It is easy to think of your assets where each one contributes to your net worth in the same way, based on their financial value. For the sake of determining the net worth number, this is essentially correct. However, the equivalency ends there, as different asset types are not equal when it comes to spending them in retirement or leaving them in legacy.
Assets can be roughly categorized as qualified or non-qualified. Qualified assets are generally pre-tax retirement plans and pensions, while nonqualified assets are most everything else. Qualified plans usually receive a tax benefit when contributions are made and they grow on a tax deferred basis, however all withdrawals are treated as taxable income. This is because those qualified dollars have never been taxed before being withdrawn. So, in a sense, qualified plans have embedded taxes.
When qualified plans are left in inheritance, those embedded taxes never go away. The beneficiary of a qualified plan must still pay taxes on withdrawals. By contrast, non-qualified assets receive a “step up in basis,” where any taxable gain is measured from the asset’s value at the owner’s death instead of their original cost. The net effect is inherited non-qualified assets can often produce tax-free withdrawals.
Legacy can mean different things to different people. In the context of financial planning, legacy usually revolves around how one will leave their assets to benefit those they love and further the values they cherish. These ideas occupy the categories of inheritance and charitable giving.
Inheritance happens whether we plan for it or not, but planning ahead can help mitigate unintended consequences. A common narrative is someone inheriting a large sum and then squandering the money because they weren’t equipped to handle it. A vital step in optimizing your legacy is thinking through how inheritance may affect the lives of your heirs.
Start by listing your heirs and an estimate of what they might receive. Consider their financial situation, the potential tax impact, and their personality and proclivities. Then work with your attorney and Nepsis advisor to utilize the tools and strategies that reflect your values and the deep hopes you have for your loved ones and future generations.
One significant unintended consequence of inheritance is the erosion of taxes. Not only are there taxes that may be embedded within an asset and passed on to beneficiaries, but there may be taxes on the inheritance itself. The degree to which taxes drag down an estate may be greatly impacted by the proactive planning one undertakes.
Taxes embedded in IRAs and other pre-tax accounts do not go away when those assets are inherited. Therefore, these are among the least advantageous assets to be inherited by an individual. Charitable organizations, however, are not subject to income taxes, therefore pre-tax accounts are ideal assets to be left as legacy donations.
The downside to leaving pre-tax accounts to charity rather than heirs is this effectively disinherits the heirs of the benefactor. However, this can be mitigated by using lifetime distributions from the IRA to fund a life insurance trust with the heirs as beneficiaries. At death, the IRA goes to charity tax-free, and the life insurance goes to heirs tax-free. Done properly, this strategy can eliminate both income taxes and estate taxes.
There are numerous ways to optimize your legacy with the pre-tax assets you have, but the details can be complicated. So, talk with a Nepsis advisor about the taxes that may be hidden within your estate and your options for maximizing your legacy impact.
“I am not afraid of death, I just don’t want to be there when it happens.”
– Woody Allen
The topic of our own mortality is difficult to talk about. Yet it is an integral consideration in our future plans and goals. We must all consider what happens with our assets and loved ones, and what our legacy will be.
It can be equally hard to discuss our finances and “final wishes”. The lack of clear communication can have significant unintended consequences where uncertainty can lead to stress and even family conflict. The last thing any of us wants is our legacy to be a source of strain and struggle. A vital part of optimizing your legacy is proactive communication.
Consult with a Nepsis advisor about putting together your Legacy Plan, as well as other questions you may have on how to maximize the positive impact you can have on those that will be recipients of your Legacy Plan. Giving With Clarity®!
Advisory services offered through Nepsis, Inc.: An SEC Registered Investment Advisor.