All posts in Retirements

08 Apr

When Life Insurance May Be Better Than a Qualified Retirement Plan

In Insurance,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 1998
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Pension and profit-sharing plans are a means to set aside funds for retirement. Congress has provided tax benefits to qualified pension and profit-sharing plans in an effort to encourage employers to provide retirement benefits to employees and to encourage the self-employed to save for their own retirement.

Because qualified plans must meet strict requirements, they may prove too burdensome for some employers. Many employers are looking for alternative ways to provide retirement benefits for themselves and key employees that will come close to the benefits of qualified plans.

One alternative is life insurance. Life insurance can have some of the same general benefits as qualified plans. To understand why, you need to know not only the differences between qualified and nonqualified plans, but also some of the tax characteristics of a life insurance policy. First let’s discuss what it means to be qualified.

Qualified for What?

One of the general principles of income taxation is that an employer can take a deduction for wages paid only when the employee is required to report the wages as income. Usually, this is when the wages are paid. Deferred compensation, which generally includes retirement and pension payments, is compensation received in a later year than when earned and currently is not deductible by the employer. However, qualified deferred compensation provides two important benefits:

1. The employer may deduct the compensation when it is, in fact, set aside for the employee, but the employee does not report the compensation as income until he or she actually receives it. This is one of the few areas where the Internal Revenue Code (IRC) sanctions a mismatch of deduction and inclusion.

2. The compensation that is set aside for the employee can earn and accumulate income tax-free until the employee receives it.

Qualified deferred compensation must be part of a plan and can take different forms:

  • Defined benefit plans. What employees receive at retirement is a percentage of salary earned while they worked.
  • Defined contribution plans. Employers put a certain dollar amount into the plan and the kind of retirement benefit employees receive depends on the investment performance of their accounts. Section 401(k) plans and individual retirement accounts (IRAs) are forms of defined contribution plans. 

All qualified plans require employers to put funds aside now so that employees can get at them later.

Stringent, Formal Requirements 

Most important, qualified plans cannot discriminate in favor of the highly compensated. Also, the participating employee’s benefit must become nonforfeitable (vested) within a short period of time (gradually from three to seven years or all at once after five years — shorter if the plan predominately benefits the highly compensated). Further, the plan must benefit a large percentage of the company’s employees.

For pension plans, there also are funding requirements. For example, employers must do more than make a promise to pay; they must put the appropriate amount into the plan each year. In considering whether a plan favors the highly compensated, compensation in excess of $150,000 must be ignored, thereby causing certain highly compensated individuals to receive benefits based on a lesser percentage of their salaries than the rank and file employees.

Why Avoid a Qualified Plan?

One of the reasons for looking for a substitute for retirement planning is to avoid the requirements necessary to be qualified. Why? You may want a plan solely for officers of the employer. By definition, a plan for officers will favor the highly compensated. Such a plan also will fail to satisfy minimum participation standards for a qualified plan because fewer than 70% of employees participate in the plan.

Life Insurance Plan Advantages

If you want a retirement plan to benefit only highly compensated or stock-owning employees, or others with a financial interest in the business, you have to use a nonqualified plan. Life insurance has several tax advantages that make providing retirement benefits desirable.

For instance, earnings in the insurance policy accumulate tax-free. Also, the owner of the policy (usually the insured) can borrow against the cash value in the policy without tax consequences if the policy comes within the IRC definition of life insurance. Generally, to fit the definition of life insurance, the policy must have premiums scheduled over a period of at least seven years. The employee must pay interest on the borrowed sum, and the interest rate often is close to the dividend rate being earned by the cash values in the policy.

Having a policy with a premium pay-in period of seven or more years, by itself, is not unusual and does not need an employer to implement it. The employee may make seven or eight scheduled annual premium payments using funds from his or her own pocket. Often, the source of the premium is an annual employer-paid bonus that is deductible to the employer as compensation paid and taxable to the employee as income. Depending on the type of insurance product used for the nonqualified plan, the scheduled premium payments can be tailored to the employee’s current financial situation and future objectives.

If an employer wants to further benefit the employee, it can contribute unscheduled premium payments (nondeductible), retaining the right to receive these payments back without interest at a later date. In essence, the employer can agree to a split-dollar insurance arrangement — the employer is making a tax-free loan to the employee’s policy.

The type of insurance policy used for a nonqualified plan often is a second-to-die (husband and wife) whole-life product that is interest-sensitive and designed for greater cash value accumulation. The nonqualified plan can continue for as long as the employee desires.

A Few Important Life Insurance Questions

Q: What happens when the employee retires?

A: Up to a certain point, the employee borrows cash value from the policy and never has to report the loan proceeds as taxable income. However, some cash value must stay in the policy to support a death benefit.

Q: How good is the rate of return on insurance policies?

