Weighing a Plan B in estate planning in light of Obama's proposed tax overhaul

You can never be too prepared

Jan 23, 2015 @ 1:45 pm

By Darla Mercado

President Barack Obama's proposed tax plan has ignited a new conversation among tax experts on which possible strategies would work best if it goes through.

Mr. Obama introduced on Jan. 17 a revamp of the tax code that would bump up capital gains and dividends rates to 28%, treat bequest as realization events — sticking beneficiaries with a capital gains tax bill for inherited assets that have appreciated in value — and blocking contributions and accruals in qualified plans and IRAs once account balances reach $3.4 million.

Naturally, the proposal didn't go over very well with advisers. It was also met with skepticism from a number of tax experts, who noted the odds of the proposal going through in its current condition are low given the Republican-dominated Congress.

As unlikely as the proposal is, however, advisers ought to pay attention because it suggests where legislation could go in the future.

“This has been proposed before,” said Michael Kitces, partner at Pinnacle Advisory Group, at the AICPA's Personal Financial Planning conference. “It's going to be DOA in Congress, but it gives us an inkling as to how legislation might change going forward.”


Bringing the top capital gains and income tax rate to 28% would be a leap from the current rate of 20%, but tack on the net investment income tax to that cap gains rate, and it jumps to about a 31.8% levy.

J. Christopher Raulston, wealth strategist at Raymond James Financial Inc., noted that charitable giving, donor-advised funds and charitable remainder trusts will be the tools advisers can use to help their high-net worth clients contend with those higher rates.

“It could be as easy as giving directly to a charity,” he said.

Life insurance will also pick up some more fans if the proposed cap on qualified account balances becomes a reality. It's not the first time that the president made this pitch: He brought this up back in 2013.

A cash value life insurance policy would combine the benefits of tax-advantaged accumulation along with tax-free withdrawals from the policy, so it might make an attractive place for additional savings. “In the absence of the full tax benefit from a retirement plan, we'd see more people moving toward life insurance,” said Mr. Raulston. “That's not going to be available to those who are uninsurable, but it's an alternative.”

Robert Keebler, partner with Keebler & Associates, recently passed along a suggestion in a newsletter that would help holders of large IRAs in light of the proposed restrictions. A taxpayer could cut the balance in the IRA by using the funds inside the account to do a Roth conversion. Alternatively, the client could use outside dollars to pay the income tax on the Roth conversion, thus preserving the balance within the account and enjoying tax-free withdrawals.

In the event of the tax overhaul, advisers will likely find themselves undoing estate planning work that they had put together in recent years. That would all be tied to the proposed change to the step-up in basis. Currently, if a beneficiary inherits an appreciated asset from a decedent, the asset will pass at its current value. It's a boon to the beneficiary, as he picks up that asset without being subject to capital gains.

The proposal will grant a step-up in basis but it will recognize the asset's appreciation, thus subjecting the beneficiary to capital gains taxes.

There is an exemption for the first $200,000 of capital gains for married couples, and the first $100,000 of capital gains for individuals.

The issue is that the estate tax exemption has become so large — now sitting at $5.43 million for an individual — that a lot of estate planning has focused around taking advantage of the step-up in basis and mitigating income taxes.

“The planning has moved from getting assets out of the estate to keeping appreciated assets in the estate,” said Ed Slott, creator of the IRA Leadership Program.

“Maybe they'd have to go back to getting property out of the estate and shifting the burden to beneficiaries in lower brackets,” he added. “People would really have to revisit their estate plan from the ground up if any of this found its way into law.”


Mr. Slott believes that if anything is endangered, it's probably going to be the stretch IRA, which is attached to most tax bills. Currently, beneficiaries can pay taxes on distributions from an inherited IRA over the course of their lifetime. But in the past, Congress has sought legislation that would push beneficiaries to pay those taxes over the course of five years from the decedent's death.

“That's one thing that most congressmen agree on for both parties: that the retirement account is meant for your retirement and for you to live off of that money,” Mr. Slott said.


How are you working with clients on their estate plans?

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