Making the Most of Your Retirement Plan Assets

Issues in Science and Technology, Summer 2001 | Go to article overview

Making the Most of Your Retirement Plan Assets


Although a tax-deferred retirement plan like a 401-K, 403 (b), or Individual Retirement Accounts (IRA) can be a good source of retirement income for you, it may prove expensive to pass it to your heirs through your estate plan. But, by designating your residual retirement assets to a charitable organization, you can provide enormous tax savings to your heirs--while acting on your fundamental ideals and values. Here's why.

Retirement plans resemble tax-sheltered savings accounts; income taxes on them are merely deferred, not avoided. So if the plan owner dies before the account is depleted, any plan assets inherited by someone other than your spouse or a named plan beneficiary will be subject to income taxes. In addition, as "income in respect of a decedent," these residual assets will be subject to estate taxes. ("Income in respect of a decedent" is the description for income someone earned but did not receive during his/her lifetime, such as residual retirement plan or employee-benefit plan distributions and professional fees or salaries.)

The combined tax hit could be as much as 75 percent of the residual plan assets.

But by employing a different approach, your residual retirement plan assets can become an effective part of a tax-saving strategy. Thus, for example, designating part or all of the residual assets to a charitable organization can substantially reduce the tax burden on other assets in your estate by giving your heirs a tax deduction in the amount of the gift. (On the other end of the equation, the tax-exempt charity will not have to pay federal income tax on the proceeds and will receive the entire amount.)

Here's an example of how this might work: Allison Hill is an unmarried engineer whose assets include an IRA of $500,000 and a block of appreciated stock worth about $500,000. She wants to designate gifts to her niece and to her alma mater, M.I.T. If she leaves the IRA to her niece and the stock to M.I.T., the IRA will be subject to income taxes. However, if she leaves the stock to her niece and the IRA to her alma mater, her niece avoids paying income or capital gains tax on the stock--because she would receive a step-up in basis on the stock at the time of her aunt's death--and M.I.T. will not pay income tax on the IRA assets. The benefit to M.I.T is the same in both scenarios, but by leaving the stock rather than the IRA to her niece, Ms. Hill greatly increases the benefit to her niece.

Another alternative is to create a Charitable Remainder Trust (CRT) for the residual retirement assets, which will shelter the assets from immediate taxation while providing an income stream for your heirs. …

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