In your initial meetings with clients, an answer to one question will give you insight into their values, lives and dreams and create a healthy anxiety that will motivate them to enlist your services.
As nonchalantly as possible, ask, “When you die, who will get your money?” Most likely, the clients:
Know, but just realize that they haven't updated their wills and beneficiary designations since the last birth, death, marriage or family feud.
Don't plan on dying, making the question moot.
But seriously, folks, this topic should not be taken lightly. Account beneficiary designations usually take precedent over a will and can also help avoid the probate process. And unless the corresponding laws and/or a client's personal and financial situation haven't changed since the last time beneficiaries were named (hah!), revisiting the subject can prevent a disastrous event from ruining a client's long-term plans and allow you to drastically reduce the tax bills of clients and inheritors.
Often these are the largest single liquid accounts in clients' portfolios. If it's an IRA or a Roth IRA that a surviving spouse needs for support, just double-checking that he or she will get the money is all that is required.
But retirement plan assets that aren't needed today can be effective estate planning tools for tomorrow, without requiring the owner to give up control of the account while alive. The “stretch” technique allows next-generation beneficiaries to take money out according to their own life expectancies after the original owner dies. Doing this could mean 30 to 40 years of tax-advantaged growth for an adult child, and 60 to 70 years of accumulation for a young grandchild.
It gets even better when a client converts unneeded IRA assets to a Roth IRA. Not only does the stretched Roth provide tax-free income, money used to pay the conversion taxes won't be subject to possible estate taxes. But make sure benevolent clients open an IRA for each child or grandchild. If multiple inheritors are named for one account, RMDs must be calculated based on the life of the oldest beneficiary.
If the retirement money is still in a 401(k) or Keogh, the tax ramifications to non-spouse beneficiaries can be especially onerous. Most providers don't allow these people to stretch out payments; instead, they might require the funds to be dispersed (and taxed) in the year the account owner dies.
But help may be on the way. A recent private letter ruling (PLR) from the IRS (www.irs.gov/pub/irs-wd/0244023.pdf) allowed the beneficiary of a Keogh account to use an annuity to stretch out payments from the account. The IRS hasn't yet opened the door on this move to anybody but that PLR petitioner. The ruling, however, could open the door to non-spouse beneficiaries annuitizing payments from work-sponsored retirement plans, potentially sparing inheritors untold millions in taxes.
Whether the account in question is an IRA, a Roth IRA or a 401(k), the stretch technique is effective only if the beneficiary chooses to delay payments as long as possible. There is nothing short of a trust (or an annuity — see below) to prevent the inheritor from taking a lump sum and splitting the proceeds roughly equally with the IRS.
Although annuities should be used primarily for augmenting retirement income, clients looking for tax-deferred growth can also use certain annuities to exert beyond-the-grave control over assets without incurring the cost and hassle of establishing a trust.
Several companies have recently added annuity contract provisions that allow clients to determine not only who gets their money but also how that money is paid out. Hartford, Pacific Life, Equitable and Manulife are among those that allow contract owners to specify that death benefits be paid out over time. Utilizing this feature can not only reduce the taxation of the benefit; it can also make sure a decadent descendant will grow up before the money runs out.
A quick check can reveal that the beneficiary of a policy bought long ago might be in need of an update for at least two reasons. First, the beneficiary could be the insured's first spouse (which, by intention or not, could cause mild anguish for the second spouse). Second, the original death benefit might have been obtained when the insured had a net worth of zero or less. Today the client might have a much larger asset base, and an ample check to the surviving spouse upon the insured's death could create an estate tax problem for the next generation.
When the sad day comes and a client does pass away, you might be the one handing the checks to the beneficiaries. You will be more likely to maintain your relationships with the inheritors (and with their money) if you can look them in the eye and say, “You're taken care of.”
Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future.