As you build your retirement nest egg, you’re probably wondering if you have enough set aside to fund the lifestyle you crave in your “golden years”.

You’ve worked your entire life to grow your wealth and to enjoy the fruits of your labor in retirement, so the last thing you want as you progress into that next phase of your life is not to have enough money to retire and enjoy this time of peace and leisure. 

The key is to ensure that the money you’ve accumulated can provide for your needs throughout retirement, allowing you to live comfortably without the fear of outliving your savings.

It’s said that a million dollars is NOT enough for most to retire comfortably, which begs some questions: How much money do I need to retire? Can I retire on 2 million dollars? 

Well, that depends… on many things. While $2 million can be a solid foundation, determining if it’s truly sufficient for a comfortable retirement depends on multiple factors like your lifestyle, healthcare needs, and investment strategy.

A 2023 survey from Schwab Retirement Plan Services found that the average worker expects to need roughly $1.8 million to retire comfortably… but it’s possible that you don’t know what to do with 2 million dollars, or what a 2 million retirement looks like!

That’s why, in this article, we’re going to break down the 5 steps to help you gauge whether you can retire on $2 million and what you can do to make it last, with helpful resources to make your retirement planning more attainable. 

Step 1: Assessing Your Financial Situation
Step 2: Setting Realistic Retirement Goals
Step 3: Invest Wisely to Reach Your Retirement Goal
Step 4: Planning for Healthcare Costs
Step 5: Creating a Sustainable Withdrawal Strategy

Step 1: Assessing Your Financial Situation

The first and most crucial step in determining whether you can retire on $2 million is to assess your current financial situation. This starts by taking inventory of your stock of your assets, liabilities, income streams, and overall financial health. By understanding where you stand financially, you can work to identify any gaps or areas that may need to be addressed.

Evaluate Your Assets

Start by listing your assets. This includes things like savings accounts, investment portfolios, real estate, and other valuable possessions. This will give you a clear picture of your net worth and how close you are to achieving your retirement goal.

Review Your Liabilities

Next, you want to take a close look at all of your liabilities, such as outstanding debts, mortgages, and other financial obligations. Reducing or eliminating your debt is a critical aspect of your retirement planning, as it can significantly erode your retirement income and overall financial security.

Estimate Your Retirement Income

Now is the time to evaluate your retirement income. Consider all potential income sources during retirement, including Social Security, pensions, annuities, and any part-time work you may plan to do. This income, combined with your savings, will help you understand the cash inflow that you will have when you retire.

By taking an inventory of your current financial situation, you can understand how reasonable it is to retire on two million dollars.

Want to know if you will be able to retire with $2 million? Download our free checklist to help you evaluate your financial situation. This simple tool will help you get a clear snapshot of where you stand.

Step 2: Setting Realistic Retirement Goals

Everyone envisions retirement differently, and your unique lifestyle will significantly impact whether $2 million will be enough. Once you have a clear understanding of your financial situation, the next step is to set realistic retirement goals. 

This involves defining what you want your retirement to look like and determining the lifestyle you wish to maintain. There are many financial complexities that you should be aware of as you set your retirement goals. Do you plan on traveling? Staying in a high-cost area? What are your expected healthcare costs? 

Your personal goals will shape the amount of income you’ll need and help you understand whether $2 million will be enough to support your desired lifestyle. Estimating essential expenses like housing and healthcare and discretionary spending like travel helps you determine if $2 million will be enough.

You’ll also want to consider your retirement timeline. When do you plan to retire, and how long do you expect to need your savings? The earlier you retire, the more you’ll need in your nest egg to ensure that your funds last throughout retirement. 

By setting clear and realistic goals, you will be able to understand if retiring with 2 million dollars is reasonable for you and your way of life. Understanding these goals will also provide you with a framework for making informed decisions about your savings, investments, and retirement strategy.

Step 3: Invest Wisely to Reach Your Retirement Goal

Having two million dollars sitting in a regular bank account somewhere is likely NOT going to support your retirement. Investing your 2 million dollars — or whatever your retirement target is — can help make this sum last throughout your golden years.

Building your retirement savings to cover all of your expenses requires long-term disciplined saving and strategic investing. Your investment strategy needs to work with your retirement timeline, risk tolerance, and financial goals to be effective for you. The earlier you start, the more time your investments have to grow and benefit from compound interest.

To reach your retirement goal, whether you’re looking to retire with $2 million or retire with $5 million, you’ll want to take advantage of key investment strategies. These include diversification, considering your risk tolerance, maximizing your tax-advantaged accounts, and staying the course of your retirement plan.

Most importantly, you want to start now!

By investing your assets as soon as possible, you get to benefit from compound interest. The younger you start, the greater the total return you can expect from your investments.

