choose not to add their child to the title.

Choosing to add a child as a joint owner of a home when there are multiple children who stand to benefit from an estate can raise additional estate planning challenges. For example, a parent could add a live-in child as a co-owner of the home under a tenants-in-common ownership structure and direct their child or other heirs in an estate plan to sell the house and divide the profit among their siblings (and other heirs) upon that parent’s death.³ But in this case, there is nothing requiring the live-in child to share the portion of the sales proceeds attributable to the interest of the property they owned directly.

Alternatively, if the child was added as a joint owner with right of survivorship (rather than a tenancy-in-common co-owner), the home will become 100 percent the child’s by operation of law, and they will be under no legal obligation to sell the home or share the proceeds, despite whatever instructions are left in a will or given verbally to the child.

When an Adult Child is a Tenant

The likelihood of an adult child living at home and paying rent to their parents is not trivial, as it can determine the child’s status as a tenant or guest.

Tenants have legal rights under landlord-tenant laws. If there is a written or even a verbal rent agreement between parent and adult child, the child may be considered a tenant, granting them certain legal rights and protections, and therefore it might not be possible to just kick them out. An adult child who is a legal tenant would have the right to an eviction process that involves a court hearing.

Eviction might not come up when the parents are alive, but it could become a problem when they pass away and the estate plan orders the sale of the house and the division of its proceeds to beneficiaries. Additionally, the adult child might not have anywhere else to go or the financial means to make alternate arrangements. Also, to further complicate matters, the estate executor is likely to be a sibling, raising the possibility of family strife.

Gifting a Family Home to a Live-in Adult Child

Mom or Dad could opt to leave their house to an adult child living at home in their estate plan instead of making them a joint owner and transferring the home to them via a contractual right of survivorship. But this course of action raises a different set of questions:

• Do they have other children?
• If they do, would the live-at-home child/heir be required to buy out their siblings’ interest?
• In the event of a sibling buyout provision, would the live-at-home adult child be able to afford the house or obtain financing?

Even if the adult child could obtain financing to buy out their siblings, somebody who has never owned a home before might not be financially prepared for hidden and unexpected expenses beyond the monthly mortgage payments. Property taxes, HOA or condo association fees, insurance, utilities, and repair and upkeep costs can easily add up to thousands of additional dollars per year.

Parents wishing to leave the family home to an adult child currently living there might have their hearts in the right place, but without addressing the financial considerations of owning a home, they could be overburdening their adult child, which could ultimately result in an unfortunate or unintended outcome.

Alternatively, parents could leave their home to their live-at-home child in an estate plan and gift other assets to their other children in an amount needed to offset the share of the value of the home they would otherwise receive. While this would give the home to the child without the need to pay off their siblings, the child would still have to contend with the financial obligations of owning a home discussed above.

Every Family Is Different. Create an Estate Plan That Fits Yours.

For better or worse, multigenerational family living arrangements have made a comeback. And while the stigma of having an adult child at home is mostly gone, that does not mean it does not present potential difficulties—both in the present and the future.

Parents should know that “fair treatment” may look different for some of their children and ultimately that completely “equal treatment” of their kids may not be possible. An adult child who has yet to fly the nest due to financial struggles may call for special attention in an estate plan. It could also be the case that parents would like to compensate an adult child who moved back home to help them out.

Whatever your family situation, careful planning can ensure that your intentions are made clear, your loved ones are properly taken care of, the potential for conflict is minimized, and your estate is taxed as little as possible. To create or update an estate plan, please contact our office and schedule an appointment.

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Footnotes

1. Paulina Cachero & Claire Ballentine, Nearly Half of All Young Adults Live with Mom and Dad—and They Like It, Bloomberg (Sept. 20, 2023), https://www.bloomberg.com/news/articles/2023-09-20/nearly-half-of-young-adults-are-living-back-home-with-parents.
2. Sophie Lloyd, Why More Parents Are Charging Their Adult Children Rent, Newsweek (Apr. 6, 2023), https://www.newsweek.com/charging-adult-children-rent-homeowner-parenting-1793021.
3. It is important to note that in a tenancy-in-common ownership structure, each owner holds an individual interest in the property, but no single owner possesses unilateral authority to sell the property. Any sale requires the consent and participation of all co-owners. In this example, therefore, the parent, as a tenancy-in-common co-owner in the property, does not have the authority to require the sale of the entire property after their death in their estate plan. They may include language regarding the sale of the property and hope that the live-in child willfully participates. If the live-in child is not compliant, the trustee, executor, or heirs/beneficiaries may need to bring a partition action with the court to get a court order requiring the sale, if such remedy is available under the relevant state law.

