Your clients probably want to leave as much as possible to their heirs. However, if they don't take minimum distributions from their Individual Retirement Accounts after they reach 70-1/2, the government could take a substantial amount of those assets.The Internal Revenue Service can charge an excise tax of up to 50 percent if clients don't take the required minimum distribution from their IRA accounts or qualified retirement plans by April 1 of the year after the year they turn 70-1/2.

In other words, if the client turned 70-1/2 in 2006, they needed to have taken the required minimum distribution by April 1, 2007. Even if clients start taking distributions earlier, once they turn 70-1/2, they need to make sure that the distributions for that year and future years meet the IRS minimum requirements.

The minimum distribution is based on the account balance divided by the remaining life expectancy or by the applicable distribution period. This amount needs to be recalculated every year to reflect changes in the account balance (for example, rising or falling stock or bond prices).

ANNUITIES IN AN IRA OR QUALIFIED PLAN

In the past, required minimum distributions for qualified accounts were calculated solely based on the prior year's December 31 account value. The IRS has adopted final regulations requiring changes in the methodology used for calculating RMDs for annuities beginning in the calendar year 2006 and forward.

Pursuant to the new regs, RMDs will be based on the "entire interest" in the annuity contract. (See Treas. Reg. 1.401 (a)(9)-6.) These regulations define the entire interest as the prior year's account value plus the actuarial present value of any additional benefits provided by the annuity contract. For these purposes, any "additional benefits" generally will include most living benefits, withdrawal benefits and some death benefits.

Since the RMD calculation is essentially based on a present value of the additional benefits, in most cases the RMD will only be slightly higher than in the past, and in some cases may be moderately higher.

Those contracts most affected will be those with a higher death benefit in proportion to contract value. Remember, this only affects those annuity contracts that are held in qualified accounts that must pay a required minimum distribution, such as a traditional IRA, a 403(b) or a 401(k), or those that are in settlement where the beneficiary has elected "stretch."

INVESTMENT OPTIONS

For clients who don't need the cash flow from a retirement account, there are some options to invest those assets in other vehicles that would not cause a tax consequence for their heirs.

For example, your clients originally invest in tax-deferred assets such as annuities and IRAs to help create a strong retirement savings plan. As they grow older and more affluent, their potential income and estate tax exposure becomes a bigger problem than their retirement planning needs. Some may no longer need these assets for income purposes.

At their death, a tax dilemma is created, because these assets would be subject to both income and estate taxes. In fact, they could shrink by up to 60 percent to 70 percent before reaching the beneficiaries.

There is a wealth-transfer-planning strategy designed to enable your clients to pass on more of their wealth to their beneficiaries. With certain assets, by addressing the income taxes during their lifetime along with the estate tax implications, their beneficiaries can receive more wealth without the burden of these taxes.

LIFE INSURANCE ADVANTAGE

Because of life insurance's tax advantages, a properly structured policy will transfer money more efficiently, offering more attractive financial results to the beneficiaries. (Note that you must be insurance-licensed to offer this solution.)

Among the client benefits of such a plan:

* It maximizes the after-tax dollars transferred to the beneficiaries;

* If properly structured, it can reduce the overall estate tax liability;

* The value of the death benefit is established during lifetime; and,

* The death benefit is distributed according to the customer's personal desires.

Among the benefits to beneficiaries:

* The death benefit is received income- and estate-tax-free; and,

* There is no shrinkage due to taxation.

Among the benefits for the planner:

* Many clients may not realize that their IRAs have created estate-planning issues;

* It is an effective prospecting tool to use with existing customers or new prospects; and,

* The beneficiaries may become customers.

Jeffrey J. Klein CFP, CFS, serves as executive manager of strategic business units at broker/dealer H.D. Vest, where he directs the growth and development of advisory services and insurance services, among other areas.

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access