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									                        Faculty Advisor
                        E-mail Newsletter

      Faculty Advisor Newsletter Edition 11:
                                                                     James Lange, CPA, JD
   Retirement and Estate Planning                                      James Lange & Associates
            Case Study                                                      Pittsburgh, PA

  The following case study suggests a likely retirement and estate plan that specifically applies to
  University faculty and even more specifically, TIAA-CREF participants. While it does not pro-
  vide all the background reasoning behind every choice and suggestion, it does outline the deci-
  sion-making process and offers realistic solutions with real benefits.

  The information in the case study is ideally supported by reading the article “Retirement and
  Estate Planning for University Faculty,” and either attending one of my free seminars or view-
  ing the new fully edited digitally mastered videotape of my seminar. Both seminar and video in-
  formation are available on my web site at or you can call 412-521-
  2732 or 800-387-1129. There are also four new sample “segments” of the video on the web site.
  I recommend that you read the case study, watch and listen to the video segments, and if you find
  any of the information relevant to your personal financial situation, then attend one of the semi-
  nars or purchase the videotape. If at that point you have further questions and concerns about
  your personal estate plan please don’t hesitate to call my office to schedule a consultation.

                                            Case Study

  David N. Academic, age 68, is a retired Biology Professor who worked for the University of
  Pittsburgh for 35 years. David is married to Alice, age 65. She is also retired. They have two
  adult children, who are self-sufficient and live on their own. David and Alice live in a modest
  house located in Pittsburgh, PA near the University. Though David made a reasonable salary at
  the University of Pittsburgh, it was difficult to save money. Taking care of the mortgage and
  maintenance on the house, buying groceries, and raising their children took most of his paycheck.
  They did manage to save some money each year for an interesting family vacation and they also
  paid for their children’s college education.

  The University of Pittsburgh has a retirement plan where the employee contributes up to 8% of
  his salary and the University matches 150% of the employee contribution up to 12% of salary.
  David always contributed his 8%. When he could afford it, David contributed to his Supplemen-
  tal Retirement Annuity, which was not matched by the University. Now, the kids are educated
  and out of the house and recently money worries have eased up. David’s retirement accumula-
  tions consist of three sets of retirement assets: retirement annuities (RAs), group retirement an-
  nuities (GRAs), and supplemental retirement annuities (SRAs). His most recent TIAA-CREF                                                                    1
Faculty Advisor E-mail Newsletter Edition 11                      Retirement and Estate Planning Case Study

   statement reported that his retirement assets have a combined balance of $1 million. Despite having
   $1 million in retirement assets, David and Alice still live modestly. They travel, but not first class.
   David drives a 10-year-old car that he does not plan on replacing soon. Now David and Alice are
   facing enormous taxes on their retirement assets both during their lifetimes and at their deaths.

   David and Alice have wills, but David was never really comfortable with the planning for his
   TIAA-CREF retirement plan. The attorney that helped them lacked specialized knowledge of the
   TIAA-CREF organization or how to plan for university faculty with large balances in their retire-
   ment plans. For instance, he remembers signing the beneficiary designations for his TIAA-CREF
   retirement plans in a pro-forma way—wife then kids—and now with the bulk of his assets in the
   retirement plans he wonders if that was the best solution. Their biggest concern is to provide for
   their mutual financial security. Providing an inheritance for the children is a secondary issue, but
   they would certainly prefer to see their kids inherit money than have it go to pay taxes.

   David has been receiving Jim Lange’s retirement and estate planning e-mail newsletters. He took
   advantage of Jim’s web site offer to purchase a videotape of his highly acclaimed seminar, Maxi-
   mizing IRA and Retirement Plan Assets. He had also read some of the articles that Jim had avail-
   able on his web site. David was confident that his financial picture was not so bleak. With appro-
   priate retirement and estate planning, faculty members with significant assets in TIAA-CREF, IRAs
   and/or retirement plans can protect themselves and their families from excessive taxes and secure a
   better future.

   After talking it over, David and Alice decided it was time to schedule a consultation with Jim
   Lange. In preparation for the meeting, they filled out a form outlining their assets. David also
   brought along a copy of their 1998 tax return. Alice was thrilled that they were finally taking the
   time to plan for themselves. She accompanied David to the consultation where they outlined
   their financial picture and important goals. The Academics have an approximate net worth of $1.5
   million, including life insurance. A detailed list of the Academics’ assets is included at the end of
   the newsletter.

   By the end of their consultation, David and Alice had a clear understanding of Jim’s recom-
   mendations for managing their retirement assets, and they felt that Jim understood their objectives
   and values. They liked the fact that Jim did not sell any investments, life insurance or other finan-
   cial products. The Academics engaged Jim to help them formulate, personalize and execute the best
   possible retirement and estate plan. What follows is a summary of David and Alice’s retirement and
   estate plan.

