Want to make a grown man cry? Tell him that all those beautiful dollars in his qualified plans (profit-sharing, 401(k), IRA and the like) are only worth $.27 cents to $.30 after taxes. Sorry, but it’s true.
The IRS hits you with two taxes: Income tax (up to 40 percent or more, including state and federal) and estate tax (up to 55 percent using 2011 rates). Then, of course, (depending on where you live) our city, country or state gets a piece of the action.
The first order of business is to get a fix on how much of your plan money is destined to wind up in some tax collector’s pocket. A call to your plan advisor is all it takes. Just to get some numbers on the table, suppose you have $1 million in all your plans combined and the estimated tax burden is $730,000. Only $270,000 to you and your family. Ouch!
You lucky Florida residents keep about $50,000 more because Florida does not have an income tax.
Can anything be done about it? Yes! But you must be proactive. There are many strategies, but let’s take a look at the two most common: The junk money strategy and the subtrust strategy. One point first, both are very complex and need an expert to cover all the details. Yet, the wonderful benefits are easy to understand and attain. Like enjoying the ride when you drive a car: You don’t know how to build one, but you drive with ease.
Both strategies use a common denominator: A life insurance product (usually second-to-die). The eventual proceeds of the life insurance (say $1 million) goes to your family free of the income tax and estate tax. Simply put, you have turned $270,000 of after-tax value into $1 million tax-free. There’s usually still plenty of money left in the plan. For example, as I write this article the cost of a second-to-die policy for a husband and wife (both age 65) is only in the $15,000 per year range. You must get your own quote.
First, the junk money strategy: It starts by using your plan dollars to buy an annuity — a tax-free transaction. A portion of the annuity (usually paid quarterly is used to pay the life insurance premium. The balance is typically used to maintain your lifestyle.
Recently, a client who winters in Florida, but lives in Ohio used this strategy to turn an $800,000 IRA (worth only $216,000 after taxes) into $3 million of second-to-die life insurance. The entire $3 million will go to his family tax-free. Cool!
Second, the subtrust: It is created as apart of your qualified plan (actually the current plan — usually a 401(k) plan or a profit-sharing plan — is easily amended or a new plan created). Then your plan trustee transfers the necessary premium dollars to the trustee of your subtrust to pay the policy cost.
As far as I know, there is nothing better in the tax law than these two strategies that allows you to snatch a tax victory out of the snarling jaws of a sure tax defeat. If you have $350,000 (or more) in your qualified plans (rollover IRA, traditional IRA, 401k plan, profit sharing plan and the like), you owe it to yourself and your family to look into both of these — junk money and subtrust — strategies.
Don’t let the horrendous tax law rob you and your family of those wonderful dollars you have accumulated in your qualified plans.
Irv Blackman, CPA and lawyer, is a retired founding partner of Blackman Kallick Bartelstein, LLP (CPAs) and Chairman Emeritus of the New Century Bank (both in Chicago). Contact Irv at 847-674-5295 or firstname.lastname@example.org. Vist taxsecretsofthewealthy.com.