Want to learn how to optimize your investments for retirement? Watch our video with [ADVISOR NAME] on investing wisely for the future. You’ll discover key investing strategies from our expert team to help you reach your target and retire with confidence.

Step 4: Planning for Healthcare Costs

Healthcare is one of the largest and most unpredictable expenses in retirement. While Medicare helps cover some costs, out-of-pocket expenses such as premiums, deductibles, and long-term care can add up quickly. Not to mention, as you age, your healthcare needs are likely to increase. 

It’s important to plan for these costs to ensure that they don’t deplete your savings. Allocating part of your savings specifically for healthcare needs, or considering options like long-term care insurance, can help protect your retirement nest egg.

Estimate Healthcare Costs

Start by estimating your healthcare costs in retirement. This includes premiums for Medicare or other health insurance, out-of-pocket expenses, and potential long-term care costs. It’s important to be realistic about these costs, as they can be significant, especially in the later years of retirement.

Consider Long-Term Care Insurance

Long-term care insurance can help cover the costs of nursing home care, assisted living, or in-home care. While it can be expensive, long-term care insurance can also provide peace of mind by protecting your savings from being depleted by high healthcare costs. 

If you decide it’s best for you, it’s important to consider purchasing long-term care insurance while you’re still relatively young and healthy, as premiums increase with age and health conditions.

Create a Healthcare Savings Plan

Another way to prepare for healthcare costs is to set aside a portion of your retirement savings specifically for healthcare. You can do this through a Health Savings Account (HSA), which offers tax advantages for healthcare savings. Contributions to an HSA are tax-deductible, and withdrawals for qualified healthcare expenses are tax-free, making HSAs a valuable tool for covering healthcare costs in retirement.

Step 5: Creating a Sustainable Withdrawal Strategy

Even with $2 million saved, how you withdraw that money will determine how long it lasts. Knowing how to retire on 2 million dollars is another key part of the puzzle.

Without a strategy that is sustainable for you and catered to your needs, you will not get the most out of the money you set aside for retirement. The final step in retiring with $2 million is to develop a sustainable withdrawal strategy. 

Creating a withdrawal strategy involves determining how much you can withdraw from your savings each year to cover your expenses — both essential and discretionary — without depleting your funds too quickly. A well-thought-out withdrawal strategy is key to ensuring that your money lasts throughout retirement and supports your lifestyle.

Many withdrawal strategies are used in retirement planning, such as the 4% rule, other fixed-percentage withdraws, adjusting your withdrawal amount for market fluctuations, adding annuities to your retirement plan, and the “bucket” strategy. 

Creating a sustainable strategy is essential to ensuring that your $2 million nest egg lasts throughout retirement. Choosing the right strategy depends on your risk tolerance, life expectancy, and financial goals. Many retirees combine multiple strategies to tailor their withdrawal plans. 

It’s important to remember that living off the interest of 2 million dollars takes careful planning and close monitoring, so you must stay on top of your financial planning as you plan to wind down from full-time employment.

Is $2 Million Enough to Retire?

So, can you retire with 2 million dollars?

Ultimately, the answer to “Is 2 million enough for retirement?” depends largely on your personal situation. By assessing your finances, setting realistic goals, investing wisely, planning for healthcare costs, and creating a withdrawal strategy, you can make informed decisions that set you up for a comfortable retirement.

Planning for retirement is complex, so it’s crucial to approach it with confidence and the right guidance. Working with a trusted financial planner who is a legal fiduciary — that is, legally obligated to act in 100% your best interest — can provide you with invaluable support! They can help you assess your financial readiness for retirement, tailor a withdrawal strategy that suits your needs, and adjust your plan as circumstances change.

For a more detailed, personalized roadmap to retiring with $2 million, download our full guide, “Is $2 Million Enough to Retire?”. This guide is packed with our expert insights and practical tips to help you retire on $2 million comfortably and confidently.

Frequently Asked Questions (FAQs)

Can you live off the interest of 2 million dollars?
Can I retire with 2 million?
How will inflation affect my retirement?
Is 2 million in my 401k enough to retire?

Can you live off the interest of 2 million dollars?

Yes, it is possible to live off the interest of $2 million, but it depends on your lifestyle, expenses, and how the money is invested. 

If you were to invest in a diversified portfolio with an average return of 4%, you could generate around $80,000 annually in interest. This could provide a comfortable living for some, but it’s important to consider taxes, inflation, and market fluctuations. The amount of money needed to retire depends on your unique situation.

Can I retire with 2 million?

When it comes to specific and customized retirement advice, we recommend that you work with an advisor to analyze your financial situation, your goals, and the needs that you will have in retirement. While it may be possible for some to retire with $2 million, some may need to have more money invested to support their retirement.

