Estate Planning Strategies for IRAs and Qualified

by Scott D. Ford

Qualified retirement plans and IRAs are popular vehicles for accumulating retirement wealth. Congress, recognizing the need to encourage taxpayers to save for retirement, has extended favorable treatment to qualified plans and IRAs. While tax benefits are granted for contributions to retirement plans and also for accumulations inside these plans, these funds will eventually be taxed when distributed. This means that income taxation is merely delayed, not eliminated. Additionally, Congress has created penalty taxes if distributions are not made in accordance with the intended use of the retirement plan, namely providing income during the retirement years. Examples of these penalty taxes include the 10% penalty for distributions prior to age 59 1/2 and the 50% penalty for distributions of less than the required minimum amount starting at age 70 1/2.

Often, a sizeable amount of wealth is accumulated in a retirement plan and may end up comprising a significant portion of your estate, particularly when the retirement plan will not be needed during retirement. Since the retirement plan may be subject to both income and estate taxation at death, as much as 70% to 80% of the retirement plan could be lost in taxes. Therefore, estate planning for IRAs and qualified plans becomes critical.
The following is a summary of three estate planning strategies for IRAs and qualified plans:

1. Fund an Irrevocable Life Insurance Trust (ILIT) with a Life Insurance Policy. Create an ILIT and fund it with enough life insurance to pay the taxes on the IRA or qualified plan. The ILIT proceeds are not subject to federal estate taxes, so they can be fully used to pay all estate and income taxes on the IRA or qualified plan.

2. Name Charity as Beneficiary. If you have charitable inclinations your IRA or qualified plan may be an ideal asset to leave to a charity. If you are married, you, as the owner of an IRA or qualified plan could name your spouse (or revocable living trust) as the primary beneficiary of your IRA or qualified plan. After the death of your spouse, you could name your favorite charity or charities as fund beneficiaries. By naming a charity as the beneficiary, the dollars pass directly to the charity without payment of taxes. Otherwise, much of it could pass to the government. This allows you to at least control how the proceeds will be used

3. Rollover Your IRA to a Roth IRA. Rollover your IRA to a Roth IRA, which can pass to your heirs income tax free. A rollover to a Roth IRA can be accomplished only under the following conditions: (1) the rollover must be from an IRA (qualified plans are not eligible for rollover to a Roth IRA), (2) the amount of the rollover will be taxed to you in the year of the rollover, (3) you must have a modified adjusted gross income of less than $100,000 and (4) you cannot file your tax return as married filing separately.

If you have accumulated wealth in an IRA or qualified plan that will not be needed, proper estate planning is essential to maximize wealth transfer.