Planning around the "success" tax.

• Author: Lusby, Roger W., III

While saving for retirement is a worthwhile objective, most people do not do so. For those individuals who have been disciplined, and have saved and properly invested their assets, the "reward" is a maze of taxes.

Of particular concern are assets held in retirement plans. Retirement plan assets can be subject to income taxes, estate taxes and, in some cases, an additional "success" tax. In many instances, the total tax liability easily can be 70%, and in some cases it reaches 95%.

The Tax Reform Act of 1986 (TRA) imposed a 15% excise tax on individuals whose taxable distributions from all tax-favored plans exceed certain thresholds. For 1996, the excise tax applies to taxable distributions in excess of $155,000 ($775,000 for lump-sum distributions). These amounts are indexed for inflation. Tax-favored plans include all retirement plans, such as defined benefit and contribution plans, Sec. 401(k) plans, Sec. 403(b) plans, profit-sharing plans, individual retirement accounts (IRAs), simplified employee pensions (SEPs) and stock appreciation rights SEPs (SARSEPs).

The TRA also imposed a 15% excise tax on estates with "excess retirement accumulations." This tax is imposed by increasing the estate tax that otherwise would be due. When coupled with the 55% maximum estate tax, large qualified plans can face up to a 70% tax rate before any income tax considerations. The excise tax cannot be sheltered by the unified tax credit or the unlimited marital deduction, although a special election is available for a spouse designated as the beneficiary. Therefore, without proper planning, the excise tax can result in a tax when the estate might not otherwise be taxable.

The term "excess retirement accumulations" is defined as the amount by which the decedents aggregate value in all retirement plans exceeds the present value of a hypothetical life annuity. The hypothetical life annuity is based on the annuity factor in Table S of IRS Publication 1457 for 120% of the Federal mid-term rate. The present value is the annuity factor multiplied by the applicable lifetime threshold amount (see Temp. Regs. Sec. 54.4981A-1T, d-7). This hypothetical life annuity is calculated as a single life annuity with annual payments equal to $155,000 for 1996. The interest rate is the IRS rate for valuing an annuity that applies in the month of valuation and the life expectancy is based on the decedent's age in whole years on the date of death. The excise tax might be reduced if...