Married couples love each other and want the best for each other. Establishing a comprehensive estate plan is one way to provide the best for each other. Not only does an estate plan protect you when you are unable to care for yourself during your lifetime, but it also protects your hard-earned money and property after your death for those you love. When your spouse is not a US citizen, it becomes even more crucial to have the proper estate planning tools, especially if you have a high net worth.

The Marital Deduction

One of the benefits associated with marriage in the United States is the unlimited marital deduction. With this tool, a person can transfer unlimited money and property to their spouse during their lifetime and upon their death without estate and gift taxes being owed. One rationale for this deduction is that married couples are assumed to rely on their joint accounts and property to fund their needs and wants during their marriage and to support the survivor. The Internal Revenue Service (IRS) is not concerned about assessing estate tax to what is left to the surviving spouse, because whatever is left over will usually be subject to estate tax at the surviving spouse’s death.

However, the unlimited marital deduction’s favorable tax treatment is usually only available if the surviving spouse is a US citizen (except in certain limited situations). For noncitizen surviving spouses, additional planning must be done to take advantage of the marital deduction’s estate tax benefits.

Why a Noncitizen Spouse Cannot Use the Marital Deduction

When a surviving spouse is not a citizen, the IRS is concerned that collecting the estate tax owed on the first spouse’s money and property may be more difficult when the surviving spouse dies. Because the surviving spouse is not a citizen, it is possible that they will return to their country of citizenship, which may make it impossible for the IRS to collect the estate tax.

A Qualified Domestic Trust Could Be the Answer

The qualified domestic trust (QDOT) balances the IRS’s interest in collecting estate tax and the public policy argument against requiring a surviving spouse to pay substantial estate taxes and be left with less than they need to survive.

What Is a Qualified Domestic Trust?

A QDOT is a trust created by the US citizen spouse during their lifetime to hold accounts and property on behalf of the noncitizen spouse. Alternatively, a QDOT can be made by the noncitizen spouse by irrevocably assigning the accounts and property they received from their deceased US citizen spouse to the QDOT before the deceased spouse’s estate tax return is due (including extensions). The accounts and property passing to a QDOT can qualify for the marital deduction with either option. However, the estate tax is deferred, not eliminated.

How Does a QDOT Work?

While the noncitizen surviving spouse lives, they will receive income from the trust. This income will not be subject to estate tax but will be subject to income tax. If any principal distributions are made from the QDOT to the surviving spouse, then the Internal Revenue Code § 2056A estate tax will be owed on that distribution. However, an exception may be made if the distribution is being made because of a hardship.

When the noncitizen spouse passes away, the money and property remaining in the QDOT will be subject to the estate tax. That is why we say that a QDOT does not eliminate the estate tax; it just defers it until the noncitizen surviving spouse passes away. Once the taxes are paid and other administrative tasks are completed, the remainder of the trust is distributed to the named beneficiaries.

What Are the Requirements for a QDOT?

For the QDOT to be legally effective, the following requirements must be met:

• Accounts and property given to the noncitizen spouse at the citizen spouse’s death must be transferred to the QDOT before the deadline to file the decedent’s estate tax return¹
• The trustee must elect the trust as a QDOT on a timely filed estate tax return²
• US state laws or the laws of the District of Columbia must govern the trust’s administration³
• The trust must qualify as an ordinary trust under Treasury Regulation §301.7701-4(a)
• The trust must include terms that qualify the trust as a power of appointment trust, a qualified terminable interest property trust, a qualified charitable remainder trust, or an estate trust if created by the US citizen spouse⁴
• At least one trustee must be a US citizen or a US corporation⁵
• The trustee must have the right to withhold estate tax in making distributions of principal to the surviving spouse and when the balance of the QDOT is distributed at the noncitizen surviving spouse’s death⁶

Additional requirements must be met depending on the overall value of the accounts and property that are in the trust.⁷

What Happens If the Noncitizen Surviving Spouse Becomes a US Citizen?

The surviving spouse may choose to become a US citizen. This could be because of the administrative burdens of a QDOT or a firmly held desire to change their citizenship status. If a change of citizenship occurs, the surviving spouse may become eligible to use the marital deduction without using the QDOT.

If the surviving spouse becomes a US citizen before their deceased spouse’s estate tax return is filed and stays a US resident after their deceased spouse’s death, then the deceased spouse’s estate will be eligible to use the marital deduction for any assets transferred to the now-citizen spouse.

If the surviving spouse becomes a US citizen after the QDOT was created and stays a US resident after their deceased spouse’s death, and either does not receive any principal distributions from the trust or treats the distributions as taxable gifts, then the QDOT can be terminated, and the remaining balance of assets in the trust can be eligible for the marital deduction.

