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IRA to Trust Conversion – Attorney Video Discussion

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I want to talk to you today about a problem many of my clients are facing. They want to protect their assets, including retirement funds, in a trust like an irrevocable or convertible trust. Many Americans have much of their savings tied up in traditional Individual Retirement Accounts (IRAs) or 401ks painting an asset picture that is “Qualified Fund Heavy”. That means their funds are locked in tax qualified funds like traditional IRAs or 401ks. These retirement savings products seem like a great idea at first. They allow you to set aside money each paycheck, pre-income tax, and allows that money to grow. You are not taxed on the gains or in other words, there are no capital gains taxes on the growth of the investments inside of the IRA package. However, you are penalized 10% for any withdrawals you make prior to age 59 and you must start taking distributions from the IRA at the age of 72. The distributions from your qualified retirement assets can provide much needed income well into your retirement. However, these types of assets (401ks and IRAs) cannot be legally protected with estate planning tools like trusts. Simply put, your traditional IRA or 401k cannot be moved into a trust to be protected; not in their current form, at least. To be placed into a trust they would need to be liquidated first… Why use a trust to protect assets like retirement funds?


Greg:

Okay, we’re here for the elder law report, and we’re talking about IRA to trust conversion. This is part of our Attorney Advisor Series. I wrote a blog piece on this that you can find on our site, MCElderLaw.com/Blog. IRA to trust conversion. Or you can just watch this video. The reason I wanted to talk about IRA trust conversion is people come in all the time and talk about IRAs, and talk about retirement assets, and other assets. And they want to put those IRAs, 401ks, qualified assets into trust. Andy you can’t. Qualified assets don’t go into trust. So to start, what are qualified assets Brent?

Brenton:

Yeah, a qualified asset is just another term for an account that has money in it, and that money has not been taxed yet. So a very common form of a qualified asset is a traditional IRA. Where if you pull the money out, you have to pay tax on it.

Greg:

What kind of tax?

Brenton:

What kind of taxes, income tax on the money. Because you didn’t pay income tax on the money in the first place when you put that money in there. You have required minimum distributions from these types of accounts at some point, because at some point they want you to pay the tax on this money, because you got the benefit of growing it, tax-free, which is really a mistake. I hear that a lot. “This is an IRA, you get to grow it tax-free.” I’m like, “No, that’s a lie.” Because you put the money in there, you don’t have to pay the tax at that time, but you will, or your loved one will have to pay that tax at some point.

Greg:

What happens with income tax, your gains are tax-free, so you don’t have to pay capital gains tax on all the gains. And I guess the trade off is, you get to put a larger pre-taxed chunk in, so you get better growth.

Brenton:

Yeah. And that’s one of the main driving factors for a lot of people when they have a traditional or qualified account. Either they want to make sure that they can grow that money, because it has compounding interest. So you want to grow a bigger principal amount. So it’s good to put pre-tax dollars in there, because that’s more money. So when you have the interest rate that is applied to that money, it’s going to grow at a higher rate. But the other thing is, if it’s sponsored by an employer, and they kick in a certain amount, obviously that’s a thing to have as well. So those are some of the driving factors behind why some will do it. And obviously, it’s good to have tax-free growth, meaning that the gains aren’t taxed, but there’s other ways other than a traditional IRA, that you can have tax-free growth. For example, you could have a Roth IRA that’s after tax non-qualified funds, or certain insurance policies, for example, can do that.

            That being said, it can be a good tool. There’s no lie that it can be a good tool to have a qualified account to grow that money. However, you can really run into some problems in the future that a lot of people don’t know about.

Greg:

Agreed. And we see many, many Americans today, many clients today that are IRA pre-tax qualified fund heavy.

Brenton:

Oh, real heavy. Yeah.