At Towerpoint Wealth, we partner with Charles Schwab. They offer a Retirement Calculator tool that helps test out different scenarios to estimate your expected total retirement savings based on your annual contributions, and exploring this can be very helpful!

How will inflation affect my retirement?

The last thing anyone wants to do is fall short of their retirement plan. Whether you can retire comfortably on $2 million depends, as we’ve discussed, on a number of factors. A factor you don’t want to leave out in your retirement planning is inflation. 

Inflation can erode the purchasing power of your savings over time, meaning you’ll need more money in the future to maintain your current lifestyle. Work with your financial advisor to ensure that your retirement plan takes inflation into account.

Is 2 million in my 401k enough to retire?

$2 million in your 401(k) could be enough to retire comfortably — that is, depending on your withdrawal rate, expenses, and expected longevity. 

You need to consider healthcare costs, taxes on withdrawals, and any other sources of retirement income like Social Security. It’s important to assess your entire financial picture and consult with a financial advisor to ensure your 401(k) balance supports your retirement goals.

Bonus Step – AFTER You Have Retired with 2 Million Dollars – Pick the Right Place to Retire

Clearly, maximizing your lifestyle post-retirement requires attention to the cost of living. Stretching a dollar is always important, and retiring with 2 million dollars “buys” options, specifically, on where you choose to live.

Click the thumbnail below for the ThinkAdvisor.com slideshow that focuses on the 12 Best U.S. States for Retirement in 2024.

It is important to note that accumulating enough money is only Act One when determining whether retiring on $2 million is feasible. Figuring out how to properly, and sustainably, withdraw money (AKA decumulate) from your nest egg is Act Two, and is just as, if not more important to get right. A way-too-simplified back-of-the-envelope computation might look like this:

• $2,000,000 nest egg x 3.5% annual withdrawal rate = $70,000/year
• $70,000/year – 25% in assumed federal and state income taxes = $52,500/year net retirement income, or $4,375/month

Information is intended to be general in nature, for simplistic illustrative purposes only, and is not intended to serve as Investment advice, since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.

However, there are a myriad of additional variables and considerations that factor into this “retirement calculus.” What about pensions? Inflation? Social Security? Income from part-time work? Variability in market growth and investment returns? Appropriateness and sustainability of a 3.5% annual withdrawal rate? Increases in health care and insurance expenses as you age? Legacy and philanthropic planning and objectives? So, when can you retire?

The list of important and yet very subjective considerations goes on and on. When developing a customized retirement income plan, the nuance in working through and deciphering each consideration cannot be understated.

However, what we can say with confidence is that if you have nearly accumulated $2 million for retirement, you have an excellent head start, and have probably secured yourself many attractive options. In our opinion, wealth is not defined by a set amount of dollars, but by the freedom it affords you. And having options and choices on how to live your life is the essence of what freedom, and retirement, truly is.

Watch our YouTube “Is 2 million enough to retire”

Our President, Joseph Eschleman, CIMA® worked with the team to put together a video reviewing what everyone should think about when they think about when can I retire and five steps to help folks get there.

Check out more YouTube videos

For more information on when to take Social Security benefits and how to reduce income tax as part of your retirement plan.

• Secure Act Explained
• How do 401 (k) loans work
• Roth IRA Conversions – How to Reduce Income Tax
• Retirement account rollovers
• When should you take social security benefits?
• Maximize the money your 401k and IRA beneficiaries
  

How Can We Help?

At Towerpoint Wealth, we are a fiduciary to you, and embrace the legal obligation we have to work 100% in your best interests. We are here to serve you and will work with you to formulate a comprehensive and tax efficient retirement strategy. If you would like to discuss further, we encourage you to call, Joseph Eschleman , 916-405-9150, or email jeschleman@towerpointwealth.com to open an objective dialogue.

Building and Protecting Personal Net Worth
Emotional Awareness – Strike a Balance between Life Now and Planning for Later
Financial Advisor vs Financial Planner
Find a Financial Advisor Who Will Understand Your Specific Goals
The First Step – Ask Around!
The Second Step – Find a Legal Fiduciary to Work With
How Does a Financial Advisor Get Paid?
How Do I Know if a Financial Advisor is a Legal Fiduciary to Me?
What Can I Expect From a Good Financial Advisor?
What are the Qualifications for a Financial Advisor?
What Will the Best Financial Advisor Do for Me and My Family’s Assets?
When is the Best Time to Hire a Financial Advisor?