Conclusion

We know that no one likes to think about death and dying, and most people do not want to pay more taxes than required. You need to plan proactively to minimize tax consequences upon your death. We are here to assist you and your spouse in creating a plan to protect your futures and each other. Please call us to learn more about qualified domestic trusts or discuss other important estate planning considerations when dealing with noncitizens.

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Footnotes

1. Treas. Reg. § 20.2056A-2(b)(2).
2. Id. § 20.2056A-3.
3. Id. § 20.2056A-2(a).
4. Id. § 20.2056A-2(b)(1).
5. Id. §§ 20.2056A-2(a)(c), 20.2056A(a)(1)(A)-(B).
6. Id. § 20.2056A-5(b)(1)-(2).
7. Id. §§ 20.2056A-2(d)(1)(i)(A), 20.2056A-2(d)(1)(i)(B)-(C), 20.2056A-2(d)(2)(ii).

Wills and living trusts are two of the most fundamental estate planning documents. While both accomplish the same primary objective in an estate plan of directing the distributions of your money and property to your desired beneficiaries after you pass away, a revocable living trust, often referred to simply as a living trust or an inter vivos trust, provides added flexibility and functionality, including incapacity planning.

Like other types of trusts, there are three roles under a revocable living trust:

• The person who creates the trust, called the trustmaker, grantor, settlor, or trustor (Indiana statutes typically uses the term “settlor” but sometimes clients more easily understand the term “trustmaker” and we will use this term in this article)
• The person who manages the trust and the accounts and property it owns, known as the trustee
• The person who receives money and property from the trust, called the beneficiary

Before setting up a revocable living trust, you should understand what you can—and cannot—do in your dual role as trustmaker and trustee. Living trusts are complex legal documents that need to be drafted carefully with help from an estate planning attorney.

Two Phases of a Living Trust: Today and Tomorrow

The living trust is a powerful tool that affects your life today and throughout certain events into the future, such as incapacity or death.

The Living Trust While You Are Alive

After creating a trust, as the trustmaker, you must retitle accounts and property that you want to be transferred to the trust—such as real estate, financial accounts, stocks, and bonds—from your name to the trust’s name. Even after this transfer, as trustee, you retain control over them and will manage them for your benefit throughout your lifetime while you have capacity.

Any time before your death, while you are mentally capable of managing your affairs, you have the legal authority to alter, amend, or even revoke the living trust as the trustmaker. For example, you can place additional money or property in the trust or take money and property out of the trust, make investment decisions about the trust’s accounts, add or remove beneficiaries and successor trustees, and change the rules regarding when and how your beneficiaries receive their inheritance.

However, because it is your trust and you retain control over the trust’s accounts and property, there are some things you cannot do.

• You cannot use the trust to shield or protect accounts and property from your creditors.
• You cannot avoid paying taxes on income earned by the trust. Because no separate tax identification number is required for trust income, income on the trust’s accounts and property must be reported on your personal tax return.
• You cannot perform trust-related business, like making investments, taking disbursements, and paying taxes, individually. You will need to sign as the trustee instead of as an individual. This limitation is manageable, however. It usually means you will sign as “John Doe, Trustee of the John Doe Trust” instead of “John Doe.”

The Living Trust After You Die (or Become Incapacitated)

This brings us to the next phase of a revocable trust: the time after your death or incapacitation.

When you pass away or suffer from incapacity (i.e., you cannot administer the trust yourself), a successor trustee of your choosing takes over trust administration per the instructions you provide in the trust document.

Depending on the trust’s terms, the successor trustee may be responsible for managing the trust’s accounts and property for an extended period on behalf of the beneficiaries and terminating the trust and distributing its money and property to the beneficiaries. If you become incapacitated, the successor trustee can serve in this role for as long as you are unable to manage your affairs. While you are alive and unable to manage your affairs, you are not allowed to be a trustee, but you will still be a trust beneficiary, so you will not be left penniless.

Many revocable trusts will close within a few years of the trustmaker’s death. Still, some may remain open for years, such as those holding accounts and property for a minor beneficiary until they hit a certain age or milestone, as specified by you in the trust agreement. In either case, it is a good idea to name a backup successor trustee if something happens to the original successor trustee and they can no longer serve.

Get an Estate Plan That Fits Your Needs and Goals

Creating a living trust makes you a wearer of many hats. You are the creator of the trust, the initial trustee, and the beneficiary. Each role comes with unique powers and duties that apply both now and upon the occurrence of certain future events, such as your incapacity or death.

Please contact us today to schedule an appointment with one of our attorneys so you can learn more about these roles and duties. Only when you understand these roles can you go on to craft your estate plan in a way that will best meet your goals.

