The Shift in Investment Strategy…

Inherently included in your estate plan will be some tax planning concepts.  Even as the imposition of estate tax becomes less relevant for the vast majority of people, other tax questions are on the rise, both during estate planning and during trust administration.  Particularly with increased taxation on investment income, conventional wisdom may prove to be less reliable in the coming years.

The maximum tax rate on capital gains has increased from 15% to 20%.  The change will affect individuals who earn over $400,000 or couples over $450,000.  Additionally, Obamacare imposes an additional 3.8% federal income tax rate to fund Medicare.  The tax is different from capital gains tax in that it taxes all investment income and applies to individuals with income over $200,000 and to married couples with income over $250,000.  It is important to note that the income thresholds are for all income, but the tax is only on investment income.  Additionally, California increased its income tax rates for 2012 and beyond.  As a result, if your tax return reflects income at or near these thresholds, it is important to speak to your tax advisor to plan current year and near-term strategies.

For middle term planning, deferring tax may provide significant tax savings, while providing additional security for the future.  Tax advantaged accounts, such as IRAs, allow for tax free growth.  Because these new income taxes affect exactly the types of assets held in IRAs, avoiding payment of any additional tax until retirement may be extremely beneficial due to reinvestment potential within the IRA.  Additionally, it is likely that your income in retirement will be significantly lower than your income now; all other things being equal, this means your income tax rate will be lower.  With proper planning, your heirs can continue the tax free growth within the IRA for many years to come through a “Stretch IRA,” and more effectively manage their own resulting income taxation.

From a long-term perspective, many estate planners have encouraged placing growth assets in bypass trusts (part of the A-B trust) in order to shelter further growth from estate tax upon the first spouse’s death.  The strategy was useful for preventing substantial estate tax.  However, with the estate tax exclusion amount so high, it may be preferable to retain growth assets in order to obtain a “step up” in basis.  The step up will prevent excess capital gains and investment income.

Alternatively, you might consider abandoning the A-B structure altogether in favor of electing “portability.”  The concept of portability essentially doubles the estate tax applicable exclusion amount (currently $5.25 million) without the requirement of a particular type of trust or the segregation of assets.  However, there are a number of potential pitfalls to consider when relying on the concept of portability.  A later marriage may derail the plan or failure to file an estate tax return may destroy the entire plan.

If all this financial mumbo-jumbo leaves your head spinning, don’t worry!  You are not alone!  However, with competent help from your estate planning attorney and other financial advisors, you can navigate the changing investment landscape to preserve more of your earnings for your use and your heirs.

Estate Planning: The Price of Organization, Rewards, Gifts, and Wondrous Tax Things… FREE REPORT: This complimentary report, focused on Estate Planning, is comprised of many of Mr. Miller’s articles from his long running column for the largest regional newspaper in San Diego County. This report will guide you through the questions surrounding getting your estate planning in order.