   David and Alice's Retirement Issues
   David and Alice have choices to make regarding their TIAA-CREF holdings. They were unfamil-
   iar with the advantages and disadvantages and some of the nuances of their contract with TIAA-
   CREF. Furthermore, they wondered if there were any compelling reasons to make transfers out of
   • David and Alice need to consider the pros and cons of annuitizing their total assets vs. partial
       annuitizing or not annuitizing any funds and electing the minimum distribution option or one of
       the other options offered by TIAA-CREF. David is rapidly approaching age 70 ½—the age at                                                                   2
Faculty Advisor E-mail Newsletter Edition 11                       Retirement and Estate Planning Case Study

         which he would have to begin taking his required minimum distributions from his TIAA-
         CREF plan and IRA. Should he opt for the MDO option, he will have to choose among the
         methods for calculating the amount of his required minimum distribution.
     •   David and Alice must determine the beneficiary designation for David’s large TIAA-CREF
         plan and Alice’s small IRA.
     •   David and Alice need to weigh the pros and cons of a Roth IRA conversion. If they choose
         to convert their CREF funds or IRAs into Roth IRAs, what is the optimal amount to con-
         vert? When should the conversion take place? Which assets should they use to pay the
         taxes on the conversion?
     •   Should they be considering additional strategies for reducing estate taxes?

     TIAA-CREF Distribution Options
     David incorrectly thought that at some point he would have to annuitize his TIAA-CREF hold-
     ings. He and Alice thought that their only option was to receive a regular annuity that would
     consist of an interest portion and a return of principle on his retirement assets that would last as
     long as he and Alice were alive. Though TIAA-CREF contracts vary for different universities
     and for individuals within those institutions, David had more options than he realized. Jim ex-
     plained that the rules changed in 1990 and that the distribution options for his CREF accounts
     were as liberal as with Vanguard or virtually any other company that invests retirement assets,
     including IRAs.

     Additionally, TIAA participants are allowed to use the minimum distribution option (MDO)
     with their TIAA balance. Prior to age 70 and ½, TIAA participants may withdraw the interest
     from their TIAA contract known as IPRO. Alternatively, they may let the account continue to
     accumulate until the participant reaches age 70 and ½. At 70 and ½ the participant may elect
     the minimum distribution option which has the advantage of continuing to defer federal in-
     come taxes until distribution.

     CREF Distribution Options
     Jim helped David examine all his options for his CREF accumulations.

     1. David could withdraw all of his accumulations, which will trigger income taxes on the en-
     tire balance. This option would not be wise. In fact, it is probably the most stupid thing David
     could do.

     2. David could opt to annuitize his retirement assets. David would receive an income for the
     rest of his life, and by choosing the most popular option, for the life of his wife as well. The
     lump-sum principal of the retirement plan is immediately gone. Other than the income from the
     annuity, David will lose access to the principle. In addition, at David’s death, his heirs will not
     receive the balance of the account that would have been available if David had chosen one of
     the other options. Annuitizing will drastically reduce options for the future. Since both David
     and Alice retired before age 70 and ½, they have some time to assess their living expenses be-
     fore they are required to begin withdrawals from their TIAA-CREF accounts. They may find                                                                     3
Faculty Advisor E-mail Newsletter Edition 11                      Retirement and Estate Planning Case Study

    that his social security and other non-CREF income, or even spending a portion of their after-
    tax (non-retirement) assets, produces enough funds for their living expenses. With this situation,
    they should consider leaving their money in CREF and allow it to accumulate tax-deferred and
    perhaps annuitize at a later point in time.

    3. David could make a tax-free rollover to an IRA. If you meet other requirements, you could
    convert your CREF into a Roth IRA. TIAA-CREF offers a Roth IRA.

    4. David could have CREF systematically withdraw a specified amount from his account, on a
    monthly, quarterly, semi-annual, or annual basis. David could change the amount of his with-
    drawal at any time and there is no limit as to the number of withdrawals he can request.

    5. If David is satisfied with CREF as an investment vehicle and he doesn’t want to make any
    withdrawals until required, then he should consider the Minimum Distribution Option (MDO).
    (This option might not be available from all providers.) The MDO assures that CREF will dis-
    tribute only the minimum distributions required by federal tax law. David can retain the right to
    exceed the minimum required distribution and make additional withdrawals whenever, and for
    whatever amounts, he desires, (subject to the potential restrictions in his institution’s contract
    with CREF). Furthermore, if David has not depleted his CREF account by the time of his
    death, then the remaining funds will pass to his named beneficiary. With sensible planning
    and prudent management, David’s beneficiary will continue to enjoy tax deferred growth or, in
    the case of a Roth IRA, tax-free growth for many years after inheriting the funds.