The Internal Revenue Code assesses a tax (gift or estate) on the transfer of money or property from one person to another during life or at death, with some exceptions. If you own accounts or property that are worth a lot of money and you expect them to continue to increase in value, you may want to transfer them out of your estate so you will no longer own them and they will not be subject to estate tax at your death. If you believe this type of planning may benefit you, then you need more than just a simple estate plan. Do not worry, though—there are strategies and tools that we can use to fulfill your goal of getting rid of an account or property while minimizing the tax consequences of this transaction.

Self-Canceling Installment Notes

A self-canceling installment note (SCIN) is a promissory note that can be used to transfer valuable accounts and property from one person to another with minimal gift and estate tax consequences due to a clause in the promissory note that states the buyer’s obligation to repay the loan ends upon the death of the seller.

How SCINs Work

A seller sells an asset (an account or piece of property) to a buyer (often a family member) in exchange for a promissory note, which includes a self-cancellation clause. The self-cancellation clause states that, should the seller die before the balance of the note is paid, the note terminates and the outstanding balance of the note is canceled. If the seller survives the term of the note, the seller will receive the total value of the note in exchange for the asset that was sold. If the seller does not survive the note term, the asset remains with the buyer, and the asset’s value is removed from the seller’s estate (with estate being defined as everything the seller owns at the time of death). Further, the note is canceled, and the remaining balance due is not included in the seller’s estate. Overall, because the asset and the unpaid portion of the SCIN are not part of the seller’s estate, it is not subject to estate tax and is not considered a gift that would be subject to the gift tax.

The Term of the SCIN

To be effective for estate planning purposes, the note’s term should not exceed the seller’s life expectancy. Determining the seller’s life expectancy and the term used for the SCIN should involve consulting with an experienced professional, as many variables must be considered.

Selecting the Right Interest Rate for the SCIN

Every promissory note needs an interest rate; a SCIN is no exception. Although the transaction may occur between family members, the correct rate must be used. Generally, the interest rate for the SCIN must be equal to or greater than the applicable federal rate (AFR) with semiannual compounding. The specific AFR that should be applied will be determined by the repayment term of the SCIN (short-term rate for repayment term of up to three years, mid-term rate for repayment term between three and nine years, and long-term rate for repayment term greater than nine years).

Your SCIN Must Account for the Risk

Because the seller may die before the note is paid in full, and the seller’s death will cause the note to terminate and cancel the outstanding balance, a premium must be included in the transaction to address this possibility. There are two ways that the risk premium can be addressed within the promissory note: an increase in the sales price to above fair market value or an increase in the interest rate above the standard AFR. Deciding on how to include the risk premium depends on the buyer and seller and their tax circumstances. A professional can help craft terms that will consider the specifics of your proposed transaction.

When Might You Use a SCIN

Although a SCIN is not for everyone, there are some circumstances in which it can be a valuable tool. For instance, if you own assets that are likely to have a large amount of future appreciation (meaning they are likely to become more valuable in the future), and you want to make sure that this future appreciation is not included in your estate for estate tax purposes at your death, you may be looking for ways to give the assets to someone else, such as a child, grandchild, or other family member. If you die before the note’s term expires, the remaining balance owed is canceled, and the asset and the unpaid balance will not be included in your estate for estate or gift tax purposes. It is important to note that the ideal time for transactions like this is when we are in a low-interest rate environment.

Additional Considerations

Many different factors go into developing the right estate plan. While taxes may be at the forefront of your mind, we must also ensure that your plan adequately addresses your other areas of concern. If you want to learn more about SCINs and their use in your estate plan, call us. We are also available to assist you in creating or updating your existing estate plan.

The first private pension plan in the United States was established in the late 1800s. Through 1980, nearly 40 percent of Americans were covered by a traditional employer-funded pension. But employer-provided retirement plans have now largely shifted to retirement savings vehicles like 401(k) plans and Individual Retirement Accounts (IRAs) that place most of the savings onus on the employee.

Pension and retirement accounts often form a large portion of an individual’s wealth and should be accounted for in an estate plan. If a retirement account holder completes a proper beneficiary designation, their account assets will bypass probate. Account holders often designate a surviving spouse or children as beneficiary, but they could also name a trust or a charity.

The benefit and beneficiary rules applicable to different types of retirement accounts vary and should be discussed with an estate planning attorney, especially with the recent passage of the SECURE Act.

How Pensions Have Changed: Defined Benefit versus Defined Contribution Plans

The American Express Company provided the original private pension plan to its workers in 1875. Soon after, banks, manufacturing companies, and utilities also began offering pension plans.^[1]

These early pensions were defined benefit (DB) plans. Funded entirely by employers, DB plans pay workers a specific monthly benefit for life once they retire. Typically, DB plans calculate a benefit based on factors like a worker’s salary and service length and make regular payments (annuity payments) over the employee’s life after retirement (or the joint lives of the employee and their spouse). The employer that provides a DB pension controls and owns the plan.

