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Maximize Tax Savings for Beneficiaries with a Retirement Plan Trust

May 14, 2014

Tax season is over, but there is no time like the present to begin considering a tax plan for your future.

Tax Savings In a Retirement Plan Trust

Over the past several years, our firm has done an extensive research to discover the best ways to help our clients eliminate or minimize tax savings for beneficiaries with a Retirement Plan Trust.  This is an important goal for many of our clients.  Today, I’d like to talk to you about one of the tools we use to minimize the burden of taxes on qualified retirement plans when inherited by your beneficiary. Most of our clients have some type of qualified, tax-deferred retirement plan (IRA, 401(k), 403(b), etc.).  Unfortunately, when a beneficiary inherits one of these plans, they are required to pay taxes on the money they receive.  This tax is known as Income in Respect of a Decedent (IRD Taxes).  IRD Taxes are taxes which were never paid by the decedent and are now due by the beneficiary inheriting the qualified plan.  IRD Taxes can end up costing a beneficiary up to 40% of the total value of the qualified plan in taxes.  There is no way to eliminate IRD Taxes on such a qualified plan; however, there are ways to reduce the burden and amount of tax the beneficiary pays.  A Retirement Plan Trust is one great tool that can leverage the plan assets to provide lifelong retirement income to your beneficiaries.

Maximizing Tax Savings with the “Stretch-Out”

The best way to maximize tax savings for beneficiaries with a Retirement Plan Trust and reduce the IRD Tax is for a beneficiary to “Stretch-Out” the inherited qualified plan over the beneficiary’s lifetime.  The IRS will allow a beneficiary to take required minimum distributions based on the life expectancy of a beneficiary at the time they inherit a qualified retirement plan.  For example, let’s say a beneficiary is 50 years of age with a life expectancy of 30 years when they inherit an IRA.  Instead of the beneficiary withdrawing all the funds immediately and paying 40% in taxes on the withdrawn funds, the beneficiary would only be required to withdraw approximately 1/30th of the IRA in year 1 and pay the taxes on only that portion.  In year 2, the beneficiary would withdraw 1/29th, and in year 3 1/28th and so on, until the individual turns 80 and they would be required to withdraw the remaining amount left in the retirement plan.The benefit of the “Stretch-Out” is it allows the money to continue to grow tax deferred.  If a beneficiary uses the “Stretch-Out” strategy, a $100,000 IRA (at 8% per year ) can grow into an income stream of over $1,000,000 based on the above timeline.  This is a much better solution than that same $100,000 IRA being cashed out in year 1, paying potentially 40% in taxes and the beneficiary only receiving $60,000 in after-tax dollars.  Unfortunately, this type of planning requires a beneficiary to see the value of the “Stretch-Out” and to use restraint by not immediately cashing out the qualified plan. The above strategy requires an individual to be listed to be listed individually as a beneficiary on a qualified plan.  Meaning, you cannot list a Revocable Living Trust as a beneficiary (as this would require the qualified plan to be cashed out within 5 years after it was inherited).  Many times a client does not have the luxury of listing a beneficiary as the outright beneficiary for various reasons.  These could include the beneficiary being a minor, having creditor issues, being a spendthrift, having special needs, and/or various other circumstances.  In order to preserve the “Stretch-Out” for these types of beneficiaries, you can list a special kind of trust to hold the assets for a beneficiary.  We call this trust a Retirement Plan Trust and it allows for a Trustee (of your choosing) to manage the qualified plan for the benefit of your beneficiaries while using the “Stretch-Out” based on their life expectancies.  This is a much better solution than listing your revocable living trust or your estate as the beneficiary of your qualified plan.  The Retirement Plan Trust could result in thousands of dollars being saved in taxes and ensure your beneficiaries have a great retirement in their golden years.  What an amazing blessing this could be given the uncertainty with Social Security, retirement, and pensions. Feel free to give the attorneys (R. Clancy Parks and/or Cameron G. Jones) at LifeGen Law Group a call at 417-823-9898 to schedule a consultation and find out how to maximize tax savings for beneficiaries with a Retirement Plan Trust.  Also, if it has been longer than 3 years since your last Estate Plan review your Financial Power of Attorney should be updated.