By Rodney Bakken, Director of Operations, Cornerstone Senior Services –
If you think income tax laws are hard to understand, you’re in good company! You’re just like Albert Einstein! Tell your friends! Even Einstein had to seek help from qualified tax experts.
Some people think that paying taxes is a bad thing. But, if you have to pay a lot in taxes, especially in retirement, that’s great news! It means you are doing better than most Americans. People with more meager incomes do not pay much in taxes. Estimates are that 47% of Americans pay no Federal Income Tax, for example. So regard your ‘tax problems’ as a blessing.
Whether the government is a wise steward of your tax dollars is another subject entirely. We can discuss how to improve our system of taxation (I have some ideas!), but that’s a subject for another time. And it’s outside the scope of what we can get into in this brief article.
For folks paying little in taxes, skip down to the Gifting section below. It has some fantastic ideas. Enjoy! For those of you needing to pursue strategies for reducing your tax burden, read on.
For nearly twenty years, Cornerstone has served folks preparing to retire. And those enjoying retirement. We’ve helped hundreds of thousands of clients in many States. Based on our experience and understanding of tax laws related to insurance products, we offer these observations. We do not give tax advice, nor do we give advice about the markets. Please consult your tax advisor and broker on those aspects of your financial life.
As estate and insurance experts, we often work with clients AND their CPAs. As the ancient proverb says, “Without consultation, plans are frustrated. But with many counselors they succeed.”
Let’s deal with the term “tax loophole”. I want you to pay all the taxes you legally owe. Obey the law, please. However, when the law gives you ways to minimize your taxes, so you can re-purpose your money to achieve your personal goals – that’s a good thing. Go for it! If you feel badly because you have a burning desire to pay more taxes, then by all means contribute extra to the operation of the government. That’s your right as an American. Though I’ve never actually met a person who wants to pay more in taxes than they have to.
Broadly speaking, there are two categories of taxation to consider.
1. Income Taxes – Paying taxes during your lifetime, on things like:
a. Pension and Social Security income
b. Investment interest or Certificate of Deposit interest
2. Estate Taxes – Paying taxes after you’ve ‘gone to meet your maker’ as they say – this is only an issue for people with estates above $5.25 million. If you have a very large estate, the taxes can be huge.
The cliché “Don’t pay taxes on money you are not using!” can be good advice. For example, we’ve seen people in ‘safe’ vehicles like bank CDs, achieving horrible returns. Yet, those returns are subject to taxation upon maturity at least, whether you actually USE that money or not. There are other options for the safe portion of your nest egg.
We are strong proponents of financial products that guarantee your principal AND defer taxes. Like Fixed Indexed Annuities. It’s one of the ways I protected a portion of my own mother’s retirement savings. I believe in annuities that much. (More on this topic in a future article.) Fixed Indexed Annuities are insurance products that can guarantee your principal, and, as they grow, taxation is deferred until you withdraw your money.
Giving it Away – Your Lifetime Gifting Options
Once upon a time I had a boss named Gary. He was reading a book advocating spending money on your adult children NOW, as opposed to giving them a larger inheritance LATER. The benefits? You get to see the blessing in their lives now. While you’re still living. Say, for example, you could help your newlywed daughter and her husband make a down-payment for their first home. That would be an incredible gift! Or, what if you could pay for your grandkids education? And what if that gift money was not taxable? Fantastic!
You can give away $14,000 each year, to a person or persons you choose. That’s $28,000 for spouses ‘splitting’ their gifts, per PERSON they give to. So if you have 10 children, you and your husband could give them EACH $14,000 a year. Tax free! The recipient does not even have to claim the gift as income on their tax return! As long as the amount is $14,000 or less each year. Powerful!
You can give away ANY amount yearly, tax-free, directly to educational institutions or medical providers, on behalf of others. This is certainly a strategy you want to explore with your tax advisor! It can be immensely powerful, and satisfying too.
Lifetime Exemption Currently, you have an individual lifetime estate tax exemption of $5.25 million. That means you won’t get taxed on the first $5.25 million of your estate, in terms of the so-called death-tax. That’s good news.
In addition to the estate tax issue, you can GIVE AWAY taxable amounts over your $14,000 yearly. Up to a maximum lifetime total of $5.25 million. Any taxable amounts you give away eat into your total lifetime maximum of $5.25 million, however.
Establish a Credit Shelter/Bypass Trust.
The credit shelter or bypass trust is a way for spouses to ensure that EACH of their lifetime $5.25 million exemptions are applied to assets. Even if one of the spouses dies before the other spouse. That’s about all the explanation I can give in this article. Establishing a trust is exceptionally wise for many reasons. For one thing, it avoids the expense, time-drain and publicity of probate. Those are strong reasons on their own. If you have above-average assets, talk to your attorney about a trust. Just remember, if he tries to steer you AWAY from a trust, you should know that most estate attorneys make most of their money from probate. So the attorney has a vested interest in keeping you in the probate merry-go-round. Fight for what’s best for your family. Not what’s best for the attorney’s bank account.
Fund Inheritance Taxes with Life Insurance
Life insurance proceeds are usually not taxable to your beneficiaries! Life insurance gives you great ‘bang for your buck’ – you spend much less in premiums than the actual death benefit. Your heirs can use these proceeds to pay for estate taxes, as opposed to using inherited dollars one-to-one to pay estate taxes. That makes great sense!
Next month: we’ll dive deeper into creating a wise plan for Estate Settlement. This is a very important family topic for people of all ages!
Let me commend Mark Keadle to you. He’s your local expert. And he’s made himself available to be your resource! He has deep understanding of the strategies we teach.
Mark Keadle | 606-356-7774