Q: I’m planning to leave some money to charities when I die. But now that I’m looking more closely at my estate plan, I’m rethinking how I’ve got things set up. I’ve got the usual retirement accounts and brokerage accounts. What’s the best way to think about splitting things up?
A: It’s good to think this through. You are likely realizing that not all assets are taxed the same way and there might be an optimal way to divvy up your wealth.
To start, your regular IRA accounts (that is, your non-Roth IRAs) have never been taxed. When someone inherits them, every dollar is going to get taxed eventually. Unless the account goes to your spouse, your beneficiaries would have ten years to distribute it all. Obviously, that reduces their inheritance.
But, charities are treated differently. They don’t have to pay any taxes. So, if you name a charity as a beneficiary of your IRA, that money won’t ever get taxed. So, retirement money is often the most efficient pot to leave to charity.
On top of that, your after-tax brokerage or trust accounts, as well as your real estate, typically get a full step-up in cost basis when you die. This means your heirs can often sell those assets without facing a tax bill.
Given all of this, the most tax efficient strategy is kind of straightforward. Consider tweaking your estate plan so that your retirement accounts are used to fund your charitable intent and your other assets are left to the people in your life. Uncle Sam will get far less.
Q: My husband and I just got our tax return back and were surprised to see an added Net Investment Income Tax. We also thought we were going to see the new senior deduction from the new tax law, but it wasn’t there. What happened?
A: It looks like you got hit by some “tax torpedoes.” They are triggered when your income crosses above certain levels and suddenly new taxes show up or deductions start to disappear.
For a married couple, the Net Investment Income Tax appears when your modified adjusted gross income exceeds $250,000. Once that happens, you get to pay an extra 3.8% on your investment income. Think of it as an extra tax on your interest, dividends, capital gains and rental income.
The new senior deduction works similarly. You could have gotten up to a $12,000 deduction for being over age 65. But, once again, it looks like your income wiped it out completely. The phaseout started when your adjusted gross income reached $150,000.
Interestingly, there might be yet another torpedo that you haven’t seen quite yet. That’s your Medicare Part B and Part D surcharge, known as IRMAA. It’s sneakier. Instead of hitting immediately, it’ll possibly show up early next year.
