Bob Ritter's Blog #12: Three Smart (and relatively unknown by clients) Tax Strategies for Retirement Accounts | Bob Ritter's Blog, ideas for financial service professionals

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Bob Ritter's Blog #12 three tax strategies for retirement accounts and retirement strategies to avoid wasting your money

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There are three significant planning strategies used to enhance the inherited value of a retirement account such as an IRA or 401(k). To ignore taking action by not using one of them means a client is willing — literally — to burn dollars that heirs would otherwise inherit.

1. Stretch-Out

This strategy involves specifically naming children as the final beneficiary of the retirement account. This procedure continues the income tax deferral of the account although minimum distribution rules will require the heirs to make ongoing taxable withdrawals. In view of the new lifetime exemptions (currently $5,250,000 for individuals and $10,500,000 for couples with both indexed for inflation), most people don’t have to worry about estate taxes taking another bite.

With large estates well in excess of $10,000,000 that include retirement accounts, a supplemental planning strategy involves the purchase of life insurance in a Wealth Replacement Family Trust to cover the estimated estate taxes so the heirs are not forced to withdraw taxable funds from the retirement plan to provide the cash flow for estate taxes.

2. Charitable

With this approach, a favorite charity is named the ultimate beneficiary of the retirement account, and the charity receives the gift free of all taxes. Note that this transfer to the charity will not occur until the death of the owner of the retirement account and a surviving spouse. Prior to this, values in the retirement account are freely available to the account owner and, at death, to a surviving spouse.

A Wealth Replacement Family Trust is often set up to hold a life insurance policy in an amount equal to the retirement account thereby providing the heirs with a replacement asset that is income and estate tax free — not simply tax deferred.

Unlike the Stretch-Out, Charitable has the added advantage of not saddling the heirs with ongoing IRS compliance or minimum distribution requirements on the inherited funds.

If a client has a strong charitable motivation, this variation has lots of happy feedback; however, the concept is so powerful for heirs that, charitably motivated or not, it makes sense.

Both the Stretch-Out and Charitable require some pre-death paperwork, but selecting one of the two is significantly better than leaving the retirement plan “as is” where the IRS can confiscate up to 50% in income tax at the death of the owner — and much more in estate taxes if the overall estate is big enough.

3. Convert to a Roth

Although there is income tax due on the conversion of an IRA to a Roth IRA, a Roth almost always has significantly better long-range economics – even after taking the conversion tax into account. The major advantages of a Roth are:

1) Withdrawals aren’t mandatory but are tax free if taken;

2) All growth is tax free;

3) Unlike inherited IRAs, inherited Roths are more valuable for heirs since all withdrawals and growth are tax free.

For those with the asset base to absorb the income tax, it’s pretty simple to design a mathematical comparison to analyze the differences. Click here to review an InsMark report which includes an analysis of an IRA vs. a Roth IRA. It also includes an evaluation of an inherited IRA vs. an inherited Roth IRA.

You may be surprised at the significant differences.

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