The US tax code includes an Estate Tax for inherited wealth. Oligarchs and other opponents of such a tax like to refer to it by a more ominous title, The Death Tax. Ooh, scary.
After the passage of the Tax Cuts and Jobs Act of 2017, this tax applies only to households with more than ~$11 million per adult (~$22 million per couple.) Fewer than 0.2% of US households qualify. (*)
I’m personally more concerned with the tax that will apply to the other 99.8% of us. The real death tax.
The Real Death Tax
Throughout this blog, I’ve shared countless tax reduction and tax minimization scenarios.
Every one of those examples includes a nice little phrase, “for a Married Couple Filing Jointly (MFJ)… Single filers divided by 2.”
The truth is, we won’t live forever. Often, that means one spouse will continue on without the other.
With significant assets. As a single filer.
Making the simple assumption that retirement income will continue as normal, involuntarily, due to RMDs, pension & SS, and dividends, then the tax burden of our beloved widower will increase significantly. Using the single filer tax brackets, each dollar of income is taxed more heavily. This could also apply at the State level.
I’ve heard it’s been said that everybody should have an estate plan. Even without an estate tax, that seems wise.
Upon the death of a spouse, reducing involuntary income is warranted. The levers we have the most control over are IRA size and Dividends, and the sooner we can start, the better.
Minimize Traditional IRA Value
Once we hit age 70.5, we will be making Required Minimum Distributions from our Traditional IRAs/401ks. To avoid an increased tax bill, it is best if the IRA values for the surviving spouse are independently below key thresholds (See Is Your 401k Too Big?)
Naturally, our Traditional accounts will already be as small as possible thanks to annual Roth conversions throughout our non-working lives.
But that may be insufficient. in which case we can:
- bequeath our Traditional IRA, in whole or part, to a non-spouse (children, grandchildren, etc…)
- ramp up our charitable efforts via Qualified Charitable Donations (QCDs) which satisfy the RMD requirements
Fortunately, a spouse can decline to inherit an IRA, but an up to date last will and testament or a Transfer on Death (TOD) registration with your brokerage will help with a seamless transition.
Our taxable brokerage accounts have been spitting off an increasing quantity of dividends, as they do. As RMDs increase, our dividend income is likely to increase with it (where else are we going to park those funds?)
Single Filer tax brackets and Social Security, with or without an RMD, could mean most or all of our dividends no longer benefit from the 0% tax bracket, instead facing rates of up to 23.8%. (Dear S&P500, please stop paying so many dividends.)
To minimize the long-term damage, we can:
- Reduce the percentage of net worth invested in high-yield assets (individual stocks, high-yield funds)
- Increase the percentage of net worth invested in non-dividend paying assets (e.g. Berkshire Hathaway)
- Gift assets to friends and family (although this keeps basis same for the recipient)
- Donate (appreciated) assets to charity
I’ve already taken option 1 and will increasingly rely on options 3 and 4, with perhaps a sprinkle of option 2.
Reflecting upon my own mortality has got me thinking… everyone needs an estate/inheritance plan, not just the top 0.2%.
Married couples benefit from larger tax brackets which cease to apply when one person passes. Without proper planning, this can result in a significant increase in tax burden for the surviving spouse. (*)
A lot of income late in life is involuntary (SS/pensions, RMDs, dividends) so options are limited. Using the non-working years to minimize RMD size/impact and total dividend income will yield the best results.
I’ll be working on formally implementing our own estate/inheritance plan over the coming weeks, because everyone needs a hobby. (TODs already in place.)
(*) This is even more relevant to us, as the estate tax exemptions don’t apply to non-resident alien spouses (NRAs.) At present, our estate plan includes the important (albeit unlikely) requirement that I am not allowed to pass first.