“Just a word of thanks to Uranga & Associates for your help in structuring the OUTSIDE method of redirecting my IRA into real estate. My wife and I were able to purchase another home and allow one of our children to rent the home from us. Thanks again for your help and your professionalism.”
B. Owens, Montana (NOTE: Photo is not a representation of client.)Professor Christopher R. Hoyt
Univ. of Missouri (Kansas City) School of Law
Do you feel that you are seeing IRAs and retirement accounts increase both in frequency and size in the estates of your clients? Recent IRS statistics confirm your experiences.
Just 15 years ago, IRAs, retirement plans and annuities only appeared on 25% of federal estate tax returns and they represented only 2.3% of the assets reported on those returns. For returns filed in the year 2000, they appeared on 53% of all returns and comprised 8% of reported assets (Table (A)). For estates under $2.5 million they comprised 12% of all reported assets (Table (B)). These are, of course, just the averages. Every estate planner has met individuals who have a majority of their wealth in retirement plan accounts.
Why the dramatic growth? It is due in large part to the fact that IRAs, 401(k) plans and other qualified retirement plan accounts are creatures of the 1980's. It was just in 1981 that Congress permitted anybody who worked to contribute $2,000 to an IRA. Although this provided an opportunity for younger workers, it was too late for retirees to take advantage of it. Consequently, the estate tax returns filed in the 1980's and early 1990's reflected the fact that most of the individuals who died during those years were ineligible to establish these type of accounts.
The situation is changing. Dealing with these accounts is destined to become an even bigger issue for estate planners in the coming years. IRS statistics give us an idea of what we are in store for. Whereas retirement accounts and annuities appeared on 47% of all federal estate tax returns filed for males in 1998, they appeared on only 43% of returns filed for male decedents over age 65 but on over 63% of returns filed for males under age 65. The statistics in Table (C) also demonstrate a stunning disparity based on gender. Whereas the frequency and size of retirement accounts in the estates of decedents under age 50 is about the same for men and women, there is a huge gender-correlated disparity for individuals over age 50. For these individuals, men tend to have retirement assets much more frequently than women. The numbers reflect the important changes in the nation's work force over the past 30 years and the shape of things to come in the long term.
Planning for retirement accounts is, therefore, a growth industry for estate planners. The challenge, though, is that it is harder to plan for retirement accounts than for virtually any other asset in an estate. The planner needs to understand not just the estate tax laws, but also income tax laws and ERISA mandatory distributions laws and how they all interact.
This is not something that planners are likely to have learned in school. Whereas most schools teach separate courses on transfer taxes and income taxes, retirement accounts are the pinnacle of integrated tax planning. These accounts can trigger both significant income taxes and estate taxes.
Except for Roth IRAs, distributions from a retirement account are usually taxed in full as ordinary income -- during the employees lifetime to the employee and then after death to the beneficiaries. Whereas these accounts are wonderful for deferring income tax, they can be an estate planning nightmare. Barring a divorce, they are virtually impossible to give away during a person's lifetime because of anti-alienation laws. A lifetime transfer or pledge of the account can be treated as a taxable distribution. Sec. 72(p)(1)(B) and (A).
At death, these accounts often magnify the size of the estate tax liability. Estate taxes must be paid on the entire retirement account balance -- including the portion of the account that represents deferred income taxes. When the maximum income and estate tax rates reach their lowest point in 2007 (35% income tax rate and 45% estate tax rate), a distribution from a retirement account will be subject to a combined estate and income tax rate of over 64% (see Table (D)). In 2001, the comparable rate was over 76%! These are the effective tax rates in states that have no state income tax. An even higher rate applies to beneficiaries who live in states with a state income tax.
It is, therefore, no wonder that many estate planners suggest charitable dispositions of these assets for people whose estates are overloaded with retirement accounts. There is increasing activity in this area. Just this year, the IRS approved two new and ingenious charitable transfer strategies in private letter rulings. They will be analyzed in next month's column.
CONCLUSION
Retirement accounts are destined to appear in over two thirds of the estates of the nation's more affluent citizens. In order to give the best advice, estate planners must learn all of the applicable fields of law that affect these assets -- estate tax, income tax and ERISA distribution rules -- and how they interact. For estates that are overloaded with these types of assets and will likely feel the pain of tax rates of 64% or more, a charitable bequest may be the choice that brings the parties the greatest satisfaction.
