By Jan P. Myskowski
November 19, 2009
By Jan P. Myskowski
November 19, 2009
Topics in this update:
It’s taken longer than usual to issue our next Trusts & Estates Update, hoping that by now there would be something to report regarding Congress’s action to address the looming sunset of the Economic Growth and Tax Relief Reconciliation Act of 2001. Lots of speculation remains, but there is nothing concrete to report, other than to share a growing concern that Congress will simply do nothing and allow the federal estate tax exemption to drop back to $1 million as of 2011 (that’s still a minority view, but a growing minority as near as I can tell). So, this update will cover a number of brief topics that may not be getting the attention they deserve in other resources you receive.
Deadline Extended to Rollover Unwanted 2009 RMDs
Most of you will be well-aware that the Worker, Retiree, and Employer Recovery Act of 2008 (“WRERA”) waives required minimum distributions (“RMDs”) for 2009 from IRAs and most other defined contribution plans. However, because WRERA passed late in 2008, many taxpayers and plan administrators had not adjusted their systems and 2009 RMDs began to flow. Earlier this year, in Notice 2009-9, the IRS pointed out that taxpayers could avoid including unwanted RMDs in taxable income by rolling them over to an eligible retirement plan or IRA within 60 days of receipt. In Notice 2009-82, the IRS announced that the period to roll over 2009 RMD’s has been extended to November 30, 2009. This extension also applies to the rollover of 2009 payments in excess or RMDs that are part of a series of substantially equal payments made at least annually, and expected to last for the life (or life expectancy) of the participant. There is no requirement that the taxpayer demonstrate that the RMD or payment was received mistakenly. Therefore, even if the RMD was taken intentionally earlier in the year, perhaps in anticipation of financial need that has not materialized, the taxpayer can now roll that payment over. Note that the usual 60-day period still applies to payments received within 60 days prior to November 30, 2009, so the deadline to roll over 2009 payments is effectively the later of November 30, 2009 or 60 days following receipt of the distribution.
The Estate Tax Benefits of Roth Conversion
Many of you will be revisiting the topic of Roth conversions in light of the broadening of the rules permitting conversions that will go into effect in 2010. Most of the analysis focuses exclusively on the effect of accelerating the income taxes deferred to date and on the relief from income taxes going forward. Little attention is paid to the potential estate tax savings that can be generated by a Roth conversion.
Take the example of Mary Smith, who has $1 million in a traditional IRA. Assuming Mary converted to a Roth IRA and that the entirety of the $1 million would be taxed at the top marginal rate of 35%, Mary would have an income tax bill of $350,000 associated with the conversion. Most analysis of the potential benefits of conversion will focus on the loss of this $350,000 from Mary’s investment portfolio compared to the potential compounding effect of the relief from income taxation of the earnings on the net $650,000. What is often overlooked is the potential additional benefit of estate tax savings.
If we assume that Mary has a taxable estate for federal estate tax purposes even without the inclusion of her IRA, such that the entirety of the IRA would be subject to estate tax, it is necessary to compare the amount that will be includible in her taxable estate both with and without a Roth conversion.
Without conversion, $1 million will be included in Mary’s taxable estate for federal estate tax purposes and will generate additional federal estate tax of approximately $450,000 (assuming the IRA is taxed at the current top estate tax rate).
If Mary does convert to a Roth IRA and pays $350,000 in income tax, she will have only $650,000 to include in her taxable estate, and the Roth IRA will generate only $292,500 in additional federal estate tax (again assuming the top estate tax rate applies to the Roth IRA). The Roth conversion effectively removes $350,000 from Mary’s taxable estate (without any gift tax or utilization of gift or estate tax exemptions because the $350,000 leaves the estate in the form of an income tax payment). Removing that $350,000 from Mary’s taxable estate saves her estate $157,500 in federal estate tax ($450,000 – $292,500). Removing an additional $350,000 from Mary’s taxable estate does not necessarily justify accelerating $350,000 in income tax, but the estate tax savings of doing so should certainly be factored into the traditional analysis of a potential Roth conversion.
Anticipated Trap in New Hampshire’s Long-Term Care Partnership
The Deficit Reduction Act of 2005 (“DRA”) modified the federal Medicaid law by enabling states administering the Medicaid program to offer program enhancements to applicants who purchase long-term care insurance.
A limited number of states, including Massachusetts, already had pilot programs that offered such enhancements. In general, these programs provided that the purchase of long-term care policies meeting certain minimum coverage requirements (such as a daily benefit of $125) would garner the disregard of assets greater than the standard Medicaid allowances for both eligibility and lien recovery. For some applicants, the purchase of such a minimum coverage policy could allow them to exclude all of their resources for Medicaid eligibility.
The DRA enabled all states to offer such program enhancements, and New Hampshire is in the process of designing and seeking federal approval of such a program to be known as the Long-Term Care Partnership. Recently, we began to see the shape of this program when New Hampshire’s Insurance Department issued proposed regulations governing the program from the insurance regulatory perspective (corresponding Medicaid regulations from the New Hampshire Department of Health and Human Services are yet to be released).
Rather than prescribing minimum coverage amounts or other policy features that will trigger preferential treatment under the Medicaid program, the Long-Term Care Partnership will allow Medicaid applicants to seek preferential Medicaid eligibility based on the purchase of any long-term care policy approved by the New Hampshire Insurance Department. In other words, there will no longer be minimum coverage requirements. In exchange for this broadening of the class of policies that will qualify, however, it appears that the New Hampshire Long-Term Care Partnership will offer only dollar-for-dollar Medicaid eligibility enhancements (as opposed to the disregard of all assets based on the purchase of a minimum coverage policy). Based on the proposed regulations, the owner of any policy, regardless of the benefit amount, will be able to exclude $1 of resources for every $1 received in reimbursement from a long-term care insurance policy (the $1 would be excluded both for initial Medicaid eligibility purposes and for purposes of estate/lien recovery).
Implementing a dollar-for-dollar offset seems simple enough until you consider the complex timing issues involved in the typical scenario. Consider a Medicaid applicant who purchased a long-term care policy with aggregate coverage of $300,000. The expectation would be that a corresponding $300,000 in financial resources could be excluded for Medicaid eligibility purposes. However, the Medicaid disregard is only for the amount of reimbursement actually received under the policy. If the policy owner applies for Medicaid before receiving any reimbursement under the policy, the application will be denied because his or her $300,000 in financial resources still count. The solution is to wait to apply for Medicaid until the entirety of the $300,000 in potential reimbursements under the policy has been received, but that carries a hidden problem.
If the policy’s daily coverage limits are less than the actual cost of private pay skilled nursing care, the policy owner will be forced to consume some (and perhaps all) of the $300,000 in financial resources during the period that the long-term care policy is being exhausted. Although New Hampshire’s Long-Term Care Partnership is likely to be more flexible in terms of the types of policies that will qualify, policy design is going to become critical. Structuring policies to allow access to the aggregate coverage as rapidly as possible will be imperative if coordination with the Medicaid program is anticipated at the time of purchase. High daily coverage limits geared toward the anticipated actual cost of care and other features that allow accelerated access to the aggregate benefit should be emphasized in those cases.
This is a problem for insurance professionals now, even though the regulations governing the Long-Term Care Partnership are still in development. This is because the regulations will likely apply to policies issued on or after April 1, 2007. While it is possible that there will be a regulatory concession allowing the full value of a long-term care policy to serve as an offset at the front end, before the benefits of the policy are actually received, policies written prior to the issuance of final regulations need to anticipate the possibility (and we think likelihood) that such a concession will not occur.
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