IRAs and Portability of the Estate Tax Exemption

Portability and Retirement Assets

Retirement assets can be quite a challenge in planning to
fund a bypass trust. Portability can be a tremendous benefit to clients with
large IRAs endeavoring to minimize estate taxes and still securing simplicity
and preferable IRA treatment.

From a purely tax perspective (which is not always
consistent with personal goals), leaving an IRA outright to a spouse is
generally the preferred approach. This provides the surviving spouse the most
tax flexibility and benefit. The increased $5 million exemption solves the
entire issue for many clients, because their aggregate estate will no longer be
subject to federal estate tax. But, for clients whose estate increases beyond
this level, portability may be a great answer.

To maximize flexibility in this uncertain tax world, many
advisers recommend the disclaimer approach. The client can bequeath all assets
outright to his or her surviving spouse, who then, with the wisdom and judgment
of hindsight can disclaim just the right amount to fund a bypass trust.

Example:
Husband and Wife reside in New York, which has a $1
million state estate tax exclusion. Husband’s estate consists of a house valued
at $2 million, a $3 million IRA, and $1 million brokerage account. The house
and brokerage account are owned jointly and Wife obtains title automatically by
operation of law upon Husband’s death. The IRA lists Wife as the primary
beneficiary. Under Pre-TRA Wife would have to disclaim as the primary
beneficiary of Husband’s IRA. If Wife disclaimed, then the IRA would pass to a
bypass trust under Husband’s will.

Assume that Wife survives Husband, but based on the
current 2011 $5 million exclusion, Wife determines not to disclaim any of
Husband’s IRA to fund a bypass trust under Husband’s will. Her reasoning is
that the aggregate estate is only $6 million, not much more than the $5 million
exclusion. She anticipates spending down the estate over time to meet living
expenses. If, in fact, her assumption proves correct, there will be no federal
estate tax, although, there will be a moderate New York estate tax on her
eventual death. However, more sound reasoning might suggest another approach.
The estate may be valued at $6 million only because housing and security values
are currently at depressed levels. If markets recover, the estate will almost
assuredly exceed the $5 million exclusion even with a spend down. This will
result in a federal and state estate tax. Post TRA, however, portability may
enable Wife to avoid any federal estate tax.

Portability is not a cure all. Even if all the
requirements (e.g., filing requirements) are met, state estate tax is not
avoided because state law does not permit (yet?) portability. On this basis,
Wife could at least disclaim $1 million of assets to remove those assets, and
future growth in those assets, from her potentially taxable estate. At the $1
million threshold, she will reduce state estate tax on her death. Wife will
also be able to reduce the federal estate tax.