Advanced Ideas in Estate Planning for Doctors
Doctors, even those who enjoy DIY finance, need an optimized estate plan, too.
While often neglected, an optimized estate plan is a vital part of a doctor’s legacy. Yet, we begin appropriate asset protection early on in our careers, the first step of an optimized estate plan. But, of course, we have no assets to protect at that time.
The need to protect your assets never goes away; legacy and the tax-efficient gift of money become important later in life.
Estate planning is so much more than the $11M plus Federal Estate Tax Exclusion amount. Sure, if you are a deca-millionaire, estate planning takes on new aspects as no one wants to pay a 40% Estate Tax.
Let’s look at an optimized estate plan for doctors, discuss issues in-depth, such as giving to children, giving to grandchildren, then discuss Asset Protection, and finally, disclaimer planning for doctors.
First: why is it important that DIY finance folks optimize their estate plan?
What is the Primary Goal of an Optimized Estate Plan for Doctors?
The primary goal of an optimized estate plan is to pay the least in taxes over your life. Actually, it is to pay the least amount in taxes over your and your heir’s life.
While taxes are important, they are not the only primary goal. The primary goal is to see your desires are met: the right person gets the right assets per your goals. So while wills and trusts are important, those are table stakes for these Advanced Ideas in Estate Planning for Doctors.
First goal, next purpose.
What Does an Estate Plan for Doctors Ensure?
What is the purpose of estate planning for doctors?
Well, you want to ensure that our assets (and our minor children!) go where they are supposed to when we die. Next, you want to minimize your death’s pain for your family, including limiting the assets that go through the public, expensive, and time-consuming probate process.
Finally, some have estate taxes to consider. Know the laws in your state to optimize your estate plan.
What are the Elements of an Estate Plan for Doctors?
The basic elements of an estate plan are the same for doctors and the rest of the people.
What is different about a doctor’s estate plan?
- Private Practice (Usually set up as a professional corporation to limit the liability between the individual doctors, and may have an LLC to limit the liability of the business)
- Unlimited Personal Liability for Medical Malpractice (though judgments almost never reach individuals). Protecting your assets against such liability is huge but usually an insurable risk.
- Incapacitation (Especially if you own a practice, what will happen to your patients if you are mentally incapable of working?)
- Delay in Making Money
- Estate Distribution
- Transfer Tax Planning (also known as the death tax, covers estate and inheritance taxes). More often a state issue rather than a federal one currently.
Purpose of an Optimized Estate Plan for Doctors
For doctors, an estate plan can be offputting. First, we don’t make a lot; then, we are busy and in debt. The next phase seems like riding the bull by the horn as you practice and maybe have a family.
An estate plan is optional and causes us to face our possible disability and inability to practice. Or death. And there are hard decisions to make, like who gets the kids if we both die?
However, the purpose of an estate plan is to avoid probate and meet your desires for your family and assets. You can minimize taxes and allow your hard work, which you turned into assets, to pass to charity or children, as is your desire.
It is going to go somewhere. So, where does it go that best serves your life’s purpose?
What if you wanted to leave it to the kids?
The Best Way for Doctors to Leave Money to their Kids
Inheritance. A goal for some is to leave behind money for their heirs. What is the most tax-efficient way to leave money to your children? What is the best way to leave money to heirs?
If your goal is your kid’s inheritance, consider which accounts you should leave behind, gifting during life, and tax implications of leaving money to your kids.
Which Accounts Should You Leave to Your Children?
There are three different types of assets from a tax perspective.
These asset buckets are: Never Taxable, Sometimes Taxable, and Always Taxable. Some are more tax-efficient to leave to your kids than others.
An example of a “Never Taxable” account is a Roth IRA.
Roth IRAs are the best accounts to leave to your children as they will never pay taxes since you already did! In addition, these accounts continue to grow tax-free after inheritance.
Since the SECURE Act, these Roth IRAs must be closed before the end of year 10. The optimal way to receive this inheritance is to leave it in the Roth for ten years and then pull it out at the end.
“Sometimes Taxable” accounts are brokerage and savings accounts.
When invested, these accounts get a “step-up” in basis when you die. Say you bought VTI at $10, and when you die, it is worth $200.
If you sold the fund before death, you pay capital gains tax on the $190 of profit. When gifted during life, the basis transfers with the gift resulting in capital gains taxes.
But your heirs get a full step-up in basis of $200 at your death. Then, they can sell at $200 without paying capital gains.
If you have appreciated assets in brokerage accounts, leave them there until your death rather than giving them away. Then, your kids get a full step-up in basis! There are no Required Minimum Distributions on brokerage accounts, but any future growth is taxable.
Always Taxable accounts require the most attention.
These “qualified accounts” are pre-tax retirement accounts. Whenever distributions are taken from these accounts–by you or your heirs–taxes are due.
