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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. Under this approach, your retirement assets go into a trust that makes payments to your heirs for their lifetimes or for a fixed period of years, after which the trust balance reverts to the charity. Your heirs pay income tax on income as received; your estate receives an estate tax deduction for the "present value" of the assets the charity expects to receive.

Here is an example of how this approach might work: Professor Woods leaves $1 million in retirement fund assets to his two children. After estate and income taxes are paid, however, they actually receive just $250,000. Had Professor Woods established a Charitable Remainder Trust, his children likely would have received lifetime payments well in excess of $250,000; and his estate would have been able to use a large tax deduction to offset taxes on other inheritable assets. Also, eventually, the balance of the assets would be transferred to Professor Woods' choice of charity.

The bottom line is that, in many cases, retirement plans are often the least desirable assets to leave to your children, but one of the best vehicles for charitable giving. Of course, when considering any estate plan options, you should consult your own financial and legal advisors to determine the best course for your individual circumstances.

More Insight Online

Taxation of inherited retirement plan assets-- and many other estate-planning issues--could be affected by tax-reform legislation now being considered by Congress. Use the online resources of e-Insight to stay abreast of the details of tax-reform and tax-reduction efforts in Washington--and to understand better the implications for you and your family. e-Insight also gives you access to an array of online estate planning resources, such as--

* E-mail access to estate planning attorney Mark Weinberg, who will provide information that will help guide your planning process and decisions with your own legal and financial advisors

* A compilation of useful background articles that will help guide you through the estate planning process, and provide food for thought about the values and priorities you hope to express through that plan

* Detailed information on specific estate planning vehicles, their uses, advantages and disadvantages.

e-Insight's estate planning resources are available online at
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Publication:Issues in Science and Technology
Article Type:Brief Article
Geographic Code:1USA
Date:Jun 22, 2001
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