There are many types of qualified plans: pension, profit-sharing, 401(k) and IRAs are the most popular. True enough, each is a great tax strategy if you ultimately need the plan funds for retirement and (1) you are in a low tax bracket when you take the funds out of the plan and (2) your estate is not large enough to kick up an estate tax problem. Perfect for more than 90 percent of American taxpayers.
But what happens if you are in the highest income tax bracket when you retire and you have an estate tax problem (say the highest bracket, 45 percent)? Sorry, the IRS has you in a tax trap. No matter when the funds are taken out of the plan (during your life or after your death), the IRS gets 67 percent of the dollars in your qualified plans. Your family only gets 33 percent. The tax trap has been sprung. A tax travesty!
Is there any way out of the trap? Actually, my network of professionals working together has developed several strategies. The one we use most often is called a “subtrust.” Here’s a typical example of how a real client used a subtrust: Joe and his wife Mary are both 60 years old. They needed $2 million of second-to-die life insurance to solve their estate tax problem. The premium cost was $22,400 per year; a bit more than Joe wanted to spend. Joe’s 401(k) plan had $400,000 in it. Joe sadly understood that his $400,000 would only net his family $132,000 ($400,000 times 33 percent).
Here’s what we did. We set up a subtrust as part of the 401(k) plan (Plan). The subtrust will pay the annual premium after receiving the funds from the Plan. Because the policy is actually an asset of the Plan, the annual premium payment is a tax-free transaction.
When both Joe and Mary pass on, their family will receive the full $2 million in policy proceeds. No income tax. No gift tax. No estate tax. The subtrust tax strategy, in this case, actually turns $132,000 after taxes into $2 million after taxes (actually more, because a portion of the original $400,000 401(k) plan funds, plus earnings, will still be in the Plan).
If you have $300,000 or more in one or more qualified plans (for example, profit-sharing, 401(k) and IRA) and have an estate tax problem, you are in a tax trap. Want to learn more about how a subtrust and other strategies that can get you out of your qualified plan tax trap? Send me (Irv Blackman) a fax at (847-674-5299); include (1) name and birthday; (2) same for your spouse; (3) total amount in all of your qualified plans: and (4) all phone numbers where you can be reached. Mark “Eagle 09-23” at the top of your fax.
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 firstname.lastname@example.org or call 417-9732. His Web site is taxsecretsofthewealthy.com.