Who should benefit from your retirement assets - you and your family or the federal tax coffers? The answer is easy: you and your family, of course. Achieving that goal is more difficult. These days, very few people stay at one job for their entire careers. So, by retirement, you and your spouse may have assets in four or five ' or even more ' employer-sponsored retirement plans and individual retirement accounts (IRAs). How you utilize those accounts at retirement can make a big difference in the amount of assets available to pass on to children or other heirs.
The Tax Bite
First, there's income tax. You'll have to pay federal income tax plus state income tax, if applicable, on the plan distributions you receive during your lifetime. Any remaining tax-deferred contributions and account earnings distributed to your family after your death also will be subject to income tax. At present, federal income-tax rates range from 10% to 35%.1
Then, there's estate tax. Depending on the size of your estate, your plan assets may be subject to estate tax at rates as high as 46%2
in 2006. And, if you leave the assets to grandchildren, your estate may have to pay a 46% generation-skipping transfer tax as well. In a worst-case scenario, your retirement assets could be reduced by as much as 80% before your heirs get to enjoy them.
What is a Multi-generational IRA?
Here's another strategy that is designed for investors who will not need the money in the account for their own retirement needs. It's called a multi-generational IRA strategy because it stretches the period of tax-deferred earnings of assets within an IRA beyond the lifetime of the person who set up the IRA, typically to another generation. In other words, it allows you to pass your IRA to a beneficiary down a generation or even several generations to your grandchildren.
To illustrate how a multi-generational IRA strategy works, consider: Alice, who's 60 years-old and ready to retire. She has $300,000 of retirement assets in three employer-sponsored retirement plans and two IRAs. Two of the accounts were inherited from her deceased husband. She would like to leave some of the assets to her favorite charity and the rest to her two children, Sue and Bob.
Here's how Alice can use a multi-generational IRA strategy in her estate planning. When she retires, Alice rolls over her retirement plan benefits into traditional IRAs, consolidating her assets so that she has three IRAs of $100,000 each. As long as she has the plan trustees transfer the assets directly into the new IRAs, there won't be any tax consequences. She names Sue beneficiary of the first IRA, Bob beneficiary of the second IRA, and the charity as beneficiary of the third IRA.
Alice decides to postpone distributions from the accounts and let all three IRAs continue to grow tax deferred until she reaches age 701/2
. Tax law requires tradtional IRA owners to begin receiving required minimum distributions based on life expectancy by April 1 of the year after they turn age 701/2
. By the time Alice begins distributions, the IRAs have each grown to $250,000, a $750,000 total for all three.
Based on her life expectancy, taken from IRS tables, Alice would have to withdraw a total of about $27,000, in minimum required distributions at 70 1/2 from the three IRAs. Each year the custodian of Alice's IRAs will determine for her the minimum required distributions needed to be taken from the IRAs. After Alice's death, her children could continue to receive annual distributions from the IRAs based on their individual life expectancy. They'll have to pay income tax on the payments. But the taxes would be spread out over the years the payments are received.
The charity, on the other hand, can withdraw all of the assets from its IRA without paying any income tax. Many charities are tax exempt and thus don't have to pay income tax on distributions received from a donor's retirement plan.
Stretching assets isn't the only benefit offered by this planning strategy. Alice's estate can claim a charitable deduction for the full fair market value of the IRA assets the charity receives, eliminating federal estate tax on the assets. In addition, Sue and Bob can claim an income-tax deduction for any estate tax paid on the IRA assets they receive.
Insurance may be a better way to handle any estate tax on Sue's and Bob's IRAs, though. When Alice uses a multi-generational IRA strategy, she also could set up an irrevocable life insurance trust benefiting her children. The trustee would purchase insurance on Alice's life in an amount that would cover any potential estate tax and, if Alice chooses, replace the assets she's leaving to charity.
As long as Alice retains no incidents of ownership in the insurance policy, the proceeds won't be included in her taxable estate. Additionally, Sue and Bob will not have to pay income tax on the insurance proceeds. Sue and Bob effectively would receive all of Alice's IRA assets with the bonus of receiving some of the assets income-tax free.
Are multi-generational IRAs the right strategy for you? It depends on your and your family's personal financial situation. Your professional advisor can help you make that decision.
The income tax rates are fully phased-in during 2006. Six marginal tax rates will apply - 10%, 15%, 25%, 28%, 33%, and 35%. Prior to 2006, each year the rates are gradually reduced.
This rate will be reduced to 46% in 2006, and will decrease by 1% per in 2007, at which time it will remain at 45% through 2009. In 2010, the estate tax is scheduled to be repealed although it will go back to 55% in 2011.
Maureen Peer is a registered representative of Lincoln Financial Advisors, a broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor.
This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.