Tax Secrets of the Wealthy: How to escape from your qualified plan tax trap

Do you have a significant amount of money ($300,000 or more) in one or more qualified plans? For example, an IRA, profit-sharing plan, 401(k), etc.

This is a bittersweet subject. Bitter if you don’t know how to legally avoid the tax-robbing laws that enrich the IRS. Sweet if you implement one or more of the strategies that follow, turning the tables on the IRS and creating (in most cases) millions of dollars of tax-free wealth.

Let’s personalize this articles just for you. Start by writing down the total you have in all your Plans. Now comes the bitter part — extremely bitter if you happen to be rich (rich by my definition, which means you are irrevocably in the highest income tax bracket, 40 percent, state and Federal and the highest estate tax bracket, 55 percent, using 2011 rates).

Here’s how the tax law robs your dollars. When your plan funds are distributed to you, using a $10,000 distribution as an example, you are socked with 40 percent in income tax. Horrified, you watch your $10,000 shrink to $6,000 after the first $4,000 tax bite. When you go to heaven, the IRS feasts again on the remaining $6,000. This time it’s the 55 percent estate tax. Another $3,300 is swallowed by the tax collector. So, your family winds up with a paltry 27 percent: Only $2,700. The IRS gets 73 percent, or $7,300. Sorry, but that’s the law. Simply put you lose $73,000 for each $100,000 in your plans. Now, multiply 73 percent times the amount you wrote down previously. Sorry, but that’s the potential tax damage to your plan’s funds.

In an evil sort of way the IRS gives you a second chance. If you die before distributing all of your plan’s funds, your heirs still get hammered for the same 73 percent double income tax and estate tax. Take a moment to apply these awful same-if-your-dead-or-alive rules to your plan’s numbers. Most of my clients cringe when they realize the sad tax consequences — $730,000 per $1 million of your plan’s funds are lost to tax collectors.

Now, we are ready for the sweet part. The part that enriches you and your family. In an attempt to personalize what you are about to read, following are real-life examples of strategies other readers of this column have used. When an example or strategy fits your facts and circumstances, get more information so you can join the tax-saving and/or wealth-creation fun. All numbers are rounded for ease of reading.

It should be noted that there are actually 12 basic strategies, along with an endless variety of combinations (necessary to make each escape plan exactly fit the facts and circumstances of each individual client). But the six basic strategies outlined below account for 90 percent of the tax-trap-escape strategies actually used for real-life readers of this column who seek our help.

Strategy 1: Use all or a portion of your plan’s funds to buy a single premium immediate life annuity (a tax-free transaction). Then use the annuity amount (It continues for as long as you live.) to buy life insurance in an irrevocable life insurance trust (ILIT). For example a single reader (age 61) turned $135,000 of after-tax plan funds into $1.2 million in his ILIT — all tax-free.

A married reader (age 64 with a 59-year-old wife) created $2.8 million of tax-free wealth in his ILIT with $148,000 of after-tax plan funds. We call this strategy the “Junk Money Plan” (JMP).

Strategy 2: This strategy is called the “Retirement Plan Rescue” (RPR). It is similar to a JMP. The only difference is the necessary amount to pay the insurance premium is distributed from the plan each year. A reader (71-year-old widower) got $2 million into his ILIT using only $176,000 in after-tax plan funds.

Strategy 3: A subtrust does the same trick as a RPR (keeps the life insurance proceeds out of your estate, but without the need for an ILIT). A subtrust rewards you with a nice bonus — the insurance death benefits — with the same premium cost as a RPR. The premiums are higher by about 20 percent than an RPR. Generally, a subtrust is used only for married plan participants. If you are married, it’s an absolute must that you check out how a subtrust will benefit you and your family. The tax savings are huge.

Strategy 4: Boost the annual average rate of return of your plan funds to 18 percent. How? Use a new software that normally enjoys an annual rate of return of 18 percent per year to manage funds in your IRA or Rollover IRA. Remember — prior results do not necessarily predict future returns. Generally a $500,000 minimum is required, but can start with a $100,000 test account.

Strategy No. 5: If you would like to make a significant contribution to charity during your life or at your death, there are many ways to use your plan funds to enrich your favorite charity without reducing the amount that will go to your heirs.

You’ll love what a Kansas reader (Ken) did with his IRA. Ken’s IRA has a balance of $610,000, and Ken plans to contribute an additional $5,000 per year for the next 15 years. He used a RPR (Strategy No. 2) to buy $3.8 million of second-to-die life insurance in an ILIT. His IRA used the software for a portion of its funds (Strategy No. 4) to boost its income. When Ken and his wife both get hit by the final bus, the $3.8 million in the ILIT will be divided between his heirs ($1 million) and charity ($2.8 million). Any balance in the plan will take advantage of Strategy No. 6.

Strategy No. 6: Make sure your professional advisor sets your plan up to take advantage of the new Stretch IRA rules when you go to heaven. These rules allow you to leave your IRA to younger family members so that distributions are made over their longer life expectancy rather than your shorter life expectancy. It’s a great wealth-creating device for your kids and grandkids, instead of losing your plan’s funds to the IRS.

Want more information about this fascinating subject? Just write the words “Plan Info” on your request along with your name, age, address and all phone numbers (work/home/cell) where you can be reached. Include the total amount in all your plans combined and the above strategies in which you are interested. Then fax the request to me at 847-674-5299.

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection. E-mail him at or call 417-9732. His Web site is

© 2009 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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