I’ve included a few advanced strategies to deal with these accounts at the end of this blog.
Other Types of Assets Left Behind
Let’s briefly look at some other assets you leave behind when you die.
Real property gets a step-up in basis upon death. Titling of these properties is important and deserves an entire blog of its own. The short lesson: don’t tile these properties as joint tenants with rights of survivorship with your children. If you do so, it only gets a partial step-up in basis.
Bank accounts similarly should not be titled as joint tenants. If you have a bank account, keep it in your name and ensure it has a Transfer on Death designation. This will keep it out of probate.
Stock and mutual fund accounts can also have a Transfer-on-Death designation. They get a full step-up in basis and shouldn’t be gifted. If you must gift stocks, gift those with the highest basis as basis transfers upon gifting.
Payouts from life insurance are tax-free.
Gifting During Life
It is best to give with warm hands.
Under current law, each spouse can give a maximum of $16,000 a year to a person without filing a gift tax return. If you give more than that, you won’t pay gift taxes until you reach the $11+ million-dollar estate tax exclusion limit ($22 million for a couple), but you have to file the return with your taxes. If you gift split—a married couple can give up to $32,000 a year to any individual—a gift tax return must be filled out as well.
You can give an unlimited amount to a university or hospital to pay for anyone’s educational or medical expenses. Just make the check directly out to the institution.
Also, think about a super-annual gift into a 529 for grandchildren. If married, put in 5 years’ worth of gift tax exclusions into a 529. This is $30,000 x 5 = $150,000 per grandchild. Remember, if grandparents own the 529, don’t use the account until the second semester of sophomore year. This keeps it from counting as income for the student for financial aid purposes.
Doctors need More than a Will
It is important to understand that whenever possible, assets should pass outside of probate. Having assets pass via a Will means they go through probate.
Probating a Will can be costly time consuming, and it is a matter of public records. Assets pass via the rule of law, trusts, and beneficiary forms before being included in probate. This is a vital topic to understand.
At bare minimum, know the beneficiary forms and have them filled out appropriately. Notably, a trust not explicitly designed for a retirement account is unsuitable. Don’t have any old trust named as a beneficiary of an IRA. This will blow up the IRA, and taxes will be due on the entire account.
Do Doctors Need a Living Trust?
In some states, you don’t need a living trust. Assets can pass on after your death via other mechanisms (see above). If there are assets that you cannot pass on any other way, consider a living trust. With this document, you make the trust owner of assets, so they don’t pass via probate. Essentially, you do the work of probate before your death, re-titling the assets to your trust. Setting up the trust is not enough. Assets must actually be re-titled into the trust. Living trusts are smart in some states where probate is particularly expensive or otherwise offensive.
Considerations for your Always Taxable Accounts
If you are a 401k Millionaire, then you have a problem. The IRS will crack open these accounts and tax the deferred income inside them. See my previous blog on The Tax Planning Window as reference, but partial Roth Conversions are an excellent strategy for gifting to your children.
What if you have a starving artist child in the zero-tax bracket? Or is your child a high-income doctor practicing in a high-income tax state? There are different considerations for partial Roth conversions during your lifetime, depending on your heir. The goal is to pay the least in taxes over both your and your heir’s lifetime.
Child in the Zero Tax Bracket
If your child has low income, why pay a lot of taxes now to convert to a Roth? When they inherit your IRA, hopefully, they will “stretch” it over ten years to pay the least amount in tax possible.
(Low Tax Bracket Heir)
Above is an example of a partial Roth conversion strategy for a couple with an heir in a low tax bracket. You can see in green they retire at age 60, and income drops from the 24% tax bracket to zero.
Note that the tax brackets have two values. The Tax Cut and Jobs Act (TCJA) expires in 2025. Tax rates will go back up from 12% to 15%, from 22% to 25%, and from 24% to 28%. Most people think that the TCJA will not be renewed, and taxes are “on-sale” currently.
There are two overlapping scenarios demonstrated above. Without partial Roth conversions, see in green, RMDs start once they turn 70. These RMDs kick them up into the 22%/25% tax bracket, and once they are 75 years of age, they pay at the 24%/28% tax bracket.
Let’s optimize this scenario for an heir in the zero percent tax bracket. You heir has access to the standard deduction and the 10% and 12% tax bracket to absorb income from the inherited IRA.
It is not cost-effective to convert too much into a Roth IRA and pay significant taxes now when your heir will pay less in taxes later.
You can see that they do partial Roth conversions up into the 12%/15% tax bracket in blue. This optimizes their taxes from RMDs but doesn’t convert too much as the heir can inherit what is left and pay taxes at a lower rate.
Remember, your goal is to pay Uncle Sam as little as possible over both your and your heir’s lifetime.
