Receiving a tax deduction andtax-deferred growth are 2 reasonsfor you to use retirementplans in your investment program. Isthere a way to magnify these results?Under certain circumstances, theanswer is most definitely, yes.
Let's assume that you have namedyour spouse as your primary beneficiaryand you leave your contingentbeneficiary blank. If your spouse predeceasesyou, your retirement planassets will automatically go to yourestate and be distributed according tothe terms under your will. Let's assumeyour will leaves everything toyour children. Because your estate isthe beneficiary, the income taxes onyour retirement plan assets must bepaid within 5 years of your death.
If, on the other hand, you namedyour children as the contingent beneficiary,they would have the optionto continue deferring the majorityof the retirement plan assets overtheir lifetimes. Under these circumstances,the law requires that theybegin mandatory distributions priorto December 31 of the calendar yearfollowing the year of your death.However, mandatory distributionsare based on their life expectancy.This results in a reduced mandatory(taxable) distribution, thus allowingfor a substantial continuation ofdeferral. Let's look at 2 examples.
Assume that you are age 45 andare the named beneficiary under yourfather's IRA in the amount of$200,000. He dies, and you elect toreceive only the minimum requireddistributions. Based on life expectancytables, your life expectancy is 37years. For your interest rate assumptionyou choose 6%, which results ina required annual distribution of approximately$14,000.When choosingan interest rate assumption, the IRSrequires that you choose a "reasonable"rate. Case law indicates that areasonable range is 6% to 8%. Forour final assumption, we will assumethat you earn 10% on the portfolio.Thus, you're able to continue to deferthe $200,000 principal plus approximately$6000 per year of the growth.Over 37.7 years (your life expectancyaccording to the IRS) the accountwould grow to over $2.5 million.
In our second example, let's assumeyour father uses this strategynaming your 25-year-old son (insteadof you) as the beneficiary. Yourson's life expectancy is 57 years. Yourfather dies and your son now electsto take minimum distributions in theamount of $12,450 per year whiledeferring any additional growth. Ifthe account earns an average of 10%per year, the account value wouldhave grown to over $3.5 million bythe time he turns age 65. This is inaddition to the nearly $500,000 indistributions that he took out overthat time period. This strategyallows you to leverage a modest retirementaccount into a multimillion-dollar financial asset.
, founder of
the Welch Group, has been
rated one of the nation's top
financial advisors by Money,
Worth, and Medical Economics.
He welcomes questions or
comments from readers at 800-709-7100 or
www.welchgroup.com. Reprinted with permission
from the Birmingham Post Herald.
Stewart H. Welch III