Traditional DB pension plans have mostly given way to defined contribution (DC) plans, such as 401(k)s. DC plans are owned and controlled by employees but are often subsidized by employers. Other types of DC plans are 403(b), 457, and 529 plans. IRAs are not employer-sponsored but can also be considered a DC plan since they involve defined contributions by the IRA owner into tax-advantaged accounts.^[2] DC plans generally pay retirement benefits as a lump sum or installments.

From 1980 to 2008, the proportion of private industry workers participating in DB plans decreased from 38 percent to 20 percent.^[3] In 2020, 85.3 million Americans had a DC plan compared to just 12 million workers with a DB plan.^[4]

In 2020, 18.2 percent of Americans were covered by an IRA-style retirement account, 34.6 percent had a 401(k)-style account, and 13.5 percent had a DB plan, reports the U.S. Census Bureau. The median value of a retirement account in 2020 was about $30,000.^[5]

Congress passed the Employee Retirement Income Security Act (ERISA) in 1974 to guarantee workers’ benefits in private pension plans. Before then, pensions had little or no protection, and there were incidents of workers losing their earned retirement benefits. ERISA covers most employer-sponsored DB plans and DC plans, but not government employee plans or IRAs.

DB Plans, DC Plans, and Beneficiaries

The only estate planning tool applicable to retirement accounts is the beneficiary designation.  Retirement accounts must be owned by an individual, so they cannot be transferred into a revocable living trust during the participant’s lifetime like most other financial accounts or property.  Further, they cannot be jointly owned. Thus, the only way to control how these accounts transfer at the time of the participant’s death is through the use of properly designated beneficiaries.

In general, participants in an ERISA-covered plan can select anyone to be the plan’s beneficiary when they die.^[6]

• Most plans regulated by ERISA name a person’s spouse to automatically receive the benefit if the account holder dies first.
• If the account holder wishes to select a different beneficiary, their spouse must consent by signing a waiver. Otherwise, the spouse is entitled to 50 percent of the plan’s benefits, even if somebody else is named as the plan beneficiary.
• An ERISA plan holder who divorces and remarries should update the beneficiary designation to their current spouse or else the former spouse may be in line to inherit the plan benefits.
• An account holder who does not have a spouse can name an alternate beneficiary. This may be a person such as a child, parent, or sibling, but it can also be a charity or a trust.
• The named beneficiary of an ERISA retirement plan takes precedence over somebody designated in a will as the plan’s beneficiary when there is a conflict between the two.
• When an ERISA retirement plan does not designate a beneficiary, the benefit passes to the participant’s probate estate and is distributed along with other probate assets according to the will (if the participant has created one) or according to state intestacy law (if the participant has not created one).

IRAs are not covered by ERISA. An IRA account holder can name a beneficiary (or multiple beneficiaries) to receive the account assets. They can also name their probate estate to be the beneficiary of the IRA, in which case the account proceeds will be distributed according to their will (if they have created one) or according to state intestacy law (if they have not created one). A trust or charity can be designated to receive IRA funds as well. An IRA with no beneficiary designation is distributed pursuant to the IRA’s governing document.

Employees with a DB plan may be able to name a beneficiary, but this right is not guaranteed because the employer owns the plan and sets the terms. For a DB plan, a current spouse may be entitled to a qualified joint and survivor annuity (QJSA) death benefit paid out over their lifetime. The plan may provide the annuity payout percentage, which could be at least 50 percent but no more than 100 percent of the annuity paid to the participant. It may be possible, with spousal consent, for a participant to waive the QJSA and select a different payment option. QJSA rules may also apply to nondefined benefit plans, but only through an election.^[7]

The SECURE Act and Inherited Retirement Accounts

Passed in 2019 and effective in 2020, the Setting Every Community Up for Retirement Enhancement (SECURE) Act affects DC plans like 401(k)s and IRAs and has implications for estate planning.

Under the SECURE Act, the age at which retirees must make annual withdrawals, called minimum required distributions (RMDs), increased from 70.5 to 72. In 2023, that age was raised to 73.

A retiree who lives a long life might deplete a large portion of their retirement account due to RMDs and have little left in the account to give to heirs. But the SECURE Act also affects those who inherit an IRA or 401(k) in a more direct way.

