Estate planning is more crucial than ever

The Secure Act drove federal taxes and tax law deeper into the lives of those other than spouses who inherit the wealth you leave behind. It made estate plannin...

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The Secure Act drove federal taxes and tax law deeper into the lives of those other than spouses who inherit the wealth you leave behind. It made estate planning more crucial than ever. And don’t wait until you’re at death’s door. With a few pointers, the director of wealth management at the Government Employees Benefit Association, Greg Klingler, joined Federal Drive with Tom Temin.

Interview transcript:

Tom Temin: Greg, good to have you back.

Greg Klingler: And thanks for having me, Tom.

Tom Temin: So as the end of the year approaches, and people think about their estates, and there’s all kinds of things going on with open season and so on. People do need to think about what comes after them. Their money is still there. They’re not. But the Secure Act really did change things profoundly. And maybe people are just dawning on to it. Give us a quick rundown.

Greg Klingler: Yeah. So the Secure Act, which we’re coming up on the first anniversary of the Secure Act, was passed in December of 2019. And it did a number of things. But one of the things that most directly affects legacy planning, and frankly, a lot of plans that people have already put in place, is it diminished the power of what we call the stretch IRA. So what the stretch IRA is, it’s the ability to, for an heir, a non spousal heir, to stretch out their distributions over effectively the course of their lifetime. Now, withdrawals from an IRA or qualified plan is subject to ordinary income tax. So if you can take it out in smaller pieces, you’re going to be subject to a smaller or a lower tax rate, a lower tax rate over the course of your lifetime ultimately saves you money. So that was really the big strong benefit of the stretch IRA, especially for federal employees who, frankly, a lot of them passed away with money in the TSP. The Secure Act said, we need to squeeze in that timeframe that you must withdraw within 10 years.

Tom Temin: And when you say non spousal heirs, that means kids too?

Greg Klingler: In most cases it absolutely is kids, it’s going to affect them the most in most cases.

Tom Temin: So is there anything with respect to estate planning that you can do to mitigate it at all?

Greg Klingler: Absolutely. So a lot of people who have had the stretch IRA as part of their estate plan, they’re now revisiting their other options. But generally, when it comes to estate planning, a lot of people think wills and trusts. And, Tom, I want to be clear, I am not a lawyer, I don’t pretend to be one, there’s a lot of things you can do outside of your traditional wills and trusts that allow for you to effectively and efficiently pass money to your heirs. When we talk about past millionaires, most people think tax efficiency. But there are definitely times where we also need to think, okay, do I need to control my money from the grave? Is my grandchild mature enough to handle this very large windfall and handle it wisely? Because I can tell you when I was 18, I’m not 100% sure, I could have taken a large windfall. So first steps, whether you’re a federal employee or not, is make sure your beneficiaries are in check. We see so many people with wealth management, who they pass away, and we find out their beneficiary is there to see spouses who passed away three years early. And then where does that money go? And does it go to the person who they want it to go to because at that point you’re sitting in probate. Titling, making sure that your accounts, your house, are titled appropriately, because if it is titled appropriately, that too allows you to avoid the cost of probate and having somebody else dictate where your money goes. So those are free, those are inexpensive, those are typically where you want to start. And then at that point, the question is, where do you go from there?

Tom Temin: But is there any way to convert the TSP funds or your IRA if that’s the case, to some other way that’s not as much subject to the tax. I don’t think there’s any way around that though, is there?

Greg Klingler: So there’s no way around that from the IRA perspective, you have 10 years to spend it, you don’t have to take out required minimum distributions, you just have to take it out within 10 years. You can take it out over the course of 10 years each and every year, or you can take it out at the end of 10 years, which I generally don’t recommend. The federal employees, they’re in a bit of a little bit more of a complex situation. Typically speaking, what we see is most surviving spouses, they maintain the TSP that their deceased spouse had. And there’s some benefits to doing that. The low fees are typically the one that’s mentioned the most when it comes to TSP. But there’s some weaknesses to having a surviving spouse maintain it over the course of their life. A surviving spouse is going to be given what’s called a beneficiary participant account, it’s just a fancy term for this is not an employee TSP, it’s the surviving spouse TSP. And if the owner of the beneficiary participation account dies, the TSP requires you to pay it out lump sum to your heirs, you can’t even stretch it out over the 10 years anymore. It’s lump sum, which can be a very, very large piece of tax consequence when you think that there’s tens of thousands of TSP millionaires out there.

