David W. Donahue ʜDavid W. Donahue, Jr., CFA

Transcription

1 David W. Donahue ʜDavid W. Donahue, Jr., CFA Much is being heard these days about the stretch IRA strategy. This idea is being suggested as the answer to the IRA and estate concerns of many investors. At our firm, we feel it is important to understand what the stretch IRA strategy means for your situation. The stretch IRA is a strategy not a special type of IRA. Instead, it reflects an approach to estate planning that attempts to maximize the tax-deferred or tax-free growth potential of IRA assets by leaving them in the IRA for as long as the law permits. The stretch IRA approach avoids large, lump-sum distributions to the IRA owner and his or her beneficiaries. By only taking Required Minimum Distributions (RMDs), the distribution of assets can be spread out over one or possibly two generations. Wealth can generally be enhanced through the tax-deferred or tax-free compounding of earnings. The rules governing distributions from IRAs enhance the advantages of stretching an IRA. The key advantages of the stretch IRA strategy include: Payments may be spread over a longer period of time. IRA owners over 70.5 use the Uniform Table to take RMDs. Upon death, designated beneficiaries will use the Single Life Table when taking RMDs from their Inherited IRAs, thus stretching the IRA assets. IRA assets are tax-deferred or tax-free even while payments are being made to beneficiaries. While RMDs are being taken from the IRA using the Single Life Table (term-certain), the bulk of the assets may continue to grow compounded on a tax-deferred or tax-free basis. Those who have inherited IRAs are able to name their own beneficiaries. The individual who initially inherited the IRA can stretch out the life of the account by taking RMDs. If the original beneficiary dies before depleting the IRA, their named successor beneficiaries will complete the original beneficiary s single life expectancy (term certain) distribution. You may want to learn more about the stretch IRA strategy if you answer true to any of the following statements: I do not need the income from my IRA during my lifetime I want to distribute as little as possible from my IRA once I reach my Required Beginning Date (RBD). RBD is April 1 of the year after the year the IRA owner reaches age 70.5 My spouse will not need to use all of my IRA assets during his or her lifetime I want to minimize taxes on my IRA distributions as much as possible I want to leave a legacy to my family

2 Spouse Beneficiaries: To provide for the spouse s financial needs after the IRA owner s death, an IRA owner names his or her spouse as the sole IRA beneficiary. This approach generally avoids probate and may qualify for the unlimited marital deduction, eliminating estate tax. An inherited IRA may be set-up for the benefit of a spouse under age 59.5 who may need to take distributions from the IRA. Here, the surviving spouse will avoid the 10% premature distribution penalty; however he or she will pay all income taxes owed on any distribution. If the deceased spouse was not yet 70.5, the surviving spouse who is the sole primary beneficiary may defer RMDs until the year when the decreased IRA owner would have reached age Until that time, the surviving spouse may take distributions from the Inherited IRA in any amount and at any time. After reaching age 59.5, the surviving spouse may want to roll over the IRA to their own name. If the deceased spouse had reached age 70.5, the surviving spouse would be required to take RMDs by December 31 of the year following the IRA owner s year of death. Here the surviving spouse would use the Single Life Table with Recalculation based on the surviving spouse s age each year. Surviving spouses inheriting their deceased spouse s employer-sponsored retirement plan can do a Roth conversion. If the employer-sponsored retirement plan holds after-tax funds, those funds can be directly transferred to a Roth IRA or an Inherited Roth IRA. Such a transaction would result in a taxfree conversion under IRS rules. The surviving spouse also has the option to convert all or a portion of the pre-tax dollars into a Roth or Inherited Roth IRA. Any resulting taxes will be generally due in the year of the conversion. Beginning in 2010, the MAGI and tax filing status requirements have been eliminated, and taxpayers are able to convert to a Roth IRA regardless of their MAGI or tax filing status. Additionally, for 2010 only the taxpayer can elect to pay 50 percent of the income resulting from the conversion in the 2011 tax filing and 50 percent in the 2012 tax filing. You may pay all taxes due on the 2010 tax filing. Taxes will be paid at whatever federal income tax rate is applicable for those tax years. Please Note: Taxes due in regard to a Roth conversion may be accelerated if a distribution is taken before Please consult your tax advisor for more information. Options available to a surviving spouse, whatever the age of the IRA owner at death: If the surviving spouse is the sole IRA beneficiary they can claim the IRA as his or her own and roll it over to a new or existing IRA in their name. RMDs would begin based on their RBD. The surviving spouse may take a lump-sum distribution from the deceased spouse s IRA. Taxes are due on the taxable portion of the distribution in the year it is received. A portion of any distribution would be exempt from taxation subject to the Pro-Rata Rule if the IRA owner had made non-deductible contributions or had rolled after-tax money into the IRA. There are times when the surviving spouse does not need or want the IRA assets; if so he or she can exercise a qualified disclaimer within nine (9) months after the IRA owner s death. The

