Is a very large IRA desirable?
For estate and philanthropic purposes, given the choice which is more desirable for a 45 year old married couple and why?
A) Assets of 10 million in non-retirement accounts still subject to long-term capital gains.
B) Assets of 11 million, 5 million of which is in non-retirement accounts and still subject to long-term capital gains, and 5 million in a traditional IRA for husband, and 1 million in a traditional IRA for wife.
Thanks.
Permalink Submitted by mk foss on Wed, 2008-10-15 23:35
The money outside the IRA is preferable.
For estate tax purposes assets outside a retirement plan get a “step up in basis” – the capital gains go away even though the assets could be subject to estate tax.
The IRA assets are also subject to estate tax but there is no income tax relief. Every dollar withdrawn is subject to ordinary income tax (unless there are nondeductible contributions).
There is some income tax relief on IRA withdrawals post mortem when estate taxes are paid but it’s not enough to make you whole.
For charitable planning purposes, you can contribute appreciated assets and avoid capital gains tax. Except for the RMD to charity limited exception, IRA owner must pay income tax if funds are withdrawn during lifetime to contribute to charity.
Permalink Submitted by Bruce Steiner on Wed, 2008-10-15 23:54
At a young enough age, the benefit of no tax on income and gains in the IRA may outweigh the fact that the IRA will ultimately be subject to income tax. You might create a spreadsheet, making some reasonable assumptions. But this is really an academic exercise, since it’s unlikely that anyone would have the choices presented.
Permalink Submitted by Kevin Tupper on Thu, 2008-10-16 11:42
Thanks for the replies.
The choice is real, at least in the sense of an “if/come” basis. The client has an investment in an IRA that they expect significant appreciation on in the next several years. They are considering taking it out of the IRAs now as an early distribution and paying the penalty and income tax, and experiencing the appreciation outside of the IRA.
So much of this is conjecture and projection as to what is going to happen with tax rates and retirement laws in the future. Since their goal is to give the money away while they are alive, they may be right in it being more beneficial to have it outside of the IRA. They don’t need the money to live on and want to be philanthropic while alive, not when they die.
If that is their desire, it seems the only way to do so in the IRA would be to take SEPP distributions and suffer a large income tax hit on the money. At current rates, it is much larger than long-term capital gains.
I guess the questions are something along the lines of….
* Are top long term capital gains rates likely to stay below top income tax rates for the foreseeable future?
* Is the government going to be more or less restrictive about laws on retirement accounts? (They certainly can change them. Obama is talking about penalty free withdrawal for a couple of years.)
* At what point will the benefit of tax free compounding, higher income tax, and SEPP schedule for distribution surpass the penalty and current income tax hit from an early distribution along with long-term capital gains when they decide to divest of the investment and begin giving the money away? (spreadsheet is a good idea!)
Guessing what long-term capital gain rates and marginal income tax rates are going to be for the next 30 years is just that, “guessing.”
I know they are leaning toward taking it out as they don’t trust what the government may do in the future given the current economic environment. And from my limited understanding of SEPP, and current laws regarding use of money in an IRA, they have much more flexibility and control with the asset outside of the IRA even at the cost of the potential benefit of tax free compounding while they are giving it away.
The main reason I joined this forum is because I don’t know all the rules and techniques for dealing with a very large IRA. Are there techniques to successfully give away income from an existing large IRA without suffering a top marginal income tax hit on everything you take out? I was hoping so. If anyone knew of a way to do it legally, it would be the experts here. It appears the answer is “no.”
Permalink Submitted by Alan Spross on Thu, 2008-10-16 21:38
You are correct about the last point. The only exception to taking a taxable distribution and then donating the after tax remainder to charity is the current temporary QCD (Qualified Charitable Distribution), and for that feature you must be age 70.5 when the distribution is made. The QCD has just been extended by Congress through the end of 2009, which would be it’s fourth year.
Other than the QCD, the distribution is taxable and may only be partially offset by the charitable itemized deduction, which is subject to limits based on AGI, and the overall ability to itemize including higher income loss of itemized deductions.
With respect to the future cap gain rate, it is bound to go up, but unlikely to ever equal the ordinary income marginal rate. That said, the current economic crisis proves that none of the tax laws are set in concrete, and messing with the tax code seems to be a chronic inclination of politicians. That makes long term forecasting not much more than a crap shoot. Eventually, however, massive deficits must lead to higher taxes, and the deficit is spiraling out of control at this time.