    TIAA Distribution Options
    Some TIAA contracts may significantly limit retirement distribution options. However, in
    David’s case, TIAA’s limitations did not cause a problem.
    • Depending on the contract with your institution and TIAA, it is unlikely that you will be able
       to make a large lump sum TIAA withdrawal from your Retirement Annuities (RA). For
       your Group Retirement Annuity (GRA) even if you are allowed to make a lump-sum with-
       drawal, there is often a 2.5 percent surrender charge. Furthermore, these withdrawals can
       only be made within 120 days following termination of employment.
    • For the retirement annuity (RA) or group retirement annuity (GRA) you can make withdraw-
       als over a ten-year period or even transfer the funds to CREF over a ten-year period. The
       ten-year transfer to CREF is called a Transfer Payout Annuity (TPA) and is something that
       can be done by TIAA participants who are still working.
    • The TIAA supplemental retirement annuity (SRA) restrictions are typically the same as the
       CREF restrictions.
    • Unlike CREF, you are not permitted to roll over your entire TIAA accumulation into an
       IRA and/or a Roth IRA.
    • The minimum distribution option (MDO) with TIAA often restricts your withdrawal to the
       IRS mandated minimum amount. You cannot, as you can with CREF, make withdrawals in
       excess of the minimum whenever and for as much as you like. Some participants may find
       themselves in a position where they want more money from their TIAA accumulations, but
       they are not able to access the funds because of the limitations on their withdrawal options.                                                                     4
Faculty Advisor E-mail Newsletter Edition 11                      Retirement and Estate Planning Case Study

    For David the TIAA limitations did not present a problem. If David needed more money than
    the TIAA and CREF mandated minimum distribution, he could always take it from his CREF
    holdings. Since David wanted at least some fixed growth with a guarantee as a portion of his
    portfolio, he decided to leave his TIAA holdings where they were. David was happy to learn he
    could maintain his TIAA investment, with its above average performance, and not be hindered
    by TIAA’s distribution limitations.

    Had his situation been different he could have chosen to begin the transfer payout option (TPA)
    where, over the course of 10 years, assets are transferred from TIAA into CREF, or any of the
    other options that TIAA allows. If David’s TIAA holdings were significantly higher, then
    David probably would have utilized the TPA on at least a portion of his TIAA investment.

    Pros and Cons of Annuitizing
    First, it is critical to understand that the decision to annuitize is irrevocable. Once you commit
    to it you have closed off other options. As a matter of principle, Jim feels strongly that options
    are desirable. Retirement involves huge lifestyle changes and sometimes the best decisions can-
    not be made before you have had a chance to adjust to your new situation.

    Jim does not like the idea of annuitizing all of David’s TIAA-CREF holdings. He prefers a
    compromise, but below he outlines some of the pros and cons of annuities.

    • Simple planning. If participants annuitize, they will get a regular source of monthly income
       for the rest of their lives, and depending on the option chosen, their spouse’s life.
    • They will never outlive their retirement assets.
    • Good for people with predictable needs and not worried about providing for their children
       or grandchildren.

    • Life is unpredictable. An annuity fixes your distribution come what may. Many people
       would be better served with the minimum distribution option. The MDO basically gives the
       participant complete control of their CREF retirement plan. Depending on individual cir-
       cumstances, the participant can change their spending habits, take as large or as little distri-
       bution as he pleases, make a Roth IRA conversion, or transfer the funds to an IRA. In other
       words, you retain much greater flexibility for accommodating your future needs. The only
       significant restrictions are the ones imposed by the IRS in the form of the minimum distri-
       bution rules.
    • An annuity precludes anything being left in your retirement account. The whole purpose of
       annuitizing your retirement assets is to assure a cash stream that will consist of interest and
       principal that will be exhausted at death. If a two-life option is chosen, the distributions end
       with the second death. Choosing an annuity with a guaranteed payout (some people’s an-
       swer to why annuitzing is still best) is not effective estate planning. In most cases where
       there are significant assets in the retirement accounts, the guaranteed payout from an annu-
       ity is not as advantageous as leaving whatever retirement assets are not consumed to your
       spouse, children or grandchildren, or any other heirs.                                                                     5
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    Happy Compromise and Method of Further Diversification
    • For some faculty members annuitzing a portion of their retirement assets is an excellent
      plan. One idea is to “cover your base” with social security and an annuity. A professor
      could retain all the advantages of the MDO for the balance of the account over and above
      what is needed to “cover the base.” That way, no matter what, there will always be a fixed
      income. In addition, depending upon the balance in the account, the majority of the funds
      will be available whenever and for whatever purpose the participant desires.

