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The RMD Choice: Take A 50% Tax Penalty Or Leave A Family Legacy

Posted By Jason Trujillo, Woodbury Financial, Thursday, March 26, 2015

The RMD Choice: Take A 50% Tax Penalty Or Leave A Family Legacy by Steve Parrish

Article appeared on March 23, 2015 on

Click here to read original article.

A long time ago, I helped my dad set up his IRA account. Years later, after he had turned 70, I received an angry call from him.

His tax person was telling him he was forced to take a distribution he didn’t want and, even worse, pay taxes on that unwanted income. More pointedly, he wanted to know why I put him into such a bad deal. He was, of course, referring to the fact that he had to take required minimum distributions (RMDs) from his IRA account, or face a 50 percent tax penalty.

He was rightfully upset because he:

  • Didn’t want to figure out how much to take each year
  • Didn’t need the money
  • Definitely didn’t want to be forced to pay taxes he hadn’t expected

RMDs have been a planning challenge since the law that created the requirement was passed 33 years ago. Objections revolve around two aspects of the law. First, people don’t like being told when they have to take – and pay taxes on – their money. Second, the rules are so complicated they almost invite noncompliance. For example, the first RMD must be taken “April 1 of the year following the calendar year in which you reach age 70½.” Huh?

Yet the law continues with few dents in its armor. In 2009 the RMD rules were suspended for one year. That was back when, because of the Great Recession, investment values were so deeply depressed that forcing a distribution was tantamount to forcing a loss. And, in the last few years, Congress has annually granted a last-minute reprieve for taxpayers who want to avoid taxes by directing their RMD payments directly to a charity.

Other than that, taxpayers remain stuck with the RMD rules.

Getting it to the next generation

Many business owners are “financially full” when they retire. In other words, they have other sources of revenue and simply don’t need or want the income from their IRAs. The RMD rules, however, require that they take a minimum annual payment that is equal to their account divided by their life expectancy.

The challenge is the RMD is subject to federal income tax in the year it is taken. Further, if the individual is sufficiently wealthy to be subject to the federal estate tax, the IRA is a taxable asset of the estate. This can result in the business owner’s heirs receiving a fraction of the actual IRA account. For a high-bracket taxpayer, income and estate taxes can conceivably erode more than half of the account.

Bottom line, if you hope to live off other income during retirement and thereby preserve qualified plan assets as a legacy for your family, the RMD rules make the IRS an unwanted partner. Your future legacy is lessened by current taxes.

A solution

Here’s an idea that could work well if you want to turn your IRA into a legacy. Say you don’t need the IRA income, and you would like to leave more after tax wealth to your heirs. The basic concept is to start annually withdrawing IRA assets to fund a life insurance policy on your life. This can start as soon after 59 1/2 as you’re comfortable with your retirement strategy, and there’s no set maximum or minimum size.

You can either own the policy personally, or if you’re concerned about estate taxes, you can have the policy owned by an irrevocable trust. Each withdrawal from your IRA is taxable, but the proceeds are used to pay the premiums on a tax-free life insurance benefit. At your death, your heirs receive a death benefit from the life insurance plus whatever’s left of your IRA. On an after-tax basis, this may well increase the legacy your family receives.

Using this approach you would have a revised, and lower, schedule of RMDs. More of your IRA account would be used to fund a tax-free life insurance policy. Less would be coming out in taxable RMDs. Particularly if you die prematurely, your heirs will receive a substantially higher after-tax inheritance using life insurance than if you had just taken your RMDs, paid tax on them and reinvested the proceeds. If, however, you live past your life expectancy, the difference between the two will lessen.

The numbers are, of course, dependent on your age and health status. That’s the nature of purchasing life insurance. But if you’re looking for a way to leverage your IRAs rather than curse your RMDs, this legacy approach to planning may work for you. I wish I had suggested this idea to my dad!



Tags:  70 1/2  after-tax inheritance  business owner  death benefit  estate planning  estate taxes  family legacy  federal income tax  financial planning  IRA  irrevocable trust  life insurance  Principal Financial Group  qualified plan assets  required minimum distributions  retirement  RMD  Steve Parrish 

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Business Growth Mantra

Posted By Jason Trujillo, Woodbury Financial, Thursday, October 9, 2014

A Business Growth Mantra: Take Big Actions; Make Little Mistakes

by Steve Parrish

Originally posted at 10/06/2014. Click here for original article.

“My life expectancy is 24 years. My money expectancy is about 15 years.” This is the opening line a new retiree makes to a financial advisor. The discussion, and a number of other financial dialogues between consumers and advisors, is showcased in this series of videos designed to encourage people to take action on their financial goals.

This past summer in Chicago, people were offered free taxi cab rides with an advisor during which they could essentially lay out their financial concerns while being driven to their requested destination. These video vignettes remind me of the popular Discovery Channel program “Cash Cab,” but in this case the test is financial honesty and the reward is useful financial advice.

Take Action
The challenge is not so much finding good advice; it’s acting on the advice given. Think about the individual who said he has a longer life expectancy than money expectancy. If he had taken that cab ride 10, 15 or 20 years ago, would there be a better match up today with his money and life expectancy? I’m guessing that “back when,” whether the advisor recommended he invest in 60 percent equities and 40 percent fixed securities, or vice versa, the resulting difference wouldn’t be all that big of an issue. As long as the individual had actually saved the recommended amount of money, his portfolio would be in far better shape than it is today.

I refer to this as the financial law of “little mistake, big mistake.” A person should consider which financial strategies entail the potential for a little mistake and which have the risk of being a big mistake.

1. An advisor suggests that a parent buy a particular life insurance policy. It turns out that the suggested policy is more expensive than another product released a few months later. I suppose purchasing the policy qualifies as a little mistake. However, had the parent decided to wait to buy life insurance coverage at a later date—and in the meantime becomes uninsurable or passes away —now that’s a big mistake.
2. An individual has money available to invest in equities. She uses dollar cost averaging to spread her entry into the market over 12 monthly installments. If it turns out the stock market had huge growth during those months, it could be argued she made a mistake. Why? She would have received a higher return on her investment had she participated in the stock market all at once. In the scheme of things, however, that’s a minor error. In comparison, not investing at all during those months would be a bigger mistake.


Taking Action in Business
You might contend that the “little mistake, big mistake” approach won’t work in the context of growing one’s business. The very nature of growing a business involves taking risks. I would counter that yes, business involves taking risks, but it also involves minimizing mistakes. When a successful business owner assesses a business growth opportunity, there is a natural balancing of the investment risk and the reward potential. For example, when an entrepreneur considers which expenses in a project will be variable and which will be fixed, that entrepreneur is in effect asking, “How can I limit my downside exposure; if it doesn’t pan out, can I limit this venture to being a little mistake by making some costs variable instead of fixed?”
Similar assessments go into the process of deciding whether to grow a business organically or through acquisitions. There are pluses and minuses to all these decisions. The trick to the decision-making process, however, is to keep the mistakes little, and the growth big.

Tags:  business decision-making  business development  business exposure  Business growth  business mistakes  business planning  business risk  financial planning  financial strategies  Forbes  INC 5000  Principal Financial Group  Steve Parrish 

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