Save part of your wealth to cover taxes

“If a man is proud of his wealth, he should not be praised until it is known how he employs it.”

—Socrates

Have you ever noticed that there are some con­tain­ers that are great at hold­ing some­thing valu­able, but are a hor­ri­ble con­duit for the receipt of that asset. Take for exam­ple, a water bal­loon. Great for hold­ing water, but a lousy way to receive it. Maybe a bet­ter exam­ple is a bee hive. This is a great way for the orig­i­nal own­ers (the bees) to use the asset, but a ter­ri­ble and painful way for the ben­e­fi­cia­ries (us) to receive it. The finan­cial world is no dif­fer­ent. Some accounts are great for sav­ing and invest­ing, but can be incred­i­bly messy and costly for your heirs to receive.

You may be aware that cur­rently, your right to trans­fer prop­erty at your death is taxed at both the state and fed­eral lev­els based on the value of vir­tu­ally every­thing you own includ­ing real estate and life insur­ance death ben­e­fits. Cur­rently, the state estate tax is 6 per­cent or 7 per­cent, depend­ing on your estate value, on all estates more than $338,333. For­tu­nately, this tax will effec­tively be elim­i­nated on the estates of all indi­vid­u­als who die on or after Jan. 1, 2013, as part of the pass­ing of the Ohio 2012–2013 Bud­get Bill 153.

Unfor­tu­nately, a 35 per­cent fed­eral estate tax remains in place for estates more than $5,000,000. While this may sound like a big num­ber, this is a very real dan­ger for many in their 50s or 60s with estates cur­rently val­ued at $1,000,000 or more. Addi­tion­ally, the exclu­sion from this tax is expected to be low­ered to $3,500,000 and pos­si­bly even down to the orig­i­nal exclu­sion of $1,000,000 after our next pres­i­den­tial election.

This is impor­tant because many good savers have used con­tain­ers like 401k retire­ment accounts, IRA’s and real estate to build and hold wealth with no real plan­ning for their use or trans­fer. While these assets have proven to be won­der­ful wealth build­ing vehi­cles, they can be as lame as a water bal­loon to receive.

Let me explain. I see many peo­ple that have saved so well, that they will never spend the wealth they have built. Fur­ther­more, they have fol­lowed the lead­ing of the gov­ern­ment and finan­cial world and now have an estate made up entirely of illiq­uid real estate and 100 per­cent tax­able retire­ment money.

Strong savers with tax­able estates will leave their heirs with an estate tax bill that will require the fire sale of real estate or the liq­ui­da­tion of the retire­ment accounts result­ing in a fury of taxes that can vir­tu­ally destroy the accounts leav­ing as lit­tle as 10 per­cent to the heirs. You see, if you are a good saver or investor, some of your wealth will be used for “social cap­i­tal” or taxes. If unplanned, you are basi­cally trust­ing the gov­ern­ment to man­age how this money should be used to improve our soci­ety through taxes.

For­tu­nately, through wise plan­ning you can choose how to direct your social cap­i­tal through char­i­ta­ble plan­ning with trusts, Donor Advised Funds or Life Insur­ance Trusts while reduc­ing or elim­i­nat­ing the estate tax bur­den to your heirs. A nice read on this sub­ject is The Retire­ment Sav­ings Time-Bomb… And How to Dif­fuse It by Ed Slott.

As a first step, con­sider how much is really enough. If you have a nice cush­ion, take a look at what you really need to live your life as desired.

Sec­ondly, con­sider what is excess and decide what you would like to see done with your “social cap­i­tal.” Maybe you believe that char­ity begins at home and sim­ply want to pass your excess onto your chil­dren or maybe you would like to impact your com­mu­nity or even some­one on the other side of the world. Let your cre­ative thoughts run wild.

Finally, put a plan in place to make it hap­pen. Take some time and con­sider the real poten­tial of your wealth. Remem­ber, the only real value wealth has is what you choose to do with it.

RC Arse­neau is a Cer­ti­fied Finan­cial Plan­ner and lives with his fam­ily in Delaware. Please sub­mit any ques­tions or topic requests to AskRc@mail.com.

The infor­ma­tion and opin­ions in this col­umn are pro­vided only for edu­ca­tional and enter­tain­ment pur­poses. Any ref­er­ence to a finan­cial prod­uct or strat­egy is not to be con­sid­ered an endorse­ment or rec­om­men­da­tion. The infor­ma­tion is of a gen­eral nature only and does not take into account your indi­vid­ual objec­tives, finan­cial sit­u­a­tion or needs. It should not be used, relied upon, or treated as a sub­sti­tute for spe­cific pro­fes­sional finan­cial, legal or tax advice. Invest­ment Per­for­mance may vary due to tim­ing and expenses. Rc rec­om­mends that you obtain your own inde­pen­dent pro­fes­sional advice before mak­ing any deci­sion in rela­tion to your par­tic­u­lar require­ments or circumstances.

Posted by RC Arseneau on Aug 21 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.