If you have two heirs in very different tax brackets, consider leaving them accounts accordingly. Your high-income heir can get the Roth and brokerage accounts. Your low-income heir can get the qualified accounts (pre-tax IRAs).
Child in a High Tax Bracket
On the other hand, if your heir makes a lot of income, perhaps you are better off paying taxes now. As a retiree, you may have little income and thus access to your lower tax brackets.
Conversely, In the future, when your heir is forced to take RMDs from the inherited IRAs, they will pay tax at their marginal (highest) tax rate. Again, the goal: pay the least taxes over the combined lives of you and your heir.
(High Tax Bracket Heir)
Let’s think about a child who will inherit an IRA who is already very successful. Assume they are paying taxes at a combined rate of 48%. If you want to leave them your IRA, YOU might plan on paying taxes at your lower rate to do partial Roth conversions.
Again, this couple retires at 60. In green are future expected RMDs without doing partial Roth conversions.
Note in blue that they utilize the 24%/28% tax bracket to do partial Roth conversions before RMDs at age 70. In addition, despite the increased taxes on their social security (and other taxes like IRMAA), they continue to do partial Roth conversions into the 22%/25% tax bracket until the entire IRA is converted into a Roth IRA.
If their heir inherits a taxable IRA while in the 48% tax bracket, they pay taxes at the marginal rate of 48%. Meanwhile, during retirement, this couple only pay taxes at less than 24%/28%.
What If Both You and Your Heir are in High Tax Brackets?
This is going to get even more complicated. I’m sorry, but this is advanced stuff.
If both you and your heir are in high tax brackets: leverage life insurance and a Charitable Remainder Unitrust.
I know, permanent life insurance is not popular in doctor financial blogs. But, if you don’t need the RMDs from your IRA, yet you and your child are in high tax brackets, this can leverage your Always Taxable money into a Never Taxable life insurance payout.
The basic idea is to get a second-to-die guaranteed universal life (GUL) policy for the death benefit. There is no cash accumulation with these policies. I’ve heard insurance salespeople don’t like GULs as they don’t pay good commissions. Salespeople may also try to sell you on cash value, but what you want is death benefit and nothing more.
Since it is a second-to-die policy, it is less expensive than a single-life policy. Use RMDs from the IRA to pay premiums. Upon the death of the second spouse, your heir gets $1-5 million dollars tax-free. That’s right, death benefits are tax-free! Apparently, these second-to-die policies may have internal rates of return above 5% per year. This is not bad considering you are leveraging an Always Taxable asset into a Never Taxable one.
Next, leave the rest of the IRA into a Charitable Remainder Trust. Without getting too far into the weeds, an irrevocable election to a Charitable Remainder Unitrust (CRUT) can pay income to your heirs for 20 or more years. Generally, depending on the terms of the trust, income is about 5-8% of total assets in the trust. Of course, this money is taxable. And at the end of the term, the remainder (at least 10% of the initial grant) must go to the named charity.
What if the named charity is your heirs’ Donor Advised Fund (DAF)? That way, your legacy will continue on in your family as they can then donate this remainder as they see fit.
That is a lot of verbiage. Best guess: you will hear a lot more about this strategy, as the stretch IRA is on the chopping block in Congress in 2019. If your heirs lose the ability to stretch inherited IRAs, they will rapidly owe massive taxes during their peak income years.
The above strategy gives them a tax-free bolus of money from life insurance. In addition, they get a taxable income for 20 or more years from the CRUT. And in the end, the money goes to their DAF or another charity of your choice.
Conclusion: The Best Way for Doctors to Leave Money to their Kids
So, what is the best way to leave money to heirs?
My advice: convert to Roth if it makes sense from a tax perspective. Roth conversions are amazingly powerful and have many indications.
Leave brokerage accounts at death for a step-up in basis.
And watch out when leaving IRAs and other qualified accounts, as only death and taxes are inevitable in this life and the next.
Finally, make sure you have your beneficiary form correctly filled out with a disclaimer system in place. More on that later.
Well, instead of leaving money to the kids, what if your purpose was to leave money to the grandkids?
How Much Money Can a Grandparent give a Grandchild Tax-Free?
Can Grandparents give money to Grandchildren tax-free? Yes, but it takes some planning and understanding the tax code.
As to how much money a grandparent can give to a grandchild tax-free, well, the number depends on what kind of tax you are talking about. Let’s dive in!
Can Grandparents Give Money to Grandchildren Estate Tax-Free?
If we are talking about estate taxes, then the answer is almost certainly yes! You could give a child nearly $11.8M in 2022, and that would be estate tax-free. That’s right, the estate tax exemption is huge right now, so you could use up your entire unified estate and gift tax amount in a single year in a gift to a grandchild.
The yearly gift limit is $16k per person. If you and your spouse want to split a gift, you could give any single grandchild $32k a year. Though you would have to report it as a gift split on your taxes, this would be a tax-free gift to a grandchild.
