As the oldest boomers, those now 59 1/2 , can begin to live off assets held in employer-sponsored qualified retirement plans, many are inquiring with increasing urgency about potential tax liabilities. On this question, much will depend on the choices they make respecting distributions.
The impact of plan elections on clients’ retirement and estate planning objectives was the theme of a June 22 audio/Web conference sponsored by the Society of Financial Service Professionals, Bryn Mawr, Pa. Titled “Keeping the Tax Sizzle in Estate Planning Strategies,” the session was presented by Eva Ribarits, a principal at Creative Transitions, Wellesley, Mass.
“In the past, I referred to retirement plan assets as tax time bombs,” said Ribarits. “With annual increases in the estate tax exclusion amounts and the repeal of estate tax in 2010, I started calling these assets tax fuses. My hope is that in doing planning with clients, advisors will be able to maintain the sizzle of these tax fuses into the next generation.”
To that end, Ribarits said advisors need to explore with boomer clients three challenges: (1) how to maximize retirement plan assets by minimizing income tax liability; (2) how to transfer assets cost-efficiently (i.e., without probate expenses and with minimal estate tax liability); and (3) how to preserve plan assets for the next generation by understanding the distribution options available to beneficiaries.
As to the first question, participants in employer-sponsored qualified retirement plans need to weigh two choices in determining how best to stretch out payments on any income tax liability. One is to elect (assuming a married couple) a joint and survivor life expectancy annuity, under which the IRS assumes a 10-year age difference between the participant and the beneficiary. If the age difference is greater than 10 years, the tax-trigger will hinge on the difference in life expectancy.
A second method, dubbed net unrealized appreciation or NUA, lets plan participants convert ordinary income tax on distributions to a lower capital gains tax. To qualify for this election the plan must, in addition to being employer-sponsored, include the employer’s securities. And the participant must be able to roll the plan into an IRA.
Ribarits noted, however, that only gains enjoyed on the employer’s securities are eligible for the conversion–and before the IRA rollover. Non-employer securities that clients transfer to the IRA remain subject to ordinary income tax.
Also to consider in weighing income and estate tax implications are the parties named as beneficiaries. Regardless of the party selected–spouse, non-spouse, charity or trust–boomers participating in qualified plans still can leverage the joint and survivor distribution option. But the selection does impact distribution options available to the beneficiary.