The Problem With IRAs



Posted: Thursday, June 11, 2009

by
The Blaine Group, Inc.

IRAs now compromise a significan portion of individual's estates. An increasing number of IRAs may be left to heirs as this trend continues. IRA distribution laws have recently changed, allowing heirs to take distributions over thier life expectancies, thus increasing the time these plans can continue to grow on a tax-deferred or tax-free basis.

However, the estate and income tax consequences of inheriting IRAs still remain. IRAs are subject to estate taxes, when left to heirs other than your spouse, if your taxable estate exceeds $3,500,000 in 2009 (or $2,000,000 in 2008). From an income tax standpoint, distributions to heirs are taxed in the same manner they would have been taxed to you. Thus, distributions from traditional deductible IRAs are fully taxed at ordinary income tax rates, earnings from traditional nondeductible IRAs are taxed at ordinary income tax rates, and qualified distributions from Roth IRAs are income tax free. The combined impact of estate and income taxes can seriously erode your IRAs' values. Heirs receive some relief in the form of a tax deduction related to this "income in respect of decedent," which partially reduces the federal estate tax liability over time as income is recognized. But the total tax burden, even after this deduction, can still reach up to 70 percent of the IRAs' value.

By converting your traditional IRA to a Roth IRA, you can reduce this burden. While you must meet eligibility requirements to do so and must pay income taxes on the taxable amount of the conversion, those taxes can be paid with funds outside the IRA, thus preserving the IRA's value and reducing your taxable estate. Then, your heirs will receive distributions free from income taxes, including any future appreciation on the balance.

Another alternative is to provide your heirs with a means to pay the estate and income taxes so they don't have to deplete the IRA balance, possibly through the use of a life insurance policy not owned by you. Your heirs receive the proceeds free of both incom and estate taxes since you don't own the policy. They could then use the proceeds to pay estate and income taxes, without using assets from the IRA. This is an easy solution to the burdens of a traditional IRA for you and your loved ones.

A financial adviser can discuss strategies with you to lessen the tax burden of inheriting IRAs.

Copyright (c) 2009 Selwyn Gerber

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For more information go to www.gerberco.com
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