Greg:

And they want to know, maybe they don’t have long-term care insurance, and estate planning, and especially elder law, which is just a subset of estate planning. We really keep our eye on the fact that 70% of people over the age of 65 are going to need some type of long-term care, either in-home assisted living, or nursing home care. And that costs a lot. It could cost, everything you’ve saved in that IRA. It could cost everything that you have, just in you, and then maybe you and your spouse to long-term care or to provide for long-term care, whether that be in-home, assisted living or nursing home care. If you don’t have long-term care insurance, and the reason a lot of people don’t have long-term care insurance is I think several reasons. One, they put it off, because it’s not an emergency today, and why pay for something today that’s not an emergency? I’ve got other emergencies that I need to pay for today, or other things that are calling for my dollars today.

            Another is a lack of planning, or foresight of what might come, and a lack of a sense of urgency. We as human beings are primarily motivated by fear and pain, and what’s urgent right now. That’s just the truth. And because of that failure to have that in place, we get hurt on the back end sometimes. So a lot of times we see people who want to use trusts. So Brenton, irrevocable trusts are a place where assets can be protected, correct?

Brenton:

Oh, absolutely.

Greg:

We’ve defined the IRA. We’re going to talk about a protective tool, a couple of types of protective tools that can protect assets as you age against a long-term care spend down. And we’re going to talk about how you might be able to achieve the best of both worlds, which is protecting that money that you have in the IRA. So that’s where we’re going. We’re going three steps to get there. So what are the tools Brenton that we can use to protect our hard-earned money and property, our house, our money? As an attorney, what can you offer me to help?

Brenton:

Right. So a lot of people don’t know this, but your IRA is not protected or exempt from being counted as an asset for Medicaid purposes. Most states give you protection as far as if you get sued, you can have exemptions on your IRA, but not for when you need long-term care. And when we talk about protection, we mean both needing to pay for long-term care, you don’t want to have to use that IRA to pay for long-term care. You want to be able to preserve that for yourself, your family, and your loved ones. And the other thing is, you want to be able to, if you do get long-term care paid for by a benefit like Medicaid, you don’t want them to be able to come back and go after those assets.

            So the best way to do that, the best tool to use to do that to just straight up protect everything is an irrevocable trust. It’s very important that you understand that it’s an irrevocable trust, and not a revocable trust. Because while revocable trusts can be amazing tools and have a lot of benefits, what we’re talking about is exempting those assets from counting against you for Medicaid purposes so you can qualify for Medicaid.

Greg:

Why does the government, why does Medicaid count a revocable trust, things that I put into revocable trust, I mean, I see people all the time, “Hey, I’ve got a trust. I’m good. I’ve got a revocable living trust.” Why are they not good?

Brenton:

That falls to the importance of the difference between the two. So let’s define the two. So a revocable trust is a trust where you, the person who creates it, the grantor, you have power of that trust in a number of ways. Typically, it’s because you’re also the trustee over that trust. But the big point is that as the grantor, the person who created the trust, you may not be the trustee of the trust, the person who can control the trust, but you still have the power to revoke the trust, which is a huge power, if you think about it, you have the power to kill that trust. And essentially all those assets that are in there, that are in the trust, and ostensibly not in your name, you could change that in a heartbeat by revoking that trust.

            So it’s not like you ever put those assets into different hands. An irrevocable trust is like its own entity in of itself. It’s like a whole different person, that you hand those assets over to, to take them out of your name so they no longer count against you as an asset. But it’s very important as well that you understand that you’re not giving away the assets at the same time, because there’s protections built in there. And that really is emblematic of the name of this tool, a trust.

Greg:

So if I set up an irrevocable trust, I have a third-party trustee, I’m not the trustee. So somebody else is really in control of those assets in the trust, right?

Brenton:

Exactly.

Greg:

However, I can still live off the interest and dividends off of the income generated in that trust from investments, things like that, right?

Brenton:

Right. And I kind of want to back up a little bit, because when we say that the trustee, the third-party trustee, the person who administered the trust is in control of those assets, they are, but then again, they also have a duty to the trust-

Greg:

Within the legal construct of the trust.