Tom Temin: In other words, if you leave it to the spouse, and the spouse dies after you, then you have this instant rollover, 100% and the tax rate could be 50% of it.

Greg Klingler: Yeah. When you look at people with account values of 50 or 100, 500, a million dollars, yes, it’d be top tax bracket. And there is discussions about that top tax bracket actually being increased over the next couple of years. So it could be a very, very large tax consequence, which means a discussion with that surviving spouse really should happen if we care about tax efficiency and passing money to our heirs.

Tom Temin: And so you can’t get around outliving your spouse or your spouse outliving you. So what do you suggest people do with IRS? Should they convert in some way toward the end of their life to make it more tax efficient?

Greg Klingler: That is a very good point. And that’s typically a conversation that needs to be had primarily with, again, that surviving spouse. The question is not really if, especially if tax efficiency is a concern, and for most people, it is. The question more so is a when. The TSP has some very good aspects to it, primarily the fees. Now with that being said, the TSP has some weaknesses as well. The I fund is a bit legislatively handcuffed in the fact that it can’t invest in some things that its peers can and it does lag its peers. The F fund is a little bit weak in the fact that it’s passive and not actively managed. But all in all, the C Fund and the S fund are excellent funds that every portfolio should have. So when do you make that transition? That’s really the key.

Tom Temin: Yeah. And it shouldn’t be when you suddenly develop some end of life stage disease, or you’re at 89 years old or something. You’re saying, in general, that you should start while you still are able to have some planning horizon ahead of you.

Greg Klingler: Absolutely. I mean, it would be a lot easier to plan if we all were sitting in front of a crystal ball and we knew exactly what was going to happen. But the reality is being conservative and planning a little bit earlier than you probably think you should, that typically benefits people more than anything else.

Tom Temin: Yeah, if we all knew the day we would leave this earth then we’d spend every dollar until that day, the kids hey you’re on your own. And on that theme of protecting the spouse and the heirs beyond you with the wealth that you’ve accumulated, what about your health insurance coverage, your life insurance coverage? How do you handle those?

Greg Klingler: In most cases, we find this is going to directly affect the spouse. So just understand the key that you have to maintain this insurance for at least five years before you retire. When you do that, you can effectively carry this type of insurance, whether it be health insurance, or FEGLI insurance, life insurance, into retirement. What we generally see from a life insurance standpoint is FEGLI is very well used over the course of the first like five, maybe ten years in retirement. After ten years, because it is age based pricing, most people are priced out of FEGLI. So if you only need it for five or ten years, maintaining FEGLI could make a lot of sense, especially if you have some health issues. But if you are in good health, and you’re going to need coverage for a longer period of time, let’s say your spouse is much younger than you or much healthier than you, or you have a special needs child, or you had a child very, very late in life — those are times where you probably want to think at something more along the lines of a permanent individual policy, taking advantage of the cheap rates associated with your good health, and ensuring that the cost of insurance doesn’t basically outrun you, because things like FEGLI in your 70s, in your 80s, you will see that a lot.

Tom Temin: I guess do you really need life insurance at that point in your life?

Greg Klingler: Yeah, and that’s really the key, most people don’t. But again, there are situations like the younger spouse or the healthier spouse with a special needs child where that small group of people absolutely needs to plan and that planning should take place probably when they’re retiring. Generally I recommend legacy planning taking place kind of in retirement, maybe seven to ten years in once you know your retirement is comfortable, once you have a good grasp of the cash flow. But for people with those unique needs, legacy planning is part of retirement planning.

Tom Temin: Alright, good note to leave it on. Greg Klingler is director of wealth management at the Government Employees Benefit Association. Thanks so much.

Greg Klingler: Thank you, Tom.

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