While beneficiaries of these accounts always had to pay taxes on all withdrawals from them, prior to the SECURE Act, they could stretch out withdrawals over their life expectancy to minimize their tax bill. Beginning in 2020, however, most nonspouse retirement account beneficiaries must completely withdraw the balance of their inherited portion within 10 years of the original account holder’s death. For minors, the 10-year rule starts when they turn 21. These new rules do not apply to a surviving spouse named as an account beneficiary. Spouses that inherit retirement accounts still receive preferential tax treatment in the SECURE Act. A popular option is for the inheriting spouse to roll over the account into their own IRA and name their own beneficiaries for the account. The spouse is then treated as the original IRA owner for income tax purposes.^[8]

Another option for an account holder when designating a beneficiary is to designate the account owner’s trust rather than naming individual beneficiaries. When the accounts transfer into the trust upon the account owner’s death, the language in the trust agreement will direct how and when the retirement proceeds are to be distributed to trust beneficiaries. The retirement account owner might prefer this option if they are concerned that the beneficiary might immediately deplete money or fail to set aside enough funds to cover taxes that might be due on withdrawals. Also, trusts can provide asset protection from creditors and help centralize asset management.

Retirement Accounts and Estate Planning

You saved hard for your retirement. The money you set aside could benefit more than just you. Most retirement accounts can be transferred to your heirs when you die, enabling them to supplement their own savings goals.

Retirement assets can transfer directly to properly designated beneficiaries outside of probate. But these assets will be subject to federal and state income tax, and possibly even estate taxes. The SECURE Act could further impact your estate planning efforts. Your retirement accounts could be the single largest store of economic value that you leave behind. To maximize their value to loved ones after you are gone, be sure that you understand the different inheritance and tax rules that may apply, review beneficiary designations regularly, and speak to an estate planning attorney about how to best provide for your family’s future.

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1. History of PBGC, PBGC (Nov. 16, 2023), https://www.pbgc.gov/about/who-we-are/pg/history-of-pbgc.
2. Adam Hayes, What Are Defined Contribution Plans, and How Do They Work?, Investopedia (July 22, 2023), https://www.investopedia.com/terms/d/definedcontributionplan.asp.
3. Barbara A. Butrica et al.,The Disappearing Defined Benefit Pension and Its Potential Impact on the Retirement Incomes of Baby Boomers, 69 Soc. Sec. Bull. 1 (2009), https://www.ssa.gov/policy/docs/ssb/v69n3/v69n3p1.html.
4. Jeanne Sahadi, Traditional Pension Plans Are Pretty Rare. But Here’s Who Still Has Them and How They Work, CNN (Sept. 7, 2023), https://www.cnn.com/2023/09/07/success/pensions-retirement-savings-explained/index.html.
5. Maria G. Hoffman, Who Has Retirement Accounts? New Data Reveal Inequality in Retirement Account Ownership, U.S. Census Bureau (Aug. 31, 2022), https://www.census.gov/library/stories/2022/08/who-has-retirement-accounts.html.
6. U.S. Dep’t of Labor, FAQs about Retirement Plans and ERISA, https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/faqs/retirement-plans-and-erisa-for-workers.pdf (last visited Mar. 25, 2024).
7. Types of Retirement Plan Benefits, IRS.gov (Apr. 21, 2023), https://www.irs.gov/retirement-plans/types-of-retirement-plan-benefits.
8. Svetlana V. Bekman & Stacy E. Singer, IRAs and IRA Beneficiaries, ACTEC, https://www.actec.org/resource-center/video/iras-and-ira-beneficiaries (last visited Mar. 25, 2024).

An intrafamily loan is a financial arrangement between family members—one who is lending and another who is borrowing. An intrafamily loan may be used to help a family member who needs money for a number of reasons:

• buying a home
• funding or purchasing shares in a business
• adding accounts or property to investment portfolios
• paying down high-interest debt
• covering education expenses

Lending to a child or grandchild can be satisfying. Your loved ones can benefit from flexible repayment terms and interest rates while learning financial responsibility. This can be beneficial if the child or grandchild would otherwise have difficulty obtaining a loan through more traditional methods. It also gives you an opportunity to add to your investment income.

When You Should Consider an Intrafamily Loan

How you give or loan money to family members has potential tax implications. The right method depends on your family circumstances.

An intrafamily loan might be beneficial in estate planning for wealth transfers between generations while minimizing estate tax implications. Further, by using an intrafamily loan to provide money to a family member rather than making a gift, you can maintain control over the principal amount and how it is used.

Intrafamily loans are valuable tools for preserving wealth and offer the following advantages:

Estate Tax Planning

Under current tax law, gift and estate taxes are not imposed on gifts up to $13.61 million for individuals and $27.22 million for married couples in 2024. While many people’s net worth is not that high, intrafamily loans may be a great option for high-net-worth families.^[1]

If the family member receiving the loan invests the money and the investment returns on the borrowed funds exceed the interest rate charged, the excess growth is passed to your family member without being subject to gift or estate taxes. This strategy preserves your lifetime estate tax exemption amount as long as all of the formalities of issuing a loan are observed. However, the initial loan amount (the principal) and interest owed to you will still be included in your taxable estate because the principal and interest are legally required to be paid to you. However, as previously mentioned, the growth in the investment will not be included in your taxable estate.

