Participation in qualified retirement plans, such as 401(k)s or some other form of a defined-contribution plan, has always been a mixed bag. Often, despite considerable efforts from companies, participation rates among rank-and-file workers fall well below expectations. When this happens, it obviously jeopardizes future retirement-living standards for those workers. A less obvious consequence is the constraints this situation puts on future retirement incomes for senior executives.
How can low retirement-plan participation among rank-and-file workers impact future retirement for senior managers? Qualified retirement plans, which are tax-deferred, operate under federally mandated nondiscrimination rules, which govern the amount highly compensated employees can contribute to their qualified plan based on overall participation levels. An additional restriction is the annual compensation limit imposed on these plans. For 2008, the compensation limit is $230,000. For an employee under 50, this means the maximum total contribution—regardless of participation levels or actual income level—is 20 percent of $230,000, or $46,000. Of that, the employee’s maximum portion of the contribution is $15,500. For those over age 50, the maximum is increased by $5,000.
Advance planning provides remedies

Given these restrictions, particularly for companies where retirement-plan participation is low, finding additional ways to provide higher retirement income for senior executives can be important for recruiting and retention purposes. It takes good planning, but there are several options available. Generally, they include:

· boosting overall retirement plan enrollment
· creating specific types of qualified retirement plans
· offering exclusive supplemental retirement and compensation plans (SERPS)

Boosting overall retirement plan enrollment helps increase the amounts senior executives are allowed to contribute, but it can be difficult to convince rank-and-file employees to begin contributing to these plans. Some workers do not believe they can afford to defer a percentage of their current income to contribute to their future retirement. Others procrastinate or simply do not understand enough about the program, so they resist enrolling.

To build participation, some companies have increased communication, created promotions and even made significant changes to their plans, such as faster, simpler applications and automatic enrollment. For plans with automatic enrollment, employees must opt out, which means natural procrastination tendencies work in favor of increased plan participation. Increasing enrollment, however, is often not enough to fully compensate senior managers.

Creating specific types of qualified retirement plans is another option. Some companies create safe-harbor 401(k) plans, which offer automatic contributions in accordance with specific federal guidelines. Plans meeting these guidelines are able to sidestep nondiscrimination tests, which allow all eligible employees, including senior management, to maximize their contributions.
Employee eligibility and contribution requirements for safe harbor 401(k) plans are the same as for other 401(k) plans, with one exception. In these plans an employer is required to make a 100 percent vested contribution for each employee or a matching contribution that adheres to federal requirements. There are several ways to structure these plans but they must provide all employees with an equal employer contribution.
For some companies with collectively and non-collectively bargained employees, separate qualified retirement plans are an option. Creating two plans tends to group highly compensated employees together, which decreases the likelihood that senior executives would face restriction on their contributions.
While these plan options may help, the annual limits on contributions to tax-deferred plans may still be inadequate for some highly compensated employees.
The final option, exclusive supplemental retirement and compensation plans, or SERPS, provides the most flexibility. Companies are not required to provide these benefits to all employees, so they can offer senior managers additional retirement compensation though this approach. SERPS are variously designed, but many offer some combination of elective compensation deferrals, various stock options, stock bonus plans or stock appreciation rights (SARS). SARS are an obligation to provide compensation, generally based on the value of a company’s stock, at a particular point in time, such as retirement. Non-qualified benefits are not protected from creditors, however, which mean senior managers could become creditors in a bankruptcy proceeding, for example, and potentially lose these benefits.
Often non-qualified compensation plans are associated with “rabbi trusts,” which are agreements between an employee and employer for payment at a specified future time. Nondiscrimination rules to not apply to rabbi trusts, so they can be provided exclusively to certain employees and, properly structured, they allow income tax deferrals for the employee.
Other compensation typically offered to highly compensated employees include various “perks,” such as tax preparation services, paid legal work or financial planning or any number of other benefits. However, these perks generally do not directly contribute to retirement.

Providing appropriate retirement compensation for highly paid senior managers does take planning, but it is often necessary to retain top talent.

