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.
Naming Beneficiaries
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.
Having Options
My beneficiaries (excluding dolphins).
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!
Folks with sizable estates need to consult an experienced estate planning attorney in their states.
Depending on how it’s drafted, giving someone broad powers to direct funds could create a power of appointment rendering such property includible in a decedent’s estate, or subject to additional gift tax, etc.
For what it’s worth, the estate, gift and generation-skipping transfer tax exemption amounts are not “shared” per-se… that is, each spouse independently has and can control his/her own exemption amounts. The surviving spouse may access unused exemption of the first, but each spouse can direct how his/her exemption is applied. If the first spouse to die doesn’t direct, the second spouse to die has much more control. When a couple feels the same way on everything, it’s good to give a lot of freedom. But when spouses have differing interests (children from different marriages, etc.) it may cause trouble.
If your estates will be well under the exemption amount, then it’s not really important, but for those in excess, deliberate and strict drafting can save millions of dollars in estate taxes and also avoid lengthy contests among heirs.
There are reasons for establishing a trust besides just the estate tax concerns. These include protecting the assets from a second spouse and from the spouse’s children, protecting the assets from your spouse’s subsequent children, and protecting the assets from being spent unwisely and prematurely by your own ( young ) children. Having the money go directly into a trust will help protect it from all those eventualities. Having it go directly to the surviving spouse will not.
Well said. Surviving spouses remarry, have kids from other marriages, become old ladies and old men who are easy to take advantage of, or are simply not good with money to begin with.
WCI do you have A-B trust set up?
No. I am nowhere near having an estate tax problem. And barring significant Congressional action, never will.
WCI, since you will not need the money from your parents, will you have them give the money (inherit I mean) to your kids, or would still want the money to come to you.
I hope they spend it. I’m not entirely convinced that this idea of passing huge quantities of money from one generation to another is a good thing. My parents have “enough” but not gobs of money. Once whatever is left is divided up 16 ways (16 grandkids so far) it won’t be a lifechanging amount of money at all. It might not even cover a year of college expenses by then.
But I’ll encourage my parents to choose whatever beneficiaries THEY want. If they want to leave it to me, great. If they want to leave it to my children, great. If they want to leave it to charity, great. Their choice.
Obviously, there are some benefits to careful planning, but the benefits in this case are more money for heirs, and since I’m not sure that’s a good thing, I guess I don’t spend a lot of time worrying about it. Truthfully, I’d like to figure out a way to convince my parents to spend more of it on stuff that will make them happier.
As I mentioned above, even if estate taxes are not an issue, you should have a trust if you have young children and assets. For example, both parents can die together in an automobile accident. The trust will help protect your assets until your children are old enough to handle the money. You probably don’t want them getting the money when they turn 18. ( Look at how badly adult physicians handle their money. ) Your children will need protection. You can appoint guardians for the children, as well as trustees for the trust. They needn’t be the same people.
I agree that it is an excellent idea to have a trust in place at the time of death, especially of the second spouse. My guardians are appointed in my will as is the keeper of the cash. But you’re right that that would only last until 18.
Is the unified credit shelter trust something that could be described in a will and formed after death (like a testamentary trust) or does it have to be in place before death?
I live in a state with a “cliff”-type estate tax. Depending on exactly where my estate assets turn out to be relative to the state exemption limit, my estate could face marginal tax rates of up to 164% in state estate taxes (and that doesn’t even consider the income taxes that might be due to the extent that estate assets come in taxable form, e.g., traditional retirement accounts and HSAs.)
http://www.thinkadvisor.com/2014/09/03/beware-of-cliff-in-new-yorks-new-estate-tax-law
So, the easiest and most tax efficient thing for me to do was to designate my donor advised charitable fund (DAF) as the contingent beneficiary on my traditional retirement accounts and the HSA. That way my children (the primary beneficiaries) will have 9 months to determine if the “cliff” applies and they can disclaim in favor of the DAF. They are the designated “successor advisors” to the DAF anyway, so they will be able to direct DAF donations to the charities of their choice in any case.
This cascade setup was super easy to do and it was not necessary to pay any expenses for lawyer’s fees to set up trusts, etc.
That’s a terrible marginal tax rate! Thanks for sharing your experience.
I’m getting ready to retire with a decent pension plan from a major oil company. I need to locate a good trust structures/asset protection attorney. I live in Houston, Texas area. Any tips on how I find the more sophisticated, advanced attorneys whom specialize & only practice this kind of law? As you all know, there’s no shortage of attorneys…at least in Texas.
You might ask for a referral from your estate attorney. But no, I don’t have a good method to use to find one. Start with Google and people who know who have seen one, identify a few and try to interview them.
Joining this old comment chain… looking into Lange group As I find their service compellingand challenging to duplicate locally (all of their various estate tax strategies and computational services)
Jim, have you had any WCI members give feedback on their service, if it was worthwhile to get a financial Masterplan done through them?
As much as I’ve worked with Jim on various projects, he’s never applied to advertise here. So no, we haven’t had any feedback. It’s an interesting approach though to combine estate planning, tax work, financial planning, and investment management together though. I have no idea what he charges but I think there’s an AUM fee in there somewhere. More on AUM fees here:
https://www.whitecoatinvestor.com/my-two-least-favorite-ways-to-pay-for-advice/
Gotta be careful with those. 1% on $200K is a screaming deal. 1% on $10 million is a rip off.