Archive for April, 2013

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

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

Should you convert to a Roth IRA?

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

Estate Planner May-June 2007
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Roth IRAs can offer significant estate planning advantages over traditional IRAs. But until recently, these advantages have been unavailable to higher-income taxpayers who often stand to benefit the most. Under tax legislation passed last year, anyone – regardless of income level – can convert a traditional IRA to a Roth IRA starting in 2010.

Know the difference

Traditional IRAs can offer current tax deductions and tax-deferred growth, but withdrawals are subject to ordinary income taxes at rates as high as 35%. A Roth IRA takes the opposite approach: Contributions aren’t deductible, but qualified withdrawals of contributions and – best of all – earnings are income-tax free.

From an estate planning perspective, the Roth IRA is the clear winner. With a traditional IRA, you have to take required minimum distributions starting at age 70 1/2, whether you need the money or not. But a Roth IRA can continue growing income-tax free indefinitely, allowing you to build a larger nest egg for your family.

Also, when you leave a traditional IRA to your children or other heirs, income taxes may take a big bite out of their inheritance because they’ll have to pay income tax on all distributions. Roth IRAs provide a dual estate planning benefit: Not only are distributions to your heirs income-tax free, but the amounts you pay in taxes on the income you contribute to the Roth IRA are removed from your estate. In other words, by paying the taxes associated with a Roth IRA, you essentially make a tax-free gift to your heirs.

Know your limits

There’s no income limit for making contributions to a traditional IRA. So long as you receive enough compensation from a job to cover your contribution, you can set aside up to $4,000 in 2007 ($5,000 if you’re 50 or older). If you’re married and your spouse has little or no income, you may also be able to contribute similar amounts to a spousal IRA.

The tax deductibility of your contributions, however, depends on your participation status in employer-provided retirement plans and your income. If, for example, one or both of you participate in a plan at work, your IRA contributions become nondeductible above specified income limits, which are quite low.

Roth IRAs are subject to the same contribution limits as traditional IRAs, but higher-income taxpayers are ineligible. If you’re a joint filer, for example, your ability to contribute to a Roth IRA in 2007 is phased out beginning at $156,000 of modified adjusted gross income (MAGI) and eliminated once your MAGI reaches $166,000. If you’re single, the phaseout range is $99,000 to $114,000 of MAGI.

It’s also possible to convert an existing traditional IRA into a Roth IRA. Previously, this option was reserved for taxpayers with MAGI of $100,000 or less. But the income limit for conversions will be eliminated – beginning in 2010 – under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), which was signed into law in May 2006. This is good news if you’ve built up large balances in traditional IRAs, either through annual contributions or by rolling over funds from a 401(k) or other employer-sponsored retirement plans.

Know your options

TIPRA opens the door for higher-income taxpayers to take advantage of the Roth IRA’s estate planning benefits. By converting a traditional IRA into a Roth, you can avoid required minimum distributions and allow your savings to continue growing income-tax free.

You’ll have to pay income tax on the amount you convert, but in many cases the benefits of tax-free growth outweigh the tax hit. Plus, if you make the conversion in 2010, TIPRA allows you to defer the tax and include half of the conversion income on your 2011 return and half on your 2012 return.

Be sure to analyze the tax consequences before you convert. Depending on the size of your IRA and your income level, a Roth IRA conversion can bump you into a higher tax bracket. If that’s the case, you may want to convert your IRA gradually over several years to minimize the tax impact.

TIPRA doesn’t lift the income restrictions on contributions to a Roth IRA. But it creates a “back door” option for high-income earners.

For example, Nancy, age 50, doesn’t have an IRA. With MAGI in excess of $200,000, she’s ineligible to contribute to a Roth IRA but can make nondeductible contributions to a traditional IRA. Nancy sets up a traditional IRA in 2007 and contributes $5,000 per year. Assuming an 8% rate of return, the IRA’s balance in 2010 is $22,531. Nancy converts the entire amount into a Roth IRA. Because her contributions (totaling $20,000) weren’t deductible, Nancy pays taxes only on $2,531 in earnings. She can include the entire amount on her 2010 return, or report half that amount on her 2011 and 2012 returns.

After 2010, Nancy continues contributing $5,000 per year to her traditional IRA, avoiding taxes on the earnings by immediately converting the funds to her Roth IRA. When she retires at age 65 (again, assuming an 8% rate of return), her Roth IRA has grown to more than $150,000, all of which can be distributed income-tax free.

Assuming that the law isn’t changed, the new conversion rule effectively allows Nancy to enjoy the benefits of a Roth IRA even though she’s ineligible to make Roth IRA contributions.

Making the switch

Under the right circumstances, the new conversion rules create valuable estate planning opportunities for high-income earners. Be sure to check with your tax advisor before opening a Roth IRA account.

08 Apr

Maintaining a Delicate Balance — The Second Estate Plan for the Second Marriage

In Second Marriage by admin / April 8, 2013 / 0 Comments

Estate Planner Jul-Aug 1997
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Estate planning is more than merely arranging to dispose of money and property — it involves people, with all their emotions, virtues, failings and idiosyncrasies. Nowhere is this more evident than in estate planning for the second marriage, particularly when children from a prior marriage are involved.