Let’s look at some other taxes.
Can Grandparents Give Money to Grandchildren Capital Gains Tax-Free?
The basis on capital gains carries over with the gift. Therefore, you cannot transfer a gift and expect to escape capital gains.
Never gift losses, as losses don’t transfer. If you have a loss asset, sell it, take the loss for tax purposes, and transfer cash. If you have a highly appreciated asset, then you can transfer it, but the basis transfers with it.
For example, if you give them $15k of ABC stock with a basis of $5k, you have transferred the basis over with the gift. If they file their own taxes, they may very well be in the zero percent long-term capital gains tax bracket, and they could sell the stock capital gains tax-free.
This is called downstream gifting and is very effective when grandchildren are initially filing their own taxes but not yet making a lot of money. Watch out for the kiddie tax, however, if they are still on their parent’s tax return!
Let’s look at some other ideas regarding tax fee gifts to grandchildren.
What are the Best Gifts to Give Tax-Free to Grandchildren?
This is important! A Grandparent can Pay a Grandchild’s college or medical bills without any tax implications. There is an unlimited amount of college or medical costs you can pay for, as long as you directly pay the college or hospital (don’t give it to the child to pay the bills).
Cash is the most common gift, but they will pay ordinary interest on any gains in a savings account (etc.).
529 College Savings Plans
College savings is an excellent idea for most grandparents. There is a $15k limit every year, but you can superfund five years’ worth ($75k) in any one year. So two grandparents could fund $150k at once (for five years) into a 529 for a child. This can be used to pay many college expenses, but also some expenses before college as long as they qualify.
And don’t forget, a 529 plan can be used as a bonus saving account!
Finally, remember that some states have a yearly state income tax benefit for funding 529 plans for grandchildren. You can get a state income tax write-off and yet have the tax-deferred goodness of a 529 plan.
Can Grandparents give money to Grandchildren tax-free? YES, Use a Roth IRA
Perhaps the best way grandparents can give money to grandchildren tax-free is to help them fund a Roth IRA if the grandchild has income reported to the IRS. Even if they spend their money, if they report qualified income to the IRS, you can set up a Roth IRA for them in the amount of the income, up to the $6K Roth IRA limit. This is the best way you can give them tax-free money!
Fund an Employer Retirement Plan
If grandchildren are working but cannot afford to put money in their 401k, a grandparent could give them the money to spend and have them increase their deduction into the 401k. After all, money is fungible, and it doesn’t care where it comes from.
Better yet, if they have a Roth 401k option, fully funding that with $20k a year is a tremendous tax-free gift to your grandchildren!
Be the Bank; Give Grandchildren a Loan for Home Purchase
When grandchildren are ready to buy a home, you could offer to be the bank. Though you need to draw up formal loan documents and charge at least minimal interest amounts (as determined by the IRS), this is a great way to save them some interest and yet have a bond alternative for grandparents.
Education is the best tax-free gift grandparents can give grandchildren. Consider A Simple Path to Wealth as a starting point.
Custodial Accounts (UTMAs and UGMAs) are accounts that can be opened at most custodians. You can manage them until the grandchild turns the age of majority (18, 21, or 26 – it is state dependent), but it does become their asset when they reach the magic age. Before that, while they are still on their parent’s tax return, custodial accounts can be very tax efficient. If the growth is less than ~2k a year, then there is minimal taxation, and the income does not stack on top of the parent’s income.
Inside, make sure you use low-cost, broadly diversified index ETFs to demonstrate good behavior to them. No individual stocks!
Cryptocurrencies. Just staying, they are going to do it anyway. Why not start young and give them some crypto?
Experiences With You! Perhaps the best gift to give is a time with you! Grandparents can take grandchildren on yearly trips or save up for something unique. This is the best tax-free gift that grandparents can give to grandchildren!
Inappropriate Gifts for Grandparents to Leave Grandchildren
I would suggest you don’t give cash for them to leave in a savings account unless they have goals in the immediate future. While a grandchild must earn, save, and then invest unless you teach them how to invest—who will? Investing in something more than a savings account is the true blessing you can leave a child.
And we all know that children will make mistakes with their money. We all did. The hope is that they make the mistakes early in life rather than with extra zeros at the end later in life.
Similarly, I don’t suggest series EE- or I-Bonds as gifts to grandchildren. These, while hopefully, they will keep pace with inflation, will not grow over time and bless grandchildren like equities will. I suggest a savings bond gift alternative such as stocks, or even better low cost broadly diversified ETFs.
Also, do not give gold or other precious metals. While coins can be a fun gift, there is no learning you are giving them, aside from how to get a haircut when you lose it or try to turn it into cash.
Finally, life insurance for grandchildren is just plum a bad deal. There are indications for permanent life insurance, but a child has no indication.
