For years, financial professionals have helped clients accumulate assets to fund retirement using a variety of investment vehicles, each with its own advantages. With the baby boomers knocking on retirement’s door, the industry has placed even greater emphasis on helping clients make the most of their assets, including the best ways to transfer wealth.
Economists believe the U.S. is on the verge of seeing one of the biggest transfers of wealth in history, and today’s financial professionals must be ready!
About a generation or so ago, virtually all assets came in the form of after-tax savings and investments, all with similar tax status. Heirs received a “step-up” in basis on these assets at the date of the decedents’ death and all future earnings were the tax responsibility of the heirs–virtually no strings attached to the deceased.
As a result, estate planners focused on meeting the client’s goals while keeping the estate tax as low as possible, primarily through creative use of trusts and life insurance. While this type of wealth transfer planning is still an important feature of estate planning, a new issue has appeared: Transferring assets of different tax status.
Because all of a client’s assets will be included in the estate for estate tax calculations, it is important to understand the consequences of each type of inherited asset. Today’s wealth transfer plans must also take into account whether the asset is in a tax-qualified plan funded with pre-tax dollars (TQ asset), a tax-free account funded with after-tax dollars (e.g., Roth IRA asset), or a traditional after-tax investment (non TQ asset).
During the distribution phase, the client will need to fund the difference between retirement spending and regular retirement income streams by making withdrawals from their assets. Which asset to take the money from greatly depends upon the client’s feelings about paying current income tax, as opposed to the desire to leave to heir’s assets having the most advantageous tax status. The IRS will always get its share; the issue becomes who pays the tax.
Assuming the client has money in all three categories of assets–TQ, Roth, and Non TQ–what is the most tax-efficient distribution method to fund retirement, while still allowing for a legacy? The answer varies based on each client and situation, but 2 key strategies can be employed: A client-focused strategy and a family-focused strategy.
The client-focused strategy