    Jim suggested that perhaps David should consider annuitizing only the TIAA portion of his to-
    tal accumulation. However, since there was no compelling reason to make the decision to an-
    nuitze immediately, David decided to postpone any final decision until he and Alice had a
    clearer picture of their retirement goals. The decision to annuitize is irrevocable. David was re-
    lieved. At this point he was not prepared to commit himself to any decision that could not be

    Calculating the Minimum Distribution
    Before seeing Jim, David was unaware he had a critical decision to make, before he turns 70
    and ½, about how his minimum distribution is calculated. This election will have significant
    consequences for the rest of his life, the rest of Alice’s life and even the lives of his children. If
    David does not explicitly state which formula he wishes to use to calculate his minimum distri-
    bution then TIAA-CREF will make the choice for him, which will be disadvantageous for
    David and his family.

    Assuming David is going to name Alice his beneficiary, he has to evaluate four different formu-
    las for calculating his minimum distribution based on different methods for expressing his and
    Alice’s life expectancy:

    1.   Term certain for himself and his wife.
    2.   Term certain for himself and recalculation for his wife.
    3.   Recalculation for himself and term certain for his wife.
    4.   Recalculation for himself and his wife.

    Please note that the TIAA-CREF office refers to the term certain method as the “One year less

    Fortunately, both TIAA-CREF and Vanguard allow David to choose any of the above methods
    for calculating his required minimum distribution. That means, taking into account the above
    discussion of the limitations on TIAA distributions, that there is no compelling reason for David
    to rollover any of his TIAA-CREF funds into an IRA unless he wants to try his skill at investing
    on his own or with a different company. David has been quite satisfied with TIAA-CREF’s
    performance and is planning on continuing to invest his money with TIAA-CREF.

    Not only is there no tax advantage for rolling his retirement assets out of TIAA-CREF into an
    IRA, there is actually a disadvantage. David’s pre-1987 balance of his TIAA-CREF funds will                                                                        6
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    not be subject to minimum distributions until he is 75. That means that for the years between
    70 and ½ and 75 David will only have to take minimum distributions on his post 1986 accumu-
    lations. If David rolls his holdings into an IRA, he will lose the “grandfathered” status of his
    pre-1987 accumulations.

    Jim demonstrated that using term certain for both lives would accelerate income taxes and re-
    sult in a rapid erosion of the retirement plan assets. After understanding the underlying reason-
    ing David followed Jim’s advice to use the recalculation method for his life expectancy and to
    use term certain for Alice. This hybrid approach produces smaller minimum distributions than
    the term certain method for both David and Alice. If David predeceases Alice, Alice will be
    able to roll David's retirement assets into her own IRA. Alice could then begin her own distri-
    bution schedule naming their children as beneficiaries, reducing the required distribution
    amounts even more. In the event that Alice predeceased David, David could continue using Al-
    ice’s life expectancy because they selected the term certain method for calculating Alice’s life

    Converting to a Roth IRA
    From viewing Jim’s video, the Academics thought the Roth IRA conversion seemed like a good
    idea, but they didn’t know if the conversion would be good for them. David liked the idea of
    tax-free growth. In addition, David was concerned that, as they aged, the amounts of his re-
    quired minimum distributions would exceed their needs. If the minimum distributions, which
    are taxable for federal income tax purposes, provide them with more income than they need,
    they will prematurely pay federal income tax. The Academics did not want to withdraw more
    money from David’s retirement plan than they needed for their spending purposes. David also
    knew that by reducing his required minimum distribution, he would not only reduce his taxes
    on the IRA distributions, but he would also reduce the taxability of his social security income
    after the conversion. David did not, however, like the idea of writing a check to Uncle Sam
    now. Expert advice was needed on this tricky issue.

    Jim proposed the idea of converting a portion of David’s CREF account into a Roth IRA. The
    primary goal of the conversion is to provide income tax free growth for David and his heirs.
    The secondary goal is to reduce David’s required minimum distribution both during their lives
    and after they are both gone. On the other hand, converting the entire CREF balance was out of
    the question because it would push them into a much higher income tax bracket, with a prohibi-
    tive amount of taxes. What was the optimal amount to convert and when should the conversion
    take place? Fortunately, Jim’s firm has created peer reviewed custom software to help with that
    exact question.

    Deciding on the Optimal Amount to Convert to a Roth IRA
    David requested that Jim prepare a quantitative analysis of the benefits of various levels of a
    Roth IRA conversion. The analysis would provide the best basis for their decision-making proc-
    ess. Initially Jim’s computations proved to the Academics that he could reduce their minimum
    distributions and keep them in the 15% income tax bracket by converting a partial amount,
    $28,000, of David’s CREF into a Roth IRA. Implementing this plan would provide an income-
    tax free source of growth for David and Alice and eventually their children and potentially their                                                                    7
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    grandchildren. This would be a conservative course that would put the Academics in a better fi-
    nancial situation than if they did not convert anything to a Roth IRA.