A: That depends on interest rates and the insurance company’s investment performance, but the unscheduled premium payment from the employer should provide additional accumulation for the employee. Your insurance advisor can provide an illustration at various interest rates. Look at a minimum at the strength of the company, the current rate the company is offering and its lowest guaranteed rate.

Q: Is an insurance pension plan right for all employees?

A: Of course not. Different alternatives are right for different people. Further, all of the tax consequences of an insurance pension plan need to be confirmed. The only way to know whether this kind of plan fits your needs is to explore the benefits, risks and costs. It may be a better alternative than a qualified retirement plan.

Insurance as Retirement Plan Substitute Can Make Sense

Under current tax laws, it will be difficult for a highly compensated employee or owner-employee to accumulate significant assets for retirement under a qualified plan. Using a private retirement plan funded with insurance as a substitute for or in addition to a qualified plan may offer retirement benefits sufficient to maintain an employee’s standard of living while providing greater flexibility in creating a program that meets the needs of both employer and employee.

Please contact us with any questions you may have about insurance pension plans or other retirement planning vehicles. We would welcome the opportunity to help you meet your business’s needs and your employees achieve their retirement goals.

08 Apr

Making the Right Senior Housing Choice

In Retirement Planning,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 2000
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You’ve probably heard of seniors having trouble with living alone and the related financial burdens. But what happens when it is you, your spouse or your parent? What options exist for an aging person, and what do they mean financially? Now more than ever, estate planning that takes elder care arrangements into consideration is essential.

Elder care is a booming business. New living arrangements for the elderly are still developing. Children of aging parents are looking for alternatives to traditional nursing homes. The most popular new option is assisted-living facilities.

Surveying the Options

Assisted-living facilities provide each resident with a room or suite, meals (sometimes in a common dining room) and a 24-hour staff who assist with daily routines, such as bathing, dressing and taking medication. Assisted living is best suited to seniors who are cognitively impaired yet physically capable or who are mentally capable but have motor or balance difficulties. Residents can retain some degree of independence and privacy while receiving needed care. The price for an assisted living unit averages $2,000 per month (higher in some geographic areas) varying based on amount and type of services provided and unit size.

Nursing home facilities are best suited for seniors with significant medical problems or memory impairment. They are also appropriate for those who have problems that their caregivers can no longer manage such as wandering, agitation or erratic behavior. A nursing home generally provides 24-hour professional nursing care, physical therapy and recreational therapy. A nursing home can cost anywhere from $1,500 to $5,000 per month or more, plus extras.

How To Choose a Facility 

When investigating a facility, ask if you can walk through the common areas and talk with some of the residents. Find out the ratio of caregivers to residents. Try to gauge whether the staff is caring and friendly. Ask residents and their visitors how responsive the staff is and how well they interact with residents. Although generally not indicative of the quality of care, a pleasing and warm decor may make seniors feel more at home. A registered dietitian may be advantageous for seniors with special dietary needs.

Also consider these questions: Is the facility conveniently located? Does it offer religious services or transportation to services? If the facility is in an urban area, does it offer special outings for residents? What reputation does the facility have in the surrounding community?

Nursing homes are regulated at both state and federal levels, while assisted-living communities are overseen just at the state level. This may result in differing standards. Carefully examine the guidelines for each type of facility. Understanding the regulations governing these types of facilities and knowing whether they are in compliance helps you determine the quality of care. Contact the health department’s senior or elder unit in the county or state where the home is located to determine if the home has a reputation for complying with regulations.

Beware of Pitfalls 

The rapid growth of the assisted-living industry has resulted in some problems. A recent survey conducted in four states found “unclear or potentially misleading language” in sales brochures for approximately one-third of the 60 assisted-living facilities surveyed. One common concern was the lack of clear guidance regarding under what circumstances a resident may be expelled. These types of facilities, as with nursing homes, are driven by supply and demand and should be looked into carefully.

How To Pay for It 

One way to manage the cost of nursing home care without forfeiting all your assets is to purchase long term care insurance, which can defray or pay the cost of nursing home care. The cost of long term care insurance depends on the age of the insured at the time coverage is purchased. For example, a long term care policy purchased at age 55 may cost $800 per year, while a policy offering the same benefits bought at age 65 may cost twice as much. As long as the cost is not prohibitive, a policy can be a worthwhile investment and an important part of the estate planning process. Be certain that the policy purchased covers all levels of custodial and skilled nursing care and builds in adjustments for inflation.

Medicaid may pay for a portion of nursing home costs if the senior meets the eligibility criteria. Be sure to verify that a nursing home takes Medicaid patients. In general, most of the individual’s assets must be depleted before Medicaid will cover the cost of nursing home care. But a nursing home patient’s spouse may retain a residence along with other minimal assets.

Because assisted-living communities are not medical facilities, Medicare and Medicaid will usually not cover their costs. But some states do permit the limited use of Medicaid funds for assisted living.

