How would you feel if you found out that you were the sole beneficiary of your uncle’s $1 million IRA? Probably pretty good. But what if you then found out that, after paying income and estate taxes, the value of your inheritance will actually be $300,000? Your excitement may quickly turn to bitter disappointment over the tax bill.
Tax awareness is an urgent issue because it’s what you take home that counts. Understanding how taxes can impact your portfolio returns is the first step to implementing a strategy to reduce your tax exposure. Knowing about important tax concepts and incorporating life insurance into your portfolio can further help you reduce your tax burden.
To start, here is a list of taxes that can eat away at your portfolio returns:
Capital gains taxes. If you buy a stock and it gains in value, you may want to sell it, right? Well, watch your timing when you do so because any stock sold within one year of buying it will be taxed at your ordinary income bracket, which could be as high as 39.6%. Anything held for more than one year is taxed at the preferable long-term capital gains rate, which caps out at 20%. You should also remember that some states charge taxes on top of that, which can further increase your capital gains tax exposure.
Ordinary income taxes. Investments that generate interest and dividends will often generate tax bills as well. Interest and some forms of dividends are taxed at your ordinary income bracket, which may approach 40% plus any state taxes. Managing this tax exposure while still owning the investments you want is a time-consuming activity. Some people put in that time or hire professionals to do it for them. Others look to alternatives, such as life insurance, which can eliminate concerns about tax generation.
Estate taxes. When you’ve accumulated substantial assets in your lifetime, estate taxes can be the worst burden of them all. The top federal estate tax bracket is currently 40% and, once again, that doesn’t take state taxes into account. Avoiding estate taxes is an urgent issue for many high-net-worth individuals. When it comes to tax-efficient vehicles that help avoid estate taxes or create the liquidity to pay for them, life insurance stands alone.
Taxable equivalent yield. This isn’t a tax but rather a tax concept. If you own a bond that pays 5% per year but is taxed at 40%, you’re really only keeping 3%. If that is the case, you may be better off buying a tax-free bond that pays 3.5%. Assessing your overall portfolio and determining your taxable equivalency is an important part of preserving your wealth and increasing the size of your legacy.
Retirement plans. Many of our life insurance strategies focus on the tax inefficiency of retirement plans, such as 401(k)s, IRAs, and annuities. While these plans tend to push the advantage of tax deferral, they often don’t speak to the distribution phase — when everything that comes out creates taxable income. Further, they can create a real mess at your death when they are included in your taxable estate. We can show you how to maximize these retirement vehicles using our life insurance strategies.
Becoming Tax Efficient with Life Insurance
A properly structured life insurance strategy can help you completely avoid income and estate taxes that would otherwise be due upon your death, thereby allowing you to pass dramatically more money along to your heirs. Even vehicles like municipal bonds, which allow people in high tax brackets to completely avoid income tax, don’t protect you from estate taxes that can wipe out half of your money.
When comparing the after-tax returns of various portfolio options, you’ll often find that life insurance blows away the competition. Not only is the payout from life insurance tax free, but it has other traits that make it a desirable investment alternative as well. Consider this very moment in time when stock and bond prices are at all-time highs. Many investors don’t want to drop money into the market, only to watch it lose value and take months or even years to recover. With guaranteed life insurance, your return is guaranteed and the amount your heirs will get is fixed. Those are rare and highly desirable benefits.
At Howard Kaye, we’ve been helping people maximize their legacies for decades. Let us help you examine the tax efficiency of your portfolio to determine if there may be a better strategy you could implement to pass more money along to your heirs. Speak to us today by calling 800-DIE-RICH and let’s get started.