Building and Protecting Personal Net Worth

You’re working hard and making money. But accumulating money doesn’t always lead directly to economic peace of mind. This money also has to be managed if it’s going to last through your lifetime. It takes time, expertise, and discipline to consistently manage a plan to protect and build your wealth. It’s common not to have the desire or patience to do this oneself. It’s important to establish and execute on a well-thought out plan, so your net worth will be enough to help you enjoy the rest of your life once you stop working.

Investing, coordinating, protecting, and managing your wealth and assets is a challenge that increases as your net worth does.

This leads to the inevitable question that many investors find themselves asking at some point in their net worth building journey – how and where can I partner with a trustworthy, qualified, and supportive financial advisor who can help me properly manage and coordinate much of this financial heavy lifting? Or in today’s parlance, asking their smartphones to respond to the directive: “Find a financial advisor near me!”

Emotional Awareness – Strike a Balance between Life Now and Planning for Later

Striking the appropriate balance between your career and your family life is challenging and stressful. Adding in the essential responsibility (some might argue “hassle”) of properly managing and coordinating all of your financial affairs creates additional stress and pressure. It is difficult to develop and execute on a well-thought-out and disciplined plan to grow and protect your personal wealth. It’s no wonder this responsibility often gets de-prioritized until you “aren’t so busy.” Additionally, the effort to grow net worth isn’t simply a task, but an ongoing process that requires constant attention and nurturing. The emotional ups and downs of managing one’s wealth are arguably more difficult to manage than the more data-driven aspects. It’s easier to worry about our net worth than it is to nurture it.

Unfortunately, for many of us, we’re looking forward to retirement as our time to be less busy. But the greatest investment planning opportunities, many critical economic decisions, and basic compounding benefits have already passed by the time we get there.

Whether you search for a financial planner vs financial advisor vs wealth manager, you want to know what qualifications for financial advisor matter. You want to find a partner you can trust. 

Find a Financial Advisor Who Will Understand Your Specific Goals

Let’s face it, most of us shop for everything on line these days, and shopping for a financial advisor could look something like asking your device to “find a financial advisor near me.” While you could simply enter find a financial advisor near me (or for that matter, find a financial planner near me) in a browser search window and go with the first result, finding a financial advisor who will understand you and your specific needs tends to be the most challenging aspect of hiring one.

Partnering with a financial advisor is about finding one who you trust and feel comfortable with and confident about. They need to be smart, and established, yes, but more than that too. The idea is that you’ll be a partner with them, and be in charge of your own finances. You’re not turning over control. An important part of the wealth building journey is partnering with the right financial advisor. Like finding a trusted doctor, accountant, therapist, or even housekeeper, this may be easier said than done!

The First Step – Ask Around!

When working to find the right financial advisor, the first step to take is to ask friends and colleagues who have a financial advisor to share their experiences with you. What qualifications for financial advisor do they consider?

Finding the right financial advisor should have a lasting positive impact on your financial future, and it is essential you are hiring the right person to partner with. For instance, if you are compensated with restricted stock units or stock options, find out if your colleagues are working with an advisor who has this area of expertise.

Find out if the advisor can help you set up your RSU strategy regarding selling and taxation of restricted stock units.

Are you working towards retirement with 2 million dollars? Are you curious about Right Capital software for retirement planning?

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 [RM1]Link to https://towerpointwealth.com/5-steps-to-retiring-with-2-million-dollars/

 

 [RM2]Link to https://towerpointwealth.com/sacramento-financial-planning-philosophy-strategy/right-capital-financial-planning-process-retirement-planning-calculator/

To increase your odds of longer-term success, your financial advisor will need to know and understand your financial life and oftentimes many aspects of your personal life as well. Providing the most appropriate and customized advice and counsel can only happen when you are as honest and open with your advisor as you expect your advisor to be with you. When an advisor has a legal responsibility to act in your best interests 100% of the time, he or she is known as a fiduciary.

The Second Step – Find a Legal Fiduciary to work with!

An extremely important step when searching for a financial advisor is to ensure they are professionally bound by the legal fiduciary standard. With the designated duty of fiduciary, a financial advisor is regulated by the Securities and Exchange Commission (SEC), and is legally held to the fiduciary standard: the highest standard in the industry. A fiduciary advisor is required to discharge their planning, counsel, and advice solely in the best interests of the client, even if it means placing the client’s interests ahead of their own.

The suitability standard is in stark contrast to the fiduciary standard. A financial advisor working with the suitability standard is required to make recommendations that are simply “suitable” for a client. Importantly, the suitability standard does not legally require an advisor to act solely in a client’s best interests.

Another significant distinction between these two very different professional standards is how an advisor is compensated.

How Does a Financial Advisor Get Paid?

