James Lange, JD, CPA, in his excellent Retire Secure!, discusses a “beneficiary plan” he has been using for years with his estate planning practice. This plan has been featured in a number of other publications, sometimes with Lange's name attached, and sometimes without. I think it is pretty smart, even if it is a bit dated due to changes in the law since publication of his second edition. The fact that it still works even after the legal changes is evidence that it was a good plan to start with. Here's how it works.
In your will, in your trust, and in your IRAs and other retirement accounts you are given the opportunity to name beneficiaries. During our accumulation years, most of us in traditional families just use an “I Love You” beneficiary designation. Basically, if we die, our spouse gets everything, and then our kids are equal partners as secondary beneficiaries.
However, there are tons of other ways to designate beneficiaries. You don't have to designate your spouse first, or even your kids. You can also use trusts as primary or secondary beneficiaries. However, Mr. Lange's usual recommendation is this plan, which he calls Lange's Cascading Beneficiary Plan:
- Primary Beneficiary: The Spouse
- Secondary Beneficiary: A unified credit shelter trust (the B trust)
- Tertiary Beneficiary: The children equally
- Quarternary Beneficiary: A well-drafted qualifying trust for the grandchildren.
Now, what's the point of having all these beneficiaries? Well, the point is to have options at death.
Mr. Lange explains the benefit of these options this way:
In 30 years I've done a lot of projections, and one thing is common to every single one of them. They are all wrong. Every time I've been wrong! People had more money than I thought. People had less money than I thought. The tax laws were different. The wrong person died first. So how can we handle this? How can we make this decision now if you don't want to come back and redo your will every year or two. I have an idea. Let's not decide. We just won't decide. I refuse to decide.
Well, how do you refuse to decide? You draft the appropriate wills and trusts and IRA and retirement plan beneficiary designations to allow your surviving spouse to make these decisions within nine months after the date of your death. Then the surviving spouse will have answers to all of these questions. The surviving spouse will know what his or her needs are. He or she will know exactly how much money there is after the first death. The surviving spouse will know the current tax laws at the first death. If you were to look at my will or my IRA beneficiary designation, with the exception of money going to charity, if my wife wants it, she can have it all. End of story.
If she doesn't want it because she is worried about an estate tax, she could put it in a trust and get the income from it. At her death, the remainder will go to our daughter. If my wife doesn't even want the income from the B trust, then the proceeds will go into a trust for our daughter. And if our daughter is grown up with kids of her own and she doesn't want it, it will go into a trust for her children. Perhaps best of all, my wife can choose to have the money directed in some combination of options.
Disclaiming an Inheritance
Just because you are named as the beneficiary of a will or retirement plan doesn't mean you HAVE to accept it. You can refuse to do so. That's called “Disclaiming.” If you disclaim all or part of your inheritance, it then just goes on down to the next beneficiary. (The trustee of the B trust, usually your spouse, can also disclaim its share.)
Why would somebody want to disclaim? The main reason is to avoid estate taxes. The main disclaimer used to be the spouse, but that's not so much an issue now that federal law has changed. More on that in a second. It might also be wise to disclaim so that an IRA or Roth IRA can be stretched further. (Remember the required minimum distributions of IRAs are based on the beneficiary's age. So if the 70-year-old spouse disclaims, and the 7-year-old grandkid gets the IRA, it will grow tax-protected for a lot longer.) Another benefit is that the kids can get some or all of their inheritance before both parents are gone, when it might be less useful than at the death of the first.
The Death of the A/B Trust
Estate plans used to all be drafted with “A/B Trusts.” So when the first spouse died, there were two trusts formed. The “A Trust” (marital trust) belonged to the spouse. The “B Trust” (exemption equivalent amount trust, unified credit trust, or applicable exclusion amount) was not owned by the spouse. That's so its contents wouldn't count against the spouse's estate tax exemption. The spouse could still spend the income from it, and could even raid the principal if needed for “health, education, maintenance, and support.” (Seems pretty broad, no?) But it was officially out of the estate. The goofy law requiring that for spouses really made estate planning attorneys a lot of money, especially when the Federal estate tax exemption was a mere $1 Million.
However, now that the exemption in 2019 is $11.4 Million ($22.8 Million if married) and rising, and now that spouses SHARE their exemption, there is not nearly as much need for an A/B Trust. I suppose it would still be useful if your primary beneficiary isn't your spouse. Or perhaps there is a state estate tax law somewhere that spouses don't share their exemption. I don't know. But the cool thing about Lange's plan is that when the law changed, his “old plan” was still just fine. It didn't require a few thousands of dollars of estate planning attorney time to be fixed up. If the law changes back, it's still fine.
Time to Review Your Old Estate Plan
If your estate plan isn't set up like this, it might be worth reviewing it. Consider what Lange calls “the nastiest trap of all.” This is when somebody drafted their estate plan so that the Federal exemption amount went to the B trust and whatever was left went to the A trust. That might not be a big deal if the estate at the first death is $10 Million and the exemption amount is $1 Million. But what if the estate is worth $5.43 Million and the exemption amount is $5.43 Million? Well, the entire estate goes into a B trust. Sucks to be that spouse who has just been legally disinherited.
Does your estate plan include an A/B trust? Why or why not? How have you designated your beneficiaries? What do you think of Lange's Cascading Beneficiary Plan? Comment below!