Avoiding the Worst of Both Worlds

A central issue for many older clients is preserving IRA assets from estate taxes. Michael T. Koenig, managing partner at FirsTrust in Daytona Beach, Florida, offers the following tips:

The IRA rules have changed in recent years, and broader opportunities have arisen which permit us to incorporate large IRAs into an estate plan in a more tax-efficient manner. Historically, since we have an unlimited estate tax deduction on qualified property that passes to a spouse, IRAs have most often been rolled over by the surviving spouse without receiving the benefit of the decedent’s estate tax exemption. This eventually left the IRA exposed to estate taxes in the spouse’s estate. The rules changed a few years ago to permit a properly structured trust to serve as the “designated beneficiary” of an IRA in order to help mitigate this problem. But this solution is not absolute and can be accompanied by a variety of devastating tax downsides if, as many people have, they simply name their revocable living trust as the IRA beneficiary.

Another common mistake is to assume that all inherited property is tax-free. Income taxes may still be due on certain items that are taxed as Income in Respect of a Decedent (IRD), of which IRAs are the most typical. Statistics tell us that as much as 70% to 80% of an inherited IRA can be depleted by a combination of federal and/or state estate and income taxes–even after the application of the tax credit afforded under Code Section 691(c).