Understanding What "Per Stirpes" Means

Sometimes it's easier not to reinvent the wheel. Back in 2006, Debra M. Simon, CPA wrote an excellent article about Understanding the Pitfalls of Beneficiary Designation Forms. Included in that article is a clear explanation what it means to name your issue, "per stirpes" compared to naming your issue, "per stirpes by representation" as beneficiaries under a retirement account, Will or life insurance policy.
I strongly recommend anyone who has more than one child read this article because if one of your children passes before you, you may inadvertently be cutting your grandchildren out of your estate plan.
Thank you to Robert Kenny, Esq. for bringing this article to my attention.

A Comparison of the Pennsylvania and New Jersey Inheritance Tax Laws

Some states, including New Jersey and Pennsylvania, have an inheritance tax. Other states, like Florida and New York, do not have an inheritance tax. An inheritance tax is a tax on the person who receives money from a decedent.

The inheritance tax rate itself depends upon the relationship between the person receiving the money and decedent. For example:

1. In both New Jersey and Pennsylvania, if the person receiving the money is a spouse (or a charity), there is no tax.
2. If the person receiving money is a sibling, there is a flat 12% tax in PA. In NJ it is a bit more complicated - the first $25,000 is exempt; beyond that there is a tax of 11-16% depending upon on the amount of the bequest.
3. Generally, if the person receiving money is anyone else (besides a child, parent or same sex partner), then there is a 15% flat Pennsylvania inheritance tax and a 15 or 16% New Jersey inheritance tax depending upon the amount of the bequest.
4. The first BIG DIFFERENCE is that Pennsylvania taxes bequests to all lineal descendants and certain lineal ascendants at 4.5%. New Jersey does not charge an inheritance tax to any lineal descendants or ascendants. (Note: Pennsylvania does not charge a tax on the bequest to a parent if the decedent was under 22 years of age.)
5. The second BIG DIFFERENCE is that Pennsylvania has a 15% inheritance tax on bequests to a same sex partner. In New Jersey, as long as the partners are in a civil union or domestic partnership, there is zero inheritance tax. If the partners are not in a civil union or domestic partnership, then there is a 15 or 16% tax, depending upon the amount of the bequest. For more information, see my blog on Estate Planning for Same Sex Couples.
6. In NJ, a bequest to a son-in-law or a daughter-in-law is taxed at the same rate as a bequest to a sibling. N.J.S.A. Section 54:34-2c. In PA, such transfers are taxed at the same rate as a bequest to a child. 72 PS 9116 (Note: If the son-in-law or daughter-in-law later remarries, this does not apply.)
7. In both NJ and PA, step children and adopted children are taxed in the same manner as natural children. New Jersey also allows inheritance tax free transfers to mutually acknowledged children in certain circumstances. N.J.S.A. Section 54:34-2a.
8. The only other significant difference in the rates is that New Jersey exempts transfers that are less than $500. Pennsylvania exempts certain transfers of up to $3,000.

New Jersey and Pennsylvania also have similarities and differences between the types of assets that they will tax. This is not a complete list, but as an example:

1. Neither state taxes life insurance, real property located outside of the state or business interests located outside of the state;
2. Both states will fully tax cash and brokerage assets of individuals who died while domiciled in their state.
3. Both states will fully tax real estate and business interests located inside the state of resident and non-resident domiciliaries.
4. Joint property held with rights of survivorship are fully taxed in New Jersey unless the recipient can prove he or she contributed to the joint property. In Pennsylvania, only the portion of the property owned by the decedent is taxed.
5. IRAs, Annuities, 401(k)s, 403(b)s and other retirement assets are taxed in New Jersey, but not in Pennsylvania, provided the account owner passes away before having the right to withdraw the money free of penalty (generally before retirement age of 59.5) AND provided that a person was named as beneficiary of the retirement plan. In PA, if the owner of the 401(k) has the right to close down the account it will also be subject to a tax, this is generally age 62 or 65.
6. Retirement plans, annuities and other benefits payable by the federal government to a beneficiary are not subject to an inheritance tax in NJ or PA.
7. In Pennsylvania, transfers made within one year of death are taxable, but each such transfer is subject to a credit of up to $3,000 per recipient. In New Jersey, transfers "made in contemplation of death" are taxable for inheritance tax purposes. There is a presumption that transfers made within three years of death are made "in contemplation of death".

