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Explosive or easy: How to make a Living Trust your IRA beneficiary

IRAIf you talk to enough people about making a living trust the beneficiary of an IRA, you will get a lot of strange looks.  They’ll say: “Oh…. you should NEVER do that.” It is possible to make a living trust the beneficiary of an IRA. It’s really not an exotic, edgy move. But you do have to be careful.

First, if a client’s kids are adults and the client’s kids are reasonably mentally and financially competent, then 98% of the time we just make them direct beneficiaries of the IRA.  But there are times you might want a living trust as beneficiary, for instance:

1. If you have minor kids (under 18)
2. If a beneficiary of the trust is on social security disability or is disabled.
3. The beneficiary is a financial maniac or spendthrift.

To name a trust as beneficiary of an IRA, the trust must meet the IRS trust rules. If not, the trust will have to withdraw all of the funds from the IRA within 5 years from the date of the IRA owner’s death. Since the whole point of an IRA is to defer income tax, it’s important to meet the trust rules, so that the IRA withdrawals can be spread over the life expectancy of the beneficiary. Good news: Almost all trusts that have no charitable beneficiaries meet the IRS trust rules. I am not going to bore you with these. Read more here if you are an absolute masochist and want to know more about the trust rules.

The wrong way to name a trust as IRA beneficiary

It does matter how one words the beneficiary form if you a going to make a trust the beneficiary. The lazy, easy way is just to name “Suzie Glutz Living Trust dated January 1, 2014” as 100% beneficiary. Then, on her death, the IRA will go to the trustee of the trust and the trustee can take distributions  from the IRA over the lifetime of the oldest beneficiary. The trustee, in turn pays out the IRA distributions from the trust to the beneficiaries or the trustee holds the distributions in the trust. The IRA has to be held as one big chunk, not as separate accounts for each beneficiary.

There are problems with this. The poor trustee will have to leave the trust open for years and will have to file trust tax returns for years. Beneficiaries don’t really like their funds commingled with other beneficiaries. They want their money now, damn it, and they don’t like it tied up with some trustee for years and worse yet, commingled with the other beneficiaries.

Let’s say you did a lazy, generic trust beneficiary designation like “Suzie Glutz Trustee of Suzie Glutz Living trust dated January 1, 2014” and the beneficiaries are rock, solid adults who don’t want the IRA held in trust. Some IRA custodians will let you distribute the IRA from the trust to the individuals even if there was a  lazy IRA beneficiary designation. This satisfies the beneficiaries because they have their own account. I have done this with Schwab, Vanguard, Fidelity and Edward Jones. However, some IRA custodians will balk at this and then you are stuck leaving the trust open for years or just tanking the IRA withdrawing all the funds from it and paying taxes on it.

The right way to name a trust as IRA beneficiary

The foolproof way to set up the IRA beneficiary designation is to specifically describe each share in the beneficiary designation form.  So instead of just writing “Suzie Glutz Living Trust” 100% on the the form, you would say this (assuming Suzie had two kids who were equal beneficiaries of the trust):

1. Separate share of Jane Glutz under Suzie Glutz Living Trust, 50%
2. Separate share of Pete Glutz under Suzie Glutz Living Trust 50%

If you fill out the beneficiary form this way, each child can have a separate share paid out over each child’s life expectancy. There is no danger of time-bombing the IRA and causing fast withdrawals over 5 years. Also, it will be much easier to convince the IRA custodian to distribute it out of the trust to the individual beneficiary if the trustee thinks that would be better.

Buying a FNMA foreclosure gets a little more expensive

If you buy a FNMA foreclosure, watch out for the fine print.  There’s a new paragraph recently added to the infamous foreclosure rider that could cost you some money.

I’ve written before about how FNMA buys are quirky and about what to watch for when buying one.

Starting in December 2012, the FNMA foreclosure rider that’s required was amended to include this more-than-a-little-overbroad statement:

Par. 10 (e) “Regardless of local custom, requirement or practice the Purchaser shall pay all costs and fees incurred in the transfer of the property, including all lender related costs and recording costs, except as expresly assumed by the Seller in this Addendum.”

This paragraph was not in prior versions of the rider and I don’t know how far FNMA will go  to collect from the buyer.

