Upon retiring, many corporate executives and other employees decide to start a second career. In some cases, these people roll over funds from their corporate retirement accounts to an individual retirement account (IRA). The IRA then purchases a business that the person runs. The goal, of course, is to avoid currently paying tax on the funds from the corporate retirement plan. There are business brokers that advocate this strategy.
Business owners frequently plan to fund their retirement with the proceeds from a sale of their business. However, they frequently fail to take the steps necessary to maximize the after-tax proceeds from the sale. One such step relates to closely-held corporations and involves making an “S election” for tax purposes.
People frequently use trusts as part of their financial and estate planning. A beneficiary typically may designate a trust to receive an interest in a qualified defined contribution plan (qualified plan) or IRA on his or her death. The problem is that the trust may not be able to stretch out the distributions from the qualified defined contribution plan or IRA. Stretching out the distributions from a qualified plan or IRA can increase the after-tax amount that the beneficiary’s heirs may receive.
Each year Americans give billions of dollars to charity. Gifting an interest in a defined contribution plan or IRA to a charity can be a very effective tax strategy for making charitable gifts. (Note: This discussion does not apply to Roth IRAs; they are subject to a different set of rules.)
Special Rule for IRAs
In previous posts we have discussed the unique characteristics of defined contribution plans (such as profit-sharing plans and 401(k) plans) and IRAs. We noted that a person is usually better off delaying distributions from a defined contribution plan or IRA as long as possible.
There are some situations where deferring distributions is not a good strategy. A few of those situations are described below. While there are other situations where deferral is not beneficial, the following exceptions warrant special attention.
We started this series of articles two weeks ago by noting the five key traits of qualified defined contribution retirement plans, such as profit-sharing plans or 401k plans, and IRAs. We mentioned the need to consider these characteristics when planning for these assets, including dispositions upon the plan beneficiary’s death.
Last week we discussed five traits of 401(k) plans, profit sharing plans, and IRAs. We need to keep these traits in mind to maximize the economic benefits of these assets. These traits come to the forefront when we are doing estate planning. This week we discuss three of the five traits and their impact: (1) plan income grows tax free, (2) plan distributions carry an income tax liability, and (3) there are required plan distributions.
For many people, an interest in a retirement plan, such as a profit-sharing plan, 401(k) plan, or individual retirement account (IRA), is their most significant asset. Planning for these assets is a real challenge.
The complexity in this area is monumental. There are many different types of retirement plans. The retirement plan that we are focusing on is sometimes called a “qualified defined contribution plan” or, popularly, a profit sharing plan or 401(k) plan. An IRA is a similar type of plan for purposes of discussing distributions from the plan. Note, however, that a Roth IRA is subject to a different set of rules than what is set out below.