Brenton:

That’s right. The way I like to explain it is, an irrevocable trust is scary for a lot of people because it sounds so definitive. It’s set in stone. But you get to set the rules of the game. And once the game starts, you don’t get to change it. But you get to set the rules of the game. And that’s a big deal. And so once you set those rules, your trustee has to follow those. And they have to act in the best interest of the beneficiaries of the trust, which you, as the person who created it will be a beneficiary of that trust. So they have that fiduciary duty.

Greg:

Right. So they have a legal fiduciary duty to act in your best interest with those funds…

Brenton:

That’s right.

Greg:

Okay. And so now we get to the bridge. So we’re going to marry these two things together. How do I take an IRA, which doesn’t fit into trust, which is pre-taxed funds. I haven’t paid income tax on it. In order to put any of those funds in the trust, I’ve got to cash out the IRA, and I’ve got a big tax hit that year that I cash out the IRA.

Brenton:

Yeah. So this is another sticking point that we run into with irrevocable trusts and this type of planning. The first one is the trust being irrevocable, people feeling like they’re giving up some sort of power. The next thing we usually have to get over is the concept of being taxed on this money. Now, a lot of the reason why this is a sticking point is because we think of IRAs the wrong way. If I have $100,000 in a traditional IRA, I don’t really have $100,000. I know that because I know how IRAs work, but if you have an IRA, and you check it every day and you see $100,000 in there-

Greg:

You have $100,000 minus the income tax you’re going to pay.

Brenton:

That’s right. Built into that $100,000 is latent tax that has not been paid out yet. So you’re only going to be able to pull out $85,000 out of that account, the rest is going to go to taxes. It may be even more. And it’s important to know that when you look at your IRA, not to see the number on the balance, and think that that is your actual, the money that you could pull out.

Greg:

Before we jump to that, I wanted to hit one more thing on the way, on the bridge to getting the IRA into the trust. And this is something as a client, I’m still stuck with the irrevocable trust, and I can’t control it. Is there something that’s the best of both worlds? I’ve heard about a trigger trust or a convertible trust.

Brenton:

That’s right, yeah.

Greg:

[inaudible 00:13:17] Will that work in this case?

Brenton:

You can have the best of both worlds, especially if you really preplan. This is really good for people who have a sense of urgency, but not necessarily because they have an imminent need for some type of long-term care.

Greg:

Sure. I know I’m going to know that down the road maybe, but right now, I still want to control it. Income taxes right now are historically low. The amount of tax I might have to pay. They’re historically low right now.

Brenton:

That’s right. And, you probably don’t want to pull all of that IRA money out in one year.

Greg:

No, no, yeah. So let’s make a plan. So tell me about the convertible trust. With a convertible trust, is it the same as an irrevocable trust, is that the same as a revocable trust? What’s it do?

Brenton:

It’s the best of both worlds. It’s a really awesome tool, and I’m very happy that we have this tool, and we’re able to provide this type of service for our clients, because it is really the best of both worlds, because we married the two. The revivable trust that gives you the comfort of having total power over those assets. And it’s already in this protective shell. And I like the analogy that you came up with, Greg. It’s like putting everything in a safe, but leaving that door cracked. Because when everything is in that revocable trust, all you got to do to protect it is shut the door. And it becomes irrevocable, and therefore protected.

Greg:

How would I convert that? Let’s say I hire McIntyre Elder Law to create a convertible trust for me and my family. And then you and I create say a five year plan where I’m going to remove money out of my IRA over five years to minimize my tax burden each year on what I have to pay taxes off of that come out. And I’m going to start putting that in an account inside, because I can set up an unlimited amount of accounts. I can set up investment accounts inside of a trust. Just can’t be an IRA, a traditional IRA or 401k. My investment guy, gal, they could still invest those funds?

Brenton:

Yeah. They can still handle them.