Let Us Help

Estate planning is more than protecting and preserving your assets for your family. It also encompasses planning for loved ones’ care, comfort and security as well as your own. Please contact us if we can be of assistance in evaluating the sometimes confusing housing options available for seniors.

08 Apr

Are Your Retirement Benefits Safe From Creditors?

In Retirement Planning,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner Nov-Dec 2000
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Maintaining a qualified retirement plan, such as a 401(k), offers long-term security. But how safe are these assets if you are subject to claims before retirement? The Internal Revenue Code specifically bars qualified plan benefits from being assigned or alienated except under certain circumstances. The U.S. Supreme Court has taken this further, conclusively holding that ERISA qualified plan benefits are absolutely protected from creditors, including in bankruptcy, other than the IRS, spouses and ex-spouses under qualified domestic relations orders. Nonetheless, several questions come to mind.

Are IRAs Protected? 

Upon retirement, retirees commonly roll over 401(k) and other qualified plan assets into individual retirement accounts (IRAs). But the protection for assets held in such nonqualified plans is unclear. Federal law does not expressly protect them, although many states have enacted statutes that do.

Are Distributions Protected? 

Whether a plan distribution is protected from creditors primarily depends on state law, and, as with IRAs, the protection afforded varies widely. Many states give some level of protection to funds that are segregated and consist only of the amount necessary for the support of the debtor.

Other states rely on federal law. Federal bankruptcy exemptions apply to distributions reasonably needed for the support of a plan beneficiary. But it is unclear whether the debtor must already be receiving payments to take advantage of the exemption. Clearly unprotected are amounts in excess of what is reasonably necessary for support.
Unfortunately, federal law mandates when distributions must begin and how much must be taken. If creditors are an issue, hold off taking distributions as long as possible.

Are Funds Contributed Shortly Before Filing Bankruptcy Protected? 

The fraudulent conveyance rules bar giving assets away to avoid paying a creditor. Conversion of assets that are not protected into assets that are, such as contributing funds to a 401(k) shortly before filing bankruptcy, should not, strictly speaking, be a fraudulent conveyance.

But a prefiling contribution doesn’t look good, particularly if the timing of the contribution is unusual for the debtor. A bankruptcy trustee can refuse a discharge order for a debtor who has engaged in transactions that appear to impede a creditor’s rights.

Smart and Effective

Maximizing contributions to plans continues to be one of the most effective retirement savings and asset protection devices available. Despite uncertainties, the potential benefit appears to outweigh the risk. If you have any questions about the security of your plan please call us. We would be glad to help you assess your accounts and advise you on ways to scrutinize the risk of loss to creditors.

08 Apr

Protecting Your IRA From Income and Estate Taxes, Choose the Best Distribution Method and Beneficiary

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 2001
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An individual retirement account (IRA) is one of the most common tools used to assure financial independence after retirement because of its tax deduction for contributions and the tax-deferred growth. But the rules regarding distributions and beneficiaries can be confusing, and a wrong decision can result in both a loss of flexibility and Uncle Sam taking a huge bite out of your nest egg — especially after your death.

In addition, the Treasury Department this year substantially revised the 1987 proposed regulations governing the required minimum distribution rules from IRAs and qualified retirement plans, both after age 701/2 and after death. So whether you are opening a new IRA or reviewing your existing account, you need to carefully consider these two key issues.

1. Taking Distributions

You generally cannot take distributions from your IRA before age 591/2 without incurring a 10% penalty. But you also will face a penalty if you don’t take minimum distributions soon enough — 50% of the amount you should have withdrawn but didn’t. Distributions must start by your required beginning date, which is April 1 of the calendar year after you reach age 701/2.

The 2001 proposed regulations make it simpler for you and your plan administrator to understand and apply minimum distribution rules. Under the 2001 and 1987 proposed regulations, you determine the required minimum distribution by dividing your account balance by the distribution period.

For lifetime required minimum distributions, the 2001 proposed regulations provide a uniform distribution period for all participants of the same age. An exception applies if the sole beneficiary is your spouse and he or she is more than 10 years younger than you. If this is the case, you can use the longer distribution period measured by the joint life and last survivor life expectancy of you and your spouse.

Use the uniform distribution table to determine your required minimum distribution for each year based on your current age and account balance as of the end of the prior year. You no longer need to elect to recalculate or not recalculate your life expectancy.

After your death, the distribution period is generally the remaining life expectancy of your designed beneficiary. Your beneficiary’s remaining life expectancy is calculated using the beneficiary’s age in the year following the year of your death, reduced by one for each subsequent year.

2. Naming a Beneficiary

Although this appears to be a simple decision, the obvious choice — your spouse or your children — may not be the best. Remember that at your death, your IRA will be subject to federal estate tax as well as income tax to the IRA beneficiary. But with proper planning and a smart beneficiary choice, you can reduce this tax liability.