    Converting a larger amount would subject David to tax in the 28% bracket in the year that he
    converted to the Roth. It was a tough decision. However, after reviewing Jim's projections, David
    and Alice understood that once the required minimum distributions started, they would be taxed
    at the 28% bracket anyway. Paying a 28% tax now on the seed (the tax on the conversion) to
    avoid a 28% tax in the future on the harvest (all the Roth IRA distributions for years to come)
    would significantly increase David and Alice’s wealth while reducing their taxes. With Jim’s
    guidance, David and Alice agreed that converting an amount that would keep them in the 28%
    bracket would not only increase their beneficiaries’ wealth, but it would also significantly im-
    prove their financial picture.

    Though David still didn’t like the idea of paying the income tax on the Roth IRA conversion, he
    converted an amount large enough to push his income to the top of the 28% bracket. The
    amounts of the conversions came to $88,000 for the year 2000 and $94,000 for the year 2001. Al-
    ice didn’t like Jim’s idea of taking out a home equity loan to pay the taxes on the conversion.
    Jim, David and Alice agreed that the Academics would use their unappreciated after-tax assets to
    pay the tax on the conversion.

    The Roth IRA conversion and the hybrid method of calculating the minimum distributions sig-
    nificantly reduced David’s required minimum distribution; also they will increase the Academ-
    ics’ wealth.

    Estate Planning¹
    Jim was quick to stress that the beneficiary designation of the TIAA-CREF and other retirement
    accounts — not the will or the living trust — determines the disposition of these funds upon
    death. With the majority of their assets in David’s retirement accounts, focusing on the design of
    David’s retirement plan beneficiary designations was the single most important portion of
    David’s and Alice’s estate plan. Though Jim helped David and Alice revise their wills, it was the
    sophisticated beneficiary designations for David’s retirement accounts that provided the most
    value to the Academics. Jim took this opportunity to explain to David and Alice the keystone of
    an estate planning technique that seemed tailor-made for their situation—“disclaimers” and
    “double disclaimers.” When applied in conjunction with the creation of trusts and sophisticated
    beneficiary designations of retirement plans, the disclaimer technique provides clients with a very
    flexible estate plan.

    Disclaimers and Double Disclaimers
    Jim recommended structuring David's retirement plan beneficiary designations so that a bypass
    trust or unified credit shelter trust will be designated as the contingent beneficiary of David’s re-
    tirement accounts, with Alice designated as the primary beneficiary. This structure provides Al-
    ice with the option of receiving the full amount of David's retirement accounts via a spousal roll-
    over, or she can voluntarily elect to disclaim part of his retirement assets into the bypass trust or

    ¹ A discussion of taxation at the state level is beyond the limited scope of this case study; thus, all references to
    taxes refer to taxes at the federal level.                                                                                             8
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    unified credit shelter trust if, for tax purposes, it is advantageous to do so.

    Jim likes to use the “double disclaimer” approach to estate planning for clients like David and
    Alice—married couples who trust each other and “share the same children.” Under the double
    disclaimer approach, David names Alice as the primary beneficiary and the bypass trust or uni-
    fied credit shelter trust as the contingent beneficiary both for David’s IRAs and 401(k) plan,
    and all after-tax assets passing under the terms of David's will and/or revocable trust. Jim feels
    the disclaimer technique is appropriate for couples like the Academics because of its flexibil-
    ity—Alice will be able to choose which assets, if any, will be used to fund the trust.

    Conventional trusts fix the terms of the will and TIAA-CREF and other retirement plan benefi-
    ciary designations based on projections about who will die first, when they will die, the fam-
    ily’s needs, and the amount of after-tax and IRA funds available to fund the unified credit shel-
    ter trust. The disclaimer approach allows the surviving spouse to evaluate all their lifestyle and
    financial issues at the time of the first death. The flexibility can be used to further the goals of
    protecting or overprotecting the surviving spouse, but it still saves estate taxes at the second
    death. Additionally, you don’t have to update your retirement and estate plan nearly as often as
    you would with more traditional planning. The whole point of the bypass trust is that the assets
    disclaimed into the trust after David’s death are not included in Alice’s estate upon her death.
    As a result the children will save huge amounts in estate taxes.

