As your financial planning evolves over time, you may find yourself thinking less about your own financial needs and more about the impact that your money might have on others, including family members and charitable causes. The first part of this article discussed how your thinking changes between the time you begin investing and the time you arrive at the finish line of your career. After you retire, you'll have a better sense of where you stand and what you'd like to do with your money both during your lifetime and after your death.
As you evaluate your financial situation and think about where you'd like your money to go after you die, you'll want to make some changes in your investing strategy. Exactly what changes you'll need to make depend on your lifetime needs and how you want to define your legacy. If you want to leave money to family members, for instance, you may need to use much different investment techniques than if you plan to leave everything to charity.
Family legacies
If you want to leave a legacy to your family, tax considerations become extremely important in how you raise money to pay living expenses and in what assets you plan to leave for your heirs. For example, many retirees do everything they can to minimize their tax liability, including taking only the required taxable distributions from IRAs and retirement plans. This keeps their net worth as high as possible and allows them to gain the maximum personal benefit from the tax deferral these accounts have. With low preferential tax rates on dividends and capital gains, retirees may feel that selling stock or other assets in taxable accounts is better than withdrawing money from retirement plan assets at the higher tax rates that apply.
However, if you plan to leave money to your children after your death, you may want to consider using retirement account assets first. Assets in taxable accounts will receive an increased tax basis at your death, effectively eliminating the capital gains tax on any appreciation in those assets since you bought them. IRAs and retirement plans, on the other hand, don't receive this stepped-up basis and are fully taxable to your children when they make withdrawals from the accounts. If your children are in the middle of their careers, it's highly likely that they'll be in a higher tax bracket than you are. This means that as your children withdraw money from their inherited IRA, they'll pay higher taxes than you would have paid if you'd chosen to withdraw your retirement assets for your own use.
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Also, Roth IRA accounts are extremely valuable to your heirs. Their tax-free treatment can continue for decades after your death. To take full advantage of Roth IRAs, you may want to consider converting traditional IRAs and retirement plan assets, even if it means increasing your own tax liability. In the long run, the benefits of tax-free Roth distributions can outweigh the costs of having to pay current income tax.
Charitable legacies
On the other hand, if you plan to leave everything to charity, much different strategies apply. Because charities generally don't have to pay income tax on assets they receive, you can maximize the amount of money your charity will receive by deferring tax as long as possible on your assets. Any dollar you spend on unnecessary taxes is one less dollar your charity will be able to use.
For instance, leaving tax-deferred assets like traditional IRAs to charity is often a great move because it allows your entire account balance to avoid tax. As a consequence, therefore, if you have a choice between making a withdrawal from your retirement account or using other assets in an account without tax deferral, it may make the most sense to use taxable account assets. This keeps as much of your money in tax-deferred retirement accounts as possible.
Mixed legacies
If you want to leave some of your assets to family and some to charity, mixing these strategies can provide you with the best result. Earmarking traditional retirement plans, IRAs, and other tax-deferred assets for charity while letting family members take Roth IRAs and taxable account assets can be the best way to keep the total value of your legacy as high as possible and keep the hands of the IRS out of your assets.
Of course, these rules of thumb are only general guidelines. Depending on your particular financial situation, your best strategy may look completely different from these suggestions. Nevertheless, these guidelines include the factors that determine the best way to change your investment strategy to incorporate your wishes after your death.
The idea of leaving something behind after your death may once have seemed impossible, but if you've successfully saved and invested your money, you may now find that it's almost inevitable that you won't spend all your money. By making just a few modifications to your basic retirement strategy, you can make a big difference in the benefits your children or other heirs receive from you.
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Fool contributor Dan Caplinger hopes to leave something behind for his daughter, but not for a long while. He doesn't own shares of the companies mentioned in this article. The Fool's disclosure policy puts its money where its mouth is.