Under the 2001 proposed regulations, your designated beneficiary is determined as of the end of the year following the year of your death — rather than as of your required beginning date or the date of your death as required under the 1987 proposed regulations. Thus, any beneficiary eliminated by distribution of the benefit — or through a disclaimer during the period between your death and the end of the year following the year of your death — is disregarded in determining your designated beneficiary.

If at the end of the year following the year of your death you have more than one designated beneficiary and the account hasn’t been divided into separate accounts or shares for each beneficiary, the beneficiary with the shortest life expectancy becomes the designated beneficiary. This approach is consistent with the 1987 proposed regulations.

Let’s take a look at your choices for beneficiaries and examine how the recently proposed regulations affect them:

Spouse. Designating your spouse as your IRA beneficiary provides him or her the most access to the funds. If your spouse survives you, he or she can roll over the benefits into an IRA in his or her own name and withdraw as much or little as he or she needs. Your spouse can then name your child as beneficiary and calculate minimum distributions using the joint life expectancy of himself or herself and the child. When your spouse dies, the remaining IRA balance will be distributed to your child over the remainder of your spouse’s and child’s joint life expectancies. This method can stretch out IRA distributions and thus extend tax-deferred growth in the account.

Children. If you name your child the beneficiary of an IRA, he or she cannot take ownership of it like a spouse can. In calculating distributions to a nonspouse beneficiary, the 1987 proposed regulations distinguished between whether you died before or after your required beginning date. Under the 2001 proposed regulations, the same rules for distributions after your death apply regardless of whether you died before or after your required beginning date.

In the absence of a plan provision or election of the five-year rule, the life expectancy rule applies in all cases in which you have a designated beneficiary. If you die after your required beginning date, your designated beneficiary, whose life expectancy is used to determine the distribution period, is determined as of the end of the year following the year of your death — rather than as of the date of your death.

If you die before your required beginning date, the proposed regulations now allow a waiver of any excise tax resulting from the life expectancy rule during the first five years after the year of your death if your entire benefit is distributed by the end of the fifth year following the year of your death.

Credit shelter trust. Naming a credit shelter trust as beneficiary allows you to maximize your estate tax savings on your IRA. Your gift and estate tax exemption ($675,000 in 2001, but up to $1 million by 2006) will protect the account from estate taxes on your death, and the trust language will keep it out of your spouse’s taxable estate. Yet your spouse can still have access to the funds.

To clarify the 1997 amendment to the 1987 proposed regulations, the 2001 proposed regulations provide examples in which a testamentary trust is named as your beneficiary. In addition, the look-through trust rules still apply.

Charity. Naming a charity as beneficiary may offer the best tax results. Designating a charity will result in a charitable deduction for estate tax purposes for the full value of the IRA. Because the charity is tax exempt, income tax will also be avoided when the IRA is distributed. Of course, this is only a viable option if your spouse and children will not need the IRA assets.

No designated beneficiary. If you elect to recalculate your life expectancy and die without a designated beneficiary, the 2001 proposed regulations provide that your remaining account balance must be distributed within your remaining life expectancy recalculated immediately before your death. Previously, the 1987 proposed amendments required that your remaining account balance be distributed in the year after your death. Yet the five-year rule automatically applies if you don’t have a designated beneficiary as of the end of the year following the year of your death.

Protect Your Nest Egg

If your IRA is subject to both estate tax (with rates as high as 55%) and income tax (with rates as high as 39.6%), it will be severely depleted after your death. That’s why it’s critical to defer and minimize these taxes. The 2001 proposed regulations simplify how you apply the minimum distribution rules.

To learn more about planning with your IRA, turn to page 6 and request a complimentary copy of our Estate MiniPlanner “Are Your Retirement Benefits Safe From Creditors?” And please don’t hesitate to call us for assistance. We’d be glad to help you navigate this complex area.

08 Apr

Are Your Retirement Benefits Safe From Creditors?

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 2001
______________________________________________________

Maintaining a qualified retirement plan, such as a 401(k), offers long-term security. But how safe are these assets if you are subject to claims before retirement? The Internal Revenue Code specifically bars qualified plan benefits from being assigned or alienated except under certain circumstances. The U.S. Supreme Court has taken this further, conclusively holding that ERISA qualified plan benefits are absolutely protected from creditors (including in bankruptcy) other than the IRS, spouses and ex-spouses under qualified domestic relations orders. Nonetheless, several questions come to mind.

Are IRAs Protected? 

Upon retirement, retirees commonly roll over 401(k) and other qualified plan assets into individual retirement accounts (IRAs). But the protection for assets held in such nonqualified plans is unclear. Federal law does not expressly protect them, though many states have enacted statutes that do.

Are Distributions Protected? 