A fiduciary financial advisor is compensated generally via an annual, asset-based fee that is computed based on a percentage of the client’s assets the advisor manages. A financial advisor who is not a fiduciary can receive compensation via commissions, and hidden compensation derived from products that can have higher fees and expenses. In fact, the White House Council on Economic Advisers has discovered that non-fiduciary advice leads investors to pay higher fees and expenses to the tune of $17 billion a year! Proving something Ben Franklin said in his aforementioned essay:

“You will discover how…small, trifling expenses mount up to large sums, and will discern what might have been…saved.”

How Do I Know if a Financial Advisor is a Legal Fiduciary to Me?

The possibility for conflicts of interest always exists. However, a financial advisor who is a fiduciary is obligated to disclose them to you, and a financial advisor who works under the suitability standard has a much greater possibility for conflicts of interest to occur. Look elsewhere if a prospective advisor is not 100% transparent about answering the following two questions:

1. “How exactly do you get paid?”
2. “Are you a legal fiduciary to me?”

What Can I Expect From a Good Financial Advisor?

There is no distinguishing set of variables that define a financial advisor vs financial planner or a wealth manager. Because every individual has unique personal and financial circumstances, a crucial first step in working with any financial professional is to jointly discuss your personal and financial goals. While this may seem straightforward, it doesn’t take long for things to become complex and nuanced, especially when you seriously consider responses to the following questions:

• What financial concerns keep you up at night?
• How would you like me to work with you so you can rest soundly?
• What are you working towards in your life?
• What decline in your overall investment portfolio, in hard dollars, would cause you great personal discomfort such as lack of sleep, anxiety, worry, or even despair?
• Why do you think you need financial help and guidance?
• Putting aside the unexpected, what life changes do you expect to occur in the future?
• How do you picture your ideal life three years from now? Five? Ten?
• How would you describe your feelings and experiences about money growing up?

This is a small sample of initial questions a financial advisor may ask you during your initial getting-to-know-you conversations (also known as the discovery process). And the questions should continue, as the right financial advisor will have a sincere interest in you. Separate from the questions to ask when hiring a financial advisor, the questions they ask you should illustrate the depth of your partnership. In addition to asking, listening to, and considering your answers to thoughtful questions such as these, any good advisor will dedicate time and energy to you to develop rapport, and ultimately, trust.

What are the Qualifications for a Financial Advisor?

According to the Bureau of Labor Statistics, there are more than 200,000 people in the US who hold themselves out as financial advisors. Financial planner vs financial advisor vs investment advisor, the actual job title matters much less than the qualifications and experience a prospective financial advisor brings to the table. Qualifications for financial advisors go way beyond whether they have an office near you.

Trust

Regardless of whether you are working with a financial advisor vs. financial planner, do you trust them with not only the intimate details of your financial life, but also with the intimate details of your personal life? The two clearly go hand-in-hand, as a quality financial advisor will help bring alignment between your money and the rest of your life.

Fiduciary Standard of Care

Are they legally bound to serve in your best interests? The opposite of a fiduciary financial advisor is any advisor employed by and first beholden to the company that employs them. Ask any financial advisor at any major Wall Street firm or bank if they are a legal fiduciary, and wait for their response. They are not.

Experience

Has the advisor been around the block, and experienced both good markets and bad? Recessions as well as economic expansions? A quality financial advisor should have a history with many successful and happy clients who are willing to step forward and attest to the advisor’s professionalism and knowledge. In other words, when you search for “financial planner near me,” you should be able to learn a little bit about their qualifications for financial advisor.

In addition to this experience, what kind of training have they had? Are they a Certified Investment Management Analyst or Certified Financial Planner? Do they pursue opportunities for continuing education and growth?

Financial Emotional Awareness

Why do investors feel smarter and more confident when the markets are rising, and dumber and less confident when the markets are declining? One word: emotions. At Towerpoint Wealth, we believe that one of the central qualities of a skilled financial advisor is the ability to help their clients remain objective, avoid overconfidence, or, on the flip side, hopelessness. Managing emotions and remaining objective when making financial decisions is an essential component of longer-term success in building net worth.

What Will the Best Financial Advisor Do for Me and My Family’s Assets?

A quality financial planner will leverage a broad-based array of resources to provide you solutions and advice, much of which you may never have been aware of, thought about, or had access to.

Resources such as Right Capital, which allows us to help our clients position themselves to retire comfortably and confidently. 

With the best financial advisor, you will have someone at your side who will help you make smart financial decisions. Want to retire early? Not sure what to do with your RSUs? Not sure if you need an estate plan? You will manage your own money with the guidance of a well-educated, responsive, focused and diligent partner.

