Go to Jeff Salisbury LWGate Home Page.From: Jeff Salisbury <jeff.salisbury@xmission.com>
Subject: Re: Take distributions from IRA or from taxable accounts at retirement?
Date: Sat, 08 Jan 2000 08:03:46 -0700
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Ira Krakow wrote:
>
> I saw an interesting article in the Motley Fool retirement bulletin board, at:
>
> http://www.fool.com/retirement/retireeport/1999/retireeport991227.htm
>
> The author suggests that when withdrawing funds where there is a mixture of IRAs and taxable
accounts, it might not be too bad an idea to withdraw from the IRAs
first. From the perspective of
tax efficiency for the *entire* family (including the heirs), the heirs
owe taxes on any part of an
inherited IRA (at *their* marginal tax rate) on which taxes haven't been
paid, so drawing down the
IRA will have a positive benefit to heirs by reducing their tax burden.
>
> On the other hand, the retiree owes more taxes by using this strategy, since taxes have already
been paid on the taxable accounts. The article contains a number of
scenarios and charts
(variables such as the marginal tax rate of the heirs, and percentage of
assets to be withdrawn
among these accounts are taken into account).
>
> Where's the balance between the retiree paying less tax and the heirs paying less tax? What
considerations should be given?
>
> Ira
>
> -
Ira,
Sorry for the delay in replying -- things have been very busy.
I strongly disagree with the author of the article you cite. I believe
there is at least one, perhaps two serious flaws in his argument.
However, before I go into them, let's review what the problem is we are
trying to solve.
The main problem with qualified retirement plans such as IRAs, 401ks,
403bs, etc. (also known as "qualified money"), is that they may be
double taxed when we die and these assets are passed to our heirs:
1. If our total estate is large enough (currently over $675K), the
qualified money gets hit with estate taxes.
2. All qualified money is subject to income taxes when it is withdrawn
because we've never paid income taxes on it until it is withdrawn.
The end result is that qualified money can be DOUBLE taxed! Here's
realistic example. Suppose that a person has a $1,675,000 estate and
part of their estate is a $1,000,000 IRA. Consider how this IRA is
taxed:
IRA Value: $1,000,000
Estate Tax @ 50%: -500,000
Income Tax @ 40%: -200,000
Net to Heirs: $300,000
Total Shrinkage: 70% (Horrendous!)
Note that the IRA is reduces by the estate tax of $500,000, which leaves
$500,000 subject to a 40% income tax.
Now, having said all this, there are ways around this problem of double
taxation. The first and main line of attack is that you don't want your
heir's to liquidate the IRA! This is where the author of the article
you cite makes his fatal mistake. He assumes that there is no choice
for the heirs except to liquidate the account.
However, the name of the game is to stretch out the IRA not only over
our lifetime, but over the lifetime of our heirs! If IRA accounts are
setup properly, they can be inherited by your spouse, then your
children, and grandchildren without getting hit with lump-sum taxes (the
highest marginal rates). But this almost NEVER happens because of a
lack of understanding of what can be accomplished with a retirement
account.
Incidentally, most company retirement plans (such as 401(k)s, 403(b)s,
TIAA/CREF, etc.) are so inflexible that they make it almost impossible
for someone to use multi-generational planning. Therefore, one of the
most important things you can do is, as soon as you are allowed, to
immediately get the money out of your employer sponsored retirement plan
and into an IRA where the funds can be treated in a more flexible
manner.
Surprisingly, most people in the financial world do not understand how
IRAs can and should be used. A Forbes study showed that 90% of the IRA
account administrators did not know the options available for IRAs. This
means that your chance of finding someone who really understands how
IRAs should work is small. But don't abandon hope. Keep searching until
you find someone who does. It will be worth the effort.
Death beneficiary designations are not just about who is going to get
your money when you die. They are among the most important selections
you will ever make in relation to your retirement money. You need to
understand all the consequences of who you designate as a death
beneficiary when you set up your IRA. Estate planning and IRA planning
should go hand in hand. If your IRA planning is done properly, it should
dramatically reduce the total amount of taxes that your family has to
pay upon your death.
Finally, it is imperative to get good financial help immediately after
the death of a participant in an IRA because, if the wrong selections
are made, often the spouse's ability to inherit the IRA is eliminated.
The children's ability to inherit the IRA as an IRA for them, without it
coming out and being taxed, is also eliminated.
I hope I haven't rambled too much...
Best Regards,
Jeff
- -
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