Conclusion—Can Grandparents Give Money to Grandchildren Tax-Free?
So, the best tax-free gifts you can give your grandchildren are education and experiences!
If you want to focus on monetary gifts, Roth IRAs, 529s, and contributions to employer retirement plans can all be lovely tax-free gifts.
If the concern is estate tax, well, just keep under the $16k yearly exclusion amount, or go ahead and use up some of your lifetime exclusion if you don’t have a massive estate.
Meanwhile, you can’t help them escape ordinary taxes unless you give them cash to help pay the taxes if they fund a Roth IRA or Roth 401k. Capital gains transfer with the gift, so there is a creative way to pay less in taxes if you gift assets between the generations.
Grandparents can give money to their grandchildren tax-free but it does take some Advanced Ideas in Estate Planning for Doctors.
So far, we have covered giving to kids and grandkids. What about giving to parents as a way to optimize your estate plan?
Asset Protection for Doctors
Doctors need asset protection. Asset Protection for doctors depends on their life stage. What do you need to know now to protect your assets?
Well, that depends on your age and your stage in wealth creation.
Let’s look at Asset Protection Strategies and determine which are right for you.
Once you start working, your major asset is human capital. Your ability to work. Protect human capital like the gold mine it is!
Later in life, as you convert human capital to assets, there are additional considerations that pile on top. What type of accounts or investments should you fund? How can you keep those various assets Safe? What are the perils and how can you mitigate them?
Still later, in retirement, tag on aging, estate and legacy considerations. Prior asset protection strategies evolve over time as your goals change, but they never completely resolve.
As a high-income earner, you are a gold mine to overactive lawyers and juries of your “peers.” Your goal– even if you are rich — don’t appear so to someone who might want to take your assets and make them their own! You cannot always prevent all lawsuits, but you can become a smaller target by avoiding some asset protection land minds.
Let’s look at protecting your resources for folks early in their career, mid-career, and in retirement to see what perils or land minds each group needs to consider.
Protecting Assets Through the Life Stages
Asset Protection for Doctors Through the Life Stages
Above, you can see different perils or risk and ideas for mitigation depending on your career stage. Let’s walk through the stages in a doctors career and see what property protection steps you need to consider.
Asset Protection Strategies for Early Career
Perils abound for the newly minted professionals. As human capital is the engine that drives asset accumulation, career risk—that is, you might lose your job—is a huge consideration. There are many ways to mitigate this risk, and maintaining income is the primary concern early in your career.
Beyond that are many insurable risks, such as life, disability, health, and liability. These are discussed below.
Finally, divorce is common and usually devastating to finances. I am not brave enough to reflect on how to mitigate divorce risk. Understand, though, that divorces is not infrequently the largest risk professionals face when protecting assets.
When you are a young, your greatest asset is human capital. This is literally the ability to work and earn income in the future. You convert human capital into over your career with the goal of using assets rather than your labor to support yourself.
How can you conserve your human capital?
If other people depend on you, then life insurance is a must. Most young folks do not have an appropriate indication for permanent life insurance, so stick with term life insurance.
Disability insurance is important. Much has been written on the topic of disability insurance in other blogs so I won’t focus on it.
Health care insurance is a must. Nothing can drain your bank account faster than the broken health care system we have.
As far as personal liability insurance, yes please! “Max out” your home and auto policies and get $2-5M worth of umbrella insurance. As a high-income earner, this is a necessary expense to safeguard your future.
Professional liability insurance is important, but outside the scope of this discussion. Malpractice insurance is a must, obviously, as is other professional liability insurance depending on your career. Despite high impact stories, it is very rare that a suit ever gets above policy limits. If so, it usually is reduced to policy limits on appeal. Personal assets are only very rarely garnered due to professional liability.
Asset Protection in Mid-Career
At least some attention should be paid to creditor protection by mid-career. That is, there is not a zero probability that you will go bankrupt at some point in your life. Many found themselves contemplating bankruptcy in 2008, and as we know the economy is cyclical. At least acknowledge what your State provides for bankruptcy protection.
In mid-career, consider predators in the context of liability. The longer you accumulate assets, the higher the chances you will become a target. In addition, families, houses, and young drivers are also sources of risk.
In order to safeguard assets, start with Exclusion Planning.
First, let’s remember that predator protection (lawsuits) differs from creditor protection (bankruptcy).
That said, some assets are protected from bankruptcy (creditors). This is State dependent, so know what your State-specific statutes say. This is the first stop in property protection. Which assets do you own that are automatically protected by State Law?
A good (though hard to read) resource is here.
Some states are more generous than others. For instance, Montana protects homesteads up to $250,000, whereas other states are more or less generous. Texas and Florida have unlimited homestead protections!