At, Towerpoint Wealth, Sacramento wealth management firm, we will learn about your unique history, and help and challenge you to clarify your distinct goals, values, and dreams, rather than simply inquiring about your balance sheet. We seek personal insight into your life in order to understand the role money plays for you. By adding our professional financial planning and wealth management expertise and wisdom, we will coach you towards your personal goals and financial peace of mind.

When is the Best Time to Hire a Financial Advisor?

Now is the best time to hire a financial advisor. Developing a customized financial and wealth management plan now will help you advance towards your personal and financial goals, grow net worth, and ultimately help you retire on your schedule. Time is money. Partnering with an advisor that understands you means you may spend less time worrying about this aspect of your life.

Are you ready to speak with an independent financial advisor? You’ve found Sacramento independent financial planner Joseph Eschleman, as well as certified financial planner Steve Pitchford, CPA, CFP^®, and our entire independent wealth management team.

We serve clients primarily in the Northern California region. Glad you’re here! Please contact us with any questions you have about our wealth management process.

Update on July, 08, 2024

Updated November 2024.

Restricted Stock Units (RSUs) can be a significant component of an employee’s compensation package. But what is an RSU package? Do you have an RSU strategy? How are RSUS taxed? When are restricted stock units taxed? How should you consider RSUs taxation? What are stock options, and why do employers offer RSUs vs stock options? How do you plan most effectively when your RSUs vest? What does net worth mean in regards to an RSU selling strategy?

The 411 on Restricted Stock Units (RSU) tackles these questions and more.

What is an RSU? | Restricted Stock Units, RSUs and Stock Options

What is an RSU?– Learn what is a Restricted Stock Unit?
RSU vs Stock Options – What are stock options? How Are RSUs Different Than Vested Stock Options?
What Is the Taxation of Restricted Stock Units? – Learn about taxation of RSUs
RSU Strategy – What Are the Risks of Holding RSUs?
How Can I Most Effectively Plan – How Can I Most Effectively Plan for Restricted Stock Units, RSUs?

What is an RSU?

RSUs, also commonly known as restricted stock units, or restricted stock shares, are a form of stock based compensation whereby an employee receives rights to shares of stock in a company that are subject to certain restrictions. These units do not represent actual ownership or equity interest in the company and as such hold no dividend or voting rights. (1) However, once the restriction is lifted, the units are converted to actual company shares and an employee owns the  shares outright (same as traditional stock ownership).  Learn more about RSU tax selling strategy.

The lifting of restriction on the units is generally based on a vesting schedule. Most vesting schedules will fall into one of two categories:

• Time-based: based on the period of employment. Common time-based vesting schedules are between three to five years and are either pro-rata or “cliff” based. For a “cliff” based schedule, all shares vest fully at the end of the schedule.       
• Performance-based: based on the company achieving a performance goal. Common performance-based vesting schedules are based on a company achieving a particular stock price or a return on equity, or earnings per share.    
  
  * There is a hybrid-approach between time-based and performance-based known as time-accelerated. Vesting is on a time-based schedule but may be accelerated by the company achieving a performance-based goal.  

RSUs vs stock options | How Are RSUs Different Than Vested Stock Options?

When most people think of stock based compensation, vested stock options, or the right to buy a company’s stock at some future date at a price established now (the strike price), are typically what first comes to mind. (2)

Historically, vested stock options have been the most popular form of stock based compensation. And up until 2004, stock options merited favorable accounting treatment as a company could avoid recognizing compensation expense by issuing the options.  

In 2004, this loophole was eliminated and subsequently RSUs/restricted stock shares, aka units, emerged as the preferred form of equity compensation.  

RSUs and stock options have some notable differences:

Restricted stock units are a little easier to understand compared to stock options. The employer grants a set of RSUs, which vest periodically over a period of time. This is an incentive for an employee to stay at the company longer. As they vest, income taxes on those shares are withheld. In other words, you pay income taxes on the restricted stock unit shares as they vest. There may be exceptions to this; you might be able to defer income taxes if the company offers a 409(a) which allows you to defer receipt or ownership of these RSUs to a later period of time, something that might be attractive to high income earners.

Two scenarios illustrate RSUs vs stock options:

Scenario 1: An employee is granted 1000 RSUs when the market price of the company’s stock is $10. When the RSUs vest, the stock price has fallen to $8. The shares are still worth $8,000 to the employee.

Scenario 2: An employee is granted 1000 stock options with a strike price of $10. During the window to exercise these vested options, the market price of the stock is always below $10. These options will expire worthless to the employee.  

*There are many other forms of nontraditional compensation, such as Stock Appreciation Rights (SARs), Phantom Stock, and Profit Interests. None of these are as widely used as RSU and Stock Options and are not a focus here.

What Is the Taxation of Restricted Stock Units?

RSUs taxation is based upon delivery of the shares, and taxes must be paid upon vesting (i.e., when the restriction has been lifted).     