Alan Goldfarb is director of Financial Strategies for Weaver and Tidwell Financial Advisors Ltd. (www.wtadvisors.com) in Dallas, Texas. A Certified Financial Planning practitioner, Goldfarb has been named Top Financial Advisor by Worth magazine six times. He holds an MBA in economics and management from the University of North Texas and a bachelor’s degree in engineering and management from Fairleigh Dickinson University. He can be reached 972-960-1100.

As a growing number of American companies dive into the global marketplace, the need for seasoned, skilled executives is stronger than ever. For top executives, that’s great news: Outside their window is a huge market for their talent.

For company owners, however, today’s competitiveness is only making it harder and harder to retain valued employees. It can be demoralizing for company chieftains who know that if they are to succeed in coming years, they must retain their best workers. Losing them doesn’t just jeopardize the ability to compete, it’s also expensive.

Historically American companies have used various methods to retain executives, including extra bonuses, promotions and pay raises, or perks such as company cars, travel privileges, extended vacation time, etc. Unfortunately, these one-time benefits rarely make much difference, studies show. They may keep someone around an extra month, or however long it takes to exhaust the benefits, but that’s about as far as they go.

What has made a difference are “golden handcuff’’ agreements, and an increasing number of companies are adopting some version of them. Although the name of these agreements may be a bit off-putting, at least it’s honest. Golden handcuff agreements indeed tie an executive to the company, but the reward can be substantial and may even include a share of ownership.

For owners, a golden handcuff agreement can be an expensive way to lock in top executives. Part of the company’s assets will have to be given up either through stock options, deferred payments, phantom stock, or a similar plan. However, if it keeps the top employee on staff it’s a move that actually should enhance revenue, and therefore should be seen as an investment and not an expense.

Golden handcuff agreements can be either very simple or highly complex. One simple agreement might be a promise by the company to repay an executive’s college debt, as long as the executive stays at the company a certain number of years. Or a company may agree to make payments on an executive’s lease car, but again only if he or she remains with the firm.

More complicated are deferred compensation or salary continuation programs, such as Secular Trusts, Rabbi Trusts or a conventional deferred compensation/disability agreement. These plans essentially grant the employee continued compensation after retirement or disability, but the employee cannot leave the company before the agreed time.

What experienced executives want the most, studies show, is some form of equity participation. There are numerous ways this can be provided, including by means of stock grants. For example, a company may simply give stock shares to a top performer. That makes him feel like an owner, and may dispel any thoughts of jumping ship. A major drawback, however, is that ownership begins whenever the shares are awarded. If the employee is so inclined, she can sell her shares as soon as she gets them and then bolt the company.

Non-qualified stock options are a better option. This gives an employee the option to buy shares at the “grant price,’’ which typically is the current share value. As the company gains in value, so does the value of the shares. However, options usually have a vesting period before shares can be purchased, which means the employee has to stay with the firm for several years. The good news for the employee, however, is there is no tax liability until the option is exercised. But it’s important to remember that options do not bring voting rights.

Perhaps the best way to bestow ownership is through “phantom stock.’’ Phantom shares are particularly beneficial for companies that don’t want to dilute either ownership or control, or have a Subchapter S and can’t exceed the maximum of 35 shareholders.
Phantom stock isn’t actually stock — it’s a deferred monetary award that is indexed to equity value or stock. The most common phantom stock plans establish compensation units that derive their base value from the value of a company’s common stock. When awarded, these units carry tax advantages similar to those of other deferred compensation.

Phantom stock plans offer numerous advantages to employees because they receive cash, not stock with an uncertain future value. In addition, they aren’t forced to invest in the company. Among the advantages to owners is that a phantom stock plan, as opposed to an Employee Stock Option Plan (ESOP), allows owners to hand-pick those who will be given ownership. An owner can do this by offering select employees the opportunity to participate in the growth of the company. For example, a key employee would receive a certain number of phantom units. Each unit would have the same value as a share of the company’s common stock on the date the unit is issued. The employee gets nothing until retirement, death or disability. Depending on how the plan is established, when the employee ends his active employment he may receive a sum equaling the difference between the original unit price and what that unit is worth at the end of his tenure. A variation would be that the employee receives full value.