TABLE A
RETIREMENT PLAN ASSETS AND ANNUITIES
TOTALS RETIREMENT PLANS/ANNUITIES
Year # of Gross # of Value
Filed Returns Estates Returns % (millions) %
(millions)
2000 108,322 $217,402 56,921 53 $17,410 8.0
1997 90,006 $162,251 41,788 46 $10,116 6.2
1995 69,772 $117,735 30,938 44 $6,632 5.6
1992 59,176 $ 98,850 22,738 38 $4,095 4.1
1989 45,695 $ 77,997 14,223 31 $2,309 3.0
1986 45,125 $ 59,805 11,244 25 $1,350 2.3
SOURCE: IRS Statistics of Income Bulletins for the applicable years.
See web http://www.irs.ustreas.gov/prod/tax_stats/estate.html
TABLE B
| [All figures are estimates based on samples--money amounts are in thousands of dollars] | ||||||||
| Size of gross estate | Gross estate | Retirement Plans, IRAs & Annuities | Average Amount | |||||
| Number of returns | Amount (in thousand $) | Number | % | Amount (in thousand $) | Percent of estate | (thousands of dollars) | ||
| All returns | 108,322 | 217,402,426 | 56,921 | 53% | 17,410,160 | 8% | ||
| $600,000 under $1,000,000 | 47,845 | 38,598,125 | 23,537 | 49% | 4,236,045 | 11% | 180 | |
| $1,000,000 under $2,500,000 | 45,248 | 66,946,098 | 25,579 | 57% | 7,808,143 | 12% | 305 | |
| $2,500,000 under $5,000,000 | 10,018 | 34,085,398 | 5,294 | 53% | 3,272,914 | 10% | 618 | |
| $5,000,000 under $10,000,000 | 3,386 | 23,286,561 | 1,649 | 49% | 1,124,415 | 5% | 682 | |
| $10,000,000 under $20,000,000 | 1,129 | 15,253,132 | 544 | 48% | 594,709 | 4% | 1,093 | |
| $20,000,000 or more | 696 | 39,233,112 | 320 | 46% | 373,934 | 1% | 1,169 | |
For this and other IRS statistics, see the IRS web page: <http://wwwirsustreasgov/prod/tax_stats/estate.html>
SOURCE: IRS Statistics of Income Bulletins for the applicable years.
See web <http://www.irs.ustreas.gov/prod/tax_stats/estate.html>
TABLE C
Estate Tax Returns Filed in 1998: Retirement Plans, IRAs and Annuities --
Variations Based on Age and Gender
(A) Percent of Returns that Report Any Retirement Plan Assets and
(B) Percent of All Assets that are in Retirement Plan Accounts
| MALE | FEMALE | ||||
| ALL 1998 RETURNS | 55,495 | 112,434 | 48,487 | 83,190 | |
| ($ millions) | ($ millions) | ||||
| % of returns with retirement assets | % of all assets | % of returns with retirement assets | % of all assets | ||
| % OF ALL RETURNS REPORTING RETIREMENT ACCOUNTS | 47% | 6% | 31% | 3% | |
| Under age 50 | 63% | 7% | 64% | 6% | |
| Ages 50 to 65 | 69% | 12% | 6% | 8% | |
| Over age 65 | 43% | 5% | 28% | 3% | |
Source: Barry Johnson and Jacob Mikow, “Federal Estate Tax Returns, 1998-2000,” Figures F and G, IRS Statistics of Information Bulletin, available at <http://wwwirsustreasgov/prod/tax_stats/estatehtml>
TABLE D
COMBINATION OF ESTATE AND INCOME TAXES ON INCOME IN RESPECT OF A DECEDENT -- (Years 2007 through 2009).
