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Retirement Planning Services
Roth IRA as an Estate Planning Tool
The Roth IRA is not only one of the most significant developments in retirement
planning in recent years, but it also can be an important part of your estate
planning as well. If you have a Traditional IRA, converting it to a Roth IRA
can be a wise estate planning strategy under certain circumstances.
Pay Now So Your Heirs Won't Have to Pay Later
Suppose you have an infant granddaughter and you want to leave her part of your
estate. If you don't need the money for your retirement, you can convert all or
part of your Traditional IRA to a Roth IRA as long as your adjusted gross
income for the year is no more than $100,000. You can name a trust for your
granddaughter as the Roth IRA beneficiary. The downside is that you would owe
immediate federal income taxes on any accumulated earnings and any
tax-deductible contributions made to your Traditional IRA. However, if you pay
the taxes out of your non-IRA assets, you effectively prepay income taxes for
your granddaughter without owing any gift tax or using up any of your
$1,000,000 estate-tax exemption. In addition, by paying the taxes, you are
reducing the size of your taxable estate.
A significant benefit of this strategy is that your granddaughter generally
will owe no income taxes on any withdrawals although estate taxes may be due on
the value of the account she inherits from you.
For as long as you're alive, the Roth IRA will grow tax free and you do not
have to start making withdrawals at a particular age, unlike the Traditional
IRA, which requires that you begin withdrawing from the account by April 1 of
the year following the year you reach age 70 1/2.
After You're Gone
When you die, the Roth IRA then becomes subject to the same minimum withdrawal
rules as regular IRAs. Your granddaughter must begin making minimum withdrawals
based on her life expectancy. If she were still young when you die, she would
be required to begin withdrawing only a small amount based on her relatively
long life expectancy. Each year, the fraction she is required to withdraw would
grow slightly. However, the rest of the money would continue to grow tax free
and could result in a substantial nest egg over time.
More After-Tax Money Goes to Your Heirs
The major advantage of this strategy is that you can transfer more after-tax
money to your heirs. Because of the power of tax free compounding, the younger
the trust beneficiary, the greater the benefit because of the longer time the
nest egg has to grow. If you have any questions about this or any other estate
planning strategy, please give us a call.
Taking Employer Stock From a Retirement Plan
Before you take a distribution from a 401(k) or other employer-sponsored
retirement plan, check into how the distribution will affect your taxes. You
may have some choices that will result in a lower tax bill.
For Example
Assume you are eligible to receive a lump sum distribution from your company's
401(k)/profit sharing plan. You have the option to take part of the
distribution in company stock rather than in cash. The stock is currently worth
$300,000 - $250,000 more than its $50,000 value when it was added to your plan
account.
If the stock were distributed to you today as part of a qualifying lump sum
distribution, you could elect to pay income taxes on the stock's original
$50,000 value instead of the full $300,000. If and when you later sold the
stock for more than $50,000, any resulting capital gain would be taxed to you
at that time.
Tax Benefit
Since tax rates on long-term capital gains are lower than on ordinary income,
you could save a considerable amount of tax with this strategy. The risk, of
course, is that the stock price might fall, leaving you with less than the
$300,000 you could have received by cashing out today.
Individuals who want to take advantage of this tax deferral strategy for lump
sum distributions of employer stock should avoid rolling over the stock to an
IRA. All taxable distributions from an IRA are taxable as ordinary income
rather than capital gains.
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A Private Pension Plan Without Contribution Limits
Isn't it frustrating and annoying? Your income may be well above average, but
federal law, in effect, restricts you to an average-size 401(k) or other
tax-qualified retirement plan account. Although your plan balance itself is not
capped, the plan's annual contribution limit imposed by the tax law greatly
restricts the growth of your account. That is why you may want to consider this
practical counter strategy: Use a charitable remainder trust (CRT) as a private
pension plan.
Unlimited Annual Contributions
With a CRT, you may add any amount you choose to the trust annually. Each
year's contribution will be partially tax deductible, and the trust assets may
accumulate without tax to become a source of future retirement income. The
deduction is available because your trust agreement will require a future
transfer of the trust assets to a charity. That will not occur, however, until
the end of the trust's term at the time of your death -- or even later, if you
name your surviving spouse or someone else as a subsequent income beneficiary.
Your contributions will be more advantageous if you are able to contribute
appreciated securities instead of cash. The trustee can sell the securities
without having to pay any capital gains tax and can then reinvest the money as
desired, but your charitable deduction will be based on the appreciated value,
not your cost.
Unlike a tax-qualified retirement plan, a CRT is not permitted to accumulate
all its income until you retire. The trust generally must distribute some
income to its beneficiary annually, and the distribution must be the lesser of
the trust's annual income or a percentage (5% or more) of its assets. (There is
also a maximum payout percentage.)
Reduce the CRT's Income and Early Distributions
How can a CRT accumulate retirement assets if it must pay you income before you
retire? You simply arrange to minimize the trust's income. The trust will not
have to distribute income it does not earn. To reduce the income, you can
contribute low dividend stocks and mutual funds, real estate that generates
limited income, or other low-income assets, or the trustee can invest in them.
With well-chosen investments, the annual income distributions can be below the
trust's minimum, or even zero. After you retire, the trust can begin to pay you
the required 5% of assets minimum plus a supplement to make up the income you
did not receive while working.
On the Other Hand…
A CRT strategy includes a significant risk you need to consider. You could die
after a brief retirement, causing a premature transfer of the CRT assets to
your chosen charity with nothing left for your family. There are ways around
this difficulty, however. As mentioned above, you can extend the term of the
trust beyond your lifetime by making your spouse or other family members your
successor income beneficiaries. Or, you can establish a second trust to buy
life insurance for you. Your family will receive the insurance proceeds free of
estate taxes, as long as all the tax law requirements are met.
A second downside of a CRT: the limited tax deduction allowed for
contributions, compared to the deduction permitted under a tax qualified plan.
The CRT deduction is based on the current value of the charity's future
interest in the trust as determined from IRS tables. The less the charity will
benefit from the trust, the lower the deduction will be.
Please contact us if you want to discuss using a CRT to supplement your
tax-qualified retirement plan.
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Specialty Retirement Planning Services
When you're well-to-do, retirement planning involves much more than just making
your funds last as long as you do. Do any of these frustrations sound familiar
to you?
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More capital than opportunity - The affluent, especially owners of
closely held businesses, frequently complain that annual contribution limits
for qualified plans don't allow them to set aside as much for retirement as
they'd like.
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More coordination required - Many wealthy individuals own not one but
several different types of retirement plans that must be carefully coordinated
to avoid tax penalties. And the wealthy are more likely to own stock from their
employer in at least one of those plans - a situation that usually demands
careful planning to prevent erosion by taxes.
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A different agenda - Affluent persons may not need the income a qualified
plan can generate after retirement and often would prefer to gift the plan's
assets to future generations. Unfortunately, regulations that make
distributions mandatory after age 70 1/2 can play havoc with this agenda.
Count on Our Experience
Over the past several decades, The Commerce Trust Company has developed special
expertise in the areas of retirement planning that matter most to wealthy
individuals. In addition to
expertise in managing assets both before and after retirement, we can
provide guidance on a wide range of topics, including:
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