Landmines and opportunities of retirement assets Featured

6:11am EDT December 18, 2003
The phone rang at 6:30 a.m., an unusual hour in the Block household, although everyone was awake and preparing for work and school. Beverly answered and heard the dreaded news. Her widowed father had been killed in a tragic automobile accident.

A few weeks after the funeral, Beverly and her sister were informed by her father's lawyer that they had been left more than $400,000 each from her father's former company's pension plan. But there was a problem. Because of an election her father had made years ago, a Lump Sum Distribution from his retirement assets was required.

This meant they'd pay federal and state income taxes of more than 40 percent on the entire amount. So, dropping her inheritance to $240,000. On top of a large income tax bill, she'd lost the tax deferral on the assets forever. Sometimes I wonder who the real beneficiary is -- the children or the IRS.

Unfortunately, Beverly's father had never taken advantage of rolling his company retirement benefits into an Individual Retirement Account (IRA) when he retired two years ago. Had he done so, Beverly and her sister could had stretched the distributions (and the related income taxes) over each of their life expectancies and enjoyed years of compounded tax deferred growth. They would have also benefited from the increased flexibility in investment options.

There are trillions of dollars in 401(k), 403(b), pension and profit-sharing plans and IRAs. For most Americans, this represents their largest investment, other than their personal residence.

Although most people are aware of the benefits of having such plans, they are not aware of the rigid rules surrounding the distribution options that will ultimately dictate how they or their beneficiary will receive the benefits.

Let's look at the pitfalls you may want to avoid and how to protect the assets in your retirement plans from excessive taxes.

* First and foremost, understand that despite your well-designed estate plan, how you fill out the beneficiary forms for your retirement plan and IRAs will dictate how the money is handled. IRAs and retirement plans do not pass according to the terms of your will. They pass by beneficiary designation -- that sheet of paper you filled out years ago and may have forgotten.

* Get a copy of the beneficiary form you completed when you signed up for your company plan or IRA. A change in marital status, addition of children or other family changes may cause you to rethink your choices.

* If your spouse is your primary beneficiary, we strongly recommend naming a secondary or contingent beneficiary.

* Find out if your employer's plan has limitations on the way beneficiaries can receive benefits. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) has liberalized distribution options, and a simple amendment to the plan document could alter the distribution elections available. Your options may have changed.

* If you've changed employers or for any other reason left your company, roll your assets out of the company plan into an IRA. Your investment choices are greater and IRAs have more flexible distribution rules. Many companies will let you keep your assets in the company plan after you've left, but this may limit the distribution choices available to your heirs.

* The new EGTRRA regulations allow you to name a trust as beneficiary of your IRA to take advantage of the estate tax exemption. You can leave your retirement plan assets and IRA assets to trusts under your will or to a special needs trust for children with developmental disabilities. This designation of the trust as beneficiary allows you to continue to plan how your assets will pass and be managed after your death.

* IRAs can be split before or after your death so that children can be treated differently. One child may be able to handle a large inheritance. Another child may not.

The rules regarding retirement plan distributions and beneficiary elections can be very complicated and should be reviewed periodically with your financial planner and/or estate planning attorney.

Jacqueline C. Berkelhamer, MBA, CFP, (jberkelhamer@cpcadvisors.com) is a senior financial planner with Consolidated Planning Corp. Her expertise includes estate and gift planning, retirement planning and tax strategies. She is responsible for designing, integrating and implementing the firm's comprehensive financial planning process. Reach her at (404) 892-1995.