Application of the Updated Life Expectancy Tables

Although Individual Retirement Accounts (“IRAs”) have become ubiquitous in the Estate Planning world, they are relatively young having been created in 1974 with the passage of the Employee Retirement Income Security Act. Recently, the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”) made significant changes to the rules regarding IRAs including raising the age at which taxpayers had to begin taking their Required Minimum Distributions (“RMDs”). Complex provisions of the Internal Revenue Code and Treasury Regulations govern RMDs and the calculation thereof. Determining the amount of an RMD for a particular year puzzles taxpayers and Estate Planning practitioners, alike.

In simple terms, the RMD is a fraction, the numerator of which is the IRA account balance on December 31 of the prior year and the denominator of which is the applicable distribution period. The IRS publishes tables in IRS Publication 590-B and Treas. Reg. §1.401(a)(9)-9 that provide the applicable distribution period based upon the age of the individual and their status as a participant, spouse, or non-spouse beneficiary. The IRS published revised tables effective January 1, 2022. The updated tables will lower the tax burden for taxpayers who use their lifetime to determine RMDs. Let’s review an example that demonstrates how the revised tables help lower potential tax liability.

Assume that Patty Participant turned 80 in 2021 and that her December 31, 2020, IRA balance was $2 million. Participants whose spouses are not more than ten years younger use the Uniform Life Table to calculate their applicable distribution period. That table gives an applicable distribution period of 18.7. Her 2021 RMD was $106,951.87 (2,000,000/18.7). Now let’s assume that Patty turned 80 in 2022 and that her December 31, 2021, IRA balance was $2 million. The updated Uniform Life Table gives Patty a new applicable distribution period of 20.2. Thus, Patty’s 2022 RMD is $99,009.90 ($2,000,000/20.2). This produces a difference of $7,941.97 between the RMDs calculated under the prior and revised Uniform Life Table. This difference could translate to a few thousand dollars in tax savings, depending upon Patty’s tax bracket.

Let’s change the facts to see how the updated tables affect certain designated beneficiaries. Assume Patty Participant dies in 2022 and names her spouse, Benjamin Beneficiary, as the sole beneficiary. Benjamin qualifies as an EDB under the SECURE Act. Spouses who are not more than ten years younger than their participant spouse determine their applicable distribution period using the Single Life Table, just like any other EDB. Let’s assume that Patty’s balance as of December 31, 2021, was $2 million and that Benjamin turns 75 in 2022. Under the updated Single Life Table, the applicable distribution period is 14.8. Benjamin needs to withdraw $135,135.14 ($2,000,000/14.8) in 2022 for his RMD. Under the prior tables, Benjamin would have had an applicable distribution period of 13.4 producing an RMD of $149,253.73 ($2,000,000/13.4). This difference resulted in an additional amount of $14,118.59 ($149,253.73-$135,135.14) distributable as an RMD under the prior Single Life Table.

Aside from surviving spouses and EDBs, certain other beneficiaries may use these tables. Let’s assume that Patty’s designated beneficiary is a non-spouse beneficiary in a pre-SECURE Act world. Pre-SECURE Act designated beneficiaries used the Single Life Table to determine their RMDs. Non-spouse beneficiaries calculate their applicable distribution period for the first year and then subtract one each subsequent year. Let’s assume that Patty died in 2015 and named her son, Brian Beneficiary, as the designated beneficiary. In 2016 Brian turned 30 and according to the Single Life Table in effect then, the applicable distribution period was 53.3. In 2017, his applicable distribution period was 52.3 (53.3-1). In 2022, six years after the initial determination date, Brian would use an applicable distribution period of 47.3 (53.3-6) to calculate his RMD. The new tables change that. Under the new tables, the non-spouse designated beneficiary uses their age as of the participant’s date of death to determine the applicable distribution period. Once the beneficiary has that number, the beneficiary subtracts the number of years that have passed since the first RMD to recalculate their RMD under the revised tables. Brian’s applicable distribution period under the new table based upon his age at Patty’s death is 55.3. Six years have passed, so his divisor for 2022 is 49.3 (55.3-6). This same process applies to any non-spouse EDB where the participant died post-SECURE, but prior to 2022.

Many advisors focus on the high-level plan without understanding the administrative details governing IRAs which they leave to the plan administrators and IRA custodians. As the Estate Planning world evolves, professionals seek ways to become better integrated advisors to their clients. The new tables extend the life expectancy for most individuals meaning smaller RMDs, which translates to lower tax liabilities. If you receive RMDs from an IRA, then it’s vital to review your RMDs to ensure proper calculation under the updated life expectancy tables. If you have questions regarding your own RMDs, reach out to me for help calculating your 2022 RMD.