Whether a plan distribution is protected from creditors primarily depends on state law, and, as with IRAs, the protection afforded varies widely. Many states give some level
of protection to segregated funds that consist only of the amount necessary to support the debtor.

Other states rely on federal law. Federal bankruptcy exemptions apply to distributions reasonably needed to support a plan beneficiary. But it is unclear whether the debtor must already be receiving payments to take advantage of the exemption. Clearly unprotected are amounts in excess of what is reasonably necessary for support.
Unfortunately, federal law mandates when distributions must begin and how much must be taken. If creditors are an issue, hold off taking distributions as long as possible.

Are Funds Contributed Shortly Before Filing Bankruptcy Protected? 

The fraudulent conveyance rules bar giving assets away to avoid paying a creditor. Conversion of assets that are not protected into assets that are, such as contributing funds to a 401(k) shortly before filing bankruptcy, should not, strictly speaking, be a fraudulent conveyance.

But a prefiling contribution doesn’t look good, particularly if the timing of the contribution is unusual for the debtor. A bankruptcy trustee can refuse a discharge order for a debtor who has engaged in transactions that appear to impede a creditor’s rights.

Smart and Effective

Maximizing contributions to plans continues to be one of the most effective retirement savings and asset protection devices available. Despite uncertainties, the potential benefit appears to outweigh the risk. If you have any questions about the security of your plan please call us. We would be glad to help you assess your accounts and advise you on ways to scrutinize the risk of loss
to creditors.

08 Apr

Should Your Younger Spouse Roll Over Your IRA After You’re Gone?

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 2001
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If your individual retirement account (IRA) balances are substantial, what’s the best way to plan your estate? Generally, you should name your spouse as the primary IRA beneficiary to provide greater flexibility. After your death, your spouse will have three options. But choosing the best can be complicated, especially if your spouse is younger.

Option 1

Your surviving spouse can keep your IRA in your name and continue to take distributions the same way you took them. Your spouse takes minimum distributions either over his or her life, or over a period not exceeding his or her life expectancy. Even if your spouse is under age 591/2, distributions from the IRS are subject only to income tax, not the 10% penalty for early withdrawals.

This option has great appeal if your spouse is considerably younger than age 591/2 and will most likely withdraw all or substantially all the IRA funds before reaching age 591/2. For example, assume that your estate consists of a house, some small investment accounts and a large IRA and your surviving spouse wants to remain in the house and will need to tap IRA funds to live on. Then income tax deferral will probably not be a concern and this is likely the best option.

Option 2

Your spouse can roll over your IRA into his or her own IRA and name his or her own beneficiaries, such as your children. No matter your spouse’s age at the time, he or she may take distributions over his or her and a beneficiary’s joint life expectancy. The IRA minimum distribution rules require starting distributions by April 1 of the year after he or she turns 701/2. Naming a younger beneficiary allows your spouse to take smaller distributions from the IRA, thus increasing the amount that can continue to grow tax deferred.

A rollover is often the preferred option, but it has one disadvantage if your spouse is younger than age 591/2 when you die: He or she will owe a 10% penalty tax in addition to regular income tax on early withdrawals. (The 10% penalty is not assessed on early withdrawals used for qualified higher education expenses incurred during the same year as the withdrawals.)

Option 3

If your IRA is large enough, the best option may be for your surviving spouse to divide your IRA into separate IRAs maintained under your name. Your spouse then can elect to treat one of the separate accounts as his or her own and roll it over into his or her own IRA, so that it grows tax deferred until he or she reaches age 591/2. Your spouse can take withdrawals from the portion left in your name without incurring the 10% penalty.

For example, Gary, age 52, dies with $1 million in his IRA when his designated beneficiary, his wife, is 40. She rolls $600,000 into a new IRA in her name and designates one child as the beneficiary. Starting when she is age 591/2, she can take distributions from her own account over her and the child’s joint life expectancies. She leaves $400,000 in Gary’s IRA and takes distributions from it — regardless of her age — as needed without incurring a penalty.

Understand the Tax Implications

If your estate consists of a large IRA and your spouse is younger than age 591/2, tax consequences could complicate your and your spouse’s estate plans. Understanding these implications now can help your spouse avoid tax after you’re gone. And for help on how to inform your spouse about your estate plan, please fax back page 6 for a complimentary copy of our Estate MiniPlanner “How To Provide Both Financial Security and Peace of Mind.”

08 Apr

How Valuable Could the New Roth IRA Be to You?

In Retirements,Roth IRA by admin / April 8, 2013 / 0 Comments

Estate Planner Jan-Feb 1998
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The Taxpayer Relief Act of 1997 provides several inducements for retirement savings. The Act creates education individual retirement accounts (IRAs). It offers the ability to withdraw funds from IRAs without penalty for higher education expenses, as well as the limited ability to withdraw funds for a first-time home purchase. It expands eligibility for the deductible IRA. It eliminates the excise tax on excess IRA and qualified retirement plan distributions and accumulations. But perhaps the greatest benefit the Act offers is the new savings vehicle called the Roth IRA.

