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Normally, a majority of people believe a financial planner’s time is spent on working plans to accumulate wealth and plan for retirement. We do work a lot in this area but maybe just as much of our time is working with clients on how to spend or give away their money.
Recent surveys suggest that 47% of Americans under age 50 do not have children and don’t plan to have any, according to the Pew Research Center. Only about 1 in 4 senior Americans plan on leaving an inheritance to their children, according to a study conducted by Northwestern Mutual. So, many Americans plan on spending down or giving away their money.
It's not as easy as you might think to do.
The biggest problem is taxes. Most people with $1 million or more accumulated will have 25%-75% in pre-tax IRA or 401(k) accounts. What is not in these pre-tax accounts are usually assets that have a large unrealized capital gain. Things like real estate, stock portfolios, collectibles, and business interests. Roth accounts are increasing, but few people have a high percentage of their assets in Roth accounts. Annuities are also a big tax problem because the gain is all subject to ordinary income tax. (No capital gains tax treatment).
So, the game plan for most is how do we give it away or spend it without giving a great majority to the government?
An elderly gentleman hired our firm to help with just this problem. He has children and grandchildren. The children have done well and have good retirement plans. He wanted to help the grandchildren and a couple of charitable organizations he has supported over the years.
One-fourth of his estate is in an IRA and the other three-fourths are in a stock portfolio that has a basis of about 20% of the value. That means that 80% of his stock portfolio is a long-term capital gain and will be subject to the favorable capital gains tax rules.
If he simply lets the heirs inherit the money, they would get a “step-up” on the basis and therefore would not owe any taxes on death for the stock portfolio. The IRA account would be taxable at the heirs’ tax rates upon inheritance of their portions. Our client is actually at a lower tax rate than his children. Also, he wants to help the grandchildren out now and experience the joy of seeing his gifts.
Giving to the charities directly from the IRA would meet his required minimum distributions, known as RMDs, which are high at his particular age, and reduce his taxable income. We can give $105,000 directly per year (double that for a married couple) from the IRA after age 70 1/2. This amount will not be taxable to the IRA owner and will meet the RMD requirements. Using the IRA for the charitable organization’s gifts saves both the client and his heirs taxes.
The taxes on long-term capital gains for stock portfolios is a graduated scale. There is a low level of 0% taxes on the gains and then a large level of 15% taxes and then for people with higher incomes the level is 20%. These levels are determined by taxable income, so after the standard or itemized deductions are taken but including the gains. Also, note that collectibles are taxed at 28%, and small businesses and real estate gains, due to depreciation expenses, are taxed at a different percentage.
Back to our client. We can sell off enough of his stock holdings to stay within the 0% tax and use that “zero tax” money to make a gift to the grandchildren. Each year we calculate what is our maximum amount within the zero bracket and sell the specific shares that have the lowest gain. It is important to sell specific lots of stocks so as to avoid an average basis on the portfolio. All of this takes some patience, calculations, and reviews with current rules each year. What we don’t give each year while the client is alive will be inherited at death and have a “step up” in basis, making the portfolio a tax-free inheritance.
This is just a basic example of the planning needed to get rid of a client’s money. Each type of asset has its own rules and it is important to stay up with those rules.
To ignore the rules is to make the government a substantial heir to an estate. This example is based on current tax laws, which often change. If they change, we change our approach.
If you are planning to retire and move from accumulating wealth to distributing wealth, I encourage you to seek the services of a Certified Financial Planning Professional™ with the CFP® marks. What you will save in unnecessary taxes will most likely exceed what the advice will cost.
Wes Shannon CFP® is a Certified Financial Planning Professional for Brazos Wealth Advisors in Fort Worth.