Estate Planning Strategies for Retirement Plan Benefits

1
Current as of 05/18/01
PROTECTING RETIREMENT PLANS AND IRAs FROM TAXES

• Willms Anderson, S.C.

2
TAX ADVANTAGES OF IRAs AND RETIREMENT PLANS

• IRAs and Retirement Plans are a very
  tax-advantageous way to save.

• Income contributed to these accounts is not
  taxed until distributed.

• Income earned inside of these accounts is not
  taxed until distributed.

• Distributions can be stretched over the life of
  the account owner and his or her designated
  beneficiary.

• Willms Anderson, S.C.

3
THE POWER OF TAX-DEFERRED COMPOUNDING
The benefits of tax-deferred compounding cannot
be overstated. Consider the following example

• Mary, who is age 30, contributes 2,000 to an
  IRA each year until she attains age 65.

• If those contributions grow at a rate of 10
  (pre-tax), by the time Mary turns 70 the IRA will
  have a balance of 963,481.

• Willms Anderson, S.C.

4
THE POWER OF TAX-DEFERRED COMPOUNDING

• Assume Mary designates her grandchild, age 20,
  as the beneficiary of her IRA.

• Mary then begins to withdraw the smallest amount
  possible from her IRA.

• Willms Anderson, S.C.

5
THE POWER OF TAX-DEFERRED COMPOUNDING

• At Marys death her grandchild continues to
  withdraw the smallest amount permissible under
  law. In this scenario the total amount
  distributed to Mary and her grandchild would be
  39,653,352!

• Willms Anderson, S.C.

6
DISTRIBUTION RULES FOR ROTH IRAs
Example 2 Assume the same facts as Example 1
but with a Roth IRA.

• The minimum distribution rules do not apply to
  Roth IRA during the account owners life.

• As a result, the Roth IRA would be worth
  3,023,816 at Marys death if no lifetime
  withdrawals were made.

• Willms Anderson, S.C.

7
DISTRIBUTION RULES FOR ROTH IRAs

• The Roth IRA could distribute 70,108,469 to
  Marys grandchild if minimum distributions were
  taken and estate taxes were paid from a different
  source.

• Willms Anderson, S.C.

8
Payment of Estate Taxes on Retirement Plan
Benefits
If estate taxes may be incurred on retirement
plans or IRAs, then it will be important to
identify a source of funds which can be used to
pay those taxes.

• Willms Anderson, S.C.

9
Payment of Estate Taxes on Retirement Plan
Benefits
Option 1 The residuary estate could pay the tax.
Problems

• Amounts outside of the retirement account may be
  inadequate.

• The beneficiary of the retirement account and the
  residue might be different.

• Depletion of residue could accelerate retirement
  account distributions.

• Willms Anderson, S.C.

10
Payment of Estate Taxes on Retirement Plan
Benefits
Option 2 Amounts held inside the retirement
plan or IRA could be withdrawn and then used to
pay the tax.

• This would trigger an income tax which, when
  combined with estate taxes, can cause over 70 of
  the retirement assets going to Uncle Sam.

• Willms Anderson, S.C.

11
NO QPIP
TAXES

To Family



Income Taxes

As little as

Plus

30 of Retirement
Estate Taxes

Account

______________

Up to 70 of

Retirement Account

• Willms Anderson, S.C.

12
Payment of Estate Taxes on Retirement Plan
Benefits

• Option 3 Life insurance could be used to pay
  the tax.

• Insurance proceeds collected by an insurance
  trust avoid both income and estate taxes.

• If the insurance trust was designated as the
  beneficiary of the retirement plan benefits, the
  insurance proceeds could be used to pay the
  estate taxes.

• Willms Anderson, S.C.

13
USING INSURANCE TO PAY ESTATE TAXES ON RETIREMENT
ACCOUNTS

• Willms Anderson, S.C.

14
USING RETIREMENT ACCOUNTS TO PAY INSURANCE
PREMIUMS
If insurance will be used to pay the estate taxes
on retirement plan accounts, then consider using
retirement account assets to pay the insurance
premiums.

• Willms Anderson, S.C.

15

PLAN DISTRIBUTIONS FOR PREMIUMS
One option would be for the retirement account to
make a distribution from the account to the
participant.

• These distributions will trigger an income tax,
  however.
• The account owner could then use the amount
  remaining after tax to pay insurance premiums.

• Willms Anderson, S.C.

16
USING RETIREMENT ACCOUNTS TO PAY INSURANCE
PREMIUMS

• Willms Anderson, S.C.

17
QPIP

• A Qualified Plan Insurance Partnership? (or
  QPIP?) is a technique which is intended to
  allow retirement account assets to be applied to
  life insurance premiums without triggering income
  taxes.

