As you know, many Americans have significant values in their qualified plan or 401(k), so this is a frequent and significant tax problem. Funding for the income tax due is yet another need that survives the recent tax reform.
Many have suggested funding the needed life insurance coverage with distributions from qualified plans, 401(k)s, or annuities during the participants lifetime, as this has the double benefit of both reducing the size of the asset that will be included in the estate and funding the need from the source of the taxation. Many software programs will quantify the advantage of taking this approach to income tax planning.
Since qualified plans by law cannot be assigned during life and assigning an annuity will trigger immediate taxation of any gains, re-titling these assets often is not an appropriate or available alternative. This gives added weight to the “spending down” approach suggested above, assuming of course that the participant is not forced into a higher tax bracket by doing so.
Transferring the values in these assets over time into a life insurance policy owned by an irrevocable trust would both lessen the estate taxes due and provide income-tax-free life insurance proceeds to the trust beneficiaries.
In fairness, I should point out that an income tax deduction is available that somewhat alleviates the double taxation of exposing these assets to both estate and income taxes. The recipient of IRD generally may take an income tax deduction for any estate taxes paid by the estate on the IRD item. The amount of the deduction is determined by comparing the actual estate tax paid with the amount of estate tax that would have been paid had the IRD item not been included in the estate. As you can see, this tax is at the highest marginal estate tax rate. This is a deduction to be used in determining the income taxes of the beneficiary, not a credit against the income tax due.
If two or more persons receive IRD of the same decedent, each recipient is entitled to only a proportional share of the income tax deduction. In addition, if the IRD is received over more than one taxable year, only a proportional part of the deduction is allowed each year.
The new tax law has us all focused on estate and capital gains tax planning. Lets not forget basic income tax planning, as the amounts involved can be much more significant than any estate or capital gains tax shrinkage. The solution can be as simple as totaling all of a clients IRD items and providing the funds needed for income taxes through the discounted dollars of life insurance. This is yet another way to preserve assets for the next generation as part of the clients overall estate plan.
is vice president, advanced marketing, at Jefferson-Pilot Financial, Greensboro, N.C. He can be reached via e-mail at [email protected]
Reproduced from National Underwriter Life & Health/Financial Services Edition, August 13, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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