Phantom stock is taxed like unfunded deferred compensation. The employee reports no taxable income, and the employer takes no deduction when the phantom stock is assigned to the recipient’s account. Once the employee retires, or fulfills the established tenure, he or she is paid in installments over a number of years and pays taxes on the income. The employer then can claim a deduction each year a payment is made.

Phantom stock, non-qualified stock options, stock grants, deferred compensation — these and other forms of golden handcuffs provide a way for companies to keep their top talent. However, company owners need to discuss their options with a legal adviser and investment counselor before putting together a formal plan. Not all golden handcuff agreements work in all situations, and all of them carry certain risks.

With the proper guidance, however, golden handcuff agreements can be a very effective tool in retaining top executives. They offer a way to keep experienced, skilled executives on board at a time when turnover is becoming inordinately expensive and disruptive.

###

Alan Goldfarb is director of Financial Strategies for Weaver and Tidwell Financial Advisors Ltd. (www.wtadvisors.com) in Dallas, Texas. A Certified Financial Planning practitioner, Goldfarb has been named Top Financial Advisor by Worth magazine six times. He holds an MBA in economics and management from the University of North Texas and a bachelor’s degree in engineering and management from Fairleigh Dickinson University. He can be reached 972-960-1100.

Participation in qualified retirement plans, such as 401(k)s or some other form of a defined-contribution plan, has always been a mixed bag. Often, despite considerable efforts from companies, participation rates among rank-and-file workers fall well below expectations. When this happens, it obviously jeopardizes future retirement-living standards for those workers. A less obvious consequence is the constraints this situation puts on future retirement incomes for senior executives.
How can low retirement-plan participation among rank-and-file workers impact future retirement for senior managers? Qualified retirement plans, which are tax-deferred, operate under federally mandated nondiscrimination rules, which govern the amount highly compensated employees can contribute to their qualified plan based on overall participation levels. An additional restriction is the annual compensation limit imposed on these plans. For 2008, the compensation limit is $230,000. For an employee under 50, this means the maximum total contribution—regardless of participation levels or actual income level—is 20 percent of $230,000, or $46,000. Of that, the employee’s maximum portion of the contribution is $15,500. For those over age 50, the maximum is increased by $5,000.
Advance planning provides remedies

Given these restrictions, particularly for companies where retirement-plan participation is low, finding additional ways to provide higher retirement income for senior executives can be important for recruiting and retention purposes. It takes good planning, but there are several options available. Generally, they include:

• boosting overall retirement plan enrollment
• creating specific types of qualified retirement plans
• offering exclusive supplemental retirement and compensation plans (SERPS)

Boosting overall retirement plan enrollment helps increase the amounts senior executives are allowed to contribute, but it can be difficult to convince rank-and-file employees to begin contributing to these plans. Some workers do not believe they can afford to defer a percentage of their current income to contribute to their future retirement. Others procrastinate or simply do not understand enough about the program, so they resist enrolling.

To build participation, some companies have increased communication, created promotions and even made significant changes to their plans, such as faster, simpler applications and automatic enrollment. For plans with automatic enrollment, employees must opt out, which means natural procrastination tendencies work in favor of increased plan participation. Increasing enrollment, however, is often not enough to fully compensate senior managers.