    The Trust is Familiar
    David and Alice recognized the concept of an unified credit shelter trust although they had
    heard it referred to by the following different terms: the credit exemption equivalent trust, the B
    trust, the family trust, the marital trust, the by-pass trust, and the residuary bypass trust. What
    they did not know was that the trust could be funded with both after-tax assets and pre-tax as-
    sets. Thus, in the event that David predeceases Alice, Alice will be able to fund a bypass trust
    with David’s retirement plan assets but only if David changes beneficiary designations on his
    retirement plans according to Jim’s sophisticated advice. On Jim’s recommendation, David de-
    cides to name his wife Alice as the primary beneficiary of his retirement plans and he creates a
    trust to be known as “The David Academic Family Plan Benefits Trust ” (PBT) to be the con-
    tingent beneficiary of the TIAA-CREF retirement plan.

    Plan Benefits Trust
    Jim and his associates often recommend naming the spouse as the primary beneficiary and the
    PBT as the contingent beneficiary of the TIAA-CREF or IRA or other retirement plan when-
    ever an individual’s gross estate is comprised largely of retirement plan assets. In this situation,
    where retirement assets comprise the bulk of the estate, it is likely that that the after tax-assets
    controlled by the will or revocable living trust will be insufficient to fully fund a traditional
    trust, specified in a conventional will or living trust, up to the allowance of the federal estate tax
    exclusion amount. This will certainly be true for David. Without the pre-tax assets to fund a
    trust up to the federal estate tax exclusion limit (currently at $675K) David effectively gives up
    this tax-free exemption. Wasting David’s exemption will not have a direct effect on Alice since
    there will be no federal estate taxes levied at David’s death because of the unlimited marital de-                                                                        9
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    duction. Using David’s exemption to fund the PBT, however, provides huge tax advantages for
    the children upon Alice’s death. Consider the following:

    •   If David leaves everything to Alice without naming a trust as contingent beneficiary on his
        retirement assets, Alice will have approximately $1.5 million (including the proceeds of
        David's life insurance) in her name upon David’s death.
    •   At Alice’s death, since her total assets will exceed her once-in-a-lifetime exclusion amount,
        there will be estate taxes on the amount in Alice’s estate that exceeds $675,000.
    •   Even assuming zero growth in the estate or assuming the growth would equal the increase in
        the unified credit shelter trust amount, the federal estate tax upon Alice’s death would be
        over $350,000. With proper planning, most of the estate tax can be eliminated.

    When set up with the appropriate beneficiary designations, i.e., with Alice as primary benefici-
    ary and the Plan Benefits Trust (PBT) as the contingent beneficiary the plan:

    •   Provides Alice with the flexibility to determine after David dies whether or not it is to her
        and/or her family’s advantage to fully or partially fund the Plan Benefits Trust with the IRA
        or other qualified plan assets (i.e., the retirement funds).
    •   Allows Alice to fund the trust by using all or a portion of David’s $675,000 once-in-a-
        lifetime exclusion amount with David’s retirement assets. Unlike a revocable trust, the PBT
        will not be funded until David dies. Please note that the PBT is a stand-alone trust and is not
        a trust created in David’s will or living trust.
    •   Gives Alice a full nine months after David dies to assess her financial needs and to make
        important decisions. This is a significant and critical strategic advantage. She knows her
        actual financial situation upon David’s death and is able to plan appropriately for her exist-
        ing circumstances. She will have the benefit of consulting with her children and Jim to help
        her make decisions as to whether or not, and how much to disclaim into the trust.

    Since the $675,000 exclusion is a moving target, the trust is drafted by means of a formula, not
    a fixed amount. The formula is designed to take advantage of the expanding “applicable exclu-
    sion amount” for federal estate tax purposes. Alice is given the option of “disclaiming” up to
    $675,000 for 2000 (or the respective increased amount for future years up to a maximum of $1
    million in 2006) into David’s PBT and/or the by-pass residuary trust in David’s will or revoca-
    ble trust. David is leaving the mechanics of making the plan a reality in Jim’s hands.

    Jim has prepared PBTs for hundreds of university faculty and more specifically TIAA-CREF
    participants. TIAA-CREF and Vanguard now routinely accept the change of beneficiary
    form with the accompanying PBT that Jim prepares.

