Beginning in the 1970’s, the tax laws were very favorable to persons desiring to contribute large amounts of their income to a qualified pension or profit sharing plan. In the early years discrimination in favor of owners was possible, the allowable deductions were high, and there was no estate tax on these funds at the time of death. As the laws continued to change, the estate tax exclusion was first reduced, and then eliminated. Now, as an overview, all of the funds in a qualified retirement plan, i.e. pension plan, profit sharing plan, IRA or 401(K) plan are subject to income tax upon withdrawal and are subject to death taxes unless the participant dies survived by a spouse. In that event, the death taxes can be deferred until the spouse dies.
Depending upon state law, the combined estate and income tax on a $1,000,000 retirement fund can easily exceed 65%. That means the children of the wage earner could end up with as little as one-third of the balance of the retirement plan upon the death of the last to die of mother and father.
Last summer, Congress repealed the 15% excise tax on excess plan withdrawals for the three years 1997, 1998 and 1999. This was an extremely important step in planning for the withdrawal of retirement benefits. An excise tax of 15% was generally applicable for amounts withdrawn from a retirement plan in excess of $155,000 per year. Now that the excise tax has been repealed for this three-year period, it is less expensive to make large withdrawals from your retirement plan.
Designating the proper beneficiary of a retirement plan is critical. In reviewing this subject with our clients, we find that the beneficiary designation is often outdated and in most instances results in an acceleration of the payment of income taxes by the children. As a result of clarifications in the tax law relating to permissible retirement plan beneficiaries, it is now possible for a person to name a trust as a beneficiary of a retirement plan, and in the trust provide for the same types of distributions as one may have provided for in a will. For example, if a child is handicapped, the parent would most likely not desire that a large portion of the retirement plan be paid directly to the child. By establishing an irrevocable trust during the lifetime of the participant, taxes can be saved and at the same time, important testamentary goals accomplished.
By “stretching out” the beneficiary designation and including a younger beneficiary, such as a child, the period over which the fund must be withdrawn (and be subject to income tax) is extended.
The basic concept that makes retirement plans attractive is that the retirement fund grows free of income taxes. Therefore, on the one hand it is advisable to maintain the fund in the tax-free environment for as long as possible. However, the ultimate combined income and death taxes can be devastating.
What’s the answer? This depends upon personal facts and circumstances of each individual. Many commentators recommend that a person should not permit the retirement fund to exceed $1.2 million. Others recommend a lesser amount. Also, during the three-year moratorium on the excise tax, questions arise as to whether a person should make significantly large withdrawals. There is no single answer. However, in most instances it would be better to delay the significant withdrawal until the year 1998 or 1999 (but before December 31, 1999) to permit tax-free accumulation during the major portion of the moratorium period.
Another question often asked by our clients is when should they start taking benefits from a retirement plan, and how much should be withdrawn annually. In general, there is flexibility for persons who have attained the age of 59 1/2, but who are younger that 70 1/2. Minimum distribution requirements begin at age 70 1/2, the basic one of which is that approximately 1/16th of the fund must be withdrawn each year.
If you haven’t reviewed your retirement plan beneficiary designation, you should do so immediately. In working with your accountant, we will be pleased to make recommendations as to when to begin withdrawing, how much to withdraw, and how to structure the beneficiary arrangement in order to maximize the stretch-out and deferral benefits and at the same time minimize income and death taxes.
Depending upon state law, the combined estate and income tax on a $1,000,000 retirement fund can easily exceed 65%. That means the children of the wage earner could end up with as little as one-third of the balance of the retirement plan upon the death of the last to die of mother and father.
Last summer, Congress repealed the 15% excise tax on excess plan withdrawals for the three years 1997, 1998 and 1999. This was an extremely important step in planning for the withdrawal of retirement benefits. An excise tax of 15% was generally applicable for amounts withdrawn from a retirement plan in excess of $155,000 per year. Now that the excise tax has been repealed for this three-year period, it is less expensive to make large withdrawals from your retirement plan.
Designating the proper beneficiary of a retirement plan is critical. In reviewing this subject with our clients, we find that the beneficiary designation is often outdated and in most instances results in an acceleration of the payment of income taxes by the children. As a result of clarifications in the tax law relating to permissible retirement plan beneficiaries, it is now possible for a person to name a trust as a beneficiary of a retirement plan, and in the trust provide for the same types of distributions as one may have provided for in a will. For example, if a child is handicapped, the parent would most likely not desire that a large portion of the retirement plan be paid directly to the child. By establishing an irrevocable trust during the lifetime of the participant, taxes can be saved and at the same time, important testamentary goals accomplished.
By “stretching out” the beneficiary designation and including a younger beneficiary, such as a child, the period over which the fund must be withdrawn (and be subject to income tax) is extended.
The basic concept that makes retirement plans attractive is that the retirement fund grows free of income taxes. Therefore, on the one hand it is advisable to maintain the fund in the tax-free environment for as long as possible. However, the ultimate combined income and death taxes can be devastating.
What’s the answer? This depends upon personal facts and circumstances of each individual. Many commentators recommend that a person should not permit the retirement fund to exceed $1.2 million. Others recommend a lesser amount. Also, during the three-year moratorium on the excise tax, questions arise as to whether a person should make significantly large withdrawals. There is no single answer. However, in most instances it would be better to delay the significant withdrawal until the year 1998 or 1999 (but before December 31, 1999) to permit tax-free accumulation during the major portion of the moratorium period.
Another question often asked by our clients is when should they start taking benefits from a retirement plan, and how much should be withdrawn annually. In general, there is flexibility for persons who have attained the age of 59 1/2, but who are younger that 70 1/2. Minimum distribution requirements begin at age 70 1/2, the basic one of which is that approximately 1/16th of the fund must be withdrawn each year.
If you haven’t reviewed your retirement plan beneficiary designation, you should do so immediately. In working with your accountant, we will be pleased to make recommendations as to when to begin withdrawing, how much to withdraw, and how to structure the beneficiary arrangement in order to maximize the stretch-out and deferral benefits and at the same time minimize income and death taxes.
-Mike Beausang