Are You Leaving 70-90% of Your IRA to the IRS?

Are You Leaving 70-90% of Your IRA to the IRS?

In the past few months, we've shown you how simple mistakes and oversights in planning for the distribution of your family's IRAs (and other retirement plans) can cost you and your beneficiaries anywhere from a few thousand to millions of dollars in excess, unnecessary taxes. We've alerted you to the fact that many legal and financial professionals are not IRA experts, are not up to speed on important IRA tax issues, and that following their advice (or lack of advice) can cost you and your loved ones a fortune in taxes and kill the wealth-building potential of your family's IRAs.

Our claims were supported by Kelly Greene's June 27th Wall Street Journal article entitled: How Retirees Are Blowing Their Nest Eggs. "When it comes to IRAs" she wrote, "investors and financial experts alike are making plenty of mistakes." She then went on to identify a number of the most common IRA mistakes and how they can be avoided. As you probably know, I was mentioned in the article for having saved Jerry Mandel and her sisters over $700,000 in excess, unnecessary income taxes on the distributions from their inherited IRAs. (Please call our office if you would like a copy of the Wall Street Journal article.)

That's Nice, Rich. But How Can You Help Me and My Family?
The purpose of this article is to show you how and why you and your loved ones can benefit from IRA distribution planning. I'll explain why the IRS wants and needs the money in your IRAs and why you should not assume that your family's estate planning attorneys have implemented all of the available tax-saving, wealth-building IRA strategies that can enable you and your family to parlay you IRAs into a fortune. I'll help you determine the likelihood of losing 70-90% of your family's IRAs to income and estate taxes. And finally, I'll show you how to determine whether or not your financial advisors are qualified to help you with your IRA Distribution Planning and how to get started.

Who Benefits From IRA Distribution Planning?
The simple answer is: anyone and everyone who either owns or will inherit an IRA.

If you own an IRA (no matter how large or small), distribution planning can ensure that your IRA ends up in the hands of those individuals, institutions and charitable organizations you want to inherit your IRA, in the most tax-efficient manner possible. It can keep you and your beneficiaries from making simple, common and costly mistakes and oversights that can result in excess, unnecessary taxation, having 70-90% of your IRA end up in the hands of the IRS instead of your loved ones, or the unintended liquidation of your entire IRA. IRA Distribution Planning can help you parlay even a modest IRA into a family fortune capable of supporting your loved ones, favorite charities and institutions for generations.

You might be thinking: "But I don't have a lot of money in my IRA. What can IRA Distribution Planning do for me and my family?" The median value of household IRAs in the United States in 2004 was only $24,000. Yet a modest $24,000 IRA left to a 10 year old child at only a 6% compound annual return will generate more than $300,000 in income over his or her lifetime. Now just imagine what a $100,000 IRA can do for a young child or grandchild. If handled properly the income from any inherited IRA can do a lot to supplement his or her earned income or help pay for a college education.

If you stand to inherit one or more IRAs from parents and grandparents, the manner in which those IRAs have been incorporated into their estate plans (IRA Distribution Planning) will determine how much of the assets in those IRAs you will actually inherit and how much will be lost to income and estate taxes. Proper IRA Distribution Planning can save you a fortune in taxes and put hundreds, thousands and possibly millions of dollars in your pocket.

"But I don't need their IRA money;" you say. "I've got plenty of my own." That's great. The wealth building potential of any inherited IRA is substantially better when left to a young child or grandchild. If you will not need or benefit from inheriting a parent's or grandparent's IRA, you can disclaim the IRA or ask them to leave their IRA directly or in trust to your children and/or grandchildren. But be very careful when leaving an IRA to a trust as it can create a number of unwanted problems. Unless there are minor children involved and/or it's imperative to control how and when IRA distributions are taken, it's generally best NOT to leave an IRA to a trust.

Your Family's IRAs: Amazing Wealth-Building Vehicle or Amazing Source of Revenue for the IRS
You might be wondering how an IRA or any other type of retirement plan can play such an important role in your estate planning and increase the magnitude and longevity of your family's wealth. For many individuals, their retirement plan is often one of their largest assets, often worth more than their home. That's why the IRS constantly keeps our retirement plans in its sights and is always on the lookout for an opportunity to confiscate as much as we will let them. Without proper planning and with a few critical mistakes, the IRS could very well get its hands on as much as 90% (in the worst case scenario) of the assets in your retirement plan(s), leaving little for you and your beneficiaries.

