Investing in qualified
retirement accounts, including IRA's and employer sponsored plans, offers several
advantages. Except for Roth IRA's, these accounts are tax deductible - the amount you put
in, up to specified limits each year, is excluded from current income taxes. Instead, the
taxes are assessed later - when withdrawals are made from the accounts.You might say, "what's the difference, I'm going to have to pay the taxes eventually". The difference is the benefit to you of before-tax appreciation in the accounts - if left to accrue over a long period of time it can double (and sometimes triple or more) the size of the accounts net of taxes as compared to similar investments held outside qualified retirement accounts.
Before-tax appreciation can be enhanced further by leaving the accounts after your death to a Retirement Plan Beneficiary Trust for younger-generation beneficiaries whose longer life spans can substantially extend the before-tax appreciation feature, as well as provide a foundation for their lifetime-needs-support. In addition, the income tax brackets of such beneficiaries are likely to be lower than the surviving spouse's.
The disposition to younger beneficiaries (as compared to the spouse) through a Retirement Plan Beneficiary Trust can be made in a flexible manner - the final decision can be made after the account holders' death (if provisions for this have been made in advance), at which time the spouse can evaluate her circumstances and make a more informed decision as to whether she will need the funds during her life - if she decides she won't then the accounts can fund the trust.
The trustee of a Retirement Plan Beneficiary Trust can be given discretion to distribute funds to those beneficiaries who are more needy, the only requirement being that all the funds must be distributed before the end of the expected life span of the oldest beneficiary. In other words, the trustee can distribute funds during the periods the beneficiaries are most in need, such as during college years.
Leaving the accounts directly to younger-generation beneficiaries (i.e., not in trust) would likely defeat the purpose of these accounts because the beneficiaries would have the power to accelerate distributions, potentially losing substantial before-tax appreciation benefits.
Roth IRA's are taxed up front whereas regular IRA's are taxed when the funds are withdrawn from the account. Roth IRA's are better for people who expect to be in a higher tax bracket during retirement. Also, they are more flexible than regular IRA's - for example, there is no requirement that withdrawals begin at any time during the account holder's life, and there are more pre-retirement withdrawal options with Roth IRA's.
One of the main advantages of employer sponsored retirement plans, such as 401K's, is that 90% of the time the employer matches contributions made by the employee. Another advantage is that these accounts are given more protection in the law from creditors than IRA's and similar accounts. (However, IRA's are also given protection - Illinois state courts generally will not enforce a judgment against IRA proceeds of Illinois residents.)
If your employer doesn't match contributions you make to your employee retirement account, and you have limited discretion as to the type of investments by the plan, it may be advisable to discontinue contributions before retirement, instead investing in stock funds if a) you don't have younger-generation beneficiaries to leave your retirement accounts to, or b) you expect you and your spouse will need all the retirement funds during your lives.
The reason for this is that nearing retirement a) you would not benefit as much from before-tax appreciation of plan contributions (unless you could leave the accounts to younger-generation beneficiaries after your death), and b) capital gains taxes will be avoided if the stocks are transferred at death - because the tax basis is stepped-up to the value of the stocks as of the date of death.
However, if you have charitable purposes it may nevertheless be advisable to continue contributions to retirement accounts because no income tax would be incurred on balances in retirement accounts given to charities, or left to them at your death.
New rules in effect as of January, 2001 no longer require you to make final beneficiary designations, for purposes of minimum required distributions ("MRD's"), by April of the year following the year you turn 70 1/2. Also, MRD's, which in most cases must begin by this time, are now simpler to determine, and only depend on your current age and the balance in your accounts, unless you have a spouse more than ten years younger - in which case your MRD's will be lower. The MRD's under the new rules, both before and after your death, are lower, thus permitting more before-tax appreciation of the accounts.