    Carve Outs
    David and Alice's main goal is to provide for themselves throughout their lives. However, the
    idea of providing for their children at the IRS’s expense was very appealing. Alice especially
    liked the idea of a "carve out"—naming their children as the primary beneficiaries on a portion
    of David’s IRAs. Designating a “carve out” will also reduce David's required minimum distri-
    butions during his life. Jim explained that David could create a separate account of his CREF                                                                     10
Faculty Advisor E-mail Newsletter Edition 11                        Retirement and Estate Planning Case Study

    balance in order to create a new account that would name his children as the primary beneficiar-
    ies. For that account the minimum distribution calculation would be based upon the joint life
    expectancy of David and the oldest child of the beneficiaries. However, by law, the oldest child
    is deemed to be no more than 10 years younger than David despite their actual age difference.
    After David’s death, the IRA that named the children as primary beneficiaries will pass directly
    to the children, who will then be able to take minimum distributions based on the children’s life
    expectancy. Therefore, the assets will continue to grow income tax deferred in the case of the
    regular IRA, and income tax free in the case of the Roth IRA for many years after David’s

    In addition, both David and Alice agreed that with $1 million of retirement assets in his own
    name, David will not need the income from Alice’s IRA if Alice dies first. Alice liked the idea
    of leaving some money to the grandchildren at her death. Jim recommended that she name a
    trust, for the benefit of all grandchildren alive at her death, as the beneficiary of her IRA. A
    carve out directly removes or carves out the retirement assets from the estate of the surviving
    spouse eliminating the necessity for a PBT. David and Alice's goal in naming the grandchildren
    as the primary beneficiary of Alice’s IRA is to provide for their education. However, they hope
    that other funds will be available to pay for the grandchildren’s education leaving the IRA to
    grow tax-deferred for much of their grandchildren’s lives.

    What Happens if Alice Predeceases David?
    In the unlikely event that Alice predeceases David, she will not have enough money in her own
    name to fully fund a unified credit shelter trust or PBT no matter what the will and/or revocable
    trust or TIAA-CREF beneficiary designations say. Therefore, it became necessary to discuss
    transferring assets into Alice’s name. The Academics decided to transfer all assets that were
    readily transferable from joint names to Alice’s name. In addition, David and Alice decided to
    transfer their house to Alice’s name, though it certainly would have been a reasonable choice
    not to make that transfer. The purpose of transferring assets to Alice’s name is to provide some
    money to fund “The Alice Academic Bypass Trust” defined in her will or living trust. Though
    Alice’s assets will be insufficient to fund the full $675,000 a partial funding is better than no
    funding at all. Jim drafted a disclaimer type will for Alice. It is David’s current plan that if Al-
    ice predeceases him, he would disclaim all her assets into her bypass trust or possibly even
    “carve them out” for the children. David does not want to commit himself irrevocably to that
    strategy which is why a disclaimer will and/or revocable trust is such a powerful alternative.

    Jim explained in their meetings that making annual gifts to children and/or grandchildren is per-
    haps the best and simplest estate planning technique. David and Alice didn’t feel comfortable
    with gifts of cash but they did consider making a gift of their existing life insurance policies to
    their children. Then, when the policies mature, the proceeds will be outside both of their taxable
    estates. This strategy is similar to creating an irrevocable life insurance trust, but without the ex-
    pense and much less annual paperwork. Jim cautioned them to carefully weigh their goal of re-
    moving assets from their estate against the survivor's potential need for cash before making
    their decision. They decided to gift the insurance policies to the children. The children will own
    the policies and they will have to pay any remaining premiums. David and Alice also have the                                                                        11
Faculty Advisor E-mail Newsletter Edition 11                        Retirement and Estate Planning Case Study

    option of making cash gifts to the children to pay for any future premiums. They decided that at
    least for the next year or two, they would only make gifts to their children for the life insurance
    premium and on an as-needed basis. Furthermore, with the income taxes due on the Roth IRA
    conversions, the funds needed to make cash gifts would be limited.

    Estate Projections or “Running the Numbers”
    The Academics asked Jim to provide them with spreadsheets showing the calculations of how
    their estate assets would change throughout their lifetime, and how much would be inherited by
    their children at David’s and Alice’s deaths—a service Jim’s office refers to as “running the
    numbers.” A concise summary of all the details on the Overview of Results page allowed them
    to see how their financial situation would be effected by each of the estate planning strategies
    Jim had suggested. David was impressed with the data included on the spreadsheets, which
    showed many details, including:
    • Their income, including social security, retirement plan distributions, and investment in-
        come from both retirement and non-retirement sources,
    • Their expenses, including their spending and gifting amounts for each year,
    • Detailed income tax calculations for each year, and
    • A pro-forma estate tax calculation on the balances at the end of each year.

