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Does Your Money Work For YOU, Or the IRS?
Too Many Assets - a Problem?
Many Silicon Valley residents have significant assets they don't often consider part of their "estate," because the assets are in the form of retirement plans, including IRA, 401(k), and company retirement plans. Even with the recent "bear" markets, these retirement plan assets are an important percentage of Silicon Valley wealth.
We always think in terms of saving for our retirement, particularly when the IRS gives us tax breaks for doing so, like with our IRA and 401(k) plans. We save, and save, and save for our retirement -- as we should. But what happens to our retirement plan funds if we don't use them up during our retirement?
Fred and Wilma Stone are ages 75 and 72, respectively. They have been married for 45 years. They have two children, ages 42 and 40. Fred is a retired physician, and Wilma is a retired accountant. Wilma has been successful at investing and tax planning for their retirement. As a result, Fred and Wilma's estate now looks like this:
| |
|
Value |
| Residence |
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$1,200,000 |
| Bank accounts |
|
50,000 |
| Stocks & Bonds |
|
150,000 |
| Life Insurance |
|
1,000,000 |
| Total Non-retirement Plan Assets |
|
$2,400,000 |
| |
| Retirement Plan Assets: |
|
|
| Fred's 401(k) |
|
800,000 |
| Wilma's pension |
|
300,000 |
| Wilma's 401(k) |
|
800,000 |
| Total Retirement Plan Assets |
|
1,900,000 |
| |
| Total Estate |
|
$4,300,000 |
Fred and Wilma have enough to live comfortably and leave a nice inheritance for their children, right? Maybe not. Would you believe that of the $1.9 million in retirement plan assets that Fred and Wilma have been working and saving for their entire lives, as much as 74% could be taxed away before it reaches Fred and Wilma's children or grandchildren!
The total federal and state death taxes and income taxes on just the retirement plan assets could reach $1,397,440!
Save Money By Giving It Away?
One way to avoid these onerous taxes on retirement plans is to give away your retirement plan to charity. "But wait" you're thinking. "If I do that, won't I lose 100% of my retirement savings instead of just 74%?" The answer is: "not if you do it right."
A charitable remainder trust (sometimes called a "CRT") is an irrevocable trust which provides for an income stream for the term of the trust to be paid to its creators or their named beneficiaries, and then after expiration of the term, the principal goes to charity. Forming a CRT allows its creators income tax deductions and/or estate tax deductions for the part that ends up going to charity, and allows for the tax-free conversion of assets from one form to another. A CRT is a tax-exempt entity, just like a charity itself. No tax is paid on otherwise taxable income received by the CRT. Income tax only applies to the income actually paid out to beneficiaries other than charitable beneficiaries.
Can a CRT Help Fred and Wilma?
Fred is a graduate of the Medical School at Bedrock State University ("BSU"). He has always been fond of BSU, and would like to make a small bequest in gratitude for his excellent education. Therefore, Fred and Wilma form a CRT, naming BSU the charitable beneficiary. The CRT provides for an annual payment of 5% of the CRT assets to Fred and Wilma during their lifetimes, and after their deaths to their two children for the lesser of their life times or twenty more years. At the end of those twenty years, the remaining CRT assets go to the BSU Medical School.
If Fred and Wilma were to name their CRT as beneficiary of their retirement plan assets, their children could defer payment of income tax on Fred and Wilma's retirement plan distributions over a twenty year period beyond Fred and Wilma's death. In addition, the estate tax burden on the retirement plan assets would be reduced by the actuarially determined remainder interest going to charity (approximately 38%). Thus, Fred and Wilma's children would be able to defer nearly $500,000 of income tax applicable to the retirement assets over the twenty years beyond Fred and Wilma's death, and save estate taxes of over $250,000.00! Perhaps even more importantly, the BSU Medical School is able to form "The Fred and Wilma Stone Kidney Research Institute"!
The Moral of the Story
By taking advantage of some sophisticated charitable gift planning, in certain circumstances your family can actually be better off financially by giving retirement plan assets away at your death, than by simply allowing them to be confiscated by the onerous taxes which would otherwise apply.
This technique does not work for everybody. But, consider it. Your children and your favorite charity may thank you. Only the IRS is left out in the cold.
Please note that this is not meant to be a comprehensive analysis of
the issues addressed but is designed merely to alert you to their
existence. The descriptions provided are not meant to serve as a
substitute for legal advice.
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Linda C. Kramer, JD, MBA, RN, is the Managing Attorney at The Kramer
Law Firm with offices in Los Altos and Campbell, California. The legal
services provided by the five attorney Firm include estate planning,
trusts, Medi-Cal planning, probate and trust administration, related tax
matters, and associated litigation and dispute resolution. Ms. Kramer
is a member of the State Bar of California, National Association of
Elder Law Attorneys, and California Advocates for Nursing Home Reform,
and is the current president of the Silicon Valley Bar Association.
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