Mike and Betty returned to their attorney’s office to continue their discussion. In their last meeting, they talked over the need for tax planning for estates over $1 million, and agreed that the thousands of dollars of tax savings – over one hundred thousand dollars in Mike and Betty’s estate - justified a consideration of tax planning.

Mike had pointed out at the end of the last consultation that their estate consisted largely of IRAs and other retirement plans, and their home. The former is currently worth nearly $1 million combined, and the latter worth three-quarters of a million dollars. Their attorney had promised to discuss planning for IRAs and retirement plans at their next meeting.

After exchanging holiday greetings and best wishes for a happy Thanksgiving, Mike and Betty get down to business with their attorney. "You explained tax planning last meeting," Mike recalls, "and discussed using two trusts to avoid Maryland and federal estate tax. But I read that you can’t put an IRA or 401(k) in a trust."

"That’s right," responds their attorney, "but you can plan to avoid taxes, maximize flexibility for the survivor, and increase retirement plan distributions and the benefit to your children. This is done through creative beneficiary designations.

"You remember that when you set up your IRAs and 401(k)s, you chose beneficiaries for your retirement plans. Most people make the spouse the primary beneficiary, and the kids the contingent beneficiary, in case the spouse does not survive."

Mike and Betty nod. Their beneficiary designations follow the usual pattern.

"To maximize both the survivor’s flexibility and benefit to your children," continues their attorney, "you would simply change the contingent beneficiary to the wage-earner’s trust. Then, when the first of you passes away, the survivor can make a choice of how to handle the retirement money.

"Let’s say Betty survives. She can choose one of three options: first, she can do nothing. If Mike is receiving distributions, she can simply continue receiving his distributions.

"Second, Betty can roll over the IRAs into her own name, and Mike’s 401(k) into an IRA in her name. Then, she can treat the new IRA as if she were the wage-earner who deposited the money into the IRA.

"She can name the children or even your grandchildren as beneficiaries, and stretch the distributions from the IRA over their life expectancies. Because the children are younger than you, the distributions are stretched over longer life expectancies. This usually results in lower tax payments, because there is less distributed each year.

"Third, Betty can disclaim the IRAs or 401(k)s. A ‘disclaimer’ is a legal action that treats Betty as if she predeceased Mike, effectively saying ‘pretend I died first.’

"If Betty died first, Mike’s IRA and 401(k) would be paid to the contingent beneficiary, his trust. Then, the payments from the plans would be received by the trust and paid to Betty over her life expectancy. This results in higher annual payments than under the ‘roll-over’ option.

"The third option, however, also keeps Mike’s IRA and 401(k) from being subject to estate tax when Betty dies, while the first two make them taxable when she dies.

"By using this planning strategy," he concludes, "you can get ‘a second bite at the apple,’ and defer the final decision until the first one of you passes away."

"That’s a lot to absorb," Mike comments. "Let us think about it. Our house is a big part of our estate. How do we plan for that?"