Greg:

So over five years, we’re going to convert a fifth each year. I’m going to move that into the account. I’m going to minimize my tax burden because I’m going to take control, because I’m going to say today, taxes are historically low, and I’m going to take advantage of that. Are taxes is going to go up.

Brenton:

Oh, yes. The only constant in life has changed, but the other one is that taxes will rise. You know what I mean? That’s a thing that anyone who’s done even a little bit of tax law knows is you want to assume that taxes will go up, especially when they’re at historically low rates, as they are.

Greg:

Why do you we think taxes will go up based on current events?

Brenton:

Well, one of the things is with the TCJA, the Tax Cuts and Jobs Act, that was enacted in 2017, 2018. That bill expires, the whole thing just goes away. It lowered tax rates, significantly. It simplified, quote, unquote, the tax code in a lot of ways by just slashing rates for corporations. It raised the estate tax threshold. So you won’t have to pay estate taxes for seven years. And there’s other things that it did, but the point is, it goes away. All of that expires. So we know that taxes are going to rise after that goes away. But the thing is, is that-

Greg:

[crosstalk 00:17:32] The places borrowing a lot of money, and giving away a lot of money here lately, too, I mean, we’ve been in the middle of a pandemic, trillions of dollars in bailout money given to airlines and other industries.

Brenton:

And when going gets tough too, I mean, they can lower that required minimum distribution age as well. That’s been thrown around, different ways of tax IRAs and 401k’s have been thrown around when it gets tough as well.

Greg:

The government has control of what your IRA is actually worth. You don’t right now, unless you take advantage of tax rates that are low. The government can raise the income tax, thereby lowering the value of your IRA.

Brenton:

That’s right.

Greg:

They can also lower the age of required minimum distributions to force you to take it earlier.

Brenton:

That’s right.

Greg:

They have already in the Secure Act that was passed, forced your non-spouse beneficiaries, so your children, to take it within 10 years. Whereas prior to last year, they could have taken it over their lifetime. Now this year, they have to take it within a 10 year period. So it forces higher tax payments to get to get that money out and those taxes paid.

Brenton:

Yeah. They’re working too, the difference is for a lot of people at the tax rate they’re going to experience when they have to have and pull out required minimum distributions, they’re going to be retired and living off social security for the most part, they’re not going to be working and having a higher income like their children will when they have to take that money out. And also over a shortened period, that 10 year period.

Greg:

What you’re saying is, by not taking my IRA during my life, I’m really passing that tax burden down to my children.

Brenton:

Right. A tax burden too. I mean, that’s an important term for it, because while it is a tax burden for you, it’s going to be more of a burden for them.

Greg:

And it’s more of a burden for my children as well, because they have to take that distribution within a 10 year period. I don’t.

Brenton:

That’s right. And at a higher tax rate.

Greg:

Okay. So I get it, so I can set up a plan over five to 10 years to move my IRAs into an account in an irrevocable trust, or maybe this convertible trust. So the convertible trust, do I have control of it when I set things into a convertible trust?

Brenton:

Yeah. So initially you have total control over the trust, but we built in triggers, okay? In this trust. So the trigger could be, you get diagnosed with some type of debilitating disease. Maybe you’re diagnosed with dementia. You have imminent placement in a long-term care facility. You become incapacitated for an indefinite amount of time. Something like that would automatically cause the trust, you wouldn’t have to do anything, it would automatically cause the trust to convert into irrevocable. And at that time, you need care, and you need to have the assets protected at the same time. So it’s very important to understand that when you’re quote unquote losing control, which you’re not, because we talked about that, but let’s just use that for now. You’re losing a measure of control, but it’s when you need that person to come in and start helping you, that’s when you need it the most.

Greg:

Absolutely. Absolutely. So I could set up a plan with McIntyre Elder Law that helps me move my assets into the trust, lets me keep control of the assets, but is irrevocable and protects that money in that retirement when I need it.

