I recently had a client call my office whose mother passed away. His mother was a great saver. She amassed a great deal in her employer’s retirement account. My client did not know what to do. He was told by her 401(k) administrator that, if he cashed out her retirement funds, he would only pay 20% in taxes. I told him, “That is not the whole story!!!”
(Related: The Love Letter Strategy)
The truth is, he would pay 20% today. What the 401(k) administrator did not consider was my client’s personal issues or lifestyle. The administrator failed to inform my client that the amount of money received would put him into a 39.6% federal income tax bracket. He would pay California tax of 11.3% and Medicare supplement tax of 3.8%.
Here’s the math:
39.6% federal tax + 11.3% California tax + 3.8% Medicare tax = 54.7% in taxes
This means that, if he started with $500,000, only $226,500 would end up in his pocket.
I asked my client “Did the GOVERNMENT save harder than your mother for this money?” He said No!!!
So then, I asked my client, why the government should get more of the money than his mother’s family.
He said, “I don’t know.”
I asked, “Do you want to give them half?”
His response was, “Hell no!!!!”
I told him that there was a way we could save a boatload of cash and avoid paying the GOVERNMENT so much. The way we could do that was with an inherited IRA. He asked, “What is that?” I told him that an inherited IRA would allow him to roll his mother’s 401(k) into an IRA in his name.
Since his mother never paid taxes on the money, I told him, the government wanted him to take required minimum distributions, or annual withdrawals, from the account, and then tax the RMDs. The RMD amount would be based on my client’s age. Because my client was 40, the government would require him to take out around 2% of the total balance each year.
This means that, if my client started with $500,000, only 2% would be taxed: 2% of $500,000 equals $10,000.
Here’s how the taxes would work for that RMD income:
15% federal tax + 4% California tax = 19% in taxes
In other words, I told my client, he would start with a $10,000 RMD, pay $1,900 in taxes, and end up with $8,100 in his pocket.
My client said, “Wow! I saved over 35% in taxes.” He wanted to know if he could take out more. I replied, “Yes, as long as you stay within your income bracket.” He said, “Great let’s do it.”
The lesson for consumers is this: When we receive a large amount of money, it is important that we pause and take a deep breath. We should meet with our trusted advisors, who can help us save money from the government, but also save ourselves from making a huge mistake.
The lesson for agents and advisors is that we have to make sure consumers know we exist, and what we do, so they think to call us when they go through big life changes. The boomers and pre-boomers are getting older, and many of their children will have to make decisions about retirement plan accounts, life insurance policies, annuities and other assets. They need to talk to us.
— Read 7 Lessons on Success From Hollywood A-Lister Will Smith on ThinkAdvisor.