The objective of your estate plan is an orderly administration and disposition of your estate. The last thing you want to do is create family issues, hurt feelings or conflicts between your current spouse and your children from a prior marriage. Unfortunately, resentment and jealousy over the terms of an estate plan are not unusual. However, if you consider all of the issues now, you can reduce conflicts after your death and help ensure your estate plan will be carried out as you wish.

Marital Trusts To Defer Estate Tax

A marital trust provides cash flow to a surviving spouse during his or her lifetime and defers estate tax until the spouse’s death. But, it has drawbacks in the context of a second marriage:

  • If your spouse is close to the age of your children from a prior marriage, your children may have to wait until old age to enjoy their inheritance.
  • If your spouse has the right to convert non-income-producing property into income-producing property, he or she may sell a family business or other non-income-producing property to the detriment of your children.
  • If the children are the remainder beneficiaries, conflict over investment decisions, such as how much income will be generated by the trust for distribution to your spouse, may occur.

Trustees and Executors

Your fiduciaries may need the skills of a tightrope walker to balance the wants and needs of your children and your second spouse. Besides investment decisions, your executors and trustees also will make property and tax elections, and funding allocation decisions.
Unless your spouse will bring something valuable to the trusteeship, such as investment know-how or a good relationship with your children, you probably shouldn’t name him or her trustee or co-trustee. Also consider whether special provisions should be established for voting authority over closely held business interests, or business- or family-related real estate.

Trust Distributions

Under your estate plan, your second spouse generally will be a trust beneficiary and your children from a prior marriage will be either additional discretionary beneficiaries or remaindermen. You may want to limit the trustee’s discretion, especially if hostility or competition between your spouse and children may arise.
Examine the trustee’s standards for trust distributions to see if they are subject to abuse and to ensure adequate safeguards are in place. For example, mandatory income to the second spouse can reduce constant challenges to the trustee’s use of discretion and spell out specific standards covering when principal may be distributed. If principal distributions are to be limited to emergencies, say so.

Homes and Personal Effects

Make clear provisions if your second spouse is to continue to live in the family residence. This may take the form of a joint tenancy survivorship arrangement, a life estate, specific trust authority, or a lifetime gift through a qualified terminable interest property trust or qualified personal residence trust. Be specific about what costs related to the residence, if any, are your spouse’s obligations.

Do you want specific items from the household to either go to your children or stay with your second spouse? Be careful with the division of your personal effects. Decide how to allocate your art collection or antiques — a trust arrangement may be helpful.

Explain the Reasoning Behind Your Estate Plan

Some of the concerns relating to an estate plan for the second marriage may be addressed in a premarital agreement. A letter to your children and wife explaining your thought process also may reduce conflicts, but make it separate from your will to protect privacy. By addressing second marriage estate planning issues now, you can reduce potential conflicts after your death.

 

Have You Broken All Estate Plan Ties To Your Prior Spouse?

Double check that:

  • Your former spouse is not still named as the beneficiary of any of your life insurance policies, employee benefit plans or individual retirement accounts (IRAs);
  • Joint tenancies with your former spouse have been terminated;
  • Old powers of attorney have been revoked.
08 Apr

A New Spouse + Children From a Prior Marriage – A Premarital Agreement Can Help You Create an Estate Plan To Meet Everyone’s Needs

In Prenuptial Agreement,Second Marriage by admin / April 8, 2013 / 0 Comments

Estate Planner Nov-Dec 1997
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A premarital agreement not only can ease family tensions that often occur in second (and third, fourth, fifth …) marriages, especially when children are involved, but also can help reduce estate taxes. How? The new spouse can agree to use his or her lifetime unified credit to transfer assets to the children from a prior marriage and agree to split annual exclusion gifts to them. Let’s compare this strategy with other options.

Because Terry, age 55 with two children from a prior marriage (ages 25 and 30) and an estate worth $6 million, plans to marry Leslie, age 45, with no children and a modest estate, Terry is creating a new estate plan with three primary goals:

1. Pass enough to Leslie to ensure that Leslie can maintain their lifestyle.
2. Pass more of the estate to the children.
3. Minimize estate taxes payable on Terry’s death.

Planning Without an Agreement

Distribute estate directly. Terry’s estate can be distributed equally among Leslie and the children on a pre-tax basis. This will reduce total taxes but leave more for Leslie than for the children. Leslie’s $2 million will qualify for the marital deduction, but the $4 million passing to the children will be included in Terry’s taxable estate. This will result in estate taxes of about $1.6 million and leave the children with only about $1.2 million each.

Distributing the estate so that Leslie and the two children will receive equal shares after taxes — about $1.33 million each — may be more appealing to the children, but will mean less for Leslie and about $400,000 more for the Internal Revenue Service, because the marital deduction is smaller.

Use a QTIP trust to defer estate taxes. Terry can create a qualified terminable interest property (QTIP) marital trust for Leslie and maximize estate tax deferral by allocating $5.4 million to the QTIP trust. The remaining $600,000 will go to the children. Leslie will receive all income from the QTIP trust and may receive distributions of trust corpus. On Leslie’s death, the remaining corpus will pass to the children. But, because of Leslie’s life expectancy, the remainder may pass to the children so far in the future that it will have a minimal present value, again, upsetting the children.