Brenton:

Absolutely. That is absolutely correct. And what we’re trying to do here, is we’re trying to preplan, we’re trying to get you in while the gettin’s good, so that we can make this a long-term plan for you. So you’re not penalized in your old age, or in your retirement for working hard, and contributing to an account that everybody told you your whole life is a good thing to contribute to, and saving.

Greg:

But what if your financial planner says, “Oh man, but moving this money over, you’re going to have to pay tax on it now.” And what if they’re scared that they’re going to lose management of this IRA?

Brenton:

What I’d say to that is, we’ve talked about the taxes. The tax thing is, someone, at some point, is going to have to pay the tax on that anyway. That’s my response to that. And the other thing is, I mean, that financial planner shouldn’t sweat because that account you move it into, that the trust holds, they can manage that account.

Greg:

And that’s motivation for the financial planner to really grow that other account tax-free.

Brenton:

Yeah. That financial planner needs to get on board with your plan, so that you can protect your assets, the legal side. Because if I’m a financial planner, I’m just trying to grow, grow, grow your assets, which is a good thing. You need to grow your assets as much as possible. But at a certain point, you need to look at protecting those assets, because it doesn’t matter how much you grew them, that risk that’s out there, that you or your spouse, or both could need some type of long-term care is so big that you have to switch your mindset to protection and growth, instead of just reckless growth with no protection. It’s so important that we’ve literally created a new type of trust to help our clients start planning very early to do this sort of thing.

Greg:

Absolutely. So I think that that was an excellent breakdown of one, what tax qualified assets are, two, the vehicles that you could move those into over a period of time to minimize your tax exposure, such as an irrevocable trust, maybe a Medicaid asset protection trust, or a convertible trust, which gives you the control now. And then later it goes irrevocable, either when you choose to make it irrevocable, or because you become incompetent or incapacitated to protect those assets, and then maybe… yeah. I think that’s a great breakdown..

Brenton:

Yeah. And I’d say that the convertible trust, the type of client that fits into really well is someone who’s about to retire, or has just retired, right around that age. Or maybe even contemplating retirement in the next, I mean, can’t start really too early with the convertible trust, to be honest with you. A convertible trust is a very useful tool at all stages of life. But once you start to get to beyond retirement age, 70s, mid-70s, things like that, we’re going to be looking at a convertible trust as a possibility, but we’re going to look at a lot of things as far as preexisting conditions, possible health issues, things like that. Because we want to consider that. And it might be that a pure irrevocable trust would be what we advise at that time. It depends on who you are, but both of those tools will be there for you.

Greg:

So every plan is individualized. And if I come to McIntyre Elder Law, will you help me pick the plan that’s right for me?

Brenton:

Absolutely. We’re going to consider everything. So we’re going to look at your assets. We’re going to look at your goals. Your goals, we don’t want to forget what you want to do with your money, your property. We want to protect it, but we also want to make sure that whatever it is, whatever legacy that you’re building, we can fulfill that. And we’re going to look at your family, who your beneficiaries are, who your trustees are, all of that, to give you a individualized, personalized, customized plan to protect your assets, and hard-earned money and property.

Greg:

Well, thank you very much, Mr. Begley, for helping me with this elder law report today. I know you work hard for your clients. I know I do as well. I’m signing off. This is Greg McIntyre with McEntyre Elder Law, Brenton Begley with McIntyre Elder Law. We’re both estate planning and elder law attorneys. And we’d love to help you. If you would like to sit down with us and talk about your estate plan, and asset protection plan, give us a call. (704) 749-9244. Or go online and book a free consult with us at MCElder Law.com/BookFreeConsult. MCElderLaw.com/BookFreeConsult, and stay tuned every week for our Elder Law Reports series, or visit our special Attorney Advisor series, which I think are next level topics that are going to just give you even more information and education on how to protect your hard-earned money and property. See you next week.

 

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