Within the next year, Congress will vote on whether or not to repeal the estate ("death") tax. While we do not believe that it will be repealed in full, it's likely that the exclusion limits will be raised and that the top tax rate will come down. This means that wealthy Americans will pay less in estate taxes and the IRS will bring in lower revenues. Since coming into office, the Bush administration has dedicated itself to cutting taxes. And while it's great to pay lower taxes, our Government still needs a source of revenue to finance the war in Iraq, disaster aid in Florida, Mississippi, Texas and Louisiana and pay down the their increasing debt. With less money coming in from estate and income taxes, where do you think the Government might look for additional tax revenues? You guessed it; the trillions of untapped dollars sitting in IRAs and company retirement plans. That's why IRA Distribution Planning is so important and can save you and your loved ones a fortune in income and estate taxes.

The Stretch IRA: How You Can Parlay Even A Modest IRA Into A Family Fortune?
In Ed Slott's book Parlay Your IRA into a Family Fortune, he writes: "With the blessing of the IRS, a scenario can be created where the value of any inherited IRA can grow into a fortune. Under this scenario, when left to the right beneficiary, even a modest $50,000 inherited IRA can conservatively grow to generate millions of dollars in income. Yet most people never create this scenario for themselves and their families for one simple reason - they don't know about it! Why not? Because the tax rules surrounding this scenario are so complex that most estate planning attorneys, CPAs and financial advisors don't know about it ei'ther - or shrink from offering any kind of tax advice. That doesn't help you and your family if your objective is to pass the money you?ve all worked long and hard to accumulate in your retirement plans intact to your loved ones, who could then parlay it into a fortune instead of losing it to taxes that might otherwise have been avoided.

The scenario I've described is a called the "Stretch IRA" because the beneficiary of an inherited IRA is able to stretch (extend the distributions) the IRA over his or her lifetime. When implemented properly, the Stretch IRA can enable you and your family to parlay your IRAs and other retirement plans into a family fortune - your family's fortune! The stretch IRA's ability to reduce taxes and increase the magnitude and longevity of your family's wealth is so powerful you would assume that every estate planning attorney, CPA and financial advisor would discuss it with their clients and help them incorporate the Stretch IRA into their estate plans. But they don't...

Is the "Stretch IRA" A Part of Your Family's Estate Plan?
Most people assume that their estate planning attorney, CPA and financial advisors have addressed all of the critical issues that will keep their retirement plan(s) out of the hands of the IRS and enable them to support their loved ones for generations. But that can be a costly assumption. And by the time anyone finds that out, it's too late, the damage has been done.

As I've stated previously, most estate planning attorneys are legal experts, not IRA experts. And because IRAs and other retirement plans do not generally transfer to beneficiaries through wills and trusts, they are often ignored or overlooked in the estate planning process. Specialized tax-saving, wealth-building IRA distribution strategies are often overlooked.

In addition, many estate planning attorneys make recommendations that can kill the "Stretch IRA" and cause major problems. The most common is leaving an IRA to a trust.

In the Ask the IRA Expert area on my website (www.winerwealth.com) I have received many emails from IRA beneficiaries whose parents were instructed to leave their IRA to a trust. As a result, the beneficiaries were unable to split the IRA and required distributions had to be taken based on the life expectancy of the oldest beneficiary. In addition, because the IRA could not be split, the beneficiaries needed to come to an agreement on how the IRA would be invested and managed, and what would happen when one beneficiary wanted to take a distribution but the others did not. These are just a few of the problems that can be created by leaving an IRA to a trust.

If you must leave an IRA to a trust because of control issues or minor children, it should be a special IRA beneficiary trust (see next month's newsletter for more information on IRA beneficiary trusts) or you must make sure that the language in your living trust does not cause unanticipated problems that (in the worst case scenario) can result in the immediate liquidation of the IRA with taxes due in full to the IRS.

"I (my parents) have a great CPA and estate planning attorney. I'm sure that they?ve addressed what you?re talking about...typical response

Do Not Make That Assumption!!
A few months ago, I called a client's estate planning attorney in Palm Beach, Florida to introduce myself. I told him that I specialize in IRA distribution planning and would like to serve as a resource to assist him with his clients? IRA issues. His response was less than ecstatic. ?Richard,? he explained. ?Our bottom client has a net worth in excess of $5,000,000 and we know and do everything you are talking about. We assist them with beneficiary designations and play stretching games wherever possible. But with high net worth individuals, there is not a lot we can do to reduce the taxes on their IRAs."

