As always before discussing the power of “stretch” TSA or IRA with your client, congratulations are in order to anyone who has succeeded at capitalizing on the best legislation Congress ever passed; Sections 403(b), 408(a) and 408(b) of the Internal Revenue Code – better known as TSA and IRA Legislation.
The money contributed to a TSA or IRA was pre - tax dollars. This is a real advantage in the accumulation of money because the taxes one would otherwise have paid are in their account and earning interest. The interest earnings also accumulate tax deferred – a second advantage.
The entire account remains tax deferred until distributed. Whatever the amounts accumulated in a TSA or IRA, they’re present meaningful dollars to whoever accumulated them. Once the TSA or IRA owner is no longer in the Contribution Period, they are facing a more important period, the Distribution Period.
The decisions made regarding the Distribution Period can be more important in determining the ultimate value of a TSA or IRA than the decisions made during the Contribution Period.
Clients who are primarily concerned with passing these savings onto their heirs are the topic for this article. Educating your client on the advantages of the options available to them can open the door to some of the largest annuity cases you’ve even seen.
Once the client realizes not only the power of the “stretch” but also the additional benefit of using insurance carriers as the custodian, it becomes a question of “can I put all my qualified funds into this?”.
Some of the basics: IRA owners must start taking distributions by tax time the year following their 70 ½ birthday. We generally have clients take RMD the year they turn 70 ½ so that they do not have to double distribute the following year. The distributions are based on the Table III of the IRS publication 590-B, also known as the Uniform Lifetime Table. The distributions start at 3.65% and continue to increase around .20% each year. Once the client passes away, generally their spouse can take the IRA as their own, assuming they were the primary beneficiary. At the passing of the spouse or if the participant elected to pass the proceeds to the heirs before the spouse, the heirs can avoid huge tax bills by using the IRS provisions designed to allow the funds to be distributed over time. For example, the graph to the right shows the taxes paid if the heir elected to distribute evenly over 5 years, the old option, versus the same taxes paid during that period using the stretch concept. This is an example of the tax savings, the other major benefit is the tax deferral that the heir can continue to take advantage of.
If the heir was a 25 year old grandchild, the RMD for the grandchild would start at 1.72%. That means that as long as the account earned more than the 1.72% that year, the account could continue to increase in value. Eventually the RMD for the heir will surpass the earnings, however that could be years down the road depending on the saving vehicle. To demonstrate this concept, see below. In this example the heir received $100,000 at age 25 and assuming they earned 5% over their lifetime the total distributions could surpass %581,000.
Last but certainly not least. RMD distribuiotns can easlily be forgotten, miscalculated and or simply not availble at some costodians, banks or brokarage houses. Because these are lifetime distibutions, who better to adminstte lifetime distrutions than an insurance carriers?
This presentation system has been one of our most successful tools to educate and motivate your clients to take action.