Leaving the right kind of legacyArticle added by Peter J. “Coach Pete” D’Arruda on October 11, 2013
Ranked: #16 (3,014 pts)
“We don't inherit the earth from our ancestors; we borrow it from our children.” ― David Brower
Ray Bradbury, world-famous science fiction writer who died June 5, 2012, was well known for inserting bits of his personal philosophy into the dialogue of his novels. In "Fahrenheit 451," published in 1953, he has one of the characters imparting this bit of wisdom about leaving a legacy:
“Everyone must leave something behind when he dies . . . Something your hand touched some way so your soul has somewhere to go when you die . . . It doesn't matter what you do, so long as you change something from the way it was before you touched it into something that's like you after you take your hands away.”
What a beautiful sentiment! It is only natural for us to wish to leave behind something of value for those we love, even if it is no more than something for which they will remember us. But, if we have the means, how much better it would be to put in place a provision that would enhance their lives. We want to make sure that our grandchildren have a college education. As they grow older, we want them to be in a position to own their own home and be able to pay for it.
When it comes to setting up a legacy for young people, doing it such a way that they can’t blow the money out of youthful exuberance is important. The touchy subject of irresponsible children often comes up when I meet with clients wishing to provide a legacy for their children and grandchildren.
“We have four children,” began one couple. “Three are responsible adults, and the fourth, the youngest, can’t keep a quarter in his pocket.” They told me that they only wanted what was best for their children, and they were worried that the youngest son would squander it as soon as he received it. “Are we wrong to think that way,” asked the wife? It was a legitimate question. They said they wished they could treat all of their children alike and that they didn’t want to hurt their son’s feelings.
A major portion of their legacy assets was contained in an IRA that the couple had spent most of their lives building. I told them that they were probably doing their son a big favor by doing some extra planning to protect their spendthrift son from his own inclinations. I assured them that they could set up their estate in such a way that all would be well served. I showed them how they could set up a spendthrift trust with the one son in mind and “stretch” the IRA so that (a) the value could transfer to the children and then the grandchildren and beyond, (b) quadruple in value over time and (c) avoid excessive taxation. They were surprised to learn how much could be accomplished for the long term good of their loved ones, with just a little planning.
Stretch IRAs are no secret, and they are not a new type of IRA. It is simply a method of transferring wealth that allows you to “stretch” the proceeds from the account over several future generations. Most IRA owners know that tax law requires that individual retirement account holders begin taking out at least minimum amounts, known as required minimum distributions, or RMDs, from their accounts once they reach age 70 ½. The amounts are based on the IRS life expectancy table. It’s pretty obvious why the IRS wants you to start drawing down these accounts when you get older. After all, your money sat in those accounts, tantalizingly out of their reach while it accrued tax-deferred earnings. If you are fortunate enough to inherit someone else's IRA, you will be required to take minimum distributions each year from the IRA account based on your life expectancy figure — regardless of your age.
Here’s where the “stretch” comes in. At the death of the owner, IRA accounts are passed on to the designated beneficiary. Most IRA owners name their spouse as their beneficiary and their children as contingent beneficiaries. There’s nothing wrong with that. But it might require the surviving spouse to take more taxable income from the IRA than he or she really needs. If income needs are not an issue, then naming younger beneficiaries, such as grandchildren and great grandchildren, allows you to stretch the value of the IRA out over generations. Why? Because the RMD for a youngster will be a fraction of what it would be for an older person. The proceeds are doled out in smaller amounts for a longer period of time. This allows the money to continue to grow, tax deferred. The effects of compound, tax-free growth are startling when you plug them into a calculator.
It confounds me why more financial planners aren’t aware of how to stretch an IRA. All that is required is a little paperwork. And yet, a blank look comes over the faces of many a financial professional when you ask them about it. Ed Slott, one of the nation’s premier experts in the field of stretch IRAs, makes the point that if we don’t make an effort to take care of our families in such a way, we will end up leaving the majority of our inheritance to Uncle Sam. There are many ways to avoid paying more than your fair share of taxes that are perfectly legal. In many cases, the details of how to go about implementing these strategies are contained in the IRS code manuals.
Many love the concept of stretching their IRAs strictly from a sentimental point of view. “I get a little choked up thinking about my great-granddaughter receiving a check each year on her birthday when I’m long gone,” said one client. The check would, of course, be the RMD paid out of an IRA that the man had started funding decades earlier.
Can you pass on the proceeds of your IRA to your loved ones in the form of a lump sum? Sure you can. But the beneficiary of a lump sum will have a whopper of a tax bill and, depending on his or her sense of thrift, may have a challenge not to spend the money irresponsibly. Setting up an income legacy to heirs is growing in popularity for obvious reasons.
