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Financial Considerations
Whether planning a funeral in advance or settling an estate after death, it is important to have professional financial guidance to effectively protect and manage your assets while assuring that they are ultimately distributed in accordance with your wishes in a tax efficient manner.
In retirement, assets should be positioned to provide guaranteed income to satisfy basic living expenses and sufficient variable income and liquidity to maintain the desired lifestyle and to provide for various life events.
At death, proper beneficiary designations on life insurance and qualified plans (401(k), IRA and pension plans) will enable these funds to avoid the probate process and be distributed without delay. Each of these instruments has unique features and tax ramifications to you and your beneficiaries. A brief overview of each is outlined below:
Life Insurance
Life insurance proceeds are income tax free to your beneficiaries. Typically proceeds are distributed in a lump sum. In some instances, it may be wise to choose alternative settlement options which can provide a guaranteed flow of income to the beneficiary for a designated length of time or the life of the beneficiary. In this instance, only the interest on the death benefits would be taxable and the death benefit would remain tax free.
Retirement Plans
Defined Benefit pension plans provide guaranteed annuity income for the life of the employee. If chosen at retirement, a survivor income benefit would be payable to the surviving spouse. All income from a pension plan is taxable as ordinary income at the recipient’s tax bracket in
the year it is received. Defined benefit plans do not typically provide a lump sum benefit. Employers typically offer several survivor annuity options from full to partial benefits to the surviving spouse. Since retirement benefits are reduced based upon the amount of guaranteed survivor benefits provided, it would be wise to review these options to develop a plan with a qualified financial professional.
Defined Contribution plans accumulate funds during your working years to provide a source of income at retirement. Profit sharing, 401(k), 403(b), ESOPs are all forms of defined contribution retirement plans. Each of these plans offers the choice of guaranteed income for life (annuity) or a lump sum benefit option. If chosen, the annuity benefit works the same as the defined benefit plan above with a full benefit for the life of the employee or a reduced benefit with survivor benefits for the employee’s spouse. All income is taxed as ordinary income in the year received. As an alternative, the retiree could choose a lump sum benefit. The lump sum can either be paid in cash (and subject to immediate taxation as ordinary income) or rolled into an Individual Retirement Account (IRA). Rollovers are not subject to income tax until withdrawn by the account holder.
Individual Retirement accounts (IRA) offer the greatest flexibility on distributions. In addition to the life and survivor annuity options discussed above, the account holder could choose to take withdrawals of varying amounts as needed. Required minimum distributions (RMD) must be taken beginning at age 72. All distributions from a traditional IRA are taxed as ordinary income when received. At death, the balance of the IRA must be rolled into an Inherited IRA in the name of each beneficiary.
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