The shares’ fair market value is included in an employee’s taxable income as compensation at the time of delivery. The taxation of restricted stock units is identical to normal wage income and as such, is included on an employee’s W-2. (3)    

The shares are subject to federal and employment tax (Social Security and Medicare) and state and local tax as well.     

Companies provide employees with either one uniform withholding method or several options to pay the taxes on their restricted stock units. They may offer:

• Net-settlement: a company “holds back” shares to cover RSU taxes and then the company pays the tax from its own cash reserve. This is the most common practice.      
• Pay cash: an employee receives all shares and covers the RSU taxes out of their own pocket. This is a riskier strategy than net-settlement, as it results simultaneously in a more concentrated equity allocation and lower cash balance (less money to pay the taxes).
• Sell to cover: an employee sells the shares needed to cover the income tax burden on their own. This method provides no real advantage over net-settlement and places the additional burden of selling the shares on the employee.   

When an employee ultimately sells their vested shares, hopefully based on their well-constructed RSU selling strategy, they will pay capital gains tax on any appreciation over the market price of the shares on the vesting date. The sales proceeds will be taxed at the more favorable long-term capital gains rate if the shares are held longer than one year after vesting. (4)

Taxation of Restricted Stock Units Example:

Here’s an example of an RSU selling strategy: An employee is granted 750 RSUs on January 1, 2018. The market price of the stock at the time of grant is $10 and the RSUs vest pro-rata over three years: 

Taxation of Restricted Stock Units : RSU strategy and RSU taxed

Each increment is taxable on its vesting date as ordinary income. The total ordinary income paid over the three years is $11,500.

The employee then sells all 750 shares of stock three years after the last shares vest.

The employee held each share of his RSU stock options for more than one year, so the gain is treated as long-term. The employee’s long-term capital gain is $11,000 ($22,500 less $11,500) to be reported on Schedule D of their U.S. individual tax return.

Ordinary income tax rates are usually paid on the fair market value of the stock at the time of vesting. Whether you eventually sell RSU stock units or hold them, is, however, not likely to impact your up-front tax bill at the time of vesting.

RSU Strategy | What Are the Risks of Holding RSUs?

Utilized correctly, restricted stock units/restricted stock shares can be a wonderful complement to a traditional compensation package and can contribute substantially to an employee’s net worth. (5) This can be, however, a double-edged sword.

The overlying risk is that an employee can have too much of their net worth concentrated in one individual stock and one individual company.

Let’s explore a scenario:

Jim has a net worth of $200,000, not including 2,000 shares of RSUs with his employer,  Snap Inc. On January 1, 2019, 100% of Jim’s 2,000 RSUs vest at $50 per share.

Great news! Jim’s net worth, on paper, has now increased by $100,000 overnight. Jim’s overall net worth is now $300,000. 

Jim decides to keep all his shares in Snap Inc. with the belief the stock price will continue to go up. 

He also sees his colleagues choosing to hold most of their shares, and fears that if Snap Inc.’s price soars, he will have missed out and his colleagues will all become wealthier than him. 

On July 1, 2019, Snap Inc. releases a weak earnings report and the share price drops to $20. Jim’s net worth is now $240,000, down 20% from January 1. 

Even worse, Jim paid taxes at his ordinary rate on the original share value of $100,000 when the shares are now only worth $40,000.

And finally, because Jim has a significant portion of his net worth in the company he works for, he faces an additional and potentially catastrophic risk. What if Snap Inc. runs into serious financial struggles and he loses his job? Not only will Jim’s net worth plunge from further declines in Snap Inc.’s share price, he also will now have lost his primary source of income.

You may see Jim as foolish, but his predicament is a common one. We often see employees dealing with the hesitation to sell the shares for reasons that can be more emotional than rational.

It might be a helpful RSU strategy to think of vested RSUs as cash available for investing: If you would take that cash and buy company stock, then keep the RSUs where they are. However, if you had this cash and would put it into a more diversified investment vehicle, then sell and move it.

How Can I Most Effectively Plan for Restricted Stock Units, RSUs?

We recommend you discuss how to effectively plan for RSU shares with your financial advisor to ensure a decision is not made in a vacuum, but rather in the broader spectrum of your entire financial picture. Of course, we encourage collaboration with your tax advisor to determine the optimal strategy from a tax perspective as well.  

In reality, when RSUs vest, you may be better off by immediately (or over a short-term schedule) selling a sizeable portion of the vested units and using the proceeds to add to or build a diversified investment portfolio.    

