Brad Rhodes column: Does your retirement account need rescuing?

Published 12:00 am Thursday, May 5, 2022

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By Brad Rhodes

Because of the accumulation benefits of tax deferral, many individuals have successfully created substantial IRA or 401(K) accounts or other qualified plans.

Many people are shocked at how much of their tax-deferred balances will be erased by current taxes when funds are withdrawn. It is not uncommon for these accounts to have amassed seven figures of total dollars. It is also usually the case that little attention has been focused on what will happen to one’s hard-earned dollars when taking money out of the Plan.

Reductions due to taxes can be dramatic

The tax-caused decrease in total assets going to family members can be dramatic. For example, we recently reviewed a client situation where the plan holder had a $6 million balance. The client wished to begin distributions at age 70 ½. Further, the client did not require any distributions to maintain their lifestyle and wanted all the funds to go to children. The client was disappointed to learn that, under the client’s current structure when distributed over 10 years, the $6 million would be slashed because of taxes by $2.6 million and only yield $3.4 million net proceeds to the beneficiaries.

The $2.6 million of asset erosion occurs because all funds coming out of a qualified plan are fully taxable as ordinary income. And, contrary to common belief, assets in an IRA do not benefit from a step-up basis when passed on. Thus, while this case was a reduction of some 43%, other plans can be crushed by as much as 75% because of income and estate taxes.

The existing Plan had other vulnerabilities, as well. One was the assets were all held inequities subject to significant drops in value. Over a lengthy period, the probability that such a reduction will occur is substantial.

How to increase net to beneficiaries without risk

Fortunately, a solution that could produce guaranteed results was possible in this particular situation. We set up a plan where taxable distributions from the IRA will be used to purchase the appropriate type of life insurance with the family named as beneficiaries. The client and the client’s family can be much better off with this solution because:

  • Assets are shifted from taxable to non-taxed.
  • Total net after-tax assets to the family are significantly increased.
  • The increase in assets is immediate.
  • There is no need to enter speculative investments to achieve the gain.
  • The value of the account is not subject to market losses.
  • The results are guaranteed by some of the most substantial financial companies in the world.
  • The entire Plan can be implemented on a set-it and forget-it basis.

Implementing IRA rescue for your qualified plan
Each rescue of an IRA or 401K or other qualified plan is custom-made for your circumstances. For individuals with separate Plans and assets, net benefits can increase from some 25% of asset value to many times the asset value. For married couples inheriting each other’s IRAs, the after-tax yield can be much higher than otherwise. IRA Rescue can be achieved by converting a client’s weakest assets – those with the most significant tax liabilities – to non-taxed assets.

And while a plan’s asset value is significantly increased immediately, the tax liability on distributions from the Plan is spread over time, much to the client’s advantage.

All plans can and should be coordinated with your accounting and legal, trust, and estate advisors, and we do that as a matter of course.

A complete solution is available with plan distributions able to be executed on schedule, trustees guaranteeing that policy premiums are paid as required, trustees delivering gifts to beneficiaries, and taxes able to be paid at the funding source. These solutions can truly be established to set and forget while delivering much more financial benefit to those for whom a client wished to provide financial security.

Brad Rhodes is a columnist in Lexington and a member of Syndicated Columnists, a national organization committed to a transparent approach to money management.