• Willms Anderson, S.C.

18
QPIP
With QPIP, the retirement account, the account
owner and an insurance trust join together to
form a limited partnership or limited liability
company (LLC).
Contributions to the partnership or LLC would
come from the retirement account and the
insurance trust.

• Willms Anderson, S.C.

19
QPIP

• Upon formation , the insurance trust would
  contribute to the entity no less than an amount
  equal of the cost of the death benefit protection
  offered by the contract.
• The balance of the entitys assets would be
  contributed by the retirement account.

• The earnings generated by these contributions
  are then used to pay insurance premiums.

• Willms Anderson, S.C.

20
QPIP

• Upon the death of the insured, the retirement
  account would receive an amount equal to the
  greater of (i) the cash value of the policy and
  (ii) the contribution it made to the LLC, plus a
  minimum guaranteed rate of return.

• The balance of the insurance proceeds would be
  distributed to the irrevocable trust free of both
  estate and income taxes.

• Willms Anderson, S.C.

21
EXAMPLE Bill Payer is age 60, married and has
three children. He and his wife have a combined
taxable estate of 4,000,000, 1.5 million of
which is invested inside of a retirement account,
500,000 is in his home, 1,500,000 consists of
commercial real estate and the balance (500,000)
is annuities, stocks and bonds.
QPIP

• Willms Anderson, S.C.

22
QPIP
Bill and his wife would like to stretch out
Bills retirement account after the survivor of
he and his wife dies to maximize its tax
benefits. Accordingly, Bill designates his wife,
then his children as the beneficiary of his
retirement account.  

• Willms Anderson, S.C.

23
Bill realizes that there will be estate taxes
imposed upon the retirement account when the
survivor of he and his wife dies to the extent
the amount in the retirement account exceeds the
survivors unified credit.
QPIP

• Willms Anderson, S.C.

24
QPIP
Will E. Live, Bills insurance agent, advises
Bill to purchase a second-to-die insurance policy
to pay estate taxes attributable to his
retirement account. However, Bill argues that he
has insufficient liquid assets outside his
retirement account to pay the premium, and
further, that he does not want to make taxable
withdrawal from the account to pay insurance
premiums.  

• Willms Anderson, S.C.

25
Will suggests to Bill that a QPIP could be used
to solve Bills dilemma. Accordingly, Bill
establishes a limited liability company (LLC)
between himself, his retirement account, and an
irrevocable insurance trust.  The LLC purchases
the second-to-die policy on Bills life.
If the retirement account is an IRA, the policy
should not be purchased shortly after the
LLC is established.
QPIP

• Willms Anderson, S.C.

26
QPIP
Upon formation of the LLC, the insurance trust
contributes to the LLC no less than the cost of
the insurance protection afforded by the policy
while premiums are payable.

• Willms Anderson, S.C.

27
QPIP
All remaining contributions come from the
retirement account. These contributions are
reflected in the members capital accounts and
invested by the LLC, with the earnings used by
the LLC to pay the policy premiums.
28

• Willms Anderson, S.C.

29
The survivor of Bill and his wife dies 10 years
later. The LLC collects the insurance proceeds.
The retirement account is credited with an amount
equal to the greater of the policy's cash value
and its investment in the LLC, plus the
guaranteed rate of return which has been
specified in the operating agreement (if any).
The balance of the death benefit is credited to
the capital account of the insurance trust.
QPIP

• Willms Anderson, S.C.

30
QPIP
After Bill dies, the irrevocable trust may
withdraw its share of the death proceeds from the
LLC. There should be no income taxes imposed on
this withdrawal because it is attributable to
insurance proceeds. Likewise, the amount
withdrawn from the LLC will avoid estate taxes,
and generation-skipping taxes as well if Bill
allocated his GST exemption to the initial ILIT
contribution.

• Willms Anderson, S.C.

31

• Willms Anderson, S.C.

32
QPIP
The amount which was paid from the LLC to the
irrevocable trust should avoid both estate and
income taxes. It could then be used by the trust
to pay estate taxes attributable to the
retirement account.

• Willms Anderson, S.C.

33
Distribution of Profit Sharing Plan at Death
Profit Sharing Or IRA

• To Family
• 100
• IRA can be reinvested pre-tax over Beneficiarys
  lifetime.
• Pre-tax growth for many years means much larger
  distribution to Family

Taxes 0 (paid by Life Insurance)
34
If you are interested in establishing a QPIP or
discussing how the new IRA rules impact you,
please contact us at 1.262.238.6996 or e-mail us
at firm_at_estatecounselors.com

• Willms Anderson, S.C.