In recent articles, I discussed the best and worst financial moves for Good Savers and Frustrated Savers about to retire. Good Savers managed to accumulate a couple of million dollars before retiring. Frustrated Savers fell short of that amount because of unforeseen circumstances. But what about those who have accumulated more money than they could ever spend? Does this mean there's no need for planning? Clearly, I wouldn't be writing this article if the answer were no!
The Super Accumulator
The Super Accumulator has gained more wealth than 99% of Americans. For this article, we will assume a Super Accumulator couple has the following net worth statement:
Checking account: $100,000 Savings account: $400,000 Portfolio: $22 million IRA: $4 million Personal residence: $3 million Cars and boat: $500,000
Total: $30 million
Net Worth: $30 million
In addition to the above, our Super Accumulator couple has the following:
- Life insurance of $1 million per person
- Updated estate documents
- Social Security benefits estimated at $2,500 per month each at age 66
- Monthly spending of $50,000
Based on this example, our couple is only spending 2% of their net worth (not considering Social Security). Clearly, they have accumulated more than they are spending.
So, what's the problem? As I've always said to my clients, four "people" can benefit from their money:
1. Themselves (the client, spouse/partner) 2. Their heirs (children, grandchildren, and so on) 3. Charities 4. Uncle Sam (taxes)
I've never found a client who prioritized contributing to Uncle Sam. Yet, without planning, it's quite possible that the U.S. government could get more than its fair share. Usually, clients want to minimize what goes to taxes. That means they want their money to be split in some fashion between items one, two, and three. Even if the clients say they want to spend it all, it's not possible to spend the last dollar on their deathbed. There will still be, at a minimum, home equity.
Thus, if you’re a Super Accumulator, the first step in planning is determining how you want to prioritize spending, whether it’s on yourself, leaving money to heirs, or benefiting charity. Here are some financial do’s and don’ts to help you make a plan.
10 Financial Do's and Don'ts
DO consult a financial planner or investment advisor. You do not need to figure out if you can afford to retire, but there are strategies that can make the most of what you have and help ensure that your money goes where you want. A good financial planner can provide a clear road map to implementing goals.
It's also a good idea to use your advisor's advice for portfolio investments. First, because you should have better things to do than manage your investments and, second, a qualified professional will do a better job for you in the long run. Professional management will ensure that your portfolio is not too aggressive or conservative and that you maintain a diversified portfolio. An advisor also will provide tax management and advise you on evolving strategies as situations change. And an advisor can help you stay the course during times of market volatility.
DON'T jump at "opportunities" or become everyone's favorite "deep pocket." Accumulating significant wealth can expose you to being taken advantage of by investment scammers and family and friends in need. Even betting on the latest hot tip can cause a substantial loss. Using the guidance of trusted and competent advisors (financial advisor, attorney, and CPA) before committing resources can avoid potential disasters.
DO consider safety nets. The safety nets of insurance and an updated estate plan are critical. However, two types of insurance are typically overlooked: excess liability (umbrella) insurance and long-term-care insurance.
Umbrella insurance can cover you for potential liabilities in excess of "standard" insurance maximums. Generally, umbrella insurance coverage is recommended to the extent of a person’s net worth. For the couple in our example, that would be $30 million. Unfortunately, umbrella insurance typically maxes at $5 million. So, if your net worth exceeds that amount, you will need the services of a specialty insurance provider that can assist with ultra-high-net-worth clients.
Another important safety net is long-term-care insurance. It is true that ultra-high-net-worth couples can self-insure. Yet, I still recommend long-term-care insurance to avoid the emotional reluctance to spend family assets on care. (For more information on long-term-care insurance, see my previous articles linked above.)
DON'T pay for unnecessary insurance. Although certain insurance is essential, once you are in or near retirement--or have accumulated assets in excess of your needs--some insurance is no longer needed, such as life insurance and disability insurance. These types of insurance are generally purchased to replace the earnings of the covered individual.
There can be justification for holding life insurance to pay potential future estate taxes. In this case, rather than holding individual policies, a second-to-die policy would be appropriate. This policy pays upon the death of the surviving spouse, when estate taxes would be due. Our Super Accumulator couple might be able to do a tax-free exchange of their current policies into a second-to-die policy.
A further planning strategy would be to place the new policy into an irrevocable life insurance trust. This technique can shelter the life insurance proceeds from estate taxes.
DO consider Roth conversions. Under current tax laws, there is still an opportunity to do Roth conversions. As I said in the previous articles, the Roth IRA is the holy grail of tax planning. Although funded with dollars after taxes, it grows tax-free, and withdrawals are tax-free--meaning that income is never taxed. Additionally, there are no required distributions from a Roth IRA. So, if you have IRAs, the opportunity to do Roth conversions should not be overlooked, even though you have to pay tax on the amount converted.
