Table of Contents

Will my heirs owe income taxes when they inherit my retirement assets?

Yes, generally under the same rules that would apply to your withdrawals of the same amounts had you lived. But consideró

Your spouse can rollover your account to his or her IRA.

No early withdrawal penalty applies, regardless of your beneficiaryís age. But a spouse who rolled over to an IRA may owe an early withdrawal penalty on an IRA withdrawal before 59 Ω.

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Will my heirs owe estate taxes on inherited retirement assets?

The estate tax burden is declining, but many tax professionals doubt that the estate tax repeal (scheduled to become effective in 2010) will occur. Under the rules applicable until then, only a small percentage of estates (based on the value of oneís assets at death, and including large lifetime gifts) will be subject to estate tax. There is no estate tax on assets passing to a surviving spouse or charity.

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Is estate tax deferred if my heir will get an annuity?

No. The estate is taxed on the annuityís present value.

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How can I minimize or eliminate tax on inherited retirement assets?

You can minimize or eliminate tax on inherited retirement assets by using the following methods:

  1. Leave them to your spouseósaves estate tax and helps postpone withdrawals subject to income tax.

  2. Leave them to charityósaves income and estate tax (though with no financial benefit to the family).

  3. Leave them to family for life, remainder to charity (a charitable remainder trust)óreduces estate tax with some benefit to family.

  4. Provide life insurance to pay estate tax on retirement assetsóprovides estate liquidity, avoiding taxable distributions to pay estate tax.

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How should I take distributions from my retirement plan?

If your assets are in a tax-favored retirement fund such as a company or Keogh pension or profit-sharing plan (including thrift and savings plans), 401(k), IRA or stock bonus plan, your likeliest options are:

  • Everything in a lump sum
  • An annuity
  • A partial withdrawal (leaving the balance for withdrawal later)
  • A rollover
  • Some combination of the above

Some plans tilt more than others towards certain withdrawal options. Annuities are commonest with pension plans. The other types of plan favor the other options. But in many plans, all or most options are available, and combinations may be available.

You may want to preserve the tax shelter as long as possible, by withdrawing no more than you need.

In some plans, your retirement assets will be distributed in kindóas employer stock, or an annuity or insurance contract.

Timing your withdrawal can be a factor, too. Withdrawals before age 59 &Mac189; risk a tax penalty. And withdrawal is generally required to start at age 70 1/2, reinforced with a tax penalty and other rules, except for Roth IRAs, and plan permitting for non-owner-employees still working beyond that age.

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When should I take a lump-sum distribution from my retirement plan?

Your personal needs should decide. You may need a lump sum to buy a retirement home or retirement business.

Or perhaps your employer makes you take it that way or you want personal control of your assets. (In these cases, an IRA rollover may be a wise move.)

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What should I do about my retirement plan assets in my ex-employer's plan if I change jobs?

There are several things you might do depending upon your needs:

  1. If you don't need the assets to live on, try to continue the tax shelter.

  2. Transfer (roll over) the assets to the plan of your new employer, if that plan allows it (this can be tricky, though).

  3. If going into your own business, set up a Keogh and move the funds there.

  4. Roll them over into your IRA.

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Can creditors get at my retirement assets?

Generally not for employer plans.  For IRAs, there's bankruptcy protection for amounts rolled over from company plans, plus up to $1 million (and possibly more).

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How will my state tax affect my retirement withdrawals?

Each state is different; youíll have to check yours. But consider:

  1. While withdrawals are generally taxable in states with income tax, some offer relief for retirement income, up to a specified dollar amount.

  2. If your state doesnít allow deduction for Keogh or IRA investments allowed under federal law, these investmentsóand sometimes moreómay come back tax-free.

  3. State tax penalties for early withdrawal (before age 59 1/2) or inadequate withdrawal (after age 70 1/2) are unlikely.

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I understand that I'm required to take money out of my retirement plan after I reach age 70 1/2. Why is that?

Retirement plans offer the biggest tax shelter in the federal system, since funds grow tax-free while in the plan. But the shelter is primarily intended for retirement. So when you reach 70 1/2 (or shortly thereafter), you must start to withdraw from the plan.

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How can I continue the tax shelter for retirement plan assets after age 70 1/2?

The shelter can continue for a large part of those assets, for a long time, assuming you don't need them to live on. You can spread withdrawals over a period based on, but longer than, your life expectancy-for example, over at least 27.4 years if you're 70 1/2 now. The shelter continues for whatever is not withdrawn. However, you are free to withdraw at a faster rate, or all of it, if you wish.

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Suppose there are still retirement assets in my account at my death. Can the shelter continue for those who receive those assets?

Generally, yes. In general, persons you have named as your plan beneficiaries can withdraw over their life expectancies (or more rapidly if they wish); your spouse can sometimes spread withdrawal over a longer period. The withdrawal period is generally shorter where no individual beneficiary is named (for example, where your estate is the beneficiary).

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Can moving to another state when I retire save me state taxes on my retirement plan?

Money from retirement plans, including 401(k)s, IRAs, company pensions and other plans, is taxed according to your residence when you receive it.

If you move from a state with a high income tax, such as New York, to one with little or no income tax (Texas, Nevada and Florida have none), you will indeed save money on state income tax.

However, establishing residence in a new state may take as long as one year; if you retain property in both states, you may owe taxes to both.

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What is a reverse mortgage?

A reverse mortgage is a type of home equity loan that allows you to convert some of the equity in your home into cash while you retain home ownership. Reverse mortgages work much like traditional mortgages, only in reverse. Rather than making a payment to your lender each month, the lender pays you. Most reverse mortgages do not require any repayment of principal, interest, or servicing fees for as long as you live in your home.

Retired people may want to consider the reverse mortgage as a way to generate cash flow. A reverse mortgage allows homeowners age 62 and over to remain in their homes while using their built-up equity for any purpose: to make repairs, keep up with property taxes or simply pay their bills.

Understand that reverse mortgages are rising-debt loans. This means that the interest is added to the principal loan balance each month, because it is not paid on a current basis. Therefore, the total amount of interest you owe increases significantly with time as the interest compounds. Reverse mortgages also use up some or all of the equity in your home.

All three types of plans (FHA-insured, lender-insured, and uninsured) charge origination fees and closing costs. Insured plans also charge insurance premiums, and some impose mortgage servicing charges. Finally, homeowners should realize that if they're forced to move soon after taking the mortgage (because of illness, for example), they'll almost certainly end up with a great deal less equity to live on than if they had simply sold the house outright. That is particularly true for loans that are terminated in five years or less.

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