Creating specific types of qualified retirement plans is another option. Some companies create safe-harbor 401(k) plans, which offer automatic contributions in accordance with specific federal guidelines. Plans meeting these guidelines are able to sidestep nondiscrimination tests, which allow all eligible employees, including senior management, to maximize their contributions.
Employee eligibility and contribution requirements for safe harbor 401(k) plans are the same as for other 401(k) plans, with one exception. In these plans an employer is required to make a 100 percent vested contribution for each employee or a matching contribution that adheres to federal requirements. There are several ways to structure these plans but they must provide all employees with an equal employer contribution.
For some companies with collectively and non-collectively bargained employees, separate qualified retirement plans are an option. Creating two plans tends to group highly compensated employees together, which decreases the likelihood that senior executives would face restriction on their contributions.
While these plan options may help, the annual limits on contributions to tax-deferred plans may still be inadequate for some highly compensated employees.
The final option, exclusive supplemental retirement and compensation plans, or SERPS, provides the most flexibility. Companies are not required to provide these benefits to all employees, so they can offer senior managers additional retirement compensation though this approach. SERPS are variously designed, but many offer some combination of elective compensation deferrals, various stock options, stock bonus plans or stock appreciation rights (SARS). SARS are an obligation to provide compensation, generally based on the value of a company’s stock, at a particular point in time, such as retirement. Non-qualified benefits are not protected from creditors, however, which mean senior managers could become creditors in a bankruptcy proceeding, for example, and potentially lose these benefits.
Often non-qualified compensation plans are associated with “rabbi trusts,” which are agreements between an employee and employer for payment at a specified future time. Nondiscrimination rules to not apply to rabbi trusts, so they can be provided exclusively to certain employees and, properly structured, they allow income tax deferrals for the employee.
Other compensation typically offered to highly compensated employees include various “perks,” such as tax preparation services, paid legal work or financial planning or any number of other benefits. However, these perks generally do not directly contribute to retirement.

Providing appropriate retirement compensation for highly paid senior managers does take planning, but it is often necessary to retain top talent.

Alan Goldfarb is director of Financial Strategies for Weaver and Tidwell Financial Advisors Ltd. (www.wtadvisors.com) in Dallas, Texas. A Certified Financial Planning practitioner, Goldfarb has been named Top Financial Advisor by Worth magazine six times. He holds an MBA in economics and management from the University of North Texas and a bachelor’s degree in engineering and management from Fairleigh Dickinson University. He can be reached 972-960-1100.

by Richard Kohan
Partner, Private Company Services/Personal Financial Services

The use of trusts offers asset protection for children as well as many other ways to reduce taxes while providing for and protecting your family members or others and, at the same time, allowing you to set initial parameters regarding the management of those assets.

There are several types of trusts. For effective gift planning purposes in the current low value/low interest environment, we will focus here on two types of irrevocable trusts—grantor trusts and non-grantor trusts. This can be confusing, since both are funded by a grantor (the person establishing the trust) and both are irrevocable, meaning the terms cannot be changed and any assets held by the trust should be excluded from the estate of the person funding the trust (assuming the terms are drafted correctly). Both are subject to gift tax upon funding (although the planning techniques discussed below are designed to reduce or eliminate actual gift tax). The difference is that a grantor trust is set up so that the person funding the trust is responsible for income taxes on the earnings of the trust (a benefit for wealth transfer planning) and a non-grantor trust is responsible for income taxes on its earnings.

Sophisticated versions of these trusts can generate impressive wealth tax savings, particularly when values and interest rates are low. Some of these include:

Grantor retained annuity trust (GRAT)s. With a GRAT, the grantor transfers highly appreciating property into a trust while retaining an annuity stream for a stated period of years. At the expiration of the term, the property remaining in the trust is transferred to the beneficiaries. Because the grantor retains an annuity stream GRATs particularly appeal to people who are cautious about giving away wealth now.

The transfer of assets to the GRAT creates a taxable gift equal to the fair market value of the assets less the actuarially determined present value of the retained annuity stream. To the extent that the amount actually transferred as the remainder interest exceeds the value calculated for gift tax purposes, the excess is transferred gift tax-free. At the end of the GRAT term, the remainder interest that passes to heirs is completely out of the grantor’s estate. Because the present value of the remainder interest is calculated based on the interest rate at the time the trust is established, GRATs can be especially effective during periods of low interest rates.