3 disclaimed assets would then be paid to the contingent beneficiaries named by the deceased spouse. In cases where no contingent beneficiary is named, the disclaimer assets would go to the individual specified under the default rules in the IRA custodial agreement. The defaults on an IRA at our firm are: -First a surviving spouse -Second surviving children under state law -Third the estate Qualified disclaimers can offer you enhanced planning opportunities when considering use of the stretch IRA strategy. As always, you should consult your tax and legal advisors for advice about disclaimers. Surviving spouses should take care to name beneficiaries for the IRAs in cases where they elect to continue the IRA through an Inherited IRA, or rollover the inherited assets into their own IRA. Keep in mind that to maximize planning flexibility, both primary and contingent beneficiaries should be named. Non-spouse beneficiaries: If an investor is single, divorced, or feels that his or her spouse does not need the IRA, then they will be naming a non-spouse beneficiary to inherit the IRA. The benefits to inheriting an IRA for the nonspouse include the following. Since many beneficiaries may be significantly younger than the IRA owner, the RMDs after the IRA owner s death will be minimized, potentially stretching out the life of the IRA. However, a non-spouse beneficiary cannot rollover IRA assets or retirement plan titled in their own name at the death of the IRA owner. The non-spouse IRA beneficiary must continue to maintain the IRA in the name of the deceased owner as an Inherited IRA. Any other process is viewed as a distribution by the IRS and can result in the IRA being fully taxable, ending any stretch IRA strategy. Non-spouse beneficiaries who inherit employer-sponsored retirement plans (401(k), 403(b), 457 plans, etc.) have the ability to request that a direct transfer of these inherited plan assets be made to an Inherited IRA. The beneficiary will need to contact their financial professional to establish an Inherited IRA and contact the employer plan sponsor for help in executing the transfer of the assets into the Inherited IRA. Remember, only a direct rollover is allowed. This is a non-taxable distribution from the employer-sponsored plan that is sent directly to the new custodian and will be reported to the IRS as a rollover. Failure to employ the direct transfer process could make this transaction fully taxable to the beneficiary and end the tax-deferral or tax-free status available under the Inherited IRA. By executing the direct rollover the beneficiary can enjoy continued tax-free or tax-deferred compounding, only RMDs need to be taken, successor beneficiaries can be named to the Inherited IRA, and he or she should enjoy a broader investment selection for the Inherited IRA assets. A non-spouse beneficiary who inherits a qualified retirement plan has the ability to request a direct trustee-to-trustee transfer to an Inherited Roth IRA

