Protecting Your IRA – Part V: An IRA Blessing for Your Heirs
By Terry Coxon - August 01, 2010

If you expect to leave an estate worth more than $1 million, your heirs could lose a lot to estate tax unless you take steps (the sooner the better) to prevent that from happening. Fortunately, estate tax is a manageable problem, provided that you start planning early.

A good estate planner can eliminate all or most of the potential liability for estate tax even if you are extremely wealthy. He has an amazing array of techniques; just give him a 15 or so years to whittle away at the problem and he'll get the job done.

But there is one thing he can't protect from estate tax – an ordinary IRA. You can't make gifts to family members out of your IRA, because that would violate the IRA rules. And with an ordinary IRA, there is no room to argue about its value. Everything in it has a readily ascertainable price – stocks, bonds, mutual funds – or can be cashed in for 100 cents on the dollar, such as an annuity. That makes an ordinary IRA completely indigestible for any estate-planning technique.

An Open Opportunity IRA, however, can be used to control the potential tax bill on your estate, since it easily accommodates what has become a conventional estate planning strategy. With the Open Opportunity structure, your IRA holds just one asset – a limited liability company (LLC) that you manage.

As already explained in Part III, "Saving Big on a Roth Conversion," the rights and powers that come with each share in an LLC can be set so that the fair market value of all the shares is substantially less than the value of the assets the LLC owns. Achieving such a valuation discount (generally 35% to 50%), is how you can cut your tax bill when you convert a traditional IRA to a Roth. It also reduces the potential estate tax associated with your IRA by a similar percentage.

Enterprising Heirs

There is a second way in which an Open Opportunity IRA can be a blessing to your heirs. And it applies even if you don't expect your estate to be big enough to attract estate tax (although it's hard to be sure about sidestepping estate tax, since the rates and exemptions keep changing).

It is very likely that part of your IRA will go to your heirs. Because an IRA's tax-deferral power is so valuable, it should be the last asset you touch after you retire. The best approach is to let it keep growing for as long as you have other sources for funding your living expenses. That means that when you retire, you should start by living on the investments you own outside your IRA. Use them up before you touch the IRA. By following that logic, unless you plan to die broke, you will be planning to leave part of your IRA for your heirs.

Let's hope they handle the money wisely.

But there is more to the story than the wealth that's left in your IRA. You can leave them more than just the money. You can leave them a piece of powerful machinery.

In Part IV, "Your Own Personal Tax Haven," I explained how you can use the Open Opportunity structure to run a Roth IRA like a business and pour your skill and energy into it to earn extra returns that escape all tax. Working tax-free is obviously a big advantage. But you can't make tax-free withdrawals from a Roth IRA until you reach age 59½. In the meantime, you need to eat.

If you have children or grandchildren whom you believe would want to run with the "Personal Tax Haven" strategy explained in Part IV, you can make it practical for them to do so. While everyone who starts a Roth IRA must wait until age 59½ to make tax free withdrawals, an individual who inherits a Roth isn't required to wait. He can make tax-free withdrawals at any time, even if he's only 12 years old.

So an enterprising individual who inherits a Roth IRA with the Open Opportunity structure could use it to follow the "Personal Tax Haven" strategy to the full, since he wouldn't be forced to wait to make tax-free withdrawals. He could work for the LLC that's inside the Open Opportunity IRA, let the IRA collect the rewards for his effort and then make a withdrawal of tax-free cash.

A nice result from something that seems so plain-vanilla as an IRA.

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