Death would not allow us to cheat the taxman.
If anyone knows the nitty-gritty in such matters it is David Foltz. He's executive vice president at Texas Capital Bank in Dallas, in charge of the Wealth Management and Trust Group. He's been one of the reigning experts on IRAs for more than twenty years.
So, if you're one of the fortunate souls who had a long career with ExxonMobil (a group that sometimes seems to account for most of the residents of Houston), or someone with a low employee number at Dell or XTO Energy, listen up. As Mr. Foltz explains it, those who exercise the Net Unrealized Appreciation option with company stock and take the stock out of the plan at retirement or separation will face two distinct tax events at death.
First, the gain over the cost basis that occurs while the stock is in the plan will remain subject to capital gains taxes. Then, the gain that occurs from when the stock comes out of the plan until death will escape taxation through the step up in cost basis allowed estates.
Suppose, for instance, that you have company stock in your 401(k) plan with a cost basis of $10 a share that is selling for $50 a share when you take the stock out of the plan. Suppose also that you continue to hold the shares and they rise to $250 at your death. What happens?
The gain between $10 and $50 will be liable for capital gains taxes when sold. This means an heir could defer taxes until they sell the stock. The gain between $50 and $250 will receive a step-up in cost basis and escape taxation.
I hate to sound like one who prefers blunt instruments, but subtleties like this are one of the reasons I believe the residents of Congress should experience cruel and unusual punishments both before and after death. It's also why I advocate the www.fairtax.org proposal for a national sales tax.
I asked Mr. Foltz if he had a list of the most common errors people make.
"The one that comes up routinely is bad information on things like required minimum distribution (RMD) factors. Last year, for instance, a broker at a major brokerage firm and a CPA both cited RMD factors for 2001. In fact, the factors had changed and they could have distributed less. So they could have paid more taxes than they had to.
"Had they distributed less than required, there would have been a 50 percent penalty from the IRS for under-distribution.
"Another error is not having a beneficiary designation or naming your estate as beneficiary (of a qualified plan). People get tired of the paperwork, and the estate has the shortest payout period of all beneficiaries."
He pointed out that careful naming of beneficiaries can extend the tax deferral of account assets significantly. An IRA that goes into an estate, for instance, would have to distribute about 6 percent a year if the decedent was 72. A group of adult children named as beneficiaries in the IRA, on the other hand, could limit distributions to half that amount.
"We recommend that the (surviving) spouse declare the IRA their own because the Unified Table (for required minimum distributions) can still be used. We always have a rollover for the surviving spouse.
"What people don't think about is that these accounts are going to be around for 70 years or more--- your spouse, your children, and maybe your grandchildren."
"Not having a power of attorney acceptable to your IRA custodian. That is a common occurrence. The issue is that everyone thinks in the present tense and forgets about getting old."
Those, unfortunately, are just the immediate and common mistakes. "IRAs," Mr. Foltz concludes, "are becoming increasingly important as part of people's estates. It's important that your attorney have all the details on these plans, if your attorney is to provide good estate planning advice."
On the web:
Tuesday, January 17, 2006: Company Shares and Taxes
Journal of Financial Planning: "Revisiting Net Unrealized Appreciation"
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.
AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.