EXAMPLE: Assume that Mother's total taxable estate is $4,000,000 and that all of it will be transferred to her sole heir: Daughter. Assume that the probate estate will pay the entire estate tax regardless of how her daughter acquired the assets (e.g., joint tenancy, etc.). If $100,000 in an IRA is immediately distributed to Daughter and if Daughter is in a 35% marginal income tax bracket, then the combined estate and income taxes on the $100,000 of IRA assets would be $64,250. The amount is calculated as follows:
Beginning Balance in Retirement Plan $ 100,000
Minus: Total Estate Tax Paid by the Probate Estate (45,000)
Minus: Income Tax On Distribution
Gross Taxable Income $ 100,000
Reduced By §691(c) Deduction for
Federal Estate Tax
Total Estate Tax $ 45,000
State Tax Credit* Zero
Deduction for Federal Estate Tax ** (45,000)
Net Taxable Income *** $ 55,000
Times Income Tax Rate x 35.0%
Net Income Tax on Income In Respect Of Decedent (19,250)
NET AFTER-TAX AMOUNT TO DAUGHTER $ 35,750
* Treas. Reg. Section 1.691(c)-1(a) limits the deduction to federal estate tax. The 2001 Tax Act provides that the Section 2011 state tax credit will be fully repealed by the year 2007 so there is no state tax adjustment.
** The deduction is an itemized deduction on Schedule A that is claimed on the last line of the form ("other miscellaneous deductions"). It is not subject to the 2%-of-adjusted-gross-income ("AGI") limitation that most miscellaneous deductions are subject to. Sec. 67(b)(7).
*** The net taxable income from the IRD will actually be greater than this amount The IRD will increase the recipient's AGI by $100,000 which will decrease the recipient's itemized deductions by 3%, which would be $3,000 in this example. Sec. 68. The 3% reduction was omitted from this calculation in order to simplify the computation.
The Journal of Wealth Management
for Estate Planning Professionals
by Professor Christopher R. Hoyt
University of Missouri (Kansas City) School of Law
“This article reinforces why our IRA/Real Estate Plan has the best solution to this problem. Our program, combining the use of IRA monies to purchase real estate with a simple and flexible estate plan, can result in unprecedented tax savings for you and your heirs. It is sad to see that the only way these estate-planning professionals can fix the problem is by giving your IRA monies away to charities (no deduction allowed). Not that I have anything against giving to charities, but it should be by choice and not for lack of an alternative.”
Alberto Uranga
Case outline: Mrs. Dawson is 57 years old, she and her husband are recently retired. Prior to contacting Uranga & Associates Mrs. Dawson and her husband had been researching the possibility of purchasing a new primary residence to retire to in another state. After completing the Compatibility Form and consulting with Mr. Uranga, Mrs. Dawson, placed approximately $500,000 of her 401k rollover in a SAFE HARBOR® IRA account. This established the structural foundation for her IRA/real estate plan. This SAFE HARBOR® IRA account, guaranteed to earn a minimum of 2% with a potential of 5% or higher as a ten-year average, insures against loss of principal value due to investment exposure during the life time of the contract. Uranga & Associates then structured Mrs. Dawson’s SAFE HARBOR® IRA account to provide an income stream to be used to pay interest and principal on the traditional 30-year mortgage obtained to purchase the new primary residence. Any tax liability generated by this income stream has been calculated to be offset by allowable tax deductions on the real estate. Mrs. Dawson and her husband plan to relocate to their new primary residence and rent their old home until the housing market stabilizes and market conditions are more favorable to sell. At that time, they will be able to keep any capital gain up to $500,000 tax free on their old home and invest that gain in such a way as to supplement their retirement income. Mrs. Dawson’s IRA will continue to support the mortgage payments on their new home for a minimum of 18 years, with a potential of 27 years or more depending upon the interest she earns in her SAFE HARBOR® IRA account.
Summary: The IRA/real estate plan enabled Mr. & Mrs. Dawson to purchase their retirement home immediately, allowing them to relocate to the community they want to live in without having to wait, possibly years, for their current primary residence to sell. By structuring Mrs. Dawson’s rollover 401k to support the purchase of the new home the Dawson’s essentially flipped the more conventional roll of their retirement monies and real estate equity. The equity they have accumulated in their current home, which they had always intended to use to purchase their retirement home, is inaccessible until the home sells. Mrs. Dawson’s retirement fund however, when structured by the OUTSIDE® method can be accessed immediately.
By using the retirement monies to purchase their retirement home, the Dawson’s achieved several things. Firstly it enabled them to take advantage of attractive prices in the currently deflated real estate market. Secondly, by structuring retirement fund withdrawals to pay the mortgage on their real estate purchase they offset most, if not all, of the tax liability they would have, at some time otherwise, had to pay when they eventually withdrew from the 401k account. Thirdly, since the Dawson’s are now in the financial position to not having to sell their old home in order to purchase the new home, they can bide their time until the market is more favorable for a profitable sale and in the meantime benefit from rental income. And lastly, and perhaps most importantly, the OUTSIDE® structure allows the Dawson’s to move on with their life. No matter what your age is, it is painful to feel trapped, unable to move ahead with your plans because of financial commitments that keep you from experiencing the change you are ready to make in your life. The OUTSIDE® method gives the Dawson’s the freedom to live the life they want, in a secure financial framework that makes sense for their future.
