Copyright © 2009 EBS Responsible Wealth

(For purposes of this discussion a Qualified Plan will also be referred to as IRA)

Although an IRA may be a valuable asset while a person is alive, it is severely taxed at death. In fact, the IRA is a tax magnet at death since the combination of estate and income taxes can produce a long-range effective tax rate in excess of 65%.

Some of the problems that lead to the significant shrinkage in values passed on to family members are:

• IRA assets do not receive a step up in basis at death like other assets you own.
• IRA assets are subject to estate tax at death.
• Your family will have to pay income tax on the IRA after your death (although they may be entitled a deduction for estate tax previously paid).
• You cannot make gifts from the IRA to family members during your lifetime without triggering an income tax consequence.

Although your family may be entitled to stretch out the income tax on distributions over their remaining life expectancy (so called “Stretch IRA”), the income tax will ultimately have to be paid. In addition, if there are insufficient assets outside the IRA to pay the estate tax related to the IRA, or if you do not wish to use those other assets, taxable distributions will need to come from the IRA to cover the estate tax. This is very tax inefficient.

Even if you are optimistic that the estate tax will be lower in the future or eventually eliminated, there will only be a partial benefit as it relates to your IRA. This is because the income tax will increase as a result of any reduced deduction for estate tax paid.

The bottom line is that there will be a substantial shrinkage in values passing to your family due to income tax on distributions during your lifetime and transfer taxes after your death.

You should consider gifting your IRA to a favorite charity at death. It is a very generous act – so generous apparently, most people do not believe they can do it without having a negative impact on what the family inherits. That perception is not accurate when you consider that the value of the IRA going to charity can easily be replaced with life insurance outside your estate. Your estate will get a 100% estate tax charitable deduction at death, and the charity will not have to pay any income tax. One hundred percent of the IRA can be available for use by the charity of your choice since it will not be diminished by transfer taxes at death.

You can pay for the insurance by taking extra distributions from the IRA, after age 59½, above the minimum required distributions, and use the after tax amount to pay the insurance premiums. You will keep total control over the IRA during your lifetime. The charity will in effect be paying the premium since the amount going to charity after your death will be reduced by the distributions for the insurance premiums. I don’t think the charity will complain. Your children will always receive the targeted insurance amount regardless of what the IRA is worth at your death. Your children can end up significantly better off depending on how much insurance is purchased.

The IRA can be left to a Private Foundation. It has been said that the “Control of wealth is the virtual equal of ownership of wealth”. Certainly the power of ownership and the power of control are virtually identical. Assuming the distribution of the charitable funds will be advised by current and future generations of family members, the overall wealth controlled by the family, directly through the insurance proceeds and indirectly through a Private Foundation, is significantly greater with this type of planning. The foundation can spring from your Will at death so there will not be any administrative issues to complicate your life.

This strategy is simple and a big win for your family and favorite charity. It completely freezes out the IRS.

 

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Copyright © 2009 EBS Responsible Wealth

 

Internal Revenue Service Circular 230 Disclosure
Pursuant to Internal Revenue Service Circular 230, we hereby inform you that any tax advice set forth herein with respect to U.S. federal tax issues was not intended or written by E. Brian Singer, Shaun Singer, EBS Group, EBS Responsible Wealth, or EBS Business & Investment Group, Inc., to be used, and cannot be used, by you or any taxpayer, for the purpose of avoiding any penalties that may be imposed on you or any other person under the Internal Revenue Code.

Our role is to help you evaluate planning techniques that can reduce your future estate tax and gift tax, and increase the wealth transferred to your family. Brian Singer is not an attorney. Although he is a CPA (Inactive-California), it is not his intention to become your CPA. He no longer engages in the practice of public accounting. This and any other analysis or discussion is not meant to address all the issues and risks as you might find in a technical legal analysis. That task, if necessary, and if you are willing to pay the fee, is the responsibility of your attorney. Brian Singer attempts to take complicated tax principles and reduce them to understandable techniques for the layperson, in plain English. Any discussion and/or written analysis are meant to give you an overview of the anticipated benefits to be derived by employing specific techniques.  Final responsibility for the tax aspects rests with the attorney of your choosing. All techniques require careful drafting by a highly competent tax attorney with specialized knowledge.  A concept that might work when competently drafted, could fail as a result of mistakes made in the documents prepared by an attorney not proficient in these areas. The appreciation rates, investment earning rates, tax rates, valuation discounts, and other factors are hypothetical assumptions.  The benefits from implementing any technique will ultimately be better or worse than described depending upon variation from the assumptions. There are no guaranteed results; either in an economic analysis or in application of the tax law. We hope you will decide to use our services. Any planning we propose is incidental to the purchase of insurance. Since insurance is used to pay estate tax, the less tax you will owe, the less insurance required. The planning is essential in the determination of your insurance needs. You are in no way obligated to purchase any insurance. If it makes sense for you, then buy it; if it doesn’t make sense for you, then don’t buy it. You are not expected to do anything that you feel is not in your best interest. We may choose to disengage at any time.