How the Roth IRA Works

Starting in 1998, a husband and wife with an adjusted gross income (AGI) of up to $150,000 (and singles with AGI up to $95,000) can each make annual contributions of $2,000 to a Roth IRA. Unlike those made to traditional IRAs, the contributions are not deductible, but they do still grow tax-deferred. And, qualified distributions from both contributions and their earnings are tax-free. By contrast, deductible contributions and their earnings are both taxed on withdrawal from a traditional IRA.

Another way to establish a Roth IRA is through a rollover from an existing IRA. At the time of the rollover, you will owe income tax on all previously untaxed contributions and earnings, but you won’t be subject to the 10% early withdrawal penalty. And, if you roll over IRA assets before Jan. 1, 1999, the resulting tax bill will be spread over four years. If your AGI for the year (not including the amount rolled over) exceeds $100,000, you cannot roll over the IRA during that year.

Should You Pay Tax Now? 

The Roth IRA promises greater long-term benefits than the deductible IRA. Why? As a general rule, as long as your income tax rate stays the same or increases at the time you withdraw funds, you will end up with more money in a Roth IRA than in a deductible IRA because the growth is never taxed. If, however, you expect your rate to be lower at retirement, you are probably better off with the deductible IRA.

Look at the example above. Assume you contribute $2,000 per year for 5, 10, 15 or 20 years, you earn a compound annual return of 8%, and you then withdraw the proceeds without penalty. For the deductible IRA, assume you were in the 28% income tax bracket when the contributions were made. As you can see, as long as your income tax rate doesn’t drop, you will have more funds available for your use with a Roth IRA.

Should You Roll Over?

To decide if a rollover makes sense, determine whether the benefit of not paying tax when you take distributions will likely outweigh the cost of the immediate income tax on the amount rolled over (which will leave less in the account to grow tax-free). In other words, when you take distributions will you have more available for your use in a Roth IRA than you would have in a deductible IRA?

Let’s look at an example. Laura has an IRA that holds deductible contributions and their earnings. In January 1998, she considers withdrawing $10,000 from her IRA and rolling it into a Roth IRA. She has $2,800 in a taxable account which she can use to pay the tax that will result from the rollover, and she expects her AGI for 1998 to be $55,000.
Assuming that the IRA will grow at 10% annually, that Laura will remain in the 28% bracket and that the taxable account will grow at a 7.2% after-tax basis, should she make the rollover? Let’s compare the possible outcomes of her two options:

1. If Laura leaves $10,000 in her deductible IRA, in 20 years she will have $67,275 in her IRA, but only $48,438 available for her use because of the 28% income tax on her withdrawal. She will have $11,247 left in her taxable account ($2,800 plus growth), for total funds of $59,685.

2. If Laura rolls $10,000 into a Roth IRA, in 20 years she will have $67,275 in her IRA which will all be available for her use because the withdrawal will be tax-free. She will have only $1,083 in her taxable account, because of the taxes of $700 per year for four years that she paid on the rollover. Her total funds available will be $68,358.
This example indicates that the Roth IRA will provide a better result for Laura. It does assume, however, that she will live for 20 more years, and, perhaps more important, that the law will not change again!

4 Key Questions

Your answers to the following four key questions will help you determine whether a Roth IRA is a better option for your situation than a deductible IRA:

1. When will you take distributions? If you still have a long time until you will retire or take other qualified distributions, a Roth IRA may be beneficial because you will accumulate a large amount of earnings that you won’t have to pay taxes on. If you have a shorter time until retirement but don’t expect to take distributions then, a Roth IRA will probably still be good for you because you can continue to let the amounts in the IRA build up tax-free indefinitely and can continue to make contributions, even after age 70 1/2.

2. Will you be in the same, a higher or a lower tax bracket when you take distributions? If you will be in at least as high a tax bracket when you need to take distributions from the IRA as you are in now, a Roth IRA may be beneficial because you likely will not pay any more in taxes by paying them up front.
If you are considering rolling over funds from a traditional IRA, also consider the following questions:

3. How long has your traditional IRA been open? If it has been open for a relatively short period of time and your answers to the previous questions also incline you toward the Roth IRA, a rollover will likely be beneficial because you won’t have much earnings to pay taxes on at the rollover and the potential for tax savings on future earnings is great.

4. Does your traditional IRA consist primarily of deductible or nondeductible contributions? If it consists primarily of nondeductible contributions and your answers to the previous questions indicate that a Roth IRA will likely be beneficial, a rollover is the best option because you will have to pay tax only on the limited deductible contributions and any earnings, and the potential for tax savings on future earnings is great.

Each situation is different and must be analyzed based on your set of circumstances. We would be pleased to assist you in determining if the Roth IRA is right for you.