Intentionally defective irrevocable trust (IDIT)s. Because an IDIT is considered a grantor trust for income tax purposes, the grantor pays the tax on income within the IDIT, increasing the after-tax trust value to the ultimate beneficiaries (as with a GRAT). However, an IDIT is structured so that its assets will not be included in the grantors estate for federal estate tax purposes. This split feature gives rise to various planning opportunities, such as a sale to an IDIT, which are particularly attractive when values and interest rates are low.

With a sale to an IDIT, the grantor makes a cash gift to the trust and also sells assets (e.g., closely-held stock) at fair market value to the trust in return for a promissory note bearing interest at the Applicable Federal Rate. (A cash gift to a new trust can be avoided if the family structure already includes a grantor trust with assets that can support the required promissory note.) As with a GRAT, appreciation (and cash flow) of the property sold, in excess of the interest rate charged on the note (or the GRAT Internal Revenue Code section 7520 rate), passes to heirs free of transfer tax. The grantor does not recognize gain or loss in connection with the sale of property to the trust in exchange for a note (or funding of GRAT). The grantor is not taxed on the interest the grantor receives on the note (or the GRAT annuity payments). The grantor indirectly retains an element of cash flow from assets sold to the trust. And, the grantor’s payment of the trust’s income tax liability is not considered to be an additional gift to the trust beneficiaries.

Dynasty trust. These are irrevocable trusts designed to pass assets through multiple generations at a reduced transfer tax cost. They have a perpetual existence and assets owned by the trust should not be includible in anyone’s estate until the trust is terminated. Grantor trust rules allow the settlor to pay the income taxes on behalf of the trust during his/her life, which further benefits future generations by allowing trust assets to grow tax-free. Further, dynasty trusts may provide creditor protection and may not be subject to marital claims. Kohan points out that an IDIT is a great trust to set up as a dynasty trust.

Want to know more about current wealth transfer opportunities?
Please contact:

Richard Kohan
Partner, Private Company Services/Personal Financial Services
617-530-7461
richard.kohan@us.pwc.com

Or visit www.pwc.com/pcs to locate the PricewaterhouseCoopers contact nearest you.

Originally published in The Fenton Report on March 29, 2004

In 2003, the federal government treated nearly 24 million families to a tax credit check. The U.S. Treasury mailed checks to many people who claimed the Child Tax Credit last year as an advance payment for the credit’s increase (tax law changes in 2003 increased the credit from $600 to $1,000 for qualifying families). The IRS used 2002 returns to determine qualified households. Qualifying children must have been born after 1986 in order to be eligible for the advanced payment.

However, to ensure that you do not believe in free lunches, the IRS is reminding taxpayers who plan to claim the credit on their 2003 federal income tax returns that they cannot claim the full $1,000 per child if they received an advance payment last year. Rather, the $400 advance must be subtracted from the credit amount computed for this year.

In the category of other news you can use from our tax authorities, the IRS recently issued new, relaxed guidelines for requesting a waiver of the 60-day deadline for IRA rollovers.

IRA owners may take a distribution from their IRA one time each calendar year without penalty or tax—as long as they get it back into the account within 60 days. Unlike Cinderella, whose coach turns into a pumpkin at midnight, your coach will be hit with tax and possibly a penalty if you are under age 59 ½ when you make this withdrawal and you don’t hit the deadline.

As we all know, sometimes even the best of intentions don’t allow us to make deadlines. For example, if you sent a check to a financial institution and they failed to get the money into your account in a timely manner, it’s too bad for you!

The new kinder, gentler IRS guidelines allow the IRS to consider “all relevant facts and circumstances,” such as whether financial institutions were late getting your check applied to the account, whether health reasons precluded you from acting in a timely manner, or whether “the dog ate the mail” and your payment disappeared. In any case, where there was once an “iron-clad” rule about being late, the IRS is now willing to consider good excuses.

While we are on the subject of IRAs, let’s review the rules for Roth IRA contributions. A Roth IRA accepts deposits of after-tax money that then may grow without taxation of dividends, interest or capital gains inside the account. When the money is paid out, it comes out tax-free, unlike normal IRA distributions, which are taxable.