Buying life insurance with the RMDs?
On one particular radio show, I asked the caller to give the producer his number. I wanted to call him back and calm him down off the air. He had just turned 70 ½ and discovered that he had no choice in the matter of taking his RMDs. To his way of thinking, the government was forcing him to take money out of an account that he had set aside for his son. He was not super wealthy, but he had plenty of income and did not need the money from the RMDs.
“Are you healthy?” I asked him.
“As a horse,” he said.
“What if you took the RMD, which you don’t need anyway, and used it to pay the premiums on a life insurance policy on you, with your son as beneficiary.”
The silence that ensued told me that the gears in his mind were turning.
“Can I do that?” he said.
“All day long,” I replied.
The amount of life insurance he purchased using that simple concept was $250,000. The policy he purchased came with a long-term care attachment. He was happy as a clam.
Life insurance is viewed by some as merely income replacement for a working family member who dies prematurely. Perhaps that’s all it was at one time, but in this modern financial world, life insurance has become an important cog in the works of leaving a legacy. You can leave a tax-free death benefit and set it up in a way that will provide a yearly payment while the balance continues to grow. Each time they get that check, they will think of you. That’s leaving a legacy. It’s all in the way you structure your financial affairs.
It’s only natural that we want our children and grandchildren to have a better life than we did. I have talked to a lot of parents who have seen their children through college and watched them grow into adults with successful financial lives. You can tell by talking to them that their passion is not so much to fatten the bank accounts of their immediate children so much as it is to see that their grandchildren are well cared for.
"I want them to remember who grandma and grandpa are,” one woman said.
When our grandchildren get older and develop a greater capacity for understanding just what kind of character their grandparents and great-grandparents possessed, then they too will have a sense of legacy, and we will have contributed to it more than we can know. They may need our help in the world they inherit. It may be that their hurdles will be a bit higher than ours, and their dreams not as achievable without our help.
Dividend reinvestment programs
Here’s an idea: Pre-fund a pension for your grandchildren. Right now, you can start putting money away that will give them a lifetime income when they retire. You can start a “drip plan” today and wait for some milestone in their life to present it as a gift for them. Dividend reinvestment programs are an excellent way of doing this. Each month, deduct $100 or $200 — some predetermined amount — from your checking account, and use it to buy shares of stock in a company that produces dividends. Each and every month, on the same day of the month, the money coming out of that account will buy whatever number of shares that amount can buy that day. If the stock price is down, it will buy more shares. If the stock price is up, the money will buy fewer shares. But dollar cost averaging will see you through. You are averaging your cost over the lifetime of the program and plowing the gains back into it. When the company issues dividends, you buy more shares of the stock. It is an excellent way to leave a legacy and teach your children and grandchildren the value of money and the principles of investing.
When I was in high school, I started one of these programs using McDonalds and Exxon. The little secret here is, you don’t want the stock to do too well at first. You want it to stay in business obviously, but you want it to stay relatively low when you are buying it. That way you can own more shares. When you select a company that you know will be around for a long time, you will see the value of the company increase as the years go by. Whether you give the program as a legacy, or you use it for your own retirement, you will eventually have something that will fund the period known as “reverse dollar cost averaging.” That’s when you are selling shares of stock as you withdraw cash from the account on an incremental basis.
I once attended a seminar where the motivational speaker issued this indictment to audience: “We are great inventors of excuses. We are turning into a generation of blamers and excuse makers. If we could spend half the time actually doing the things we are thinking up excuses for not doing, it would be amazing how much we could accomplish.” That put me to thinking. I ran down the mental checklist of my own procrastinations, and I had to admit that the speaker was right. We do have a tendency to put things off. It’s only human nature. See, I just did it again!
“Roll up your sleeves and put your shoulder to the wheel and your nose to the grindstone,” he continued. “Make a plan and stick to it. The only one you really have to blame is the one whose thumbs are pointing back at you when you put your elbows up at 90 degree angles like this.”
He placed his arms in a position where his thumbs were pointing back at himself. Then he pointed his finger at the audience.
“Remember, when you point the finger at someone else, there are three others pointing back at you.”
“Make a plan and stick to it,” he had said. Naturally, I thought of a financial plan, although I don’t think that was necessarily what he had in mind. I wondered how many people were putting off getting on track with a workable financial plan and what excuses they might come up with for their procrastination. According to the speaker, most people will spend more time planning their next vacation than they will planning how they’ll spend the rest of their lives. I think he’s right. It seems to be that acting in our own behalf is sometimes the most difficult act to perform.
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