Additionally there are estate planning benefits to this IRA real estate plan that are not covered in this brief synopsis.
Cases featured in this section are actual case histories of IRA/real estate plans structured by Uranga & Associates. Names have been changed to protect the privacy of our client(s).
Case outline: Mr. Collins is 39 years old, married, owns a primary residence and is an institutional trader. Believing real estate in Florida to be attractively priced he decided the time was right to purchase the vacation home he and his wife had dreamed of owning one day. Mr. Collins first heard of the OUTSIDE™ method of investing in real estate from searching the web. Having always believed an IRA could only invest in traded assets, (stocks, bonds, money market, and mutual fund shares), Mr. Collins was intrigued with the idea of being able to reallocate his IRA to support the purchase of real estate that he, his wife and family could enjoy now, during their active years, rather than having to wait until retirement before gaining any benefit from their hard earned savings. After completing the Compatibility form on the Uranga web site Mr. and Mrs. Collins had a telephone meeting with an Uranga consultant to more thoroughly understand how the OUTSIDE™ structure could apply to their scenario and determine if it was suited to their situation.
The Collins’ decided to allocate $100,000 of their IRA to the purchase of their $89,000 vacation home. Using $21,000 of non IRA monies for the down payment the Collins’ obtained a second home mortgage in the amount of $68,000 to finance the balance of the purchase price. To establish the structural foundation of the IRA real estate plan Uranga & Associates assisted Mr. Collins in transferring his allocated IRA monies to a SAFE HARBOR® IRA account. This SAFE HARBOR® IRA account, with a potential to earn 5% or greater as a ten-year average, also insures against loss of principal value due to investment exposure during the life time of the plan. Uranga & Associates then structured Mr. Collins’ SAFE HARBOR® IRA account to provide a reliable monthly income stream to be used to make the mortgage payments. Any tax liability generated by withdrawals from the IRA was calculated to be offset by allowable real estate tax deductions, resulting in a zero tax outcome.
Summary: The implementation of the OUTSIDE™ structure of IRA real estate has enabled the Collins’ to purchase a vacation home for their personal use within a secure financial framework. Believing to have bought their real estate in depressed market conditions the Collins’ anticipate to eventually benefit from an attractive rate of appreciation while at the same time earning interest on the principal value of their IRA, a financial strategy they believe will help support their eventual retirement. Additionally, the enjoyment they expect to experience from the use of their vacation home over the next many years is priceless.
An email we received from our client, Randy M. from Utah last week reflects the sentiments of many right now.
He wrote:“I have been reluctant (scared) to move forward since last Wednesday when I got my February IRA statement in the mail. It showed that my IRA balance had dropped to $309,000 and that every day last week the market continued to drop. This certainly would have been easier a year ago when my IRA balance was close to $450,000. Do you have any advice? I keep thinking that this market is going to turn around, and that I will recover some of these losses, but it only seems to be getting worse.”
Surely we must be close to the bottom – is the view of many investors and understandable they are reluctant to sell their stock portfolio at the bottom. The investment manager for Yale’s endowment was quoted on NPR just the other day as saying “buying at the top and selling at the bottom is a tough way to make money”. There is a huge media drive at the moment, in large part politically driven, to persuade investors to not only NOT sell equities into the falling stock market, but to buy – claiming now to be a terrific time to get in at a bargain price. The incentive behind this media push is most likely an effort to try to stop the free fall and restore some confidence in Wall Street to the American public. But wait a minute…..where are the housing lobbyists? If it’s such a great time to buy into the stock market, would now not also be a good time to buy real estate? After all history demonstrates that stocks and real estate tend to rise and fall together.
Now, back to the email received from our client. The question I have for him is this. What was the value of the real estate a year ago that you would like to buy today? Has that real estate depreciated over the past twelve months, just as your IRA value has?