An individual can contribute $3,000 to a Roth in 2004. This limit goes up to $4,000 for 2005-07 and $5,000 in ’08. The maximum contribution limits are phased out for individuals with adjusted gross incomes between $95,000 and $110,000 and for married couples filing a joint return with AGI between $150,000 and $160,000.

Finally, I have noticed a number of revised brokerage 1099 statements being sent out. A primary reason for revised statements is the reclassification of certain mutual fund dividends from non-qualified to qualified. Qualified dividends are taxed at the lower 15% rate, while ordinary dividends are taxed as ordinary income. The bad news is that you may have to file an amended tax return to properly account for the changes. The good news is that in most cases, this should result in lower taxes.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Coming up with a retirement plan to replace a weekly paycheck once retirement comes knocking is essential to making sure your money lasts as long as you do. The basics for designing this plan rest on the “three legged stool of retirement”…government pensions, personal savings and investments, and employer supplied retirement benefits.

An individual has little control over two of the three. But when it comes to managing the personal investments leg, a number of choices emerge.

Rules for investing retirement assets abound. A frequently quoted rule states that your portfolio should consist of bonds in proportion to your age minus 100. For example, a 60 year old would have his investment accounts invested in 60% bonds and 40% stocks.

The logic behind this rule is sound…as you age you need to reduce investment risk and increase certainty in your portfolio. Bonds held to maturity making predictable income payments are generally less risky than stocks held for price appreciation.

The problem with “rules of thumb” is that they do not account for individual preferences and situations. For example, individual risk tolerances might allow some seniors to maintain a riskier portfolio than a person half their age.

A retiree with a proportionately larger portion of their retirement income coming from government and company pensions (or other low or no risk income sources) may choose to be more aggressive in their investment strategy since the risk of investment loss is not as catastrophic to their plan.

Taxes play a part in determining an investment plan. For example, interest payments on corporate bonds are taxed as ordinary income while dividends and long-term capital gains are taxed at 15% (5% for taxpayers whose top marginal tax bracket is 15% or less).

Since all payments from a traditional IRA are taxable at ordinary income rates, a retiree with two portfolios…an IRA and a non-qualified investment account…would hold bonds paying interest in the IRA and dividend paying stocks or stocks held for appreciation in the non-qualified account.

This does not hold true for tax-free municipal bonds, which should always be held in the non-qualified account.

With the appreciation in real estate, many see their homes as a piece of the retirement income puzzle. I am commonly asked about the wisdom of paying off a home mortgage in lieu of holding the equivalent in an investment account.

A paid for home should be viewed as a bond in the portfolio. It provides a tax-free, risk free economic benefit…rent…to the owner. The cost to carry the mortgage is the after tax cost of the interest paid (equal to [1- your marginal tax rate x the mortgage interest rate]).

If a mortgage is carried, and the money to pay off the mortgage is invested, the investor should reasonably expect to earn the taxable interest on the mortgage plus 3% to 5% more to compensate for risk and taxes on investment returns.

Again, this decision to invest or pay off the mortgage should be based upon an individual’s risk tolerance, and investment time horizon (length of time before the investments have to be spent).

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

If IRA account assets are withdrawn prior to age 59 ½, not only will the owner pay ordinary income taxes on the withdrawal but also a 10% excise tax penalty. Section 72(t) of the Internal Revenue Code allows the plan owner to withdraw funds from a retirement account without the 10% penalty if the withdrawals are a series of substantially equal periodic payments.

Once the owner begins taking distributions as part of a SEPP, the payments must continue for the longer of five years or to age 59 ½. For example, a 53-year-old IRA owner must take distributions for five and a half years until age 59 ½, whereas a 56-year-old owner is only required to take distributions for five years to age 61.

The amount you can withdraw is a function of the account balance and one of three calculation rates allowed by the IRA. Each results in a different allowed withdrawal amount, making it possible to tailor the distribution to meet your specific need.

