• Tax Rates: With Jean’s increased medical expenses from assisted living this year, her itemized deductions had increased to the extent that she had no taxable income. The plan called for giving Jean sufficient income from her portfolio to bring her no higher than the top of the 24 percent marginal tax bracket. The financial advisor pointed out that the extra income would mean that Jean would have to pay more for Medicare due to her higher income and estimated that it would be the equivalent of an extra 3 percent tax on the extra taxable income. However, this was more than offset by the fact the family would save about 10 percent from the 37 percent marginal tax rate that Rick and his wife pay.

• Annuity: Because of the death benefit on the annuity, they did not think it wise to liquidate the annuity. Instead, they changed the beneficiary from Rick to his two children, who are in their 20s, just starting out in their careers, and in lower tax brackets. When the two children receive their $200,000 portion of the death benefit, of which $145,000 would be taxable, they would have several options for withdrawing the proceeds in the most tax-efficient manner (such as a lump sum, spread over five years, or systematic withdrawals over life expectancy).

• Savings Bonds: Although Rick thought that Jean should redeem the savings bonds, realize the $10,000 of income, and invest the proceeds into a higher yielding investment, Jean likes having them as a remembrance of her late husband and wants to keep them. Given this, Rick arranged for Jean to report all of the income earned on the bonds to date for her tax return this year. She must continue to report income earned on the savings bonds every year. Consequently, Rick will inherit the bonds with only a minimal tax liability.

• IRA: Each year going forward, Rick will work with his and Jean’s accountant near year end to get a good estimate of what her taxable income will be and how much additional income she can have to bring her to the top of the 24 percent tax bracket. They will then do a Roth conversion in the determined amount. They estimate that they will be able to convert over $100,000 of IRA assets each year to a Roth IRA, saving the family over $10,000 in tax liability and getting tax-free growth in the future.

8. Shifting Future Growth Out Of The Taxable Estate

Joe and Sandy had recently sold their business. The proceeds were large enough that their estate exceeded the amount of assets that could be excluded from taxes. They had two young children and had decided to start a new business. Anticipating the future success of the new business they gifted their interests in the new business to their two children. Since the company was just formed and had no assets, it had no value. Thus, gifting their interests in the new business to an irrevocable trust for their two children did not use up any of their estate tax exemption. In addition, if the venture was successful, all the future growth in value would occur outside of their estate.

9. Gain Harvesting

Jake recently retired from full-time work at age 65. He has decided to wait to claim his Social Security benefit until age 70. Until then, his portfolio, consisting of a $100,000 traditional IRA and $900,000 in a taxable brokerage account with a cost basis of $800,000, will provide the cash needed to meet his spending needs.

In December of his first year of retirement, Jake and his advisor estimate his taxable income to be $10,000. Jake had more than $28,700 remaining in his 12 percent federal income tax bracket. His advisor discussed two alternative strategies. First, he showed Jake that he could convert $28,700 of his traditional IRA dollars to a Roth IRA at the 12 percent ordinary income tax rate. Alternatively, he could choose to “harvest long-term capital gains” within his taxable account of the same amount and lock in the 0 percent federal long-term capital gain rate that applies when taxable income does not exceed $38,700 for single filers (as of 2018 tax brackets).

Jake evaluated the difference between the rates for these two different kinds of income that he has the option to pay now, versus the rate at the next highest bracket for each. In the case of ordinary federal rates (applicable to Roth conversions), the next bracket above 12 percent is 22 percent—a 10 percent difference. In the case of long-term capital gain rates, the next bracket above 0 percent is 15 percent—a 15 percent difference. Favoring the larger difference, Jake chooses to harvest gains within the zero percent federal long-term capital gain bracket. Jake will likely be able to engage in the same strategy for a few years before he runs out of capital gains to harvest. At that point, he will switch to Roth conversions to fill up his 12 percent ordinary income federal bracket in continued pursuit of paying the least amount of total tax over his retirement.