We’re conditioned to think of 65 as the tipping point into old age. Or at least we used to. But actuarial tables tell us something different, as does the attitude that “70 is the new 50.” Amid these changes we have come to look at aging differently, specifically at how we consider clients’ needs for protection from taxes.
We make a mistake if we lump everyone 65 and older together. There are actually three distinct stages in this time of life: I call them “late old age,” “early old age” and “later middle age.”
In this column, I will address late old age, offering tips for your clients and their family members about how to protect their assets and buttress their sense of security. (I’ll write about the other stages in later installments.)
Defining ‘Late Old Age’
It’s difficult to say when late old age starts (age 85? 90?) since much depends on the person’s health, mental status, family history and luck.
But picture this: An individual in late old age is often widowed and, if well-to-do, has more assets than they can spend in their remaining years (after accounting for what they need for long-term care). Their free-spending days are memories.
It is best to keep financial advice simple at this stage. But you want to confirm that your clients have made plans for their beneficiaries in a will, designated beneficiaries in retirement plans and other accounts, and taken steps to minimize the taxes the clients’ heirs will be liable for when the clients pass on.
In other words, tax and estate planning should have been done well before late old age. Nevertheless, I urge advisors not to neglect these cases.
Every plan needs a close look at least once a year, and not just because of the recent changes in the tax treatment of inherited retirement accounts. There will also likely have been deaths or marriages in the client’s family that require them to re-examine their estate plans.
Advisors must develop and sustain good relationships with their clients’ beneficiaries, since it could garner them referrals and new assets to manage.
The Advance Work
If you’ve been someone’s advisor for a while, then you’ve likely done the foundational work that limits any significant shifts in their strategy or goals, namely:
1. You have directed consistent, constant dollar levels of withdrawals from the client’s traditional individual retirement accounts (IRAs). By doing this, you’ve avoided catapulting your client into a higher tax bracket with “lumpy” withdrawals, used charitable deductions to save on taxes, and retained enough of their IRA assets that they can take advantage of lower tax brackets in their late old age.
2. You have topped off their required minimum distributions (RMDs) with voluntary withdrawals to fund Roth conversions (if the client was married, these should have begun when the spouse was alive, and the couple was taxed more advantageously than the widowed individual).
You’ve also likely encouraged clients to contribute to a donor-advised fund or family foundation by selling highly appreciated stocks.
And if one spouse’s death was anticipated, you likely recommended that the couple transfer shares of appreciated stock held in joint accounts to a separately owned account so the stock gains a step-up in basis when the spouse dies.
Your Mission Is …
In the best of all financial worlds, your client in late old age has their investment assets mostly held in Roth IRA and brokerage accounts, and only a tiny allocation is appreciated stock.
Now, you have three priorities:
1. To ensure that the client’s IRAs reflect the beneficiaries’ current preferences—specifically, that beneficiaries’ taxes will be minimized if they stand to inherit a traditional IRA.
2. To confirm that a trusted family member understands the older relative’s investments and bequest preferences and can become one of their executors, keeping the plan on target amid any turmoil both before and after the client dies.
3. To keep the client aware of any imminent increase in their inheritance tax liability imposed by federal or state law, and to suggest that the client contemplate a charitable gift in response.
Some clients may want to take steps to limit their beneficiaries’ exposure to taxes. They can do so by taking the following steps:
• Switching IRA beneficiaries to grandchildren or younger family members who are in lower tax brackets. Since beneficiaries must now empty the accounts in 10 years according to changes in the law, these monies should be going to people in lower brackets.
• Helping wealthy children who don’t need inheritances designate their children (or others in the family’s next generation) as the beneficiaries of other, non-IRA assets in the estate.
• Making a planned charitable gift that will help them avoid federal and state inheritance taxes and capital gains taxes on appreciation that the estate will owe before probate is completed.
A trusts and estates lawyer will handle legal filings after the client’s death. Still, I can’t emphasize enough how important it is for the lawyer to be part of a team that includes a competent executor who is sensitive to the client’s intentions and a financial advisor familiar with the client’s assets and transaction history.
Perhaps You’re The Recovery Crew
You may inherit or acquire a client in late old age who didn’t get the advice you would have given them before to help them minimize their taxes. Now you’re working to salvage what you can. Perhaps the client did one of these things:
1. Took RMDs only and didn’t take advantage of Roth IRAs. Or missed opportunities for Roth conversions while filing jointly at more moderate tax brackets than they’re now in.
2. Exhausted their brokerage accounts, realizing long-term capital gains, or overlooked opportunities to liquidate unrealized gains of stocks held in a brokerage account.
You still have some options with these clients. You can still evaluate voluntary IRA withdrawals to fund Roth conversions. The Roth accounts can be rainy-day funds or be used to reduce taxes for the client’s beneficiaries.
Suppose a client has a spike in their out-of-pocket costs for things like healthcare and caregiving. In that case, you can identify the most tax-efficient moves, comparing the sale of assets in brokerage accounts (which come with the realization of long-term gains) with the tax bills the client would see if they took voluntary IRA withdrawals.
Remember These Things
As an advisor to a wealthy individual in late old age, you should keep these two thoughts in mind:
1. The client portfolio’s asset allocation does not matter at this stage of their lives. The time horizon is short, and their beneficiaries can adjust their investment mix later when they inherit the assets.
2. Even a client with a limited life expectancy deserves your attention. Probate periods can be long and extend your advice’s life span and consequences.
In my next column, I’ll write about the strategies for minimizing taxes that you can recommend as an advisor to clients in “early old age,” shortly after they’re retired, when they are still in good health yet need to plan.
Paul R. Samuelson is the chief investment officer and co-founder of LifeYield.