IRAs - estate planning alternatives.

• Author: Picolo, Sharon E.
• Position: Individual retirement accounts

Individual retirement accounts (IRAs) are, by design, supposed to be simple, uncomplicated vehicles by which to make tax-deferred contributions (and obtain tax-deferred income growth) into a retirement nest egg. They were originally designed to give individuals in low-income brackets who did not participate in employer-sponsored plans an incentive to save for their retirement.

Individuals who are participants in an employer plan and who earn more than the income limit are not allowed to make a deductible contribution. IRAs are usually not considered in the estate planning scenario, because the typical textbook IRA is held by a low net worth individual. There are, however, many rollover IRAs that hold large investments. These IRAs deserve special consideration when providing estate planning services to clients, because the beneficiary designation and payout provisions greatly affect the tax implications.

The entire amount in an IRA is included in a decedent's gross estate under Sec. 2039. Additionally, an estate may be subject to an additional estate tax equal to 15% of the deceased participant's excess retirement accumulation. The unified credit and state death tax credit are not allowable as an offset to this additional "penalty" tax. Further, neither the marital deduction nor the charitable deduction is available. This provision can mean an effective estate tax rate of 70% (for estates in the 55% bracket) on the fair market value of the account. Distributions from an IRA are subsequently taxed to the beneficiary.

A surviving spouse who inherits an IRA from a deceased spouse can elect to treat the IRA as that of the surviving spouse. Minimum distributions are determined based on the surviving spouse's age. Alternatively, the surviving spouse may roll the IRA distribution, tax free, into the surviving spouse's own IRA. This is important to note if the estate is the beneficiary of the IRA, and the surviving spouse is a beneficiary of the estate. A beneficiary who is not a surviving spouse cannot roll the distribution into an IRA, and will be taxed on any distribution. IRAs qualify for the marital deduction.

An IRA becomes an "inherited IRA" after the death of the IRA owner, unless the beneficiary is the IRA owner's surviving spouse. Distributions from an inherited IRA do not qualify for rollover treatment and are taxed on distribution. If a trust is named as beneficiary of an IRA, the IRA is an inherited IRA even if the surviving spouse is...