The amortization method is determined by using the life expectancy of the taxpayer and his or her beneficiary, and a chosen interest rate. This interest rate cannot exceed 120% of the federal mid-term rate, which for January 2005 was set at 4.53%.

The annuitization method is similar to the amortization method; however the amount is determined by using an annuity based on the taxpayer’s age, age of beneficiary and chosen interest rate.

The required minimum distribution (RMD) method calculates an annual payout by dividing the account balance for that year by the life expectancy factor of the taxpayer and beneficiary. Using this method, the amount to be paid will be recalculated each year.

To see how this works, let’s consider John Smith, age 53, wife age 52, who has a $250,000 IRA he wishes to tap for early retirement income. His IRA investment return is 6% annualized. He plans to continue the withdrawals for 8 years, and then tap other retirement accounts, leaving this IRA to accumulate. Using joint life expectancy and an interest rate of 4.53%, his withdrawal amounts would be as follows:

• Amortization Method: Annual payment of $13,908 and account balance at the end of 8 years of $260,809
• Annuitization Method: Annual payment of $14,942 and account balance at the end of 8 years of $250,573
• RMD Method: Annual payment beginning at $6,579 and a balance in 8 years of $315,441.

John’s choice of withdrawal calculation will be based upon his need for income and his plans for his IRA once his required payment to age 59 ½ has been met. He can change his distribution type one time without penalty from the Annuitized or Amortized methods to the Life Expectancy (RMD) method if he feels the fixed amount would prematurely deplete his account.

Other rules that must be followed to avoid the imposition of the 10% penalty tax include the prohibition of withdrawing additional sums, or making transfers from this account. The owner may transfer the full amount without penalty to another custodian or trustee as long as the payments continue. Finally, additional contributions may not be added to the account balance while part of a SEPP plan.

For example, Jim suffers a stroke. His largest asset is an IRA naming his brother as the beneficiary. The brother needs the money from the IRA to pay Jim’s medical expenses. Without a durable power of attorney giving him authority to act for Jim, he will not have access to this IRA resource without a court order.

Or, consider the case of Mary, who became incapacitated as the result of an automobile accident. Her life partner has no right to make medical decisions on her behalf without the durable power of attorney authorizing her to do so.

If you become incapacitated and you haven’t prepared a durable power of attorney for your finances, a court proceeding is necessary to allow your spouse, closest relatives, or companion to exercise some authority over at least some of your financial affairs. If you are married, your spouse retains some authority over property you own together—to pay bills from a joint bank account, for example.

If your relatives go to court to get someone appointed to manage your financial affairs, they must ask a judge to rule that you cannot take care of your own affairs—a public airing of a very private matter. And like any court proceeding, it can be expensive if a lawyer must be hired. When the courts act and appoint a conservator, or guardian of the estate, you lose the right to control your own money and property.

The appointment of a conservator is usually just the beginning of court proceedings. Often the conservator must post a bond—a kind of insurance policy that pays if the conservator steals or misuses property, prepare (or hire a lawyer or accountant to prepare) detailed financial reports and periodically file them with the court, and get court approval for certain transactions, such as selling real estate or making slightly risky investments.

Properly designed durable powers of attorney will solve these problems. When you execute a power of attorney, you give another person legal authority to act on your behalf. This person is called your “attorney-in-fact,” or sometimes referred to as your agent.

The word “durable” plays an important part in the process. If the word “durable” is not used, the power of appointment lapses, or ceases to be effective, when the person who granted the power is incapacitated.

Durable powers of attorney are most often used to give “attorneys-in-fact” power to act on the financial and health affairs of the grantor of the power. While a revocable living trust will often name a successor trustee to act for the beneficiaries of the trust, many assets and situations that need management are not governed by the living trust, such as property held in joint tenancy, or retirement accounts with a named beneficiary.

A durable power of attorney can be drafted so that it goes into effect as soon as you sign it. But you can also specify that the durable power of attorney does not go into effect unless a doctor certifies that you have become incapacitated. This is called a “springing” durable power of attorney. It allows you to keep control over your financial affairs unless and until you become incapacitated.