This is a big one. Remember ERISA plans (401k and defined benefit pensions) have federal protection, whereas other requirement accounts are State-specific. 403b and governmental 457 plans are technically not protected by ERISA but have equivalent significant protection. IRAs are usually covered up to $1M plus, however, inherited IRAs are not considered retirement accounts and treatment is State-specific. Finally, remember non-governmental 457s are not even your asset (they are an asset of your employer and subject to their creditors).
This, again, is very State-specific. Look up and see if annuity payments are protected from bankruptcy, and how much of the cash value of permanent life insurance policies is covered. Disability payments and medical and group payments are also state specific but less frequently considered.
Varies depending on the State. For instance, Montana protects personal property up to $4,500 and Tools up to $3,000. What about my horses and cows?
Tenants By the Entirety is important to understand. This is also State-specific so see below. Tenants By the Entirety is a way to title assets such that you don’t fully control the asset, so the asset can’t be taken away from you if you are individually named. This is a powerful asset protection trick so find out if your State allows TBE titling.
Additional Mid-Career Considerations
In reality, there are three paths to wealth.
The first, paper assets, focuses on retirement and brokerage accounts. If there are absolutely no other alternatives, consider insurance products (the dreaded annuities and life insurance) if you have a significant need for asset protection.
Secondly, real assets (owning business and real estate) require professional guidance with titling, incorporation, and other protection issues.
Finally, the entrepreneur who builds businesses should also seek professional assistance.
Protecting your assets depend heavily on your chosen path.
For all three paths, the high-income earner should consider tax-deferred retirement accounts as a primary savings vehicle. Don’t forget beneficiary designations!
This really is the heart of “classic” asset protection. What to do with your growing assets in mid-career? There is no magic bullet, unfortunately. Focus on the titling of assets, risk mitigation, and get professional assistance.
Let’s transition now to estate and legacy issues.
Safeguarding Assets in Retirement
You must address the known risks in retirement. There are many known risks, but health care and Long-Term Care are front and center for most folks, and will be specifically mentioned below.
Estate and Legacy planning are also times to think about safeguarding assets. You have amassed much. How it is spent when you are gone is an important consideration.
Sure, you should have an estate plan in place. This includes a will, but a will is not enough! Make sure you have your designated beneficiaries in place for those accounts that transfer outside of trusts and/or probate. This is an important, yet neglected consideration.
Predators, Creditors, and Long-Term Care
There are actually three monsters to concern yourself with at this life stage: predators, creditors, and Long-Term Care.
I have discussed Long-Term Care Insurance, and it truly is a difficult decision. The current pitch to doctors is hybrid life insurance / Long-Term Care Insurance products. If you are considering one of these hybrid policies, make sure you understand the Tax Implications of Long-Term Care Insurance because the person selling you one surely won’t mention this massive downside.
Traditional Long-Term Care Insurance, while it provides more comprehensive coverage, is expensive and likely to continue to have increasing premiums. Self-funding is a third option. Again, Long-Term Care insurance is a difficult subject and there are truly no good options currently.
What about healthcare costs? Medicare is important. Expect (and plan for) healthcare costs to increase faster than inflation during retirement. This may include a buffer account for future expenses, or build your floor income with especially high health care inflation in mind. Keep IRMAA in mind!
Let’s focus on trusts for a second, as they are also misunderstood.
Trusts for Safeguarding Assets
If you are a lumper, there are two types of trusts: Revocable and Irrevocable.
Revocable (or living) trusts are NOT for protecting assets. They may make your assets more difficult to discover, but as you control and benefit from a revocable trust, there is no property protection. Remember, these trusts are for passing assets outside of probate and to protect you if you become incapacitated.
Irrevocable trusts remove the asset from your control, thus providing property protection.
Initial irrevocable trusts are intended for estate TAX planning. Currently, the estate tax exclusion is over $11M ($22M with spousal portability), so we are usually not concerned with estate TAX planning.
There are three parties to an irrevocable trust: the grantor (who provides the assets), the trustee (who manages the assets), and the beneficiary (who benefits from the assets).
Generally, the grantor cannot be the beneficiary (as irrevocable implies you give away the assets and cannot benefit from them).
So, in summary, we have revocable trusts which are used for estate planning, and irrevocable trusts which are used for estate TAX planning. In the middle is property protection.
What is the Point of Asset Protection Strategies?
A brief word about the goal or the point of asset protection.
Asset protection seeks to separate control and ownership of assets. That is, you still control the asset, but if someone has a judgment against you, you don’t own the asset so there is nothing to take!
Specifically, asset protection does not protect you from lawsuits, it just makes you a less appealing target. If you don’t own many assets, or it is not easy for lawyers to see through your assets and decide you are a fat target, you are less attractive to sue.
So, when protecting assets, you place a legal barrier between you and your assets. This does not make you judgment proof but does provide you with leverage to settle claims rather than pay them out.
