Whether you recently accepted a GM or Ford pension buy-out, or you accepted an early retirement buy-out years ago, there are several legal, tax and estate planning issues that you may not have planned for.
What happens when you die?
Most pension plans allow you to accept a slightly smaller monthly payment in exchange for a continuing pension for your spouse if you die first. This often provides a good amount of security, knowing that your spouse will have a continuing income stream to help them pay the monthly bills when you are gone. With the buy-out, this safety net no longer is there. You may want to consider life insurance or other financial options to plan for both your life and your spouse.
With most pension buy-outs, you receive the money before taxes. The IRS calls these types of retirement accounts, “qualified” accounts. Many people choose to leave as much money in these accounts as possible, and only take out required minimum distributions based on their age, when the IRS requires it. This may seem like a sound strategy, because who would want to pay a tax before they had to? However, when we look at the big picture, some people would be better off strategically paying a little more taxes each year, rather than only taking required minimum distributions.
Why would you ever want to pay taxes sooner than you have to? Well, there are two excellent reasons: first, so you don’t have to pay more taxes in the event of a crisis; and second, so you do not pay more taxes to Uncle Sam when you die. We work with a lot of clients that had only taken out the required minimum distributions. Then, when a crisis comes along such as a need to pay for assisted living, nursing home or other emergency, they then have to take a large sum out of their retirement fund all in one year. This bumps them up to a higher tax bracket and they pay a larger tax.
The second reason is based on what happens to your retirement funds after you die. Since you are on a fixed income, you are likely in a lower tax bracket than when you were working. Your kids are still working and probably are in a higher tax bracket than you. Is it better to pay part of the taxes now at your lower tax bracket, or after you die at your kid’s higher tax bracket? That is assuming the best case scenario that the kids choose to “stretch out” the payments from the retirement plan to receive a small portion of the money every year and pay a small portion of the taxes every year. Most children do the opposite. They cash out all of the money in the first year and put themselves in the highest tax bracket and pay the maximum tax. Guess what? If you have two or more children, you just adopted Uncle Sam and made the IRS the biggest beneficiary of your retirement fund.
You can avoid this with a properly drafted “IRA stretch” trust. Most trusts do not qualify for this “stretch” tax savings. Finally, there are a few politicians out there (including the President) that want to get rid of the stretch option on IRAs after your death. If they have their way, all IRAs will need to be cashed out and the taxes paid after the death of both parents.
What happens if you live?
This is where most people fail to plan. In the old days, we got older, we got sick, and then we died. Today, with advances in medical care, as we get older and become sick, we often continue to live. We eventually will need some level of continuing long term care. According to the U.S. Congressional Budget Office*, 33% of seniors over age 65 will spend at least 3 to 12 months in a nursing home. In Michigan, the average cost of a nursing home is over $7,032.00 per month. So, even 12 months would cost more than $84,384.00.
What is worse is that the C.B.O. report states that 24% of seniors over age 65 will spend at least 1 year to 5 years in a nursing home. A full 9% of seniors age 65, will spend more than 5 years in a nursing home. That is worth repeating… Nearly one in ten seniors will spend more than 5 years in a nursing home!
If you need long term care, Medicare and your insurance will not pay for it! Most people do not understand that long term care is not covered by your medical insurance or Medicare! With a pension, even if you spent all of your money on long term care costs, you knew that you still had money coming in every month to help support you and your spouse. However, with a buy-out, all of your funds are at risk to long term care costs. There are solutions to protect yourself and your family. You may want to consider a specialized asset protection trust and long term care insurance. Your regular trust will not help you with protecting assets. Assets in a regular trust are still at risk to long term care costs.
The good news is that there are solutions to these extra problems created by the buy-out. A well-qualified attorney who is up to date on asset protection, working together with your financial advisor can create a plan to address all of these concerns. A good comprehensive solution will factor in the complications presented by the buy-out, and will be tailored to meet all of your personal circumstances.