OVER THE YEARS, this tax column has ground out more than 1,200 articles on a ton of tax subjects. But never have I heard more from readers about a subject — phone calls, letters and faxes — than about two topics that are sort of kiss'n cousins. The subjects? Income in respect to a decedent and subtrusts. Not exactly the kind of stuff that draws cheering or excited crowds.
IRD (a very unfriendly critter in the tax law) is a problem (we'll explain it in a moment). A subtrust, on the other hand, is a tax friend and, as you will see, offers a total solution to the IRD problem.
The basic playing field for both IRD and a subtrust is qualified plans, such as a profit sharing or pension plan, 401(k) plan, rollover IRA and most other such plans. This article is must reading if you have a substantial amount of money in all such plans combined. The more funds you have in qualified plans, the more you will relish what you are about to read.
IRD is a tax-you-twice, dollar-burning monster. Slay the monster or it will destroy your dollars.
First the problem. Say you have $1 million (please substitute your own number) in a qualified plan. Every dollar you take out of the plan is subject to income tax. Unless you spend it, the balance (after income tax) is subject to estate tax. In the highest brackets from last year (35% income tax and 49% estate tax), your family gets only 33.15%, or $331,500 of that $1 million. The IRS gets 66.85%, or $668,500. Of course, your home state usually grabs a piece of the action, further reducing your family's share.
Now here's a tax fact that can really scare you: Under current law, those highest brackets are scheduled to be 40% (income tax) and 55% (estate tax) in the year 2011. Then, your family will only get $270,000 ... the IRS a whopping $730,000 out of that nice $1 million. Insanity!
Slay the IRD monster or it will destroy your dollars.
Now, suppose you die with $1 million in your plan. The IRS gives you a second chance to get clobbered with double IRD taxes. Your heirs, in effect, pay the same amount you would have paid if you had withdrawn the funds during your life. Result: Dead or alive, a horrible confiscatory tax! The monster wins.
Now the solution: subtrusts to the rescue. A subtrust allows you to use your plan funds to buy life insurance. Actually, you have a choice: You can have the plan buy insurance on your life (single life) or on you and your spouse (second-to-die). At your death (or you and your spouse if second-todie), the policy proceeds are paid to your heirs. All the money is estatetax free. In the real-life world of the taxpayer vs. the IRS, a subtrust legally turns the tables on the IRD tax disaster.
Let's look at a few real-life examples: Married client Jim, 54, with wife Mary, 53, had $215,000 in a 401(k) plan ( receiving additional annual contributions of $12,000 each year) purchased $2.5 million of second-todie insurance in the subtrust. The premiums are $ 19,750 ( paid by the subtrust) per year. Jim and Mary's kids and grandkids are the subtrust's beneficiaries.
Jim got a nice tax-free cash bonus out of the deal. He pocketed $132,000 of cash surrender value on an old $350,000 policy on his life that was no longer needed.
Joe, 65 and single, had $821,000 in a rollover IRA. If Joe died the IRD monster would burn ( using 2011 rates) $599,330 in taxes, leaving only $221,670 for his heirs. Instead, Joe had his professionals create a new 401( k) plan and rolled the full $821,000 into it. Then a subtrust purchased a $1.2 million policy — annual premiums of $51,960 — on his life. Bye, bye, IRD monster.
Whether you are married or single and fortunate enough to have $200,000 (or more) in your qualified plans, a subtrust is probably the best wealth-building opportunity in the entire bag of legal tax strategies. Look into it.
Readers often call and ask me how to go about determining if a subtrust might work for them. They typically tell me something like, "I can't find anyone who knows what to do." OK, I hear you.
If you would like to determine if a subtrust should be in your future, just send me these two items: a personal financial statement (you and your spouse) and a family tree (name and birthday for you, your spouse, kids and grandkids). Don't forget to include all phone numbers (business, home, cell). Send it (by courier is best) to "Subtrust Test," Irv Blackman, 3830 Estes Ave., Lincolnwood, IL 60712.
Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Chicago, IL 60606; tel. 312/207-1040, or e-mail [email protected].