Given fraudulent transfer concerns, protect your assets preemptively, before you are sued.
Asset Protection Structure
Above, you can see a schema of a complicated strategy. There are many different versions of this, but let’s focus on some basic elements.
LLCs own separate assets. Keeping assets in separate LLCs prevents a judgment against one asset from affecting others.
Above that, there is a holding company that may be in a state that provides anonymity for your assets. In addition, this holding company has discretion so it does not have to distribute assets to creditors even if there is a judgment.
As an aside, it is often better to have your brokerage account assets in an FLP or TBE.
On top, all assets are owned by your living trust. This does not provide protection for you, but does avoid probate upon your death and is a source of protection for your heirs.
A full discussion of this type of protection scheme is beyond the scope of this little ditty. It shows you what you might be in for if you truly want a comprehensive strategy…
Conclusion- Asset Protection for Doctors
Asset protection for doctors is not a one-and-done game. It is a process that depends on where you are in your life cycle. Continued learning and assessment of your current strategy is an important component of your overall financial health.
There are no magic bullets. Understand what perils are common and do your best to mitigate known risks.
When you are young, protect your human capital. As human capital becomes assets, optimally utilize State-specific exclusion planning.
Designated beneficiary forms and asset-specific planning are important. Wills and sometimes trusts are early components of a comprehensive estate plan. Moving on to retirement, complexity grows as you access your assets for income and mitigate known risks.
With the growth of assets, safeguarding them becomes more complicated. It is worthy consideration, however, to protect you, your family, and your legacy.
Best Use of Beneficiary Forms: Qualified Disclaimer Estate Planning
Qualified Disclaimer Estate Planning is the most flexible and tax-efficient way to pass on pre-tax retirement accounts to your family. While thinking about death and taxes is not much fun, both are going to happen at some point. Someone is going to pay the taxes after you die! Might as well make a plan!
What is Qualified Disclaimer planning and how can you use it in your estate plan? If you have a large amount in your pre-tax retirement accounts, pay attention! With just a minimum amount of planning, you can save a huge amount in taxes and give your spouse and children the flexibility to spilt your wealth after your death.
What is the Purpose of Qualified Disclaimer Planning?
Let’s start with the basics.
First, when you have pre-tax retirement accounts such as IRAs and 401k plans, the assets pass at your death via a beneficiary form. Not a will or trust, only via the beneficiary form.
It is almost never appropriate to name your estate as beneficiary of these pre-tax retirement accounts. This drags them back into probate which is inefficient and can be costly.
Next, trusts are poor beneficiaries of pre-tax accounts! Read that sentence again. If a trust is the beneficiary of your IRA and you don’t need to control the money from the grave, chances are you needlessly lose 40% of the money due to taxation. If you don’t get that, read my blog on the 10-year rule and retirement accounts.
So, the obvious question is: who should be beneficiary of your pre-tax retirement accounts? Well, it depends on the purpose of the money!
Remember the “I” in IRA stands for individual. It is yours until you die. You cannot transfer it to a charity or even to a spouse or child while you are alive (without paying the taxes first).
This money has not been taxed yet, and when you die, it is called “INCOME in Respect to the Decedent.” This IRD is treated differently than other assets in your estate. It still needs to be taxed! Remember, when you die your IRAs are not assets, they are deferred income that will be taxed.
The purpose of disclaimer planning is to allow the family member who needs the money to access it in the most tax-efficient way. Qualified disclaimer estate planning is tax-efficient, and it is flexible.
What is Qualified Disclaimer Estate Planning?
Since most of us don’t really know when we are going to die, it is really hard to plan for IRDs in an IRA. What tax bracket is your spouse in after you die due to the widow/widower tax penalty? It depends on when you die and other income sources that go with you. Or, what about the tax bracket of your children for the 10-years after you die? Who knows! But post-mortem, they might have a better sense of income needs and future tax liabilities over the next ten years.
Enter qualified disclaimer estate planning: the post-mortem way to maximize the utility of your retirement assets. It optimizes your pre-tax retirement accounts for your heirs.
Remember, since the SECURE Act killed the stretch IRA, you need to change the philosophy of your estate plan. This is especially true for your IRD.
An Example of Disclaimer Planning in Use
Say there is a wife with a large IRA. She lists her husband as primary beneficiary, and her two children as 50% contingent beneficiaries.
When she passes, her husband has 9 months to decide if he needs the IRA. If he needs the money, by all means take it!
If he only needs half, or any percentage of it, then pass the rest on to the kids now and get a head start on a 10-year ‘mini’ stretch. That is, instead of waiting until he dies to pass on all the IRD, pass some on now. Hopefully, it will be 10 more years before he dies, so each heir gets two mini-10-year stretches. This can prevent spiking the income into higher tax brackets for the heirs as bad as if they got all of the IRAs all at once upon the death of the second spouse.