This attorney's response was not uncommon. And based on his response, reputation and the size of his fees, one would assume that he is an IRA Distribution Planning expert and that his clients? IRAs are properly incorporated into their estate plans. A review of his work proved otherwise.

The first problem I noticed was that the primary beneficiary of each IRA was my clients? family trust. As you now know, IRAs should only be left to a trust if there are extreme control issues or minor children, in which case the IRA should be left to a special ?IRA Beneficiary Trust.? Estate planning attorneys often recommend leaving IRAs to a trust and most will tell you that their trusts are okay. They are wrong. Following their recommendation will make it impossible for your beneficiaries to split the IRA and take distributions based on their individual life expectancies. It could also cause them to pay more and higher taxes. If your family's estate planning attorneys do not believe me, you can direct them to the Ask the IRA Expert section of our web site where they will find the email above from an IRA beneficiary whose father's estate planning attorney had instructed the father to leave his IRA to a trust. The writer and his siblings were looking for an attorney who might help them sue the attorney who gave their father the bad advice and made it impossible for them to split the inherited IRA.

The second problem I noticed was a planning oversight. My clients want to leave a substantial amount of money to a charity at their death. Although they had recently mentioned this to their estate planning attorney, he did not make the obvious (at least to me) recommendation that their charitable bequest be taken from IRA assets, a strategy that could save their children more than $200,000 in income taxes.

Most estate planning attorneys do an excellent job of helping their clients transfer assets like homes, stocks, insurance and other property, all of which are easy to inherit. Although IRAs (and other retirement plans) are easy to establish, they are NOT easy to inherit. IRAs are subject to such complex tax rules that most estate planning attorneys, CPAs and financial advisors who don't specialize in IRAs either don't know them or avoid giving advice that might subject them to running afoul of such complex tax laws. Most estate planners and financial advisors do not know, recommend or implement the highly specialized tax-saving, wealth-building strategies that can help you and your loved ones minimize taxes and increase the magnitude and longevity of your wealth.

Take the IRA Challenge
Here's a quiz you can take to help you determine whether or not critical tax-saving, wealth-building strategies like the Stretch IRA have been incorporated into your family's estate plan. Every YES answer means that your financial and estate planning advisors are up to speed on these issues and that your family's IRAs have probably been properly incorporated into your estate plan.

On the other hand, every NO (or I Don't Know) increases the likelihood that you and your family will lose as much as 70-90% of your retirement plan assets to taxes, miss the opportunity to implement the Stretch IRA and miss opportunities to increase the magnitude and longevity of your family's wealth.

Here we go:

  1. Had you heard about the "Stretch IRA before today?"
  2. Do you know whether or not the "Stretch IRA" has been incorporated into your family's estate plan, including your parents? and grandparents? estate plans?
  3. Do you know about any restrictions your company may put on post-death distributions from your company retirement plan?
  4. Do you know if your IRA custodians allow beneficiaries to alter the designated beneficiary forms, transfer the IRAs at death and implement the "Stretch IRA?"
  5. Do you (or your advisors) know about the NUA discount on company stock held in your retirement plans and how it can reduce your income taxes?
  6. Has everyone in your family reviewed and updated the beneficiary forms for their retirement plans in the past year to ensure that they are completed properly?
  7. Has everyone made sure not to name individuals and charities or institutions on the same beneficiary form? Do you know why?
  8. If anyone has named a trust as the beneficiary of their IRA, is it a special IRA Inheritance or IRA Beneficiary Trust?
  9. If anyone is leaving money to charity or institution, are those assets coming from a retirement plan? They should be!
  10. Are all potential beneficiaries aware of the IRD deduction on inherited IRAs?
  11. Are all potential beneficiaries aware that a non-spouse cannot roll over an inherited IRA?

Those are just a few of the IRA issues that need to be addressed properly in your family's estate plan. There are a lot more.

If you answered NO to one or more of the questions above, it's critical that you discuss these issues with your family and your family's estate planning attorneys as soon as possible. Their knowledge (or lack of knowledge) of these issues will determine the success of your family's estate plan and whether or not your family is successful in minimizing taxes, implementing the ?Stretch IRA? and increasing your family's multigenerational wealth.