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Jewish World Review April 11, 2005 / 2 Nisan, 5765 How can I avoid a taxing legacy? By Jan L. Warner & Jan Collins
http://www.JewishWorldReview.com |
Q: My wife and I are comfortably retired and are in our 70s. We own
one home in a small town and another in the mountains, and both are
paid for. The bulk of our assets are in a brokerage account, with
the vast majority being in IRAs that I rolled over from my 401(k)
when I retired. We have two children, both of whom are
professionals. Thankfully, our health is good and we purchased
long-term-care insurance years ago.
We don't have a taxable estate, and don't expect one. However, no
one knows what will happen to the estate tax laws by 2010, and we
want to give a large part of what we leave to our church and a
couple other favorite charities. Eventually, we want to downsize
into one home, and can't decide which. We're wondering about leaving
one of our homes to the charities and our other assets to our
children, when the second of us dies. Is this a good way to handle
things?
A: It looks as if you have done your homework, and transferring your
401(k) into IRAs made sense because many 401(k) accounts are
inflexible and not the best vehicles for intergenerational planning.
While many couples want to make charitable contributions when the
last spouse dies, a large percentage of folks don't leave the "best"
assets to the charities. In your situation as you describe it, we
believe that you're leaving the wrong assets to the charities.
Assets such as homes, stock accounts and bank accounts were acquired
with "after-tax" dollars — meaning that you have already paid taxes
before you acquired them. On the other hand, 401(k) accounts, IRAs
and other deferred accounts contain "pre-tax" dollars — meaning
that you have not paid income taxes before acquiring them and, when
the funds come out too fast or in the wrong hands, the income taxes
can be significant. But this can be avoided.
Since IRAs do not receive a "step-up" in basis (fair market value of
the assets) at death like real estate and stocks, when you make a
charity a beneficiary of an IRA when the second of you dies, the IRA
proceeds that go to the charity will not be taxed (assuming, of
course, that the charity is one that is qualified as a tax-exempt
entity by the Internal Revenue Service). Most churches will qualify,
but it never hurts to check.
Since your homes and other non-qualified assets will pass to your
beneficiaries with a stepped-up basis — meaning the fair market
value of the assets at the time of death — there should be no
capital gains taxes due should your surviving spouse or children
sell the assets at the same fair market value established at the
time of death.
Thus, by giving the tax-deferred assets to the trust and the assets
with increased cost bases to your children, significant taxation can
be avoided, even if you don't have a taxable estate.
In addition, if you do not name your children as contingent
beneficiaries at the time the second of you dies, the balance of the
IRAs will pass to the survivor's estate, an event that will require
total distribution to your children over five years rather than
their respective life expectancies. This would mean significantly
more income tax that could have been saved.
Depending on your estate tax situation, because no one knows what
will the law will be in 2010, you can use a trust with your wife as
beneficiary in order to defer estate taxes until the death of the
second spouse. And, if you don't want to give your children free
access to the IRA funds, you can establish an IRA trust with your
children as beneficiaries and allow only yearly disbursements of the
required mandatory distributions. This means that your children will
not be able to invade the IRA.
Because of the complexity of these issues, you should seek out a
competent lawyer with tax experience to guide you through the maze
of rules and regulations.
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JAN L. WARNER received his A.B. and J.D. degrees from the University of South Carolina and earned a Master of Legal Letters (L.L.M.) in Taxation from the Emory University School of Law in Atlanta, Georgia. He is a frequent lecturer at legal education and public information programs throughout the United States. His articles have been published in national and state legal publications. Jan Collins began co-authoring Flying SoloŽ in 1989. She has more than 27 years of experience as a journalist, writer, and editor. To comment or ask a question, please click here. © 2005, Jan Warner |
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