Estate planning Category
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Dear Liz: Your tax expert’s answer to a person who wanted to roll over a $30,000 capital gain on a mutual fund missed an important point. Since the couple were solidly in the 15% tax bracket with a taxable income under $72,000, they should qualify for the 0% federal capital gain tax rate. (They may, of course, owe state taxes.)
Answer: They may not have had a capital gain at all, as other tax pros have pointed out. When people own mutual funds, the earnings are often reinvested each year. If the couple paid taxes on those earnings, their basis in the mutual fund would increase each year. To know if the couple had any capital gain, we’d need to know that adjusted tax basis. In any case, the original answer — that you can’t roll over the gain on a mutual fund into another investment to avoid capital gains taxes — still stands.
Dear Liz: My wife and I accrued $28,000 of credit card debt over the past eight years. In addition to a sizable student loan bill for law school, our home mortgage and the expenses associated with three young children, we are struggling to get ahead enough to knock our credit card debt down. While we make good income between the two of us, it would seem not enough to pay more than the minimum on our debts. We have curbed a number of our bad habits (we eat out less, take lunch to work, say no to relatives) but the savings are not translating to lowered debt. Our 401(k)s are holding steady and we continue to contribute and I don’t want to touch those (I did when I was younger and regret it.). We’ve been considering taking out a home equity line of credit to pay off the cards and reduce the interest rate. Of course we have to be disciplined enough to not go out and create more debt, but I think my wife got the picture when I said no family vacations for the next few years. What are your thoughts?
Answer: You say, “Of course we have to be disciplined enough to not go out and create more debt,” but that’s exactly what many families do after they’ve used home equity borrowing to pay off their cards. They wind up deeper in the hole, plus they’ve put their home at risk to pay off debt that otherwise might be erased in Bankruptcy Court.
Bankruptcy probably isn’t in the cards for you, of course, given your resources. But before you use home equity to refinance this debt, you need to fix the problems that caused you to live so far beyond your means.
You’ve plugged some of the obvious leaks — eating out and mooching relatives — but you may be able to reduce other expenses, including your grocery and utility bills. If those smaller fixes don’t free up enough cash to start paying down the debt, the next places to look are at your big-ticket expenses: your home, your cars and your student loans. There may not be much you can do about the latter, although you should explore your options for consolidating and refinancing this debt. That leaves your home and your cars. If your payments on these two expenses are eating up more than about 35% of your income, then you should consider downsizing.
What you don’t want to do is to tap your retirement funds or reduce your contributions below the level that gets the full company match. Retirement needs to remain your top financial priority.
Reducing your lifestyle may not be appealing, but it’s better to sacrifice now while you’re younger than to wind up old and broke.
Dear Liz: I’m 65 and my wife is 62. We recently sold a business for over $900,000 and will net somewhere between $550,000 and $600,000. Should we use the proceeds to pay off our mortgage? Our home is worth about $1.5 million with a mortgage of $390,000 at 3.586%. We contribute an extra $200 per month to reduce the principal. We have no other debt. Our savings, retirement and brokerage accounts total $1.2 million. My wife receives a pension of $483 a month and works part time as a substitute teacher. I plan to continue working until age 70 with a salary of about $170,000 per year. On retirement we should receive about $4,400 per month in Social Security benefits.
Answer: Many people feel more comfortable having their mortgages paid off by the time they reach retirement age — even when the interest rates on the loans are so low they’d almost certainly get better returns elsewhere. (The after-tax cost of your mortgage is likely less than the longtime inflation rate of about 3%.) Not having a mortgage payment can substantially reduce your monthly expenses, which means you have to take less from your retirement accounts. Such withdrawals often trigger taxes, so you essentially save twice.
Other people feel perfectly comfortable carrying a mortgage into retirement. They’re happy to take advantage of extraordinarily cheap interest rates and keep themselves more liquid by deploying their savings elsewhere. And many people have to carry debt because they can’t pay it off before they retire, or paying off the mortgage would eat up too much of their available funds.