Single individuals, those with no immediate family nearby, and certainly anyone with property or investment assets should have current durable powers of attorney for financial affairs and health management. A simple will or even a living trust is not enough.

The federal tax system can extract a terrific bite out of such an IRA upon the death of an owner. For example, an IRA left by a decedent is subject first to the federal estate tax, which can be as high as 55% for larger estates. Then, the designated beneficiary, or the estate if no beneficiary is named, is taxed at ordinary income tax rates on every dollar withdrawn from the traditional IRA.

There are a number of planning steps that can be used to reduce some of the tax bite. Always name a beneficiary for each IRA. If the beneficiary is the spouse, two important benefits are realized.

First, a spouse who does not roll over the IRA and who is under age 59½ can draw from the IRA without the 10% penalty that otherwise applies, although income taxes must still be paid. Or the spouse can elect to roll over the IRA into his or her own name. Since this transfer qualifies for the unlimited marital estate tax deduction, there is no estate tax. Further, since the rollover is going directly into the spouse’s IRA, there will be no income tax paid until the money is distributed from the plan.

If the IRA is going to a non-spousal beneficiary, such as the decedent’s child, the beneficiary may elect to receive the IRA payments over his or her lifetime. This allows the IRA to possibly grow tax-deferred as a minimal amount is distributed each year. However, should the owner make the mistake of not naming a beneficiary, and if there is no spouse, the estate or heirs do not have the option of lifetime distributions.

Another solution is to spend the money while alive. It is counter-intuitive to think of spending dollars that represent taxable income if one has other less-taxed assets to spend first. However, keep in mind that by spending the IRA while alive, your estate will not be taxed twice at your death. Consider protecting other capital assets that will receive a step-up in basis at death. Even though these assets will be subject to estate taxation, they can be sold at the date of death and incur no income taxation. Such is not the case with an IRA.

Also consider giving your IRA to charity. If your estate plan calls for a sizable charitable bequest, make it out of an IRA. Your estate will receive a charitable deduction, reducing the value of the estate for death tax purposes. Since the charity does not pay income taxes, Uncle Sam misses out entirely.

Finally, when planning with a large IRA in your estate, by all means seek qualified tax advice. Laws are constantly changing, providing both opportunities for the informed and traps for the unwary.

It’s the very size of IRA accounts that raises planning problems, however. Where Dad’s IRA might have been for a few thousand, today it’s not uncommon for his children to have IRAs in six or seven figures.

The problems these larger IRAs pose are three-fold:

1. Managing the assets pre-retirement
2. Managing the assets after retirement, including dealing with complex required minimum distribution rules
3. Deciding what to do with an IRA for estate planning purposes.

This and my following column will speak to these issues.

Prior to retirement, the obvious objective is to manage the account to maximize growth and protect the principle. It is important not to trigger unintended taxation of the account. For example, it is not uncommon for an employee to change jobs every few years, each time leaving behind an orphan 401k plan. These orphaned plans should be consolidated into one IRA account through a trustee-to-custodian transfer.

Such a transfer will be considered a qualified rollover and not require mandatory withholding of 20% of the amount transferred—as would be the case if the employee withdrew the funds directly and then opened a new IRA account to accept the transfer.

Moreover, if an employee under age 55 attempts the do-it-yourself route and hangs on to the money more than 60 days, the rollover is disqualified and the owner will pay income taxes plus a 10% excise tax penalty for a premature withdrawal.

While you cannot borrow from an IRA as you can from many employer-sponsored retirement plans, you are allowed to roll the money over (take it out of the account and use it as you desire) for 60 days each year. Once per year per owner—but be sure it’s back not later than the 60th day!

By consolidating IRAs, the owner gains the advantage of ease of management. If set up in a brokerage account, then stocks, bonds, CDs, mutual funds, etc., may be combined in the IRA and the owner will see the entire account on one periodic statement.