FNMA has to pay for title insurance, pay the real estate commission and give a tax credit under the rider, so those costs are “expressly assumed,” but that’s about it.  In the closing I handled,  the Seller used Par. 10 to charge  my client for state and county transfer stamps and for the $400 cost of obtaining the paid assessment letter from the association. Both of these costs are normally paid by FNMA. But, due to the brand new rider clause my client was stuck paying them.

There is not much that can done to prevent this, except to change the rider under the attorney approval clause (good luck with that). So all of you FNMA buyers out there, please beware that you might be stuck with some extra costs at closing.

Strategic Default in Illinois: Q&A

One client had no problem deciding to strategically default on his Chicago condo due to a triple-witching hour of crime, an abandoned condo complex and a declining market that left the unit worth one-third what he originally paid. For most people, though, the decision to walk away from a property is not easy. Here are some common questions about the process:

What will happen to my credit score and when will I be able to buy another house?

Your FICO score will drop to about 520 when you miss about three mortgage payments. You can get an FHA mortgage with a score of about 650 and over 720 is considered “good” credit. How quickly you rehab your credit is up to you. It will take a minimum of two years to be able to get another mortgage and it may take as long as five years.

Do I apply for a loan modification first?

You can certainly try to apply for a loan modification under HAMP. It is unlikely that your loan modification will be approved and I pretty much consider it a waste time. Some say that HAMP is basically dead, a failed program. Loan modifications are for people who want to stay in their homes.

Should I try a short sale first?

Some owners try a short sale first. Most short sellers are behind on the payments already and are near or in foreclosure. If the property is an investment property, you absolutely should try a short sale first because it will lessen the tax impact.  Many owners can’t stand the thought of the many delays inherit in a short sale.  I think it is smart to at least try a short sale first in most cases.

Once I quit paying the mortgage, when will a foreclosure be filed?

Usually, the foreclosure case is filed about 4 months after the first payment is missed.

Do I have to accept the summons and will they serve me at work?

For the owner, the day the sheriff serves the summons and complaint is a very dark one. The abstract becomes real and owners get very upset by this. A plain-clothes officer will ring the doorbell and ask if you are you. Then the officer hands you the summons and complaint and walks away. Generally, the sheriff will try to serve the summons for about two weeks and then they quit trying. After they quit trying to serve you personally, they will serve you by publication (meaning a notice is published in a legal newspaper). Owners are not supposed to evade service of process by refusing to answer the door (many do). In general, most process servers don’t try very hard to serve the summons. I find that lenders usually will NOT try to serve you with the summons at your work.

Do I have to respond to the complaint and file an appearance after the sheriff serves me?

In most cases, it is not necessary to file an “appearance” with the court or to appear in court. In fact, filing an appearance submits you to the court’s jurisdiction and will allow the lender to get a deficiency judgment against you. Ninety percent or more of foreclosure cases are “default judgments” where the defendant does not appear.

Do I have to go to court?

For some reason, owners want to go to court to explain the case to the judge. This is not necessary and not productive. The judge is overwhelmed with cases. There is no reason to go to court in 99% of strategic default foreclosures.

How long can I stay in the home without paying?

In most cases, an owner can stay in the house without making payments for one year from service of summons. It can be as short as ten months or as long as two years, but one year is about average.

When do I have to hand over the keys?

Some lenders actually call you early in the process to “make arrangements to pick up the keys.” This amazes me, since they have no authority to ask for or to take the keys. They are hoping that you will just turn the keys over. Generally, possession is given to the lender after the sheriff’s sale is confirmed by the court. This takes about one year from the time you are served with the summons. Most owners leave much earlier in the process because they find it too hard to continue to live in the house. You will have to leave the house once the order of possession is entered. If you don’t leave then the lender can file the order with the sheriff and have you evicted, which is a very unpleasant thing that I would not wish on anyone.

Do I have to keep paying the homeowner’s insurance and taxes?

If you are still living in the house, you should keep the homeowner’s insurance in effect since it covers all of your personal property. Once you leave the house, there is no reason to continue paying for homeowner’s insurance. Most owners stop paying the real estate taxes (if there is no escrow) once they stop paying the mortgage. It takes about three years to lose a home for unpaid real estate taxes.

