Choose the Right Partner

Posted: Oct 21, 2010 12:01 AM

If you have ever read anything I written before, you know how I feel about taxes. Every day it becomes more apparent that we are headed for a tax system that penalizes those who work the hardest, take the risks, and actually buy into the concepts of capitalism and free markets. This “war on wealth” is creating a targeted class of individuals I call accidental philanthropists-- and you may be one of them. Accidental philanthropy is an involuntary redistribution of wealth- -your wealth-- wherein our government representatives redistribute the taxes that you pay through the social programs they choose to fund and the causes they select! Each time the current administration grabs more governmental power, it chips away at the freedoms we enjoy most. The government wants to be our partner in everything, and it is costing us power and control over our own hard-earned dollars.

Nowhere is accidental philanthropy more prevalent than in the attack on our retirement plans. I’m sure you know that the “minimum retirement distribution” rules that govern IRAs require you to take money out each year after you reach age 70 ½ and pay tax on it--even if you don’t want it! But did you know that at the surviving spouse’s death, the entire IRA is subject to income tax and estate tax? Your IRA could lose as much as 40% to 66% to taxes in the years ahead. Your “government partner” could get more of your retirement dollars than your kids!

There is a way to regain control over your IRA and in so doing preserve more wealth for your children, pay far less in taxes, and create a lasting legacy for the charitable organizations that are important to you. All you need to do is choose a different partner!

If you are familiar with Roth IRA conversions, you’ll grasp this in heartbeat. If you’re not, you may want to do some research on Roth conversions before you move forward. I call this technique, a “Charitably Leveraged IRA Conversion.” It is clearly not for everybody, but it has incredible power for folks who are charitably inclined, are over the age of 60, and don’t plan on using all of the money accumulated in their IRA. If your goal is to get your IRA to your kids and grandkids, this approach is worth a look. The mechanism is pretty simple and uses only two moving parts, a charitable remainder annuity trust (CRAT) and cash value life insurance policy (CVLI). Here is how it works: The parents (that would be you) withdraw the IRA assets they intend to go to their children, and then use them to fund a specially designed CRAT with a ten year term and a reasonable annuity rate. The CRAT would make payments to the parents for 10 years. Whatever is left over at the end of term 2 would pass on to charities that are important to the parents. The parents then use the ten annual payments to a fund permanent life insurance policy that would go to their children. The life insurance is used to replace the CRAT (formerly the IRA) with tax-free dollars. A second-todie life insurance policy in an irrevocable trust works best. Suppose the parents (both age 65) want to convert a $500,000 IRA. Normally, that would generate about a $200,000 tax bill and still be subject to estate taxes. But they could chop that bill to $105,000 by investing the $500,000 in a charitable remainder annuity trust--and avoid future taxation. If the CRAT paid the parents $32,500 a year and the parents are in reasonably decent health, they could buy $1.6 million in life insurance that would ultimately go to their children--tax free. That is more than three times the value of the $500,000 IRA. Meanwhile, the trust would ultimately leave $600,000 to charities, assuming only a 5% return. Recap: • Start with a $500,000 traditional IRA when both parents are age 65 and in OK health. • Use the IRA assets to a fund charitable remainder annuity trust (CRAT) with a 10-yr term (assuming a 5% return) • Income tax on IRA withdrawal is $200,000 (assuming 40% tax-bracket), but the charitable gift to the CRAT cuts it to $105,440. • Use the annuity payments of $32,000 a year to buy $1.6million worth of second-to-die permanent life insurance for your children. • At age 75 (ten years from now) the CRAT ends and about $405,000 goes to your favorite charities. • At the death of the second spouse the $1.6million is paid to your children via the taxfree insurance proceeds. If the policy is held in an irrevocable life insurance trust, the proceeds will be free from estate tax as well. • This is an illustration only for educational purposes and uses current assumptions that are not guaranteed. Always consult with a professional legal and tax advisor. This strategy is not for everybody and you really need to fit the criteria I established above for it to make sense. As with all techniques of this magnitude, remember that this is not a do-ityourself plan. I am not an attorney or an accountant and I don’t provide legal or tax advice. If anything I said here makes you want to take a closer look, please talk with a qualified legal or 3 tax professional. The bottom line is that if you choose your partner wisely you can regain power and control over your assets and leave a legacy that will last generations. To me, this is a great way to add meaning to your money.