Pre-Tax Assets

    Protecting Inheritances

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    Decisions about pre-tax assets – such as 401(k)s, 403(b)s, simple IRAs, SEP IRAs, and traditional IRAs – can either protect or greatly reduce the beneficiary’s overall benefits, so make sure you understand related terms, options, and strategies.

    A pre-tax asset’s true value may be somewhat misleading. When you own pre-tax assets and monitor your account balances, keep in mind that not all the money noted on your statement is actually yours. For example, a $500,000 account held by someone in a 25 percent tax bracket has an estimated value of $375,000 after the government’s $125,000 tax liability. The net also can vary according to when and how it is distributed.

    Disbursement may be complicated. When an account holder dies, pre-tax assets can be transferred fairly easily to a spouse named as beneficiary. However, when the next-in-line is someone other than a spouse, there are three options for distribution: over a five-year time period; over life expectancy; or through lump-sum distribution. The latter is when all benefits are taken in full during the first year after the account holder’s death. While lump-sum distribution is the most common choice, it is not the wisest because the entire account balance is added to the beneficiary’s income for the year in which it is received. The extra income can take the beneficiary into a different tax bracket, perhaps at a much higher tax rate.

    Defensive financial planning by the account owner can help reduce the negative impact of lump-sum distribution. Continuing with the same example, if prior to retirement, the account owner also had purchased a life insurance contract for $125,000, its death benefit would have been in place to fully cover the lump-sum distribution’s tax liability. Though he would have been required to pay a life insurance premium each year that he lived, even if he lived another twenty-five years with an annual premium of $2,187 (which varies according to the product selected), the premiums would have totaled $54,675. So after paying off the tax liability, the resulting net would have been around $70,325, saving 56 percent. Though many variables could impact this scenario, one thing is certain: Waiting too late in life could impact the ability to leverage in this way. A person’s health dictates qualification for life insurance and determines the actual cost. So the younger and healthier you are, the better the opportunity for leveraging this defensive measure.

    Even if life situations had caused the account holder’s financial plans not to go as well as hoped, there would have been powerful flexibility in the life insurance product. If more money were spent during the account holder’s lifetime, causing the asset and the amount transferred after death to be substantially lower, the life insurance policy’s death benefit would have simply become a direct legacy to the heir or heirs. Or if money was needed for chronic care while the account owner was still alive, riders may have been available for purchase that allowed use of the death benefit
    for chronic care needs.

    The best offense is always a good defense, so make sure your financial planning includes some protective strategies with lasting impact – for yourself and your heirs. Knowing what you want and taking action to talk it through with a knowledgeable adviser can make a substantial difference for your beneficiaries, in terms of process and proceeds.

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    Angie Shay
    Angie Z. Shay has worked in the financial services industry for more than 22 years. She is president of THE PATH Financial Strategies, LLC. Angie Shay is a financial adviser with Eagle Strategies LLC, a Registered Investment Adviser and an indirect wholly owned subsidiary of New York Life Insurance Company. THE PATH Financial Strategies, LLC is not owned or operated by Eagle Strategies or its affiliates. Neither THE PATH Financial Strategies, LLC or Angie Z. Shay provide tax or legal advice.