What Is a Qualified Distribution?

Qualified distributions from Roth IRAs are not subject to income tax or the 10% early withdrawal penalty. Distributions are qualified if:

  • The account has been open for more than five years, and
  • Distributions are made after age 59 1/2 or as a result of long-term unemployment, disability or death, or are used to buy a first home.

Roth IRA: Total available on tax-free withdrawal

Years in IRA
5
10
15
20
Paid out tax-free $12,672 $31,292 $58,648 $98,845

Deductible IRA: Total available after taxes on withdrawal

Years in IRA
5
10
15
20
If tax rate drops to 15% $13,849 $35,162 $63,242 $105,182
If tax rate stays at 28% 12,446 30,249 55,763 92,401
If tax rate rises to 31% 12,122 30,391 54,036 89,451
If tax rate rises to 36% 11,581 27,910 51,157 84,533
If tax rate rises to 39.6% 11,191 26,795 49,084 80,992

Other Roth IRA Benefits

  • Although nonqualified distributions coming from earnings in the IRA are taxed, distributions are treated as coming first from contributions, which are not taxable.
  • No minimum distribution rules.
  • Post-age-70 1/2 contributions allowed.
08 Apr

An Air of Uncertainty: The Roth 401(k) may be good for your Estate Plan, but will it last?

In Estate Planning Strategies,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner September-October 2006
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Beginning this year, businesses can establish a Roth 401(k) plan or add a Roth contribution option to an existing 401(k) plan. Yes, these plans offer attractive retirement benefits, but the estate planning benefits may be their biggest draw. You must, however, bear in mind that the Roth 401(k) plan provisions expire at the end of 2010 unless Congress acts to extend them.

Tax-free retirement income benefits

Like a Roth IRA, contributions to a Roth 401(k) aren’t tax deductible, but earnings accumulate tax-free and can be withdrawn tax-free in retirement. This can be a big advantage, particularly if you expect your income tax bracket to increase after you retire.

High income taxpayers, however, haven’t been able to take advantage of the Roth IRA. (Under the Tax Increase Prevention and Reconciliation Act of 2005, beginning in 2010 there will no longer be any income limitation on converting a traditional IRA to a Roth IRA.) Eligibility for contributing to a Roth IRA is phased out beginning at $95,000 of modified adjusted gross income (AGI) – $150,000 AGI for joint filers. The Roth 401(k) provides you an opportunity to enjoy the Roth benefits, because there are no AGI limits for contributing.

Contribution limits for Roth 401(k) plans are the same as for traditional 401(k) plans: In 2006, the maximum contribution to all 401(k) accounts is $15,000, plus a $5,000 “catch-up” contribution if you’re 50 or older by the end of the year. If no AGI phaseout applies, Roth IRA contributions are limited to $4,000 plus a $1,000 catch-up contribution.

Stretch out estate planning benefits

It’s often said that traditional IRA and 401(k) accounts are the worst assets to leave to your heirs. Why? Because the combination of income and estate taxes can shrink these accounts to a fraction of their original value. But Roth accounts don’t have this drawback because qualified distributions aren’t subject to income taxes.

With careful planning, assets in a Roth 401(k) account can continue growing tax-free throughout your lifetime and beyond – provided you have other sources of retirement income. Although a Roth 401(k), like a traditional 401(k), is required to begin mandatory distributions when you reach age 70 1/2, IRS rules allow you to roll the funds over into a Roth IRA, which isn’t subject to mandatory distribution requirements until the death of the Roth owner.

This technique allows you to stretch out the account’s tax-free benefits, providing a valuable nest egg for your children and even your grandchildren. Heirs are required to take distributions, but the distributions can be spread out over their lifetimes. Depending on the size and growth rate of the account, this means there may even be more left in the account for the grandchildren’s benefit.

Too good to last?

If Congress doesn’t act to extend the Roth 401(k) provisions, you’ll have to stop contributing to the account after 2010. But you should be able to leave your previous contributions in the account or roll them over into a Roth IRA.

If you feel a Roth 401(k) is right for you, and your employer offers it, at the very least you’ll have a little over four years to take advantage of its retirement and estate planning benefits.

08 Apr

IRS Allows More Trust Options

In Estate Planning Strategies,Retirements by admin / April 8, 2013 / 0 Comments

Estate Planner May-Jun 1998
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Regulations on Trusts as IRA Beneficiaries Are Loosened

An individual retirement account (IRA) or other retirement plan is often an individual’s largest and most difficult-to-handle asset. Decisions regarding when and how to take distributions, distribution amounts, and choice of beneficiaries all affect both income and estate taxes. While changes in the Taxpayer Relief Act of 1997 have eased the tax bite on IRAs, the rules remain complicated. The Internal Revenue Service (IRS) has, however, simplified the requirements for treating trusts as designated beneficiaries for distribution rule purposes.

