Shielding Retirement Assets From Taxes

The impact for retirees and their heirs

Executive Summary

The retirement assets you’ve worked so hard to save will typically be taxed once distributions begin. Fortunately, there are strategies that can reduce taxes for you and your heirs.

As hard as it is to believe, today’s tax-advantaged plans—including individual retirement accounts (IRAs), 401(k)s, and rollover IRAs—have the potential to make many employees millionaires.

A 401(k) contribution of $433 per month, at 8% per annum compounded monthly, would be worth more than $1 million after 35 years.1

This is a hypothetical example shown for illustrative purposes only. It does not represent the performance of any specific investment product.

These plans are also highly vulnerable to unintended tax costs if they are not bequeathed properly. For instance, a $1 million IRA inheritance could be whittled to almost nothing under particularly bad circumstances, such as a combination of estate taxes, top income tax brackets, and missed withdrawal deadlines.

Saving your heirs tax dollars on your retirement money often hinges on the decisions you make before you retire. Therefore, it’s important to take a look now at how to protect heirs from tax headaches later on.

RMD Rules Simplify Things

The IRS rules for calculating the required minimum distribution (RMD) from IRAs and qualified retirement plans provide some longer-term planning advantages.

For the tax conscious, the premise behind retirement plan distribution requirements is simple—the longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year. Because your heirs could inherit this payout schedule along with the assets’ tax bill, talk to your tax or financial advisor about how these rules should be applied to best meet your goals and objectives. Keep in mind that if you or your heirs do not withdraw minimum amounts when required, a tax penalty equal to 50% of the required amount may apply.

Stretch Out the Tax Bill

There are various other ways to make the tax payments on retirement assets easier for heirs to handle. These are:

Select a beneficiary

If no one is named, your assets could end up in probate and your beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal, because they have several options that aren’t available to other beneficiaries, including the marital deduction for the federal estate tax and the ability to transfer plan assets—in most cases—into a rollover IRA.

Consider the options for multiple beneficiaries

If you want to leave your retirement assets to several younger heirs (such as your children), the rules applicable to stretch IRAs2 provide added flexibility in that beneficiary designations need not be finalized until December 31 of the year following the year of the IRA owner’s death for the purposes of determining required distributions. An older beneficiary (e.g., a son or daughter of the IRA owner) may be able to either cash out—or disclaim—their portion of the IRA proceeds, potentially leaving the remainder of the IRA proceeds to a younger beneficiary (e.g., a grandchild of the IRA owner). As long as this is done prior to December 31 of the year following the year of the IRA owner’s death, distributions will be calculated based on the younger beneficiary’s age. Because rules governing use of these strategies are complex, speak with a tax attorney or financial advisor to make sure that correct requirements are followed.

2 A stretch IRA is an estate planning concept that may extend the financial life of an Individual Retirement Account (IRA) across multiple generations.

Be Generous

Plan assets given to charity are fully estate tax deductible, and federal income tax is due on this gift. You should contact your tax or financial advisor to gain a better understanding of the tax benefits of donating IRA or qualified plan assets to charity.

Consider naming trusts as beneficiaries

Because qualified plan assets qualify for the unlimited marital deduction, spousal beneficiaries may inherit these assets without tax consequences when the assets are left intact as part of the estate. Some estate planning experts have developed strategies naming trusts as beneficiaries. This type of planning is very complex and requires specialized expertise in estate planning.

Strategies for

Consider a rollover IRA
With rollover IRAs you can practice some creative tax planning, such as setting up stretch IRAs for your children or recalculating the distribution schedule for yourself.

 “Disclaim” IRA assets if you don’t need them
If you are the primary beneficiary of an IRA and your child is the contingent beneficiary, you may be able to disclaim your right to the IRA proceeds. If done by December 31 of the year following the year after the IRA owner’s death, future distributions may be based on your child’s age, effectively spreading those distributions out over a longer period of time. Be sure to check with a tax attorney prior to using this strategy.

Strategies for Nonspouse Beneficiaries

With  stretch IRAs, do not change the name!
Under IRS rules, your inherited IRA becomes immediately taxable if the name on the account is changed to the beneficiary’s name.

Watch the calendar
The account also becomes immediately taxable if you don’t take your first required payout from an inherited IRA by December 31 of the year after the account owner’s death.

“Disclaim” IRA assets if you don’t need them

Similar to the strategy for spouses, consider disclaiming assets if you don’t need them.

Talk to the Right People

With careful planning, your retirement assets can remain as vital after your death as they were during your lifetime. Talk with your financial advisor and with those who may bequeath a retirement legacy to you—such as parents or grandparents—to see what type of tax planning they’ve put in place.

Opening the doors to this discussion could make your tax burden lighter later on and bring peace of mind to your family.

The tax information contained herein is provided for informational purposes only. AMG Funds does not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific financial or tax situation. Investing involves risk, including possible loss of principal.
AMG Distributors, Inc., is a member of FINRA/SIPC.
AMG Funds LLC is a subsidiary and U.S. distribution arm of Affiliated Managers Group, Inc. (NYSE: AMG).

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