Are You Trapped with Retirement Plan
Assets?
“Give my stuff to charity! What kind of crazy estate plan is that?” That’s a typical response when clients ask
about ways to eliminate unnecessary estate taxes and are told to make gifts. It's an understandable reaction. It’s also not intuitively obvious how giving
away something the client needs can be a good thing, especially if the
potential donor was raised during the Depression. The epiphany comes when clients look at the choices
they have for assets not consumed to support their lifestyle; those remaining
assets can only go to children, charity or Congress. Once the options are explored, many people
make an informed decision to pass property to heirs and other assets to
charities that either had or will have some impact on their family’s life. How can they be smarter making that decision?
Good assets and bad assets.
Actually, most people don’t
see much difference between the two, as any inherited asset ought to be a good
asset, right? Well, some inherited
assets come with an accompanying income tax bill, even in estates too small for
an estate tax. Who’s at risk? Many professionals and retirees have worked a
lifetime and have accumulated a significant 401(k), 403(b) or an IRA and don’t
realize that their heirs will not receive the full value of that account.
Option #1. As it turns out, giving heirs all the assets
that can be legally excluded from tax and leaving the rest of the estate to
charity works if (and it's a big if) tax avoidance and philanthropy are the
only goals. It's a simple, easy to understand
process with no need for expensive tax planning or specialized legal
advice. While this technique might
shortchange family heirs, it is an ideal solution for charitably motivated
families. However, even if the family
has an altruistic desire to make a charitable gift, there's no reason it can't
be done in a tax efficient manner. How
so? Make those charitable bequests with
assets that otherwise would be taxed twice.
For example, in 2002 and 2003 anything in excess of $1,000,000 is subject
to a federal estate tax. A simple estate plan would sweep anything above that
level to charity. A better plan would be
to give away those assets on which an added income tax is owed. What qualifies? Use those “income in respect of a decedent”
(IRD) assets. Start with an IRA, a
retirement plan account, a deferred annuity, savings bonds and don't forget
earned, but uncollected professional fees; these are all unattractive and
taxable assets for your heirs. Instead,
a bequest made from that donated IRA means a charity receiving $100,000
collects the whole value without paying any tax. In the traditional estate plan, children
might be penalized 75 or 80 percent if they inherited those IRD and
tax-deferred dollars. Better to let family
heirs inherit assets that “step up” in basis, so if they're sold later, there
won't be much of an income tax due. This
proactive approach is more tax efficient, as the charity receives more, the
heirs get to keep more and the IRS gets zilch.
Option #2. With the latest rules on required minimum
distributions, many financial planners propose “stretch IRA” programs and make
a good case for their use.
Unfortunately, for all the planning that goes into them, few heirs leave
the plans alone long enough for the stretch to do any good. For owners of significant retirement plans,
naming a charitable remainder trust as beneficiary might make better financial sense. While there’s usually no charitable income
tax deduction, there’s often a significant estate tax deduction and this
charitable roll-over still ensures a steady income stream for a surviving
spouse that’s not going to be subject to required distributions that erode the
value of the asset. For older heirs, a
CRT funded with IRD assets might be an ideal solution to eventually convert an
ordinary income pump to an income stream taxed at capital gains rates.
The problem is that without
changes in beneficiary designations or specific language in the Will, the
estate can't make charitable gifts of income.
Bequests are normally made from principal unless there has been a
proactive decision to give away tax liabilities. Seek guidance from competent professional
advisors to make sure these gifts are properly implemented, and do it now.
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A
good plan deals with concerns beyond tax efficiency; it must also meet the
needs of the family. For instance,
will the plan provide for proper management by underage or unprepared
heirs? Has it been decided if there's
an upper limit on what heirs could or should receive? What does the concept of money mean to the
client? How much is too much? Could an inheritance provide a disincentive
to work and succeed? Does the plan try
to pass assets to all heirs equally, or have past gifts and interactions been
considered in an effort to be equitable?
Since there's more to a legacy than just money, the estate plan should
include passing down a family's value system and influence. How have the family's core values been
addressed in the master plan? The
problem is that few professional advisors like to deal with such intimate and
personal questions. Most tax and
estate planners spend years honing their analytical skills only to find that
clients don't create and implement estate plans for purely logical
reasons. Instead, there's an
overriding emotional motivation that's often unsolicited in discussions with
client. The problem is that even an
elegant estate plan that does everything it's supposed to accomplish won't be
well received if the family doesn't understand and agree with its goals. As a result, there's paralysis by analysis,
and nothing gets accomplished until both the logical and emotional needs for
family continuity planning occur.
Rather than try to plan an estate on an asset-by-asset basis, take a
big picture view of the family's goals and values and see how the planning
can be made to meet those needs. |
Last Updated: February 4, 2002 Gift & Estate Planning Services © 2002 |