You might also consider loaning the money to a trust for the benefit of your family member as part of your planning strategy. As opposed to the strategy of loaning funds directly to your family member, the loan would be made to the trust. If the rate of return from investing the loan proceeds exceeds the loan’s interest rate, the excess is considered a tax-free transfer to the trust.

Flexible Interest Rates

With intrafamily loans, you have the flexibility to set the interest rate at a level lower than commercial lenders, as long as the rate is not below the Applicable Federal Rate (AFR) (read below for further discussion on the AFR). The cost savings for the borrower can be significant. Further, if the AFR is high when you initially make the loan, it may be easier to reissue the note from you to take advantage of any future lower interest rates than it would be to refinance a note from a third-party lender.

Family Business Succession

Intrafamily loans can play a crucial role in transferring a family business from one generation to the next. By providing financing to family members who wish to take over the family business, for example, you can ensure a smoother transition and help sustain the family legacy.

Determining the US Interest Rate to Use with an Intrafamily Loan

Determining the interest rate for your intrafamily loan is crucial to avoid unnecessary tax consequences. The Internal Revenue Service (IRS) publishes AFRs^[2] monthly, broken down into three tiers for short-term, mid-term, and long-term rates.^[3] Rates can be fixed or variable and structured to the advantage of both parties. The minimum AFR rate must be charged for loans over $10,000 regardless of a loved one’s credit rating, and it is usually lower than most commercial lenders. If the interest rate for your intrafamily loan is below the AFR, the IRS may require you to pay income tax on the income you should have received under the applicable AFR even though the borrower did not pay you that amount (called imputed interest). Also, the amount of interest you did not collect but should have may also be considered a taxable gift to the borrower, potentially reducing the amount of gift and estate tax exemption available to you.

Documenting the Terms

Since the IRS generally assumes that wealth transfers between family members are gifts, it is essential to have the proper documents showing that the transfer is intended to be a loan. You and your family member must sign a promissory note that adheres to the state-specific rules to properly document the loan transaction.

Important Things to Remember When Using an Intrafamily Loan

A comprehensive written promissory note is crucial. It helps avoid unnecessary tax consequences and clearly communicates the terms of the loan between family members to avoid misunderstandings and conflicts.

Every financial decision has the power to strain family relationships. When trying to determine if an intrafamily loan is right for your situation, ask the following questions:

• Will lending to one child appear unfair to others?
• Should various loan types be considered for different children based on their personal situations?
• If the child is unable to pay off the loan, will a loan default cause family friction?
• Will the loan be forgiven at my death, or will it be considered a debt owed to my estate or trust? In either case, how would that affect the other children?

Gifts versus Loans

You must carefully consider the decision to gift versus use intrafamily loans, including the income, estate, and gift tax implications. The tax rules regarding intrafamily loans are complex and may result in unintended consequences if the loan is not done correctly. If you are interested in learning more about this tool, give us a call. Additionally, if you already have an intrafamily loan in place, it is important to properly document it in your estate plan to ensure that everything will proceed smoothly if you pass away before the loan has been paid back. We are happy to meet with you and your tax advisor to make sure that this strategy is right for you and your family.

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1. Kelley R. Taylor, What Is the Gift Tax Exclusion for 2024?, Kiplinger (Jan. 19, 2024), https://www.kiplinger.com/taxes/gift-tax-exclusion.
2. Applicable Federal Rates (AFRs) Rulings, IRS.gov (Aug. 8, 2023), https://www.irs.gov/applicable-federal-rates.
3. Id. 

Death is a personal and private affair that affects the deceased’s close family and friends. However, there is at least one aspect of death that may require state oversight: probate.

Probate is the court-supervised process of either (a) carrying out the instructions laid out in the deceased’s will or (b) applying state law to distribute a deceased’s accounts and property to their family members if the deceased did not have a will. The main purpose of the probate process is to distribute the deceased’s money and property in accordance with the will or state law. Not all wills, and not all accounts and property, need to go through probate court. And just because a will is filed with the probate court does not mean a probate needs to be opened. But whether or not probate is necessary, most state laws require that a will be filed when the creator of the will (testator) passes away.

Understanding Probate, Wills, and Estates

Estates, wills, and probate are distinct, yet interrelated, estate planning concepts.