Purchase life insurance benefiting the spouse. Terry can purchase a life insurance policy to provide for Leslie and leave the $6 million estate to the children, who will receive $3.25 million after taxes, the same as if Terry had not married.

Purchase life insurance benefiting the children and use a QTIP trust. Terry can use the unified credit to fund an irrevocable life insurance trust (ILIT) for the benefit of the children. This may support a $4 million insurance policy on Terry’s life that will be out of the estate for estate tax purposes. As in the previous QTIP trust example, Terry can then leave $5.4 million to a QTIP trust for Leslie, thereby deferring all estate taxes and benefiting the children on Leslie’s death.

Planning With an Agreement

Agree to use the unified credit. Leslie can agree to use all or part of the unified credit (and perhaps the generation-skipping transfer tax exemption as well) to split gifts to the children. If Terry uses both unified credit amounts to fund an ILIT for the children, the $1.2 million can support an $8 million life insurance policy. Terry can then leave $4.8 million to a QTIP trust for Leslie, and no estate tax will be payable on Terry’s death.
Agree to make joint gifts. If Leslie also agrees to split annual exclusion gifts to the children, Terry can double the amount that can pass to the children each year tax-free.

Balance the Needs of Children and Spouse

With proper planning and a well-designed premarital agreement before a second marriage, you can meet the needs both of your children from a prior marriage and of your new spouse, and pass on more to your children at a lower tax cost. The agreement is not magic, but it does ensure everyone is on the same page. If you’d like to learn more, give us a call.

08 Apr

What Can You Do To Avoid Transfer Tax Audits?

In Taxes by admin / April 8, 2013 / 0 Comments

Estate Planner Mar-Apr 2000
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In recent years, the IRS has frowned on several widely used estate planning techniques. But if you always strictly follow the IRS’s approved path, you could end up paying more transfer tax than you should — not all positions taken by the IRS are upheld in court. If you anticipate that some of your transfers will receive heightened scrutiny, you may take additional steps to prevent an audit or reduce the controversy surrounding an audit.

Valuation Discounts

One area under IRS scrutiny is valuation of family entities where discounts for minority interest and lack of marketability are claimed on transfers of business interests to family members. The IRS has focused on examining valuation discounts for these entities. Gifts of interests in closely held businesses are notoriously hard to value because no ready market exists in which interests in them are bought and sold. So, the value of such a business as a whole is often a matter of opinion. In addition, when family members give business interests, they often take discounts that further depress the gifts’ value. These discounts can arouse the IRS’s interest.

Similarly, gifts of interests in family limited partnerships (FLPs) that include fractional interest and marketability discounts are also commonly audited. FLPs reduce estate tax by transferring limited partnership interests to a younger generation. The value of these interests is discounted when the gifts are made to reflect their lack of marketability. The idea is that willing buyers would pay less for these interests because the owner is not easily able to sell the interests to someone else. Generally, limited partnership interests are not traded in any public market and lack a reasonable prospect of being registered for trading in a public market. A discount is also taken to adjust for interests being minority interests that the buyer is not able to exert control over.

Donors of interests in family businesses often limit the gifts to the donor’s $10,000 annual exclusion from gift tax ($20,000 for a married donor whose spouse agrees to split the gift). Even though the donor will not owe gift tax, filing a proper gift tax return is important. Though it may seem counterintuitive, one way to lessen an audit risk is by fully disclosing all relevant facts when filing a gift tax return. Adequate disclosure of the gift prevents the IRS from extending gift tax statute of limitations. Inadequate disclosure allows the IRS to revalue the gifts and assess additional tax. The donor is obliged to file a complete return and report the value of the gifts. While the IRS does not require an appraisal, it can be helpful to have an expert opinion to support your valuation.

Crummey Powers

The use of Crummey powers commonly used in irrevocable insurance trusts is another example of IRS hostility. The IRS has refused to issue rulings on these powers and has repeatedly challenged them in tax court. But despite these attacks, people still use them.

Crummey powers in trusts allow a donor to apply the $10,000 annual gift tax exclusion that is available only for current gifts to transfer to the trust. Without Crummey powers, if you establish a trust for the benefit of your children and your children lack control over the trust assets, gifts of cash to the trust might not be considered to be of a present interest and would thus fail to qualify for the exclusion. Crummey powers give beneficiaries the right to withdraw cash for 30 days after the deposit so that the gift becomes a present interest. The best way to protect against a challenge to Crummey powers is to comply with all rules and to use them reasonably. It is safer to provide Crummey powers only to those beneficiaries who have a real interest in the trust. Adding remote relatives just to obtain additional annual exclusions will draw IRS attention. And follow all technical rules regarding Crummey powers and IRS-required notices.

 

Help Us Help You

As you will always want to stay within the law when reducing tax, you should seek the assistance of a professional. Be sure to contact us for help in these often complicated matters so you can minimize the likelihood of an IRS audit or adverse audit findings.