Top 7 Tax Mistakes Made in Planning a Wealth Transfer

We are approaching the biggest wealth transfer ever as Baby Boomers prepare to hand off their life savings to their heirs. But will their heirs actually get the full amount of the wealth intended for them…or will a large amount be lost to unnecessary taxes?

When it comes time to transfer what we have worked so hard to accumulate, how we transfer our wealth can have a significant impact on how much of our wealth is actually received by our heirs and how much is transferred to Uncle Sam. I like this quote by Judge Learned Hand:

“In America there are two tax systems; one for the informed and one for the uninformed. Both systems are legal.  Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

Tax mistakes can account for the loss of of a lot of hard earned money if we are not careful. Below are what I consider to be the Top 7 Tax Mistakes made in wealth transfer planning. With proper planning and counsel, we can wisely transfer our wealth without losing a bulk of our wealth to unnecessary taxes.

  • IRD Taxes. Most people are familiar with income, capital gains and estate taxes; but most people don’t even know what “IRD” Tax is (and most professional advisors don’t proactively plan around this huge tax. I call it the “Gotcha Tax” because it’s the tax that is going to “get” most people. IRD stands for “Income in Respect of the Decedent” & basically it’s the income tax your heirs will pay on Tax Deferred assets such as Traditional IRAs, 401k, annuities, etc. Often these taxes will push your heirs into the highest marginal tax bracket so that a $1 Million IRA/401k could lose almost $400,000 because of the IRD Tax! There are numerous strategies for reducing or even eliminating the IRD Tax…and you should have a plan around this if you have a 401k or IRA or annuities. By gifting IRA & 401k assets to charity and non-IRD assets to your heirs, you can save them almost 40% in IRD Taxes! The use of a Charitable Remainder Trust can provide a Tax-Efficient way to create a “Charitable Stretch IRA” for your Children or Grandchildren.
  • Charitable Giving mistakes. Most people do their charitable giving with “after tax” cash from their income. This is not the most efficient way to give. Gifting highly appreciated securities, real estate, or even business interests can give you a double tax benefit by eliminating capital gains taxes and still getting the charitable tax deduction (and it can actually increase your cash flow & spendable income!).
  • Dying without a well-designed Estate Plan. Over 70% of Americans die without even a simple Will! Additionally, a Will, by itself, subjects your assets (and heirs) to the stress, delays, and costs of Probate. A well-designed Estate Plan can help reduce or eliminate both Probate and Estate Taxes. If you love your family and want to be a Wise Steward of the wealth you’ve been blessed with, you may want to review and update your Estate Plan.
  • No (or Improper) Beneficiary Designations. Improper beneficiary designations can equate to a loss of inheritance. For retirement accounts such as IRAs or 401(k) plans, properly designating beneficiaries is essential to avoid the loss of further income tax deferral at death. If you don’t have primary and contingent beneficiaries named on all your accounts they will have to go through Probate and could cost unnecessary IRD taxes (as well as “Family Feuds”!). Improper or unwise beneficiary designations is one of the most common mistakes people make (and one of the easiest and cheapest to fix!).
  • Improper Titling of Business Interests. It’s common to see the business (Corp or LLC, etc) titled just in the business spouse’s name (often the husband). The problem with this is when he/she dies the business itself must go through the costly (and public!) process of Probate! This can hamper the running of the business or transition of the business because the Executor has to get permission from the Probate Court for most major decisions. This often takes months and is very expensive and stressful for both the spouse and other business partners or leadership. This is not what you need at a time of crisis following the death of the business owner!
  • Unwise Ownership & Beneficiary Designations on Life Insurance. Life insurance can be a great financial planning tool providing much needed liquidity at the time of need. It can also be a great Wealth Transfer tool whether for Estate Planning or Business Planning. However, if the ownership & beneficiaries are not done correctly then the Life Insurance benefits itself can actually be subject to Estate Taxes; which could cost 40%+ of the death benefit to be lost to Taxes! What a waste! Life Insurance can be kept Tax-Free through the use of various Trusts (such as an ILIT or better yet, a SLAT) or other methods.
  • Giving the WRONG Assets to your Children, Grandchildren & Charity

This is one of the most common mistakes people make in Wealth Transfer planning! Many people leave a percentage of their estate to their children, another percentage to their children and then a percentage to their favorite charities (or Donor Advised Fund); and they do this all through their Will or Trust. Their goals are commendable but this is NOT the wisest way to distribute your hard earned assets from a tax perspective! If you give a percentage of your IRA or 401k assets to your heirs through your estate plan, they could lose almost 40% of it to IRD Tax! Instead, you should use IRA (and other IRD assets such as 401k) for your gifts to Charity and, instead, give Non-IRD assets (such as cash, real estate, life insurance, Roth IRA) etc to your Children and Grandchildren. Giving the wrong assets to your heirs could cost a lot of mony in unnecessary taxes! We call this “Tax-Wise” Giving. Be wise in what you give, to whom!

Wisely stewarding and transferring our wealth requires being wise with the tax laws and the rules that govern them. To aid you in your preparation, here is a free download with key financial data to help you in tax planning. With wise planning, you can ensure that your loved ones are well-taken care of.

Need additional tips for how to successfully plan a wealth transfer? Create A Thriving Family Legacy: How To Share Your Wisdom And Wealth With Your Children And Grandchildren is available on Amazon or at major book retailers. Contact our office for a free consultation. In addition to assisting with wealth transfer and estate planning, we assist clients in developing an intentional, proactive plan for mentoring and discipling their children and grandchildren and in creating family unity and purpose in a multi-generational context. If that sounds like something that would be a blessing to your family, please contact us to schedule a conversation.