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.”
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.