State Income Taxation of Social Security Benefits

Since the onset of the pandemic, many individuals have decided to relocate. Some move to be closer to family, others for better weather. Still others change domicile for financial reasons, like the pursuit of different job opportunities or for lower taxes. I advise individuals who move to update their Estate Planning documents to conform with the rules of the new state of residence. Numerous factors impact an estate plan, many of which originate from the state of domicile. For example, it’s important to know whether the state is community property, elective community property, or a separate property state. It’s important to understand what forms of ownership the state acknowledges and the nuances of property ownership in that state. Understanding the property ownership and nuances of the state left behind may also impact Estate Planning. Finally, new residents need to understand how state and local taxation works, including whether the state imposes an income tax, gift tax, estate tax, or inheritance tax. If the state imposes an income tax, then the resident needs to determine what types of income will be subject to taxation and may be surprised to learn that their new state taxes Social Security benefits.

The federal government includes in income a portion of your Social Security retirement, disability, and other benefits if your income exceeds a certain amount. Some states follow the federal government’s lead and include these benefits in income for state income tax purposes. Let’s start, however, with those states that do not include these benefits in income. Eight states, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not impose a state income tax. This means that a resident’s Social Security benefits are safe from state income tax liability. Of the remaining forty-two states, only twelve states include Social Security benefits in the calculation of taxable income. North Dakota used to tax Social Security benefits but amended its tax code in 2021 to remove Social Security benefits from the statutory definition of taxable income. Thus, less than one-quarter of the states in the United States impose a tax on Social Security benefits, some of which depend upon the resident’s income or age. Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia tax some or all their residents’ Social Security benefits.

In the states that impose taxes on these benefits, the policies and rules regarding taxation vary widely. For example, Colorado imposes a flat tax of 4.55% on Social Security benefits; however, it also allows an offsetting deduction of up to $20,000 in retirement income for those aged 55 to 64, which increases to $24,000 for those aged 65 and older. Colorado passed legislation that will allow residents to deduct all federally taxable Social Security benefits from their state income beginning in 2022. For residents in Connecticut, Kansas, Nebraska, and Vermont, if their state Adjusted Gross Income (“AGI”) is below a certain amount based upon filing status, then residents need not worry about taxation of their Social Security benefits. Nebraska began to phase out taxation of Social Security benefits in 2021, with the phase-out continuing until 2025 when at which time lawmakers will vote on whether to eliminate the tax on Social Security benefits altogether by 2030. In Missouri, if state AGI is below a threshold amount and the resident is over the age of 62, then the state will not tax Social Security benefits. Even for those Missourians whose income exceeds the threshold amount, the state may only partially tax benefits. For residents in those states whose income exceeds the set amount, the state’s department of revenue generally imposes tax at the same rate as other income.

Minnesota, Montana, and New Mexico follow the Federal guidelines to some degree by allowing Social Security benefits for those residents whose state AGI does not exceed $25,000 for single filers, or $32,000 for married filing jointly, to escape taxation. States deviate slightly from the Federal model in determining the amount of Social Security benefits subject to taxation and the rate of tax. For example, Utah uses the Federal formula to determine how much of a resident’s benefits will be subject to tax but applies its own rate of tax. In addition, Utah offers residents partial credits for those Social Security benefits taxed at the Federal level.

Rhode Island does not impose taxes on Social Security benefits for anyone who has reached full retirement age as defined by the Social Security Administration if their state AGI does not exceed $86,350 for single filers or head of household and $107,950 for married filing jointly. Finally, West Virginia has begun to phase out state income taxes on Social Security benefits for those making less than $50,000 ($100,000, if married) in 2021 by allowing residents to exclude 65% of Social Security benefits from taxable income. In 2022, West Virginia will not tax Social Security benefits for those residents with income below those amounts. If income exceeds those amounts, the benefits will be taxed according to the Federal model.

As is clear, it’s important to understand how your state views Social Security benefits. There is no uniformity in the treatment of these benefits. For each state’s specific guidelines, contact that state’s Department of Revenue or a qualified Estate Planning attorney. Regardless of whether or how your state taxes Social Security benefits, it’s important to consider the ramifications and examine ways that you might be able to reduce your tax burden. Your after-tax income will determine how you, your spouse, and your loved ones will spend your retirement. Remember that just because a state taxes Social Security benefits does not make it unsuitable for retirement. I can help you decide what’s best for your family and how to plan for your potential tax liability.