For those in a high tax bracket, paying tax on IRA balances now can be a tough pill to swallow. But eliminating future taxation at expected higher rates on principal and growth as well as eliminating required minimum distributions can be a great benefit. For the couple in our example, converting their entire IRA balance of $4 million will not only allow that amount to grow tax-free, but the tax paid can reduce the amount subject to estate taxes.
DON'T write checks to charity. If you itemize, you might get a tax benefit from writing checks to charities. If you don't itemize or you're on the edge of itemizing, you get no tax benefit from charitable contributions (except for up to a $300 single above-the-line deduction this year). But there are better ways to give to your favorite charities than writing a check.
Contributing appreciated stock or mutual fund shares is one way. Assuming the shares were held at least one year, the deduction is the full fair market value, and there is no tax on the accumulated gain. It's a way to contribute using partially pretax funds. Obviously, this strategy can only work with material contributions to charities that can handle stock transfers.
A more beneficial method of charitable giving is the donor-advised fund. A donor-advised fund is like a charitable IRA. You get a deduction as soon as you contribute to the account, the money grows tax-free, and you can "take money out" by designating grants to charities of your choice over as long a period of time as you wish. It's easy to set up through a local community foundation or a national provider, such as Schwab, Fidelity, and Vanguard. Although you can write a check to the donor-advised fund, you save more taxwise by transferring appreciated shares or property.
For those older than age 70 1/2, a qualified charitable distribution is an option to make charitable contributions of up to $100,000 per year directly from an IRA. This essentially allows a deduction for contributions even if you don't itemize. By paying the contribution from your IRA, rather than deducting it as an itemized deduction, your adjusted gross income is reduced, which can also lower your tax on Social Security income. And you can even use your required minimum distribution for a qualified charitable distribution.
DO give to charity while you are alive. Many people assume that leaving money to charity in their wills or living trusts is a good way to go. This strategy of waiting is good to ensure you don't compromise your ability to fund retirement, and it can lower potential estate taxes. But as a Super Accumulator, you have a slim risk of running out of money during your lifetime. By giving while you are alive, you save income taxes and estate taxes. Plus, you can enjoy the benefits of seeing your money being put to good use. You might even get to participate in galas and other special events!
DON'T leave everything to heirs. There are two major issues with Super Accumulators leaving everything to heirs. First, if they live to expected life spans, it's possible that their kids will be in their 60s or 70s when they eventually inherit. That's hardly the time to make a difference in their lives! Second, there's a saying: You want to give your kids enough to do anything they want but not so much that they can do nothing. In the example of our Super Accumulator couple, even if income and estate taxes reduce the estate balance to $24 million, two children would each get $12 million. A 5% withdrawal rate would provide each child with a monthly income of $50,000--in their old age!
What is the solution? Give some money to charity and give money to your family now. For example, each person can gift up to $15,000 per year per person without affecting the estate exemption. Our Super Accumulator couple can gift $30,000 to each child (and grandchild) each year. This isn't enough to make a huge difference in estate tax liability, but it could make a difference to their kids' lives. Our couple can also make larger gifts during their lifetime. Although it will use some of their exemption amount, it will also remove future appreciation from the estate. There are other ways of gifting that use discounts and charitable strategies.
Finally, spending money on family vacations is a great way to use your resources. A group cruise or stay at a resort can create memories and bind families together. As an active financial advisor for decades, I can attest that every client who has taken my advice on this has thanked me profusely.
DO leave retirement accounts to charity. Rather than leaving a dollar amount or percentage of the estate to charity, consider designating charitable beneficiaries for retirement accounts. Although leaving money to charity reduces the taxable estate value, leaving retirement accounts to charity also avoids income tax. Should a sizable IRA be left to heirs, they would pay income tax and possibly estate tax on the balance, leaving almost nothing. If the IRA is left to charity, the entire balance will benefit the charity--unaffected by income and estate taxes. By specifically allocating taxable investments to heirs, current tax law allows a step-up in basis to date of death value. This means that the investments, although subject to estate tax, would be virtually free of income tax.
DON'T let your estate plan go stale. Changing tax laws, family circumstances, and personal preferences can all be reasons to update your estate plan. If it's been a few years since you've last reviewed your estate documents, make an appointment with your attorney.
To sum up, having substantial net worth is not a reason to skip financial planning. Take note of the suggestions here, and, above all, hire a qualified financial advisor. For commission-free, unbiased advice, I recommend a member of the National Association of Personal Financial Advisors. You can find someone near you at https://www.napfa.org/fin.
Sheryl Rowling, CPA, is the founder of Rowling & Associates, an investment advisory firm, and a columnist for Morningstar. Morningstar acquired her Total Rebalance Expert software platform in 2015. The opinions expressed in her work are her own and do not necessarily reflect the views of Morningstar or of Rowling & Associates LLC.
The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.