This particular gentleman has his eye on a home currently priced at $250,000. A year ago its market value would have been at least $330,000. He could buy it today for $80,000 less than he would have paid for it a year ago. So this is where there has to be some soul searching. Why does this client want the real estate? Will it be a home for him and his family, or will it generate rental income for additional cash flow? If he were able to remove the fear and regret of realizing stock market losses and look at the situation objectively he would have to admit that today is just as good a time to commit his IRA assets to supporting the purchase of real estate as it would have been one year ago, if not perhaps better. Why better today than a year ago? Because he can buy the real estate for substantially less and because of this he stands to benefit from a higher likelihood of future appreciation in the home’s value and he benefits from mortgage interest rates at an historic low.
OK, that all sounds good, so instead of waiting it out in the stock market, hoping the value of his IRA will recover at some point in the future, (read our Feb 6th post “How Many Years to Recover Your Diminished IRA Value?), he transfers his investment into real estate with the expectation that he will eventually recover his stock market losses with the appreciation gained from the real estate while at the same time benefiting from the intrinsic value of occupancy or from rental income – case closed.
Not entirely case closed! Those of you who have benefited from a consultation with Mr. Uranga will understand the OUTSIDE® method does not utilize the cash value of the IRA all at once for the real estate purchase. Instead, the IRA monies are placed in SAFE HARBOR® while they are supporting the purchase of the real estate over a period of time. So picture if you will, you now own two assets, the real estate and the IRA, independent from one another but at the same time mutually supporting.
Since the real estate is purchased with borrowed money, (a mortgage), supported by the SAFE HARBOR® IRA the potential return on investment is far greater than where the investment is purchased with 100% cash as is usually the case with equities. Not only can you benefit from the advantage of cash-on-cash returns, from the real estate but at the same time you are earning interest in your SAFE HARBOR® IRA account. For those of you who are reticent to realize your stock market losses take heart in understanding that one of the SAFE HARBOR® custodian choices offers several account strategies which allow you to earn interest credits that are linked to the performance of several different indexes allowing you to benefit from positive market performance while the principal balance of your IRA is protected from potential market losses. So, if you really want that real estate but at the same time are bullish on the market and having a hard time deciding which way to go, the OUTSIDE® program offers you the best of both worlds. Your IRA can have the opportunity for upside potential linked to a specific index or combination of indexes with built-in downside protection while at the same time you can benefit from owing real estate to either enjoy as a home or to generate income as well as have the potential for capital appreciation over the time you own it.
Cases featured in this section are actual case histories of IRA/real estate plans structured by Uranga & Associates. Names have been changed to protect the privacy of our client(s).
Case Outline: Mr. & Mrs. Anderson responded to an advertisement in Delta’s Sky Magazine. The Andersons have been hit hard by the recent down turn in the economy. Mr. Anderson who is in his late fifties had heard he was to be laid off from his executive level position in the technology industry and his wife’s hours in her retail position had already been cut back. Faced with a dramatically reduced income and no immediate job prospect in site, the Andersons were concerned with being able to make their mortgage payment. After viewing Uranga & Associates advertisement the Andersons were intrigued with the idea of applying their IRA to save them from potential financial distress with their primary home mortgage so they scheduled a telephone appointment with an Uranga consultant to explore how the OUTSIDE® structure could help them out.
Structure: A total IRA transfer of $320,000 established a SAFE HARBOR® IRA account as the foundation for the Andersons IRA real estate plan. Uranga & Associates then structured the IRA to make regular monthly payments in the amount of $1,700 to be applied to the Anderson's home mortgage payment. After five years, by which time, hopefully, the economy will be back on track and the Anderson's employment situation will have improved, they can choose to discontinue the cash flow stream from the IRA to allow it to revert to building equity for their future retirement.
Summary: For the Andersons Uranga & Associates structured the SAFE HARBOR® directed IRA real estate plan to provide cash flow assistance as a short term solution to their financial needs. The Anderson's customized plan allows the flexibility for them to discontinue the cash flow stream from the IRA after five years or continue it for as long as they choose. If they do decide to discontinue the transfer of IRA money into their primary residence after 5 years, they can expect, with a worst case scenario, a minimum value of $259,000 to still remain in their SAFE HARBOR® IRA account even after $102,000 of its original value has been transferred into their primary residence. This financial plan gives the Andersons the security and peace of mind they need to weather the economic storm and come out of it unscathed.
Other estate planning benefits are derived from the OUTSIDE® structure. Please visit our website for further information.