    Additionally they were able to see calculations that illustrated the difference between how much
    their heirs would inherit with and without the estate planning strategies they had decided upon.
    The table below outlines two scenarios. Assuming that David dies in the year 2003 and that Al-
    ice survives to age 83, the results are as follows:

                                  Amounts Inherited by the Children

                                                  Without Estate Planning         With Estate Planning

    After-Tax Cash Investments                           $523,486                         $112,509
    Alice’s IRA Funds                                     944,636                          190,725
    Plan Benefits Trust – TIAA-CREF Funds                       0                          700,000
    Roth IRA Funds                                              0                          555,475
    House and Personal Belongings                         304,045                          304,045
    Life Insurance Proceeds
    (Not subject to tax with planning)                    110,000                          110,000
    Less Federal Estate Tax                              (381,975)                         (66,731)

    Net Assets to Heirs                                $1,500,192                       $1,906,023

    Less 28% Tax on IRA Funds                             (264,498)                        (249,399)

    Net Asset to Heirs After Taxes                     $1,235,694                        $1,656,624

    Implementing Jim’s estate plan would provide their children with an inheritance 34% greater
    than without his plan. Jim also pointed out that this figure really understates the value of their                                                                          12
Faculty Advisor E-mail Newsletter Edition 11                      Retirement and Estate Planning Case Study

    inheritance because the children would have over half a million dollars in a Roth IRA which
    could continue to provide additional value through its tax-free growth long after it had been
    inherited. In addition, though shown as an immediate offset in the above chart, the 28% tax on
    the traditional IRA funds would not be due and payable upon the second death.

    The spreadsheet calculations and analyses that Jim prepared provided the Academics with the
    statistical and mathematical reassurances that they had done the right thing. Jim’s advice and
    the documents his staff drafted were well worth the cost of the engagement!

    With Jim’s expert guidance, David and Alice designed a retirement and estate plan that opti-
    mized their assets for themselves and eventually their children. After the design of the plan
    was completed, Jim’s staff prepared all the necessary paperwork to execute the plan. They
    drafted the wills, the trusts, the beneficiary designations of the TIAA-CREF, IRAs and retire-
    ment plans, etc. Jim’s staff also ensured that the right papers were delivered to the right places
    so that there would be no problems executing the plan. The Academics were relieved. Finally
    they had made the decisions they had been delaying for years. Jim and his staff provided them
    with an estate plan that made it possible to achieve their goals and minimize estate taxes.

    We encourage you to attend one of Jim’s acclaimed seminars. Visit http://www.faculty- for a list of his next speaking engagements. Jim’s next set of seminars run from
    January 25 to February 3, 2000 including a seminar in the Oakland Holiday Inn on January 25.
    If the seminars are not convenient, we urge you to have Jim’s seminar delivered to your door
    by purchasing the new digitally mastered video of his seminar at http://www.faculty-advisor.

    Contact Information
    Jim is a tax attorney and CPA who provides specialized retirement and estate planning services
    to university faculty members with significant retirement plan accumulations. He has prepared
    over 400 simple and complex retirement and estate plans for faculty members and their
    spouses. These plans include tax-savvy advice, will and trust preparation, and sophisticated
    beneficiary designations for TIAA-CREF accounts, IRAs and other retirement plans.

    Jim is the sole owner of a law firm and a CPA firm that serves faculty members. His office is
    located in Pittsburgh on the corner of Murray and Phillips Avenues in Squirrel Hill, one block
    from Poli’s restaurant. If you should have any questions, Jim can be reached at 412-521-2732.

    The information contained in this case study is not intended as legal advice. Due to the per-
    sonal nature of retirement and estate planning, the fictional estate plan discussed in this
    case may not be appropriate for another situation.                                                                     13
Faculty Advisor E-mail Newsletter Edition 11                                       Retirement and Estate Planning Case Study

                                        INDIVIDUAL                   SPOUSE                            JOINT
      House                                                                                       $125,000.00
      Mortgage                      (                  )         (                  )         (          0      )
      Home Equity Loan              (                   )        (                   )        (          0      )
      Savings                                                                                     $10,000.00
      Mutual Funds                                                                                $50,000.00
      Stocks                                                                                      $40,000.00
      Bonds                                                                                       $30,000.00
             Subtotal                                                                             $255,000.00

                                               TAX-DEFERRED INVESTMENTS
      IRAs                                   $100,000.00             $30,000.00
      TIAA                                   $300,000.00
      CREF                                   $600,000.00
      Other 401(k)
             Subtotal                        $1,000,000.00           $30,000.00

                                                      OTHER ASSETS
      Personal Property                                                                            $15,000.00
          Subtotal                                                                                 $15,000.00

                                         (                   )       (                    )        (                 )
                                         (                   )       (                    )        (                 )

                                                     LIFE INSURANCE
      Term Life – University
      Term Life
      Whole Life                              $100,000.00            $10,000.00
             Subtotal                         $100,000.00            $10,000.00

                                 INCOME FROM SOURCES NOT LISTED ABOVE
      Income from Pension Plans
      Social Security Income                   $16,000.00/year           $4,000.00/year
    GRAND TOTAL                                $1,100,000.00              $40,000.00                   $270,000.00

                  Of course all this information is subject to the attorney/client confidentiality privilege.                                                                                           14

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