Irv Blackman Irv Blackman
Independent Financialservices Professsional

Your IRA from a Tax Loser to a Tax Winner

December 1, 2015

Sadly, most taxpayers play their IRA cards wrong. Result: Your family loses. This article provides a roadmap of what to do and what not to do with your IRA.

First, some basic rules on traditional IRAs, which allow for a deduction when you put funds in and defer income taxes on profits, income and gains until you take the funds out.

1) All other qualified plans, such as 401(k)s, can be rolled over into your IRA.

2) You must take required plan distributions (RPDs) every year, starting with the year after you reach age 701⁄2. RPDs are based on life-expectancy tables, so the percentage required to be distributed increases a bit each year.

3) If you make the beneficiary of your IRA your spouse (younger than you) the RPD—when you pass away—will be smaller than yours. Good tax planning!

What if you make your kids beneficiaries? Now the friendly life-expectancy tables make the RPD so small, almost all of the IRA funds can grow—tax deferred—for another full generation. It's called a stretch IRA. Make that two generations if you leave all (or some) of your IRA to the grandkids. More great tax planning!

What Not to Do

Do not make your IRA beneficiary your estate or trust—this prohibits you from creating a stretch IRA. Instead, pick live family members: typically your spouse, then kids and/or grandkids. Remember, the enemy is a possible double-tax on your IRA—income tax, and (if your estate is large enough) the estate tax. The average double-tax rate is 64 percent.

Why Make Your Spouse the IRA Beneficiary

Let's look at the tax goodies that follow by making your spouse the beneficiary:

1) Your spouse can roll your IRA funds into her own IRA, pushing the RPD down the road to her 701⁄2 age.

2) Your spouse can name new beneficiaries—most likely your kids and grandkids—based on current circumstances.

3) Your spouse can convert the IRA into a Roth IRA, delivering a huge tax advantage to your family's younger generations. The conversion can take place all at once or over several years. Don't forget, any income tax paid is gone and no longer subject to estate tax.

The Conversion Process

What started as a good idea early in life—to park deductible contributions into a qualified plan—turns into a lousy tax-prone asset later in life. What to do?

The goal of this tax strategy is simple: Turn the dollars parked in your IRA or other qualified plans, subject to double tax, into tax-fee (no income or estate tax) dollars. We call it Retirement Plan Rescue (RPR). For an IRA:

Step 1: The IRA buys an annuity—often it’s one or more annuities already owned by the IRA.

Step 2: Annuitize the new/old annuity, which provides a flow of guaranteed income (annuity amount) to the IRA every year for as long as you live, or as long as either spouse lives (second-to-die).

Step 3: The IRA distributes to you annually the annuity amount—subject to income tax, which you pay. The distribution often is all or part of your RPD.

Step 4: You buy a life-insurance policy (single life if not married; second-to-die if married). You use the distribution to pay the policy premiums.

The sooner you implement the above strategy the better, because premium costs rise each year and health issues might lock you out as you age.

Having the policy owned by an irrevocable life-insurance trust avoids the estate tax, and insurance proceeds are income-tax-free according to the Internal Revenue Code.

One warning: Every possibility, tax trap or opportunity is not covered above. Only implement your estate plan with experienced advisors.

Want to learn how an RPR will turn your potential 64-percent tax loss into millions of tax-free dollars? E-mail Irv at MF
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