What Everyone Should Know about the New FDIC Regulations

While I recommend creating a basic estate plan, usually with a revocable trust as the centerpiece. Revocable trusts provide an easy, yet effective way to avoid probate in most states. In those states in which probate is not a concern, we use trusts to provide asset and creditor protection or to protect a beneficiary from themself. As estate plans become more complex, they tend to involve more trusts. These trusts may contain large sums of money, sometimes all in one account. I have fielded many a question from clients regarding how much of the funds in the trust were insured. If the funds are deposited in a bank or savings and loan that is insured by the Federal Deposit Insurance Company (“FDIC”), then it’s possible to answer that question although the rules can be confusing. Recently, those rules were simplified. To understand the changes fully, we must understand the protections offered under the existing framework.

Under the current rules, which remain in place until April 1, 2024, deposits are insured up to $250,000 per depositor, per ownership category, per institution. As a simple example, let’s assume that Johnny has $200,000 in BigBank and no other accounts anywhere. His entire $200,000 is covered. Now let’s assume that Johnny’s $200,000 was titled in a revocable trust, with Johnny as the sole grantor. Upon Johnny’s death, the assets will pass to his daughter, Lyla. For a revocable trust, the FDIC would insure up to $250,000 per institution, per trust beneficiary, up to a maximum of 5 beneficiaries for a total of $1,250,000. The rules look to the primary beneficiaries of the trust, which the FDIC defines as those individuals who would take upon the death of the grantor of the trust. Contingent beneficiaries and more remote beneficiaries are not considered. In our example above, then, Lyla is the sole beneficiary of the trust upon Johnny’s death meaning that the entire $200,000 would be protected. If Johnny had $500,000 in the account with BigBank, only $250,000 would be protected. He could, however, transfer $250,000 to HugeBank and that amount would be covered as well because it’s at a different institution. If Johnny had 5 children, all of whom were the beneficiaries of his revocable trust upon his death, then $1,250,000 in a revocable trust account at BigBank would be FDIC insured (5 x $250,000). If he had more than that, then he would have to transfer the overage to a new bank, keeping in mind that the FDIC insures no more than $250,000, per institution, per beneficiary, up to a maximum of $1,250,000 regardless of additional beneficiaries or funds. If Johnny were married and had a joint revocable trust, assuming that there were five beneficiaries that took upon the death of both grantors, then the FDIC would cover up to $2,500,000 at any one institution.

Let’s change the facts a bit and assume instead that Johnny’s trust is irrevocable. How does that change the analysis? If the beneficiaries of the trust can be identified and are non-contingent beneficiaries, then the FDIC insurance would work like it does for a revocable trust. If, however, some of the beneficial interests are contingent, then those contingent interests would be added together and insured up to a maximum of $250,000, regardless of the number of beneficiaries or the allocation of the funds among the beneficiaries. To demonstrate, let’s assume that Johnny has 5 children and that Lyla’s interest is the only non-contingent interest. If Johnny has $600,000 in BigBank, only $500,000 would be covered because the contingent interests would be added together and treated as one interest, notwithstanding that there are 4 contingent interest beneficiaries. Thus, $250,000 for Lyla’s non-contingent interest and $250,000 for the collective contingent interests would be covered.

Note that if the funds in an account represent both contingent and non-contingent interests, then the FDIC would separate those interests and apply the rules as described above. It’s easy to see how multiple trusts complicate these rules. Interestingly, according to the FDIC, it receives more inquiries related to insurance coverage for trusts than all other types of deposits combined. To simplify the rules, the FDIC issued new rules on January 21, 2022, with a delayed effective date of April 1, 2024.

The new rules merge the categories for revocable and irrevocable trusts and use a simpler, more consistent approach to determine coverage. Now, each grantor’s trust deposits will be insured up to the standard maximum amount of $250,000, multiplied by the number of beneficiaries of the trust, not to exceed five. It no longer matters whether the trust is revocable or irrevocable or whether the interests are contingent or fixed. These rules effectively limit coverage for a grantor’s deposits at each institution to $1,250,000 for a single grantor trust and $2,500,000 for a joint trust, assuming that there are five beneficiaries of such trusts. The streamlined rules provide depositors and bankers guidance that’s easy to understand and will facilitate the prompt payment of deposit insurance, when necessary.

While these rules do not go into effect immediately, it’s important that we begin understanding them now so that we can make any changes that may be necessary prior to the effective date. If you are concerned about FDIC coverage for trust accounts, or in general, talk with me about it. I can help you understand current coverage levels and advise you regarding any moves that you should make now or in the future to receive maximum FDIC insurance coverage.