Case Studies – Which Assets to Spend & Which to Pass On

by | Jan 28, 2021 | Insights

In the first article of this series, Which Assets Do I Spend and Which Do I Pass On?, we discussed how different kinds of assets can be strategically used to accomplish three big goals:

  • Create Income to Enjoy Life – “Financial Independence”
  • Provide for Loved Ones – “Family”
  • Impact Causes You Care About – “Charity”

If you haven’t read the first installment, we’d recommend starting there. In this article, we’ll build on those principles. We’ll still assume you live in Washington state and have a $10,000,000 net worth divided into the following financial assets:

  • $2,000,000 home
  • $2,000,000 in a taxable brokerage account
  • $2,000,000 in pre-tax 401(k) and IRA retirement accounts
  • $2,000,000 in tax-free Roth 401(k) and Roth IRA retirement accounts
  • $2,000,000 in rental property

Now we’ll walk through how you can strategically use these assets with each of the following primary goals.


Family AAll to the Family

You’ve never been “big spenders” and, while you’ll enjoy life, you plan to live simply and leave 100% of your assets to your family. A few tips can increase impact for your loved ones.

  1. Home. You can leave the home directly to your kids
    • Under current tax law, they’ll receive a cost basis step up when they inherit the home and be able to sell with little tax.
    • To reduce future estate tax exposure, transfer the property to a Qualified Personal Residence Trust, which moves the property out of your estate but allows you to continue living in the home.
  1. Taxable brokerage account. As with the home, your kids will receive a cost basis step up at your death, so they won’t incur a large income tax bill on these funds under current law.
    • Consider making annual gifts to the kids from these funds to reduce the value – and tax – of your estate at death.
    • Otherwise, leave these funds to grow rather than using for your living expenses.
  1. Pre-tax 401(k) and IRAs. These accounts are least effective to leave as they could be triple taxed – federal estate tax, state estate tax, and income tax.
    • Use these funds for your living expenses and focus on getting the rest out of your estate.
    • Consider funding a Wealth Replacement Trust, which can pass estate tax-free, and potentially income tax-free.
    • Converting portions of these pre-tax accounts to Roth can also turn these tax traps into income tax-free income for your kids.
    • NOTE: if you have kids in different states, consider leaving these taxable assets to the ones in low tax states and other assets to kids in high tax states. For example, a CA resident might pay more than 50% in tax on these funds when state taxes are included.
  1. Roth 401(k) and Roth IRAs. These are some of the best assets to leave behind because your kids will be able to withdraw them income tax-free.
    • Leave these to grow tax-free.
    • Pass to your kids so they benefit from tax-free income rather than spending during your life.
  1. Rental property. These are income generating assets that, depending on the structure, can be a tax benefit or a tax hinderance. Look for ways to move these out of your estate without giving up the income.
    • A Family Limited Partnership can start to transfer these properties out of your taxable estate, especially if they are appreciating quickly.
    • You can also use a trust that loans the rental property to your kids, taking a small income stream in exchange for getting any future growth and income outside of your estate.


Family BBalance between Family and Charity

Like the first family, you plan to live simply, but you plan to leave half of your estate to your kids and the other half to charity. Much of your strategy will resemble the first family, except with the pre-tax retirement accounts.

  1. Home. No change in strategy here – leaving directly to your kids, potentially through a QPRT, will be a good move.
  2. Taxable brokerage account. Again, little change here. Consider annual gifting to family and leave them the balance when you pass.
  3. Pre-tax 401(k) and IRAs. This is your big change – these are among the best accounts to leave to charity because they are exempt from the income taxes your kids would otherwise pay. So, leave these to grow and designate your favorite cause as your beneficiary on these accounts.
  4. Roth 401(k) and Roth IRAs. No change here – leave these accounts to your family so they benefit from the income tax-free withdrawals.
  5. Rental property. Have a conversation with your kids about whether they want to keep and manage these properties. If not, consider donating them to a Charitable Remainder Trust – you’ll receive an upfront tax deduction, annual income, and leave the rest to charity when you pass.


Family C – Comfortable Retirement

You’ve worked hard for what you earned, and you plan to use it while you’re alive. This is likely to include memorable experiences with family and support for your favorite charities, but you don’t plan to leave anything after your death.

  1. Home. You’ll continue to live here and, though you’re not focused on leaving an inheritance behind, decide if remaining equity will pass to family or charity. You could also consider tapping into the equity during your life with a reverse mortgage.
  2. Taxable brokerage account. These can be used for periodic larger purchases, as little tax will be generated when you make withdrawals. You can also use distributions here for annual lifetime gifts to family or to fill in the gap between taxable retirement income and total monthly need.
  3. Pre-tax 401(k) and IRAs. Use these as an income base annually. You’ll need to coordinate with your tax and financial advising team to make sure you’re paying attention to tax brackets and not accidently creating more tax burden than needed.
  4. Roth 401(k) and Roth IRAs. Use these to fill a gap between total need and monthly taxable income from retirement accounts. For example, if your total annual need is $150,000, but taxes increase significantly at $100,000, take the first $100,000 from taxable retirement sources and the remaining $50,000 from these tax-free accounts.
  5. Rental property. Prioritize income above growth here – some properties balance growth and income, while others provide higher income. Since you’re not focused on the remaining value at death, make sure your property cashflows or use a 1031 exchange into one that does. You can also tap into equity, if desired, through lines of credit or cash out refinances, though this increases risk.

You might fit Family A, B, or C, or maybe you’re somewhere in between. The important point is that each of these families should use a distinctly different spending plan because, though they have the same assets, they have fundamentally different ultimate goals. Strategies like those discussed here can dramatically increase the impact of exact same assets depending on your goal. It all starts with a comprehensive plan that includes clearly articulated goals. Only then can you chart the best path forward.

Zach Hamilton

Partner, Financial Advisor

About the Author

Zach graduated from Gonzaga University with degrees in Marketing and Finance. While growing up, Zach heard stories from his grandfather about his work as an insurance agent, and other stories from his dad who was an investment manager. They both spoke financial “languages” but had completely different dialects. Recognizing the breadth of the financial vocabulary ultimately led to Zach’s passion for financial planning. He credits his family for this enthusiasm. Zach sees his time with clients as an opportunity to translate all of the different – and often confusing – information they’ve heard and provide clear guidance for each unique situation.

Zach enjoys working with people – his clients – who also appreciate that their financial decisions have an impact not just on themselves, but also on their families, charities and their own life legacy. Many of Zach’s clients have a strong desire to “make a difference”, and they rely on his financial expertise to magnify their philanthropic goals.

The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.

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