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Make Heirs Apparent
Many Fools will accumulate substantial assets due to successful investing (so we hope!). Those assets will be divided between taxable accounts maintained with brokers, mutual funds, and banks on the one hand; and with tax-deferred accounts such as 401(k) plans and IRAs on the other. Know that on the owner's death all of those accounts are subject to federal estate taxes, while the tax-deferred accounts are also subject to income taxes. You may leave a spouse an unlimited amount of assets at death, free of estate taxation, through what's known as the "unlimited marital deduction." Additionally, all amounts in tax-deferred accounts may stay in those vehicles untaxed until your spouse must take mandatory minimum required distributions (MRD) based on when you would have or when your spouse does reach age 70½. Whose age 70½ will be used depends on how he or she elected to take those assets. Usually, though, problems with estate or income taxes do not occur at the first spouse's death. Rather, they occur at the second spouse's demise.

In 2001, you may leave up to $675,000 free of estate taxes to heirs who are not your spouse. Amounts above that sum will be taxed at a rate of at least 37%. The amount that may pass tax-free to heirs will increase in steps to $1,000,000 between now and 2006. While the sum appears large, the estates of many people will exceed it. One of these people may be you. If your assets are approaching this level, then, to avoid paying unnecessary estate taxes, you'll need the services of an estate planning attorney. This is especially true of couples who, through the use of the unified estate tax credit, may each shield up to $1,000,000 from the tax man -- allowing up to $2,000,000 to pass to children estate-tax free. Sure, you'll be gone, but think of your kids partying the night away, week after week, year after year, 'til the end of time, once they get over their grief.

Indeed, depending on the complexity and value of the potential estates, some fancy trust planning may be needed. That's a topic that is well beyond the scope of this seminar. In general, though, the higher the value of the estate, the greater the need for sophisticated estate planning.

Another fly in the ointment is the taxation of traditional Individual Retirement Accounts (IRAs) and qualified retirement plans. (Remember, we talked about these in Lessons 3 and 4.) Both are counted as part of your estate, so both are subject to estate taxation. However, any income in those accounts that has never been declared and taxed to you during your life will be taxed to your beneficiary as ordinary income when the beneficiary receives a distribution from those vehicles. Under new distribution rules recently announced by the IRS, beneficiaries of IRAs and defined contribution plans (like 401(k) and 403(b) plans) may now take distributions from those retirement accounts over their lifetimes. Doing so may enable those beneficiaries to avoid heavy income taxes on those distributions. In the case of defined contribution plans, though, the plan may force an earlier payout.

For IRAs, this issue becomes even more important at age 70½ when MRD must start. The required beginning date (RBD) for such distributions is April 1 of the year following the year one reaches age 70½. For planning purposes, the required beginning date is a highly important one, because if you miss it, Uncle Sammy will assess a 50% penalty on the amount you should have taken. So it's a date you absolutely, positively, do not want to forget!

Social Security and the Company Pension
If we kick off into the great beyond, will our Social Security benefits pass to a survivor? That depends on whether we were the primary wage earner in the family. If so, then a surviving spouse and/or other surviving dependents may receive a survivor's benefit. You may verify who would be eligible to draw a death benefit based on your work record by checking with the Social Security Administration.

What about an employer-provided pension? The pension may or may not pass to a survivor, too. That depends again on the payment options allowed by your plan, and the option you choose at retirement. Federal law stipulates that when you elect any payment option that does not provide for a continuing payment to a surviving spouse when you die, your spouse must agree to that option in writing over his/her notarized signature.

Work may also provide some payment to survivors through employer-provided life insurance, but usually it won't. Other income arising from assets you own will go to heirs in accordance with your beneficiary designations or the terms of your will.

Personal savings will always pass to survivors as part of your estate. To whom they pass depends on your beneficiary designations or the provisions of your will in the absence of such designations.

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