• An estate consists of everything that a person owns—including their personal possessions, real estate, financial accounts, and insurance policies. Virtually everyone leaves an estate when they die.
• A will is the legally valid written instructions that a person creates describing how they want their money and property distributed upon their death. Wills are highly recommended, but there is no legal requirement to have one. To make a will legally valid, it must be properly executed in accordance with state law. Executing a will involves signing the document in front of witnesses. Additionally, at the time of signing, the creator must have capacity (i.e., be of sound mind).
• Probate is the legal process that formally distributes the accounts and property that are in the decedent’s sole name, do not have a beneficiary designated, and have not been placed into a living trust prior to the decedent’s death (sometimes referred to as probate assets). During probate, a decedent’s probate assets are identified and gathered, their debts are paid, and the probate assets are distributed to beneficiaries named in the will or their heirs as determined by state statute if there was no will.

Probate with a Will

Assuming that a decedent does have a will, here is how probate typically proceeds:

• The person nominated in the will to act as executor (sometimes called the personal representative) files a copy of the death certificate, the original will, and any required documents or pleadings with the probate court. If the person nominated in the will does not file these documents with the court, state statute will determine who else has priority to make such filings (possibly another family member, an attorney, or even a creditor of the decedent).
• The court examines the will and other documents filed to confirm their validity and gives the named executor the legal authority to carry out the decedent’s wishes, as specified in their will. This legal authority is conferred in a court-issued document called letters of authority, letters testamentary, letters of administration, or another similar name.
• The individual appointed as executor inventories and values the decedent’s estate assets and identifies any outstanding debts of the estate, such as loans and credit card debt.
• Once estate debts are paid, the remaining accounts and property are distributed to named beneficiaries and the estate is closed, ending the probate process.

The length of a probate can vary depending on many factors, including the size of the estate, state laws, and whether the will is deemed invalid or contested.

Avoiding Probate

In some cases, avoiding probate altogether can cut down on the amount of time it takes to wind up a deceased person’s affairs. There are also other reasons to avoid probate, such as keeping probate filings out of the public record and saving money on court costs and filing fees.

Beneficiary designations, joint ownership, trusts, and affidavits are common ways to avoid probate. Here are some examples of these probate-avoidance tools in action:

• Pensions, retirement accounts like 401(k)s, and other accounts that allow for designated beneficiaries may not need to be probated. Transfer-on-death (TOD) and payable-on-death (POD) accounts are generally treated the same as accounts that have a beneficiary designation.
• Accounts and property that are jointly owned and have a right of survivorship can bypass probate.
• Accounts or property held in a trust may also bypass probate. But trusts are not without administrative and cost burdens. Also, if the deceased forgot to transfer ownership of an account or piece of property to the trust, a pour-over will may be needed to transfer those accounts and property to the trust through the probate process upon the trustmaker’s death.
• Some states have laws that allow probate to be skipped if the value of an estate is below a specified value and does not contain any real estate (often referred to as a small-estate exception). The threshold value for qualifying for this exception varies by state. For example, probate can be skipped in Arizona, Texas, and Florida for estates worth less than $75,000. In California, the threshold is $184,500; in New York, it is $30,000.

Filing a Will versus Opening Probate

Filing a will with the probate court and opening probate are separate actions. A will can be filed whether or not probate is needed. Remember that probate is needed only under certain circumstances, such as when the decedent passed away while owning probate assets. Further, not only cana will be filed with the court when a probate is not needed, some state laws actually requireit. Some state laws require the person who has possession of a decedent’s will to file it with the court within a reasonable time or a specified time after the date of the decedent’s death. The consequences for failing to file a will vary by state but may include being held in contempt of court or payment of fines. Additionally, the person in possession of a will might also be subject to litigation by heirs who stand to benefit from the estate under the terms of the will. The latter also applies if the will-holder files a will but does not file for probate. Failing to file for probate (when probate is necessary) prevents inheritances from being properly distributed.

These legal consequences are usually imposed only on a will-holder who willfully refuses to file a will. If someone you love has passed away and you have their will in your possession, we recommend that you work with an experienced probate attorney who can assist you in determining whether a probate must be opened and whether the will needs to be filed.

Avoid Probate Issues When Drafting a Will

Probate avoidance may be one of your goals when creating an estate plan. You should also consider implementing tools in your estate plan to minimize issues that may arise if your estate does require probate. 

Your will may have been written years ago and might not reflect current circumstances. You could have acquired significant new accounts or property, experienced a birth or death in the family, left instructions that are vague or generic, or chosen an executor who is no longer fit to serve. An outdated or unclear will can spell trouble when it is time to probate your estate, making it important to identify—and address—issues that could lead to problems, including will contests and disputes.

It is recommended that you update and review your estate plan every three to five years or whenever there is a significant life change or a change in federal or state law. You cannot be too careful when stating your final wishes. For help drafting an airtight will that avoids possible complications, please contact us.