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Two Rules | Rule #1 Do Not Lose Your Principal | Rule #2 See Rule #1

Husband and wife talking.

“Ahhhhh!” You think, “We’ve done it!”

“Well what have we done? We have worked hard, saved, have all the things we have ever wanted. We have our retirement plans intact, and with good health we are looking forward toward retirement in the near future.”

“We did our financial planning to get to this phase of our life, and now with retirement close by, how do we manage our funds? How do we manage our funds to last our lifetime? How much do we pass on to our children? Our grandchildren?”

“So I guess we have everything covered? Right?”

Well let’s see what you have done . . . .

Your assets are as follows:

Home – free & clear $800,000
Investments outside of retirement plans $2,000,000
Retirement plan funds $1,500,000
Other assets, such as jewelry, antiques, second home, life insurance proceeds, furniture, etc. $1,500,000
Medical or dental practice $500,000
Automobiles $100,000

You get the picture, the amount you have for estate purposes could be a great deal of money. In fact, what is listed above totals $6,400,000.

Now how is this handled with good estate planning? Now I know you are saying there is no estate tax at this time. I know that, but if you think it is not coming back, well you are more of an optimist than I am. In fact it will likely be back with vengeance come this January 1.

I am going to make some assumptions:

  • The Estate Tax in 2011 allows an exemption of $1,000,000.
  • The Estate Tax Rate will be in the range of 50%.
  • The combined Income Tax Rate for someone living in California or New York will be about 50%.

What do we do to save on taxes?

In our wills, we divide the estate into two parts. One part will go directly to your spouse, and the other will go to a trust. The trust will get $1,000,000 so it will stay under the exemption and therefore there will be no estate tax.

The other part will go to the spouse. This is done, as there is an unlimited exemption for funds at death going to the spouse.

In our example from above, $5,400,000 goes to the spouse Estate Tax Free, and $1,000,000 goes to a trust, Estate Tax Free.

But, hold on . . . What happens at the second death? (Which for our discussion occurs the following month.)

The trust will go to the trust beneficiaries and, assuming it has not grown, Estate Tax Free (Remember the $1,000,000 exemption).

But what happens to the other part? You know . . . . the part the surviving spouse had inherited.

This part is comprised of the following as per the asset description from above:

Home – free & clear $800,000
Investments outside of retirement plans $1,000,000
Retirement plan funds $1,500,000
Other assets, such as jewelry, antiques, second home, life insurance proceeds, furniture, etc. $1,500,000
Medical or dental practice $500,000
Automobiles $100,000
Total $5,400,000
Remember, $1,000,000 went to a trust.

Now you are thinking . . .

“Our heirs are getting the $1,000,000 trust, and the $5,400,000 balance less the Estate Tax.”

“But what will they be getting? At least they are getting the Retirement Plan that we put away. We worked hard, saved, and deprived ourselves of things to leave this legacy to our kids.”

“Well how is the $5,400,000 taxed? There is a $1,000,000 exemption so that there will be $4,400,000 subject to tax. At 50% that comes to an exorbitant amount of $2,200,000 tax. But through proper planning we saved about $500,000 at the second death because we placed money into a trust.”

“So starting with $6,400,000 we lost $2,200,000 to estate tax. The Balance we leave our heirs is $4,200,000. Great . . . Maybe . . . .”

But now we come to the sickening part of this discussion: How much of your retirement plan was passed to your heirs?

Remember from above, the estate that contained the $ 1,500,000 retirement plan was taxed at the 50% level. That means $750,000 was paid in tax from other liquid funds. Now your heirs have the entire $1,500,000 retirement plan.

Great . . . But hold on . . . .

There are only three things you can do with your money . . . .

  • Spend it. That is what we do to enjoy our life. Food, shelter, entertainment, hobbies, education, etc.
  • Give it away . . . We can give $13,000 to each person we want to, per year, without any gift tax. We can give to charity, and other organizations.
  • THE GOVERNMENT TAKES IT . . . .

Now back to the Retirement Plan. Now that your heirs have the retirement plan, (All $1,500,000) they will spend it. And when they spend it, it will be subject to Income Tax. So as they spend it, $750,000 will be taken out in tax.

So let’s recap . . . .

  • $750,000 to Estate Tax on the Retirement Plan
  • $750,000 to Income Tax on the Retirement Plan

“OH MY . . . The Government Took It All . . . All $1,500,000.”

That’s correct . . . If you do not plan, the Government will take your entire retirement plan after you and your spouse are gone. Only with planning can this be mitigated. If you want to leave those funds to your heirs, planning with Life Insurance is necessary to replace the funds taken by the Government.

The Government planned it this way. The attitude is that the Retirement Plans are for your retirement. Not for your heirs . . . .

Dr. Liebman’s views are his own. They do not necessarily reflect the views of management, or vice versa. This information is intended as a public service to provide information of a general educational nature to members, clients, advisors and others who have previously requested information about CFO and/or other interested persons. Such information herein is not to be construed as financial planning, investment, insurance, legal and/or tax advice. By providing this information, neither Dr. Liebman nor CFO are creating an advisory relationship with any reader.