Planning with Retirement Accounts, 05/31/2006

For many of us, our retirement fund is our largest single asset. It could be an IRA, a 401(k), 403(b), or other qualified plan. Retirement assets require careful consideration because unique rules apply to them.

Retirement assets are favored assets in some ways, and disfavored in others. Retirement assets are favored in that they are exempt from your creditors in bankruptcy, at least up to the amount that is needed to fund your retirement. On the other hand, retirement assets are disfavored in that they generally have income tax liability built-in. When saving for retirement, you put away money before taxes, deferring that income taxation. However, this built-in tax liability makes planning for retirement assets more complicated than other assets.

Retirement assets require careful planning in order to achieve your goals. There are several methods to achieve your goals. First, if you expect you will owe estate tax, you may consider taking your IRA and converting it to a ROTH IRA, if you qualify to do so. By doing this you pay the tax owed on the IRA while allowing the IRA to grow tax free. More importantly, there is no longer estate tax payable on the money you used to pay the income tax.

Another strategy is to do a “rollover” of the plan assets to your spouse upon your death. This allows you to stretch the payout in order to defer payment of taxes for as long as possible, while qualifying for a marital estate tax deduction. Then, at your spouse’s death, the assets can be left to your children and drawn out over their life expectancies. You may also want to consider leaving these assets to your children in trust in order to protect the assets from your children’s creditors or future ex-spouses.

Another strategy used for those who are charitably inclined is to remove money from the retirement plan in order to give it to charity or to a charitable remainder trust. Basically, you use the charitable deduction to offset the income tax generated by the withdrawal from the retirement plan.

Planning for retirement assets is a complicated matter. Morris Hall, with our focus on estate planning, is here to help you navigate the retirement asset minefield.