Tax Secrets: Double tax on qualified plans can be beat?

Irv Blackman

The positive trumpets continue to blare: qualified retirement plans (pension plans, profit-sharing plans, IRAs, 401(k) plans, etc.) are great. Do you agree? If so, you have lots of company.

After all, a current deduction for contributions to your plan, plus tax-deferred accumulation of earnings could never be a bad tax move. Right? The clear answer is it all depends … on (1) whether you will need that money someday for retirement; or (2) you turn out to be rich.

If you are already rich (or become rich), all of your qualified plan money will be caught in a huge tax trap ... a tax disaster. Simply put, you have a lousy tax asset.

Tax Secrets

Why? How can this be? Well, let’s look at $100,000 (substitute your own real number) in your profit-sharing plan or other qualified plans: The IRS will get 64 percent ($64,000), your family only 36 percent ($36,000). A tax travesty!

Here’s how the tax law robs your dollars. Each plan distribution is socked by 40 percent (Federal and State combined) in income tax (substitute the total of your federal, state and local income taxes).

Note: Florida residents get a break – no state income tax – but still get socked for the federal income tax.

Painfully, you watch your $100,000 turn into $60,000. When you go to heaven, the IRS feasts on the remaining $60,000: this time, it’s the 40 percent estate tax leaving your family with $36,000.

Note: The tax rates (federal/state) may change from time to time, but the tax-you-twice-bad-tax-law concept will stay the same.

In an evil sort of way, the IRS gives you a second chance to pay the double tax. If you die before distributing all of your qualified plan funds, your heirs still get hammered for the same double income tax and estate tax. Stop! Take a moment (or ask your tax professional) to apply these awful same-if-you’re-dead-or-alive rules to your plan numbers.

You are probably wondering if there is a way out of this expensive tax trap. Actually there are a number of ways. But here’s one way that is easy to do and works all the time: the annuity/insurance strategy. For example, suppose Joe (married to Mary) has $1.75 million in his qualified plans. Joe has the plan trustee buy a joint and survivor annuity (continues to pay as long as either Joe or Mary is alive). They use a portion of the annuity to make an annual gift to an irrevocable life insurance trust (ILIT) that buys a $2 million second-to-die policy (on Joe’s life and Mary’s life). After both are gone, the IDT will have $2 million – free of taxes – for their family. Not only is the $1.75 million in the qualified plans fully replaced, but the $2 million insurance proceeds will create an additional $250,000 in tax-free wealth.

Remember, that $1.75 million in the qualified plan is only worth $630,000 (36 percent of $1.75 million). Plus, Joe and Mary will receive the annuity payment – every year – as long as either one of them is alive. A portion of the annuity, after paying the policy premium, will be available for Joe and Mary to spend as they desire. Yes, some of my clients call this strategy, “a money-making machine.”

The variations on the Joe and Mary scenario described above are endless.

Actually, when you know what to do, it’s easy to escape the Qualified Retirement Plan tax trap. Be proactive. Do nothing and the tax law will eat your qualified plan funds for lunch. Use this article to get started. Don’t wait. Time favors the IRS.

Join the tax-saving fun. I have arranged to have your personal situation professionally analyzed. To participate, just fax the following information (to 847-674-5299) or email to irv@irvblackman.com: (1) Your name and birthday (also your spouse); (2) address; (3) phone (office, home and cell); (4) total amount in all of your qualified plans combined. Mark “Eagle” on your page.

Chances are we can turn your double-tax asset into a money-making machine.

Have a question? Call me (Irv) at 847-674-5295.