Note: An inheritance tax is not to be confused with an estate tax. A state can have either an inheritance or an estate tax, both, or neither. Additionally, many of the assets that are exempt from inheritance tax (such as life insurance) are subject to an estate tax.

The NJ inheritance tax is due within 8 months from the date of death. In PA, the inheritance tax is due within 9 months of the date of death, but there is a 5% discount if the tax is paid within 3 months from the date of death.

The NJ Inheritance tax statute can be found at N.J.S.A Section 54:34-1, et. seq. The PA Inheritance tax statute can be found at 72 PS 9101, et. seq.

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Edited on January 20, 2011 thanks to input from Patricia Picardi.

A Good Time to Buy that First House – But How?

Many experts think this is a great time to buy a new house, especially if you are a first time home-buyer. Interest rates are low and home values are depressed. The problem, however, with this credit crunch is having enough cash for the down-payment. There are programs out there so that you can buy a home with almost no money down, but that can lead to the monthly payment of Private Mortgage Insurance (PMI), which is expensive, and opens the homeowner to the possibility of owing more than the home is worth if the value declines.

In order to put have an adequate down-payment, many prospective homeowners will consider dipping into their IRAs, 401(k)s or 403(b)s for the down payment. Tapping into these retirement accounts options have significant drawbacks and the cost of such withdrawals should be carefully considered.

IRAs

Best features:

* You can withdraw up to $10,000 without a 10% early withdrawal penalty. (A husband and wife can each withdraw $10,000 to make a $20,000 down-payment.)
* You may withdraw for immediate family such as a spouse, child, grandchild, parent or other ancestor.

Pitfalls:

* The withdrawal amount will be taxable as ordinary income.
* There is no ability to re-contribute money.
* Funds can only be used towards: buying, building or rebuilding the primary residence; and any usual or reasonable settlement, financing or other closing costs.

401(k)s/403(b)s

401(k)s and 403(b)s function in very similar fashion to each other. There are 2 ways to access your retirement fund to purchase a home: withdrawing it outright, or taking a loan out against it. It is usually a far better option to borrow against a 401(k)/403(b) than to withdraw from it due to the pitfalls.

1. If you withdraw money from your 401(k)/403(b):

Best features

* You do not have to be a first-time homebuyer to withdraw 401(k)/403(b) funds (any financial hardship as described by the IRS will suffice).

Pitfalls

* You need to be purchasing a primary residence, as withdrawals are only permitted under “hardship” circumstances. (The government considers the need to purchase a primary residence as a hardship circumstance.)
* The withdrawal amount will be considered taxable income.
* You will be assessed a 10% early withdrawal penalty if you are under age 59.5.
* You lose the compounding interest.
* You may also be prohibited from making any additional contributions for a period of one year.

2. If you borrow against your 401(k)/403(b):

Best Features

* You may borrow the lesser of $50,000 or ½ of your account balance. However, if ½ your account balance is less than $10,000, it may be possible to borrow $10,000.
* A loan from a 401(k) allows you time to pay it back. (This is usually at prime + 1% and the typical payback period is 10-15 years, but it may be as long as 30 years.) A 403(b) typically has a payback period equal to the duration of the first mortgage. However, you should check the specific payback period identified in your plan.
* There is no penalty for borrowing against your 401(k).
* Assuming that you pay the loan back in a timely manner, there are no adverse income tax consequences to receiving the loan.

Pitfalls

* If you lose your job, any unpaid loan amount would either be due in a period as short as 60 days. If you do not pay back the loan, the unpaid amount will be considered income, which is then both taxable and possibly also subject to a 10% early withdrawal penalty.
* Most plans prevent you from contributing extra savings until the loan is repaid.
Conclusion

While IRA, 401(k) and 403(b) funds could be used to fund the deposit on a first time home purchase, the tax drawbacks and risks are significant. You will want to consider how use of these funds will affect your retirement and your estate and the tax implications before taking such drastic measures. Obviously, if you are in your 20s with many years until retirement, and perhaps not at the peak of your earning potential, the use of your IRA and/or 401(k) and/or 403(b) funds can help you buy a piece of the American dream. However, if you are looking towards retirement or the rate of return on these funds makes withdrawing funds a particularly costly proposition, it is best to look elsewhere for your down-payment.

Special thanks to Nancy McMillin in the preparation of this post.