Shielding Retirement Assets From Taxes
As hard as it is to believe, today's tax-advantaged plans -
including individual retirement accounts (IRAs), 401(k)s, and
rollover IRAs - have the potential to make many employees
millionaires. A 401(k) contribution of $433 per month, at 8%
compounded monthly, would be worth more than $1 million after 35
These plans are also highly vulnerable to tax losses, if they are
not bequeathed properly. For instance, a $1 million IRA inheritance
could be whittled to almost nothing under worst-possible
circumstances, such as a combination of estate taxes, top income
tax brackets, and missed withdrawal deadlines.
Saving your heirs thousands of tax dollars on your retirement
money often hinges on the decisions you make before you retire.
Therefore, it's important to take a look now at how to save heirs
tax headaches later on.
RMD Rules Simplify Things
The IRS rules for calculating the required minimum distribution
(RMD) from IRAs and qualified retirement plans provide some
longer-term planning advantages.
For the tax conscious, the premise behind retirement plan
distributions is simple - the longer you are expected to live, the
less the IRS requires you to withdraw (and pay taxes on) each year.
Because your heirs could inherit this payout schedule along with
the assets' tax bill, talk to your tax or financial advisor about
how these rules should be applied to best meet your goals and
objectives. Keep in mind that if you or your heirs do not withdraw
minimum amounts when required, taxes can take half of what should
have been withdrawn.
Stretch Out the Tax Bill
There are various other ways to make the tax payments on these
assets easier for heirs to handle. These are:
- Selecting a beneficiary - If no one is named,
your assets could end up in probate and your beneficiaries could be
taking distributions faster than they expected. In most cases
spousal beneficiaries are ideal, because they have several options
that aren't available to other beneficiaries, including the marital
deduction for the federal estate tax and the ability to transfer
plan assets - in most cases - into a rollover IRA.
- Consider the options for multiple
beneficiaries - If you want to leave your retirement
assets to several younger heirs (such as your children), the IRS
has issued "private letter" rulings that suggest that the assets in
a stretch IRA may be split into several accounts, each with its own
beneficiary. That way, distributions will be based on each
beneficiary's age. In addition, the rules provide added flexibility
in that beneficiary designations need not be finalized until
December 31 of the year following the year of the IRA owner's death
for the purposes of determining required distributions. Therefore,
an older beneficiary (e.g., a son or daughter of the IRA owner) may
be able to either cash out or "disclaim" their portion of the IRA
proceeds, potentially leaving the remainder of the IRA proceeds to
a younger beneficiary (e.g., a grandchild of the IRA owner). As
long as this is done prior to December 31 of the year following the
year of the IRA owner's death, distributions will be calculated
based on the younger beneficiary's age. Because rules governing use
of these strategies are complex, speak with a tax attorney or
financial advisor to make sure that correct requirements are
- Being generous - Plan assets given to charity
are fully estate tax deductible, and no income tax is due on this
gift. You should contact your tax or financial advisor to gain a
better understanding of the tax benefits of donating IRA or
qualified plan assets to charity.
- Consider an irrevocable trust - Because
qualified plan assets qualify for the unlimited marital deduction,
spousal beneficiaries may inherit these assets without tax
consequences when the assets are left intact as part of the estate.
Some estate planning experts have developed strategies using an
irrevocable trust. This type of planning is very complex and
requires specialized expertise in estate planning.
|Strategies for Spouses
- Consider a rollover IRA - With rollover IRAs,
you can practice some creative tax planning, such as setting up
stretch IRAs for your children or recalculating the distribution
schedule for yourself.
- "Disclaim" IRA assets if you don't need them -
If you are the primary beneficiary of an IRA and your child is the
contingent beneficiary, you may be able to disclaim your right to
the IRA proceeds. If done so by December 31 of the year following
the year after the IRA owner's death, future distributions may be
based on your child's age, effectively spreading those
distributions out over a longer period of time. Be sure to check
with a tax attorney prior to using these strategies.
|Strategies for Nonspouse
- With stretch IRAs, don't use your name! -
Under IRS rules, your inherited IRA becomes immediately taxable if
you switch the account into your name.
- Watch the calendar - The account also becomes
immediately taxable if you don't take your first required payout
from an inherited IRA by December 31 of the year after the account
Talk to the Right People
With careful planning, your retirement assets can remain as
vital as they had been during your lifetime. Talk with your tax
advisor and with those who may bequeath a retirement legacy to you
- such as parents or grandparents - to see what type of tax
planning they've put in place. Opening the doors to this discussion
could make your tax burden lighter later on and bring peace of mind
to your family.
Points to Remember
- If retirement plan assets aren't bequeathed properly, heirs
could lose half of this inheritance to taxes.
- The longer your life expectancy is for distribution purposes,
the smaller the annual tax bill will be for both you and your
- Some easy ways to make plan distributions more tax efficient
for your heirs include opening stretch IRAs, leaving a portion of
retirement assets to charity, and transferring assets into an
- Plan heirs can reduce taxes on inherited plan assets by using
rollover IRAs, observing minimum distribution deadlines, and taking
special tax deductions, if eligible.
- Consult a qualified tax professional to see how the new
distribution rules may affect your financial affairs.
1This example is hypothetical and is not meant to be
tax advice. Please contact a tax attorney or financial advisor as
to how this information could apply to your situation.
© 2011 McGraw-Hill Financial Communications. All rights