Do I have to pay for utilities?

Yes, all utilities are personal bills and the utility will file suit against you if you don’t pay.

Does it matter if I am served personally or by publication?

Yes, if you are served personally the lender can get a deficiency judgment against you. If you are served by publication, the lender can’t get a deficiency judgment. For more about deficiency judgments, see here.

Does it make any difference if I own a condo?

Yes, it does. If you are planning a strategic default on a condo, the condo association will file a separate lawsuit against you for the unpaid condo dues. So you may have to settle that case or continue to pay the dues until the condo foreclosure is final.

Can the lender sue me for deficiency judgment?

Most foreclosure complaints ask for deficiency judgments. This means that if the lender sells the property at the sheriff’s sale for less than you owe, the lender can try to collect this deficiency from you. Most lenders in Illinois are not seeking deficiency judgments. More information on deficiency judgments is here.  The lender can get a deficiency judgment against you AND 1099 you for the forgiveness of debt, but this is pretty rare.  Most lenders 1099 you for the forgiveness of debt and leave it at that.  However, if you have a second mortgage it is possible that the lender will file a collection case against you. In my opinion, this is a much greater threat than  a deficiency judgment.

Will the lender take my other assets or file a wage garnishment after the foreclosure?

Yes, they could, but it’s rare. If a lender gets a deficiency judgment, the lender could garnish your wages or try to take other property from you. The lender cannot take IRAs, 401ks or life insurance. I have never seen this happen.

Will I get a 1099 after the foreclosure?

Yes, lenders are required to send a 1099 for forgiveness of debt after a foreclosure. Read more about the 1099 issue here. If the property foreclosed was your primary residence then you file form 982 and this makes the income from the 1099 nontaxable.

Will I get 1099’d if I walk away from an investment property?

If the property was an investment property, then you will get 1099’d. Unfortunately, you have to claim the 1099 as income, unless you filed bankruptcy BEFORE the 1099 was issued or unless you can show you are insolvent. Walking away from an investment property has severe tax consequences and you should do everything possible to avoid doing so.

Will I need to file for bankruptcy?

Most likely you will not need to file bankruptcy. Generally, you file a chapter 13 bankruptcy to keep your house, not after a strategic default. You file a chapter 7 bankruptcy to get rid of credit card debt and other personal bills. The only reason to file bankruptcy after a strategic default would be in the unlikely event that the lender got a deficiency judgment against you, if a second mortgage holder filed a collection action against you or if you defaulted on an investment property. The chapter 7 bankruptcy would be needed after a strategic default on an investment property, and the case must be filed prior to a 1099 being issued for forgiveness of debt. Filing bankruptcy after a 1099 is issued will not work.  A chapter 13 bankruptcy can be useful if a homeowner has a high income or other assets that he or she wants to protect. The homeowner files the chapter 13, “surrenders” the home in full satisfaction of the debt and gets rid of any deficiency judgment and tax consequences that way. There will be some payments that have to be made to the bankruptcy trustee but those depend on income, assets and other debts.

Long term occupant exemption

Many Cook County homeowners received a long term occupant exemption application in the mail from the Cook County Assessor. If you have lived in your house for more than 10 years, and your income is under a certain level, the increase in the assessment level of your real estate taxes will be limited to either 7 % or 10% by signing the form.

The assessor has no mention of this on his site which is weird.

This is a strange “exemption” and I, for one, really don’t see the need or reason for it.

Illinois Security Deposit Hassles

I just finished a rather bitter case involving a security deposit. The rules on security deposits are as follows:

1. If the property is in a complex of 5 or more units (this does not mean that the landlord has to own all 5 units, but that the complex has 5 or more units); then,

2. The landlord has 30 days to give the tenant an itemized list of damages;and,

3. The landlord must return the security deposit within 45 days of the tenant moving out.

If the landlord does not do #2 and #3 above, the tenant can file a court case for two times the amount of the deposit plus costs and attorneys fees.

If the property is a single-family house or in a complex of 5 or fewer units the above rules do not apply; you will have to look in your lease for the rules on returning your deposit.

The City of Chicago (click here for a pamphlet on the Chicago rules or here for a good summary of the Chicago ordinance)and some other suburbs including Evanston have their own very specific rules on this topic.