Back to the example, say he has his own large IRA. If he takes his wife’s IRA, he might be hit with the widow/widower tax penalty, and thus it saves in taxes to disclaim his wife’s IRA now. He doesn’t need the IRD as he is in a higher tax bracket as a widow, and his kids can start the mini-stretch with part of the IRA while he is still alive.
Or, if his kids are in really high tax brackets, he should take the IRA and pull out the money at his lower tax bracket. Next, invest the money in a brokerage account to get the step up in basis when he dies.
You can see how flexible this plan is! Once you are dead, your spouse and kids have a sense of their income needs and tax brackets. Keep some, and pass as much as you can on now. Or, if there is no need, pass all of it on now and start the 10-year clock early.
How to Set Up Qualified Disclaimer Planning
Spouse is the primary beneficiary. They can disclaim part or all of the IRA to the contingent beneficiaries.
Make the kids contingent beneficiaries. It is that simple to set up!
Next, tell your spouse that they have 9 months upon your death to disclaim whatever percent they think is appropriate to pass on the most to the kids over the longest period of time.
Is a Disclaimer a Gift?
Next, let’s clarify some other issues in disclaimer planning.
First off, even though your pre-tax retirement accounts pass via a beneficiary form, they are still included in your estate for the purposes of estate taxes. Since the estate tax exclusion is currently greater than $11M per person, this isn’t a huge issue for most folks.
Even if you give your IRA away to charity when you die, it is included in your estate (though your estate gets a deduction for the charitable gift so it comes out in the wash). This is again a reminder that someone will always pay taxes on this deferred income.
Next, when you leave your pre-tax retirement accounts to someone else at death, it may be considered a gift for estate planning purposes. If you leave it to your spouse, it doesn’t count as a gift due to the unlimited marital deduction. If you leave it to your kids, it is a gift, but is not double taxed against your estate tax exclusion. But if you leave your IRA to grandkids you need to think about GSTT (generation skipping transfer tax) but only if you are near the estate tax limit. Yes, that gets super confusing so don’t worry about it unless you might have a taxable estate.
But a qualified disclaimer is not a gift from the primary beneficiary to the contingent beneficiary. Qualified when talking about retirement accounts means that it is subject to ERISA. Qualified when talking about disclaimers means that it is specifically allowed by tax code not to count as a gift.
What Is a Qualified Disclaimer?
A qualified disclaimer is specifically one allowed in the tax code.
Anyone who inherits property can disclaim it, which serves the purpose of allowing the asset to go to the contingent beneficiaries.
In order for a disclaimer to be qualified it must hit the following criteria:
- Writing: the refusal must be in writing.
- Timing: the disclaimer must be made within nine months after the date of death unless the disclaiming beneficiary is under age 21.
- No Acceptance: the disclaiming beneficiary must not have accepted any interest in the benefits. This does not include a final yearly RMD.
- No Control: the disclaiming beneficiary cannot control to whom the property passes.
Make sure you follow the rules for this, which should be pretty straightforward in most cases for assets. Assets can be qualified or non-qualified.
If you have a qualified disclaimer, it is as if the primary beneficiary never inherited the property. With a non-qualified disclaimer, on the other hand, the primary beneficiary is treated as if they got the property and then passed it on. This sucks, because there are taxes and gift tax implications. If the disclaimer is non-qualified, then the disclaimant, rather than the decedent, is treated as having transferred the asset to the contingent beneficiary.
The Disclaimer Need Not be for the Entire Amount
There are actually three ways to disclaim an asset:
- Full Disclaimer. This is pretty self-evident.
- Pecuniary (or dollar figure) Disclaimer. You can specify how much is disclaimed in dollars.
- Fractional Disclaimer. Here you can disclaim just a proportion of the account. Say 10%. Or 50 or 90%. Keep what you need, pass on the rest.
Summary: Qualified Disclaimer Estate Planning for a Flexible and Tax-Efficient Legacy
A “qualified” disclaimer is an irrevocable refusal by a primary beneficiary to accept benefits or transfer of property. When done appropriately, the property passes to the contingent beneficiaries as if the primary beneficiary is dead.
The disclaimer can be complete or partial. In essence, disclaimer estate planning allows your family to decide the best way to split up your pre-tax retirement accounts after you die. Flexibility and the ability to control the taxes are key. Remember, there is an optimal way to leave money to charity, and there is an optimal way to leave money to your heirs.
There is little reason that most folks shouldn’t participate in disclaimer planning for their assets that pass via beneficiary form.
Conclusion: Advanced Ideas in Estate Planning for Doctors
We talked about giving and then covered other advanced ideas like disclaimer planning, and asset protection.
The goal is the pay less in taxes. The purpose is to leave a legacy.