Clients with large individual retirement accounts (IRAs) holding $1 million or more in assets could face serious “double tax” consequences. Large IRA assets could be hit hard by federal income tax and estate tax. Income tax rates are as much as 35% and estate taxes are currently as high as 49%. The large IRA tax problem can be devastating to clients and their families. There are, however, several creative techniques designed to manage the tax risks.

Extend the IRA

One IRA tax planning strategy is to create a multi-generational or “extended” IRA. By passing the IRA assets to a younger beneficiary, the IRA’s tax-deferred earnings period can be extended. A typical “extended IRA” scenario goes like this: After the original IRA owner dies, the surviving spouse takes the inherited IRA into his or her own account and names a new beneficiary, usually the couple’s child. When the surviving spouse dies, the IRA can be paid out over the child’s life expectancy. The child can even name a back-up beneficiary, perhaps a grandchild, to insure that the tax savings continue as long as possible.

Donate the IRA

The philanthropic client may choose to avoid double taxation-- both income and estate tax--- by donating his or her IRA to charity. The charitable deduction that results from the gift can eliminate both the estate and income taxes. The client can chose to give the IRA to charity during his or her lifetime (an “inter vivos” gift), or have the assets pass to the charity after the IRA owner’s death (testamentary gift).

A gift of IRA assets to charity during the owner’s lifetime requires taking a taxable distribution prior to gifting the IRA proceeds. The gift is income tax deductible, within certain limitations. This will help defray the income tax caused by the distribution from the IRA. Since assets that are given away are no longer part of the client’s estate, the client’s potential estate tax is also reduced. Or the client could choose to make a testamentary charitable gift of his or her IRA. This way, the donor has access to the funds during his or her lifetime. At death, the IRA gift qualifies for an income and estate tax charitable deduction.

Create a Unitrust

The charitable remainder unitrust (CRUT) is another IRA planning option with both income and estate tax benefits. IRAs, other retirement plan assets, as well as securities, real estate and cash, can be used to fund a CRUT.

The CRUT provides the client with a stream of income that is a fixed percentage of the trust’s assets, which are revaluated at least once a year. At the end of the trust term, a charity receives all of the property in the trust. The client can take an immediate income tax charitable deduction equal to the present value of the amount that will eventually pass to the charity. The transfer of the trust’s remainder interest to charity qualifies for the gift or estate tax charitable deduction.

A variation of the unitrust is the testamentary CRUT, or “T-CRUT.” IRA assets are used to fund the T-CRUT at the owner’s death. The entire amount of the IRA initially contributed to the T-CRUT by the client’s estate can grow in the trust, rather than losing a large amount to tax upfront. The T-CRUT itself is not subject to income tax, so long as it has no unrelated business taxable income.

Establish a Family Limited Partnership

A family limited partnership (FLP) can be used to hold a large IRA. The account owner and the custodian form the FLP. The account owner contributes assets to the FLP in exchange for a 2% general partnership interest, and the custodian contributes the IRA in exchange for a 98% limited partnership (LP) interest. The custodian then distributes LP interests, discounted for lack of marketability and for minority ownership, to the account owner. The discounts will decrease the IRA minimum distributions, thereby decreasing related income tax. This would leave substantial assets in the IRA to continue to grow in a tax-deferred environment.

If you find that you have significant assets contained in an IRA, either through direct contributions or as the result of retirement plan rollovers, you should consider mapping out a tax strategy to protect them. This office is prepared to help you do so in a way that can provide you and your family with maximum savings and flexibility.