Because you do have choices, discuss them with a fee-only financial planner. If you pay off the mortgage and invest what’s left, you could draw about $50,000 from your retirement funds the first year without a huge risk of running out of money. That plus your Social Security and your wife’s pension may give you enough to live on. If not, you may want to invest your windfall and continue paying the mortgage down over time.
Dear Liz: You’ve been writing about people who expect inheritances they don’t get. Here’s another situation. My elderly dad thought he’d tied up everything in a trust, but his surviving elderly second spouse regularly invaded the principal instead of just receiving the interest. She would simply call her broker and ask for whatever she wanted. The broker, not being a knowledgeable trust officer, would send her the money. Finally, to soothe a fretting sibling, my husband and I paid for an estate lawyer to move the trust from Stepmom’s broker to a good third-party trust institution. It took more than a year plus paying a fee (OK, a bribe) for Stepmom to relinquish her direct access to the trust. She continued to receive the interest and was quite well off. She never did understand why we thought she was doing something wrong.
Answer: People set up trusts for a variety of reasons, but the type you’re describing is usually used to preserve an inheritance for the children while allowing the surviving spouse to live off the income. These trusts typically allow the survivor to tap the principal for certain purposes (“health, education, maintenance and support” is the usual phrase used). A trustee who’s asleep at the switch may allow the spouse to dig too deep, which not only reduces the children’s inheritance but also endangers the whole structure of the trust, which is designed to save future estate taxes. Your investment in hiring a competent trustee could save a lot of expense and hassle in the long run.
Dear Liz: I am 70 and my wife is 59. My pension covers us for both our lifetimes. We have no debt. My wife and I do not need the required minimum distributions I will soon have to start taking from my 457 deferred compensation plan, which is currently worth $1 million. I planned to invest these distributions in an index fund to leave to our son. My accountant recommends instead that I buy a joint whole life insurance policy for me and my wife because it will be tax free when our son inherits our estate years from now. Does it make sense to buy insurance as an estate planning tool?
Answer: Does your accountant sell insurance on the side, by any chance?
Because a tax pro should know that the money in that index fund would get a so-called step up in tax basis when you die and your son inherits the account. If he promptly sold the investments, he wouldn’t owe any taxes on the growth in the account (the capital gains) that happened while you were alive. Even if he hangs on to the investments for a while, he would owe capital gains tax only on the growth in value since your death. That’s a pretty awesome deal.
If you buy life insurance, by contrast, you’d have to weigh any tax benefit against the not-insubstantial amount you’d pay the insurer for coverage. At your ages, such a policy would be far from cheap.
Any time someone suggests that you buy life insurance when you don’t actually need life insurance, you would be smart to run the proposed policy past a fee-only advisor — one who doesn’t receive commissions or other incentives to sell insurance.
There’s an outside chance that your accountant recommended a permanent life insurance policy for estate tax purposes. These taxes will be an issue only if the combined estate of you and your wife is worth more than $10 million. If that’s the case, you should consult an estate planning attorney about your options.
Dear Liz: Both of our sons, ages 63 and 59, are currently unemployed. We are 93 and self-supporting with Social Security and my retirement benefits. We live in our own home and are able to handle all our expenses, even though my wife requires a companion for 12 hours each day.
I believe we should financially aid both sons, to the limit of our ability, but my wife disagrees.
They are the two main beneficiaries of our estate. Each one is scheduled to receive about $40,000 upon our deaths. How should we proceed?
Answer: If your estates won’t amount to much more than $80,000 at your deaths, it doesn’t sound as if you have the financial wiggle room to help your sons. Your wife already requires significant care and may need more in the future. Plus, she’s likely to outlive you, which would mean getting by on less (certainly a smaller Social Security benefit, and perhaps a smaller pension amount as well). Any money you give them, in other words, is likely to be to her detriment.