Estate Planning Scenario to Lessen Tax Liability

¶ … Reduce Tax Liability

One of the most important steps in developing an estate plan is identifying the most suitable or right beneficiary for a client's retirement plans. This is primarily because failure to do so generates several consequences because of the resultant financial effects. Actually, the failure to name the right beneficiary for a conventional retirement plan contributes to loss of the "stretch" life expectancy payout for the benefits. Moreover, it contributes to subsequent acceleration of income taxes, which can be financially detrimental. This is an issue that Johnson encountered in estate planning with regards to naming the right beneficiary for his assets. Johnson problem emerged from the fact that he had some assets in a traditional retirement plan, a Roth plan, and nonretirement investments which he wanted to leave to charity, his wife, and his children though choosing a right beneficiary to lessen tax liability.

In Johnson's situation, all three proposed beneficiaries are regarded as tax-favored options given their long life expectancies. Charity is a tax-favored choice because it is income tax-exempt whereas the wife is tax-favored because she can roll over to her own Individual Retirement Account (IRA). On the other hand, children are tax-favored choices because they can promote a long tax-deferred "stretch" payout since they have long life expectancies (Choate, 2011). Even though the three choices in Johnson's case are tax-favored, identifying the right beneficiary is vital to help lessen tax liability.

Based on the details of the case, leaving the traditional retirement plan to charity is not only attractive but also appropriate. In essence, Johnson should name charity as the beneficiary of his traditional plan because the charity can receive the traditional retirement plan benefits income tax-free. This would help reduce tax liability as compared to when the plan is given to the wife or children. Actually, leaving the traditional plan to the wife or children would generate some tax burdens because they will be subjected to taxation. On the contrary, leaving it to charity is the most suitable option since benefits will be accrued tax-free, which helps in lessening tax liability during estate planning. Moreover, the suitability of leaving the traditional plan to charity is evidenced in the fact that the charity's income is tax-exempt. Therefore, the charity will not have to pay any taxes even if income tax is accelerated when it could have been deferred if distributed immediately after Johnson's death.

Johnson should leave the Roth plan to his wife because she can roll over to her own Individual Retirement Plan. The Roth plan is not suitable for charity because the plan is already income tax-free, which implies that there is no benefit of leaving it to an entity that is income tax-exempt. Roth plans are advantageous in the sense that they can be passed on or rolled over to an heir if the individual dies (RothIRA, 2011). The wife will have the option of rolling over this plan to her own IRA or cashing it out without any penalty despite her age. The significance of leaving the Roth plan to the wife is attributable to the fact that proceeds from this plan are not subjected to probate. This in turn accelerates the process of funds disbursements because the heir can easily access the money without tying up the distribution in probate court. Therefore, by leaving the Roth plan to his wife, Johnson will significantly reduce tax liability.