4 - If the employer-sponsored retirement plan holds after tax funds, those funds can be directly rolled to an Inherited Roth IRA. Such a transaction should result in a tax-free conversion under the IRS rules. - The non-spouse beneficiaries also have the option to convert all or a portion of the pre-tax dollars into an Inherited Roth IRA as a direct rollover. Any resulting taxes will generally be due in the year of the conversion. - Keep in mind, RMDs will need to be taken each year from an Inherited Roth IRA. If a beneficiary has an Inherited Traditional and Inherited Roth IRA, RMDs will need to be taken from both accounts to take advantage of the stretch IRA strategy. It is important to remember that non-spouse beneficiaries who inherit Traditional IRAs cannot convert them to Inherited Roth IRAs Investigate all options for handling an inheritance of retirement assets with tax and legal advisors before executing a strategy. Remember that stretch IRA strategies are designed for investors who will not need the money in the account for their own retirement. There is no guarantee that there will be assets remaining in the account at the time of the IRA owner s death Non-spouse IRA beneficiary options: The non-spouse IRA beneficiary may take a lump-sum distribution from the IRA. The distribution would be fully taxable in the year it is received. A portion of any distribution would be exempt from taxation subject to the Pro-Rata Rule if the IRA owner made non-deductible contributions or rolled after-tax money from an employer-sponsored retirement plan into the IRA. RMDs to a non-spouse beneficiary may be made over the beneficiary s single life expectancy (term-certain), if an IRA owner dies before or after his or her RBD. Term certain means that the beneficiary s life expectancy will be reduced by one for each later year of distribution. This is also referred to as the stretch IRA strategy. If the beneficiary does not take a distribution in the year following the IRA owner s death and the IRA holder dies before their RBD, it is possible that distributions would be made under the Five Year Rule. Under this rule, the entire IRA must be distributed by the end of the fifth year following the year of death of the IRA owner s death. The use of a qualified disclaimer is also available to a non-spouse beneficiary if he or she wishes to relinquish any or all rights to the inherited IRA assets. The disclaimer must be exercised within nine (9) months of the death of the IRA owner. Multiple beneficiaries: Some thought should be given to the following matters for those with multiple primary beneficiaries During the gap period (the time between the IRA owner s death and September 30 of the year after that death), designated beneficiaries are determined. Each beneficiary will be able to use his or her own life expectancy as long as separate Inherited IRAs are established by December 31 the year following the IRA owner s year of death. Each beneficiary will then have his or her own Inherited IRA maintained in the name of the deceased IRA owner. RMDs will be calculated separately for each beneficiary using that beneficiary s single life expectancy (term certain). Term certain means that the beneficiary s life expectancy will be reduced by one for each later year of distribution. The advantages of this approach are that each beneficiary can make his or her own investment decisions and they can

5 take advantage of the stretch IRA strategy. This technique also allows the individual to name their own successor beneficiaries to the Inherited IRA. RMDs must be calculated using the single life expectancy (term certain) of the oldest beneficiary if the IRA is not divided into separate accounts for each beneficiary by December 31 the year following the year of the IRA owner s death. This approach increases the amount of the distribution and reduces one s ability to take advantage of the stretch IRA strategy. The chart below will help you understand the potential importance IRA planning can have for your family. A beneficiary who chooses wisely may avoid paying income taxes on an Inherited IRA all at once, and stretch distributions over his or her lifetime. The Stretch IRA Concept Total IRA distributions over beneficiary s lifetime Age Life Expectancy Value of IRA when inherited by beneficiary $100,000 $500,000 $1,000,000 Total Projected Distributions years 53.3 years 43.6 years 34.2 years 1,740,307 1,045, , ,695 8,701,264 5,226,414 3,201,872 2,038,414 17,402,515 10,452,821 6,403,739 4,076,824 Assumptions: RMDs only taken, 7 percent annual return. This chart is hypothetical and is provided for informational purposes only. It is not intended to represent any specific investment. When deciding whether to initiate a stretch IRA strategy, an investor should consider such factors as possible changes to tax laws, the impact of inflation, and other risks. Please note that designating a beneficiary two or more generations below the IRA owner may result in additional taxes when the distribution is made (exemptions may apply). Please consult with your tax advisor for more information. Trust, charity, or estate as beneficiary: When a trust is named as the IRA beneficiary and the trust meets certain IRS requirement, RMDs will be based on the age of the oldest trust beneficiary s single life expectancy (term certain). A lump-sum distribution is also available when a trust is named as IRA beneficiary If the IRA owner dies before his or her RBD, distribution may be taken under the 5-Year Rule explained previously. Again, proper planning of the trust beneficiaries can help to take advantage of the stretch IRA strategy. In some instances a trust or estate may be able to disclaim (refuse) IRA assets within nine (9) months after the plan IRA owner s death.

6 When a trust that does not meet IRS requirements of a lookthough trust, or a charity, or estate is named as the IRA beneficiary, the options for extending the life of the IRA are limited to the remainder of the IRA owner s single life (term certain) expectancy, if the IRA owner died after his or her RBD. Otherwise, distribution must be made under the Five-Year rule discussed previously At EagleClaw Capital Management we understand your desire to maximize the benefit your family receives from your IRA. Please contact us for further information on your stretch IRS strategy. We look forward to helping you and your family build your financial future. Please Note: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on tax information and legislation as of April Since each investor s situation is unique, you need to review your specific investment objectives, risk tolerance, and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since EagleClaw Capital Management does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences. Accounts carried by First Clearing, LLC, Member NYSE/SIPC First Clearing, LLC. ECG Products and Services offered through Moors and Cabot Investments, Member FINRA, NYSE, SIPC.