The Regulations

In 1987, the IRS issued proposed regulations to explain the then recent amendments to the Internal Revenue Code (IRC) relating to required distributions from qualified plans and IRAs. The regulations stated that:

Distributions to a plan participant (or IRA owner) cannot generally begin without penalty before the participant reaches age 591/2.

  • Distributions must begin by April 1st of the year following the participant reaching age 701/2, the date known as the required beginning date.
  • Distributions must be made at least annually and/or based on the life expectancy of the participant and, if applicable, the designated beneficiary named by the participant.
  • Post-death distributions must be completed at least as rapidly as lifetime distributions. If no designated beneficiary has been named as of the required beginning date, then the participant is treated as having no designated beneficiary when determining the minimum required distributions. In that situation, distributions are based on the participant’s life expectancy.
  • If the participant dies before the required beginning date, distributions must begin within one year of the participant’s death and must be made over the life or life expectancy of the designated beneficiary. If there is no designated beneficiary, distributions must be completed within five years of the participant’s death.

A Question of Trusts

The IRC defines”designated beneficiary” as an individual designated as a beneficiary by the participant. The term “individual” generally rules out the possibility of naming a trust, the participant’s estate or a charity as a designated beneficiary. Under the 1987 regulations, however, a trust can be a designated beneficiary for minimum distribution purposes if it meets the following requirements:

1. The trust is valid under state law.
2. The trust is irrevocable.
3. The individual beneficiaries are identifiable from the trust instrument.
4. A copy of the trust instrument is provided to the plan administrator.

As a result of these requirements, naming a revocable trust did not appear to be an option. While naming the revocable trust was arguably a viable option if a plan participant died prior to the required beginning date (since, on the death of the participant, the trust would become irrevocable), this would not be possible for a participant who is approaching or has reached age 701/2.

Revocable Trusts Allowed

After more than 10 years, the IRS has determined that allowing a revocable trust to be a designated beneficiary makes sense and adopted revised requirements in December, 1997. Under the modified proposed regulations, a trust can either be irrevocable or become irrevocable, by its terms, on the death of the participant. In addition, the rule saying a copy of the trust instrument must be provided to the plan administrator has also been revised to allow alternate methods for satisfying the documentation requirement.

The preamble to the proposed regulations indicates that taxpayers may rely on the revised proposed regulations pending the issuance of final regulations. Also, note that the IRS did not indicate that the revised regulations should apply prospectively only. It would, therefore, appear that these proposed changes apply retroactively to the effective date of the existing proposed regulations.

Careful Planning Is Key

We have only touched on the issues regarding distributions from IRAs and other qualified plans. The importance of proper IRA distribution planning cannot be over emphasized. We would be pleased to discuss these issues with you in greater detail.

Rules For Spousal Beneficiaries

The rules relating to a spouse as a designated beneficiary are somewhat different than the general rules. Specifically, if a participant’s spouse is named as a beneficiary of the IRA, the spouse has several options. One is to transfer and rollover the IRA benefits into his or her own IRA, allowing the spouse to defer taking distributions until he or she reaches age 701/2, if desired. This also allows the spouse to designate a new IRA beneficiary, potentially allowing further deferral until after that beneficiary’s death. If the spouse is older, he or she can also elect to retain the participant’s IRA and defer taxable distributions until the participant would have reached age 701/2.

Another benefit: Naming a spouse as beneficiary not only means possible tax advantages, but also allows you to use the marital deduction for estate tax purposes. However, if you do not want your spouse to have full control over your IRA benefits on death, you should consider other alternatives.

Penalties Loosened

Under the prior rules, not only are issues regarding the timing of distributions and the designated beneficiary complex, but severe penalties were imposed when a participant took out too much from the plan in any given year (excess distributions) or died with too much in the plan (excess accumulations). Changes made by Taxpayer Relief Act of 1997 repealed the excise tax on both excess retirement distributions and excess retirement accumulations for distributions after 1996 and for taxpayers dying after 1996. Other penalties and excise taxes still apply however:

1. With limited exception, a 10% additional income tax is imposed on distributions made prior to the time when the participant reaches age 591/2.
2. A 50% penalty tax continues to be imposed on the amount of a required distribution that is not actually distributed.

An Example

Dan Jones, who will reach age 701/2 in 1998, named as his IRA beneficiary a revocable trust for the benefit of his sister, Melissa. The terms of the trust provide that it becomes irrevocable at Dan’s death. Dan has provided a copy of the trust agreement to the plan administrator. Under the proposed regulations as modified in December, 1997, Melissa will be treated as Dan’s designated beneficiary, so distributions can be made over their joint lives or life expectancies. Under the prior proposed regulations, Melissa would not have been treated as Dan’s designated beneficiary unless Dan amended the trust to make it irrevocable by his required beginning date.