estate planning for IRAS and retirement plans
The funds in qualified retirement plans, individual retirement accounts (“IRA”) and deferred annuity contracts are subject to both estate tax and income tax at the time of the death of the participant. Accordingly, the effective tax rate on such an asset can exceed 65%. In order to maximize the funds available to your beneficiaries there are several methods to increase the after tax amounts received by your beneficiaries.

To maximize the funds available to your beneficiaries, consider withdrawing from these accounts and using the net funds to purchase life insurance through an irrevocable insurance trust. Under current law, if you make lifetime transfers of the IRA or retirement plan benefits to charity, there would be a deemed distribution to you that would trigger a current income tax. However, if the charity is named as beneficiary of the IRA or plan upon your death, your estate will not incur an income tax upon the distributions, the charity will not recognize income on the benefits they receive, and the IRA or plan will be deductible from your estate for estate tax purposes. In this manner, you can increase the funds payable to your other beneficiaries by making the charity the beneficiary of your plan or IRA instead of funding your charitable gifts with other assets. There is proposed legislation before Congress that would allow a current transfer of an IRA account to charity without the corresponding tax cost. In other words, you would be entitled to an income tax deduction for the full value of IRA assets whereas your family would only have received such assets after income tax. It may be advantageous to wait to see if this legislation is passed before making any charitable decisions.

In order to maximize the funds available to your beneficiaries, you should consider withdrawals from these accounts and the use of the net funds, after payment of income taxes on such withdrawals, to purchase life insurance on your life through an irrevocable insurance trust. By way of example, every $10,000 in your IRA or Annuities would result in only $3,500 in funds to your beneficiaries if kept in such accounts until your death. Even if the $10,000 doubled in value, as a result of tax free income accumulation in such accounts, your beneficiaries would still only receive $7,000, after taxes were paid. If instead you withdrew the $10,000 and paid income taxes on it, you could use the net proceeds to fund the premium cost for an insurance policy owned by your irrevocable trust.

The trustee of the irrevocable trust would purchase life insurance on your life or on the life of your spouse, or both (referred to as “second-to-die” life insurance). The proceeds from the insurance policy would be paid to the trust and pass estate tax free to the beneficiaries of the trust. The amount of insurance which could be acquired would depend on the age and health of the proposed insured. The benefit to your beneficiaries is greatly enhanced by using the IRA and/or annuities accounts in this manner. There are additional generation-skipping tax advantages, which can be accomplished through this structure as well.

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