IRA & Estate Basics
I have a client with approx. $3M in an IRA. Couple of questions, upon death if the bene if not a spouse, is the full account value subject to estate taxes? If so what are some proven strategies to reduce the estate taxes? Is the estate tax liability the same if it left as a stretch IRA? What about if it is converted to a Roth? Thanks in advance!!!
Permalink Submitted by Alan Spross on Wed, 2008-04-23 20:06
IRAs are fully included in the estate of the owner in common law states, although in community property states if the IRA is community property, then only half of it is in the decedent’s estate. Portions left to the spouse can be deducted using the unlimited marital deduction. If left to a non spouse individual there is no exclusion regardless of any stretching potential for distributions. A Roth conversion is a strategy that will shrink the gross estate by the amount of income taxes paid on the conversion and the beneficiary will be left with a more valuable asset.
You cannot gift an IRA while living, however Congress may extend the qualified charitable distribution (QCD) that allows a direct transfer to a qualified charity up to 100,000. The distribution is excluded from taxable income. Note that the unified credit increases to 3.5 mm in 2009, and while Congressional action is needed to extend the credit at this level, it is expected that in succeeding years the credit will not be less than that figure.
Permalink Submitted by Stephen Rhodes on Thu, 2008-04-24 12:50
So by Roth Conversions do not reduce the estate taxes? Also I have heard of advisors that recommend a client take withdrawals from and IRA to fund life insurance as a way to take care of estate taxes. Any thoughts on this strategy? What are the pros and cons of this approach?
Permalink Submitted by Bruce Steiner on Mon, 2008-04-28 01:40
There are several concepts involved. Making gifts is generally good (from an estate tax standpoint). After you’ve used up your non-IRA assets, there’s a tradeoff between the estate tax benefits of withdrawing more than required from your IRA to fund gifts and the income tax benefits of withdrawing no more than required. To the extent of the annual exclusion gifts, it probably makes sense (in a taxable estate) to make gifts, even if it means having to withdraw more than required.
Whether the donees (whether individuals or a trust or trusts) are better off investing the gifts in life insurance or other assets turns on how long the IRA owner lives, as well as how well the investments perform. If the IRA owner dies substantially before life expectancy, then the donees will do better investing the gifts in life insurance.
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srhodes wrote:
Also I have heard of advisors that recommend a client take withdrawals from and IRA to fund life insurance as a way to take care of estate taxes. Any thoughts on this strategy? What are the pros and cons of this approach?