Regardless, before you make any decisions, it can be helpful to explore the following questions:   

• How much of your overall wealth is tied up in RSUs?  
• Is your company growing quickly or slowly?   
• What is your current tax situation? Is it better to wait more than one year after the shares vest to sell them to receive the more favorable long-term capital gains tax treatment?  
• How long do you plan to be with the company?
• What is your tolerance for risk?
• If the market value of the stock was instead received in the form of a cash bonus, how much of this would you invest in the company stock?   

How can we help with your RSU and stock options?

While we at Towerpoint Wealth continue to believe in the importance of a diversified portfolio, we also understand every individual situation is unique, what growing net worth means to each individual is different, and understand emotions can play a significant albeit oftentimes problematic role in making sound financial decisions. This is especially the case for RSUs. If you would like to speak further about what is an RSU vs stock options, or need an RSU strategy (or have questions about any nontraditional compensation for that matter), I encourage you to call, 916-405-9166, or email Steve Pitchford (Certified Financial Planner) email spitchford@towerpointwealth.com.

Learn more about Maximize stock compensation and What are RSUs?

Visit Towerpoint Wealth’s YouTube Channel

Visit our library of financial guides and checklists.

(1)   While RSUs hold no automatic dividend rights, companies may choose to issue dividend equivalents. For example, when a company pays cash dividends to common stock holders, RSUs can be credited dividends for the same amount. These credits may ultimately be used to pay the taxes due when RSUs vest or can simply be paid out in cash.

(2) RSU strategy – Stock Options can either be Incentive Stock Options (ISOs) or Nonqualified Stock Options (NQOs). They are treated differently for tax purposes.  

(3) When received, dividend equivalents are subject to the same tax rules as RSUs.

(4) Important to note that the shares must be held more than one year for long-term capital gains treatment. If sold exactly one year from the vesting date, they will be taxed at the higher short-term capital gains. 

(5) Net worth means the total value of all of an individual’s assets less their liabilities.

Towerpoint Wealth, LLC is a Registered Investment Adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth, LLC unless a client service agreement is in place.

From Properties to Profits: Part One Mastering Taxes as a Real Estate Investing Pro!
AUTHOR: MEGAN M. MILLER, EA, Associate Wealth Advisor, Towerpoint Wealth

MEGAN M. MILLER, EA With a bachelor’s in Economics from UCLA, Megan began her career at Pricewaterhouse Coopers (PwC) in their individual tax group, primarily consulting and working with employees of Fortune 500 companies through their international work assignments. She then migrated from Los Angeles to Northern California, gathering experience and guiding Sacramento and Bay Area business owners, technology entrepreneurs, and venture capitalists at two Northern California firms.

In continuing to build and apply her wealth advisor experience and expertise, Megan is excited to leverage and apply her deep tax knowledge and economic proficiency to help Towerpoint Wealth clients properly coordinate all of their financial affairs in a fully comprehensive capacity. Working as a true fiduciary at a fully independent wealth management firm aligns well with her values, and she is excited to use her wisdom and skills to help guide TPW clients towards achieving their personal and economic goals, acting as a legal fiduciary and always putting their best interests first.

Transition from simply owning real estate to building true wealth by mastering the art of tax and retirement planning as a real estate professional. In this guide, we will explore advanced tax-saving strategies, retirement account options, and investment techniques that will help you more efficiently grow and protect your long-term wealth.

Are you just starting out in real estate investing and want to make sure you’re getting all the tax deductions allowed to you?

Or are you a real estate investing pro interested in reducing your current tax bill and planning for a financially secure future?

Regardless of your experience level, if you are a real estate investor, this guide was designed for YOU! Below you will find actionable strategies to help you minimize the income taxes you pay, and reduce your obligation to Uncle Sam in order to “get better gas mileage” as a real estate investor.

If you’re new to the game, our first suggestion is to JUST GET STARTED. We see many potential real estate investors get stuck in “analysis paralysis” regarding which type of business entity to create and how to structure their real estate investing business. However, if you don’t have many assets yet to protect or minimal investment income to strategize around, you’re likely better off starting off as a sole proprietor, which requires no formal entity organization.

This simply means establishing a separate business bank account (and credit card, if you’d like) and tracking your real estate investing expenses and income. Whether it be flipping, wholesaling, owning short-term or long-term rentals, contracting, lending, etc., once you have your business account setup to receive deposits and pay bills, use an expense tracking tool to keep your business organized. (An app like QuickBooks Self-Employed is an excellent choice.) JUST GET STARTED.

Move on to consider entity creation and business structure when you really need it – when you begin to accumulate assets or are receiving substantial income that warrants more complex (and often costly) tax planning.

PART ONE: MASTERING TAXES

Keep it in the family

How doing business with family could be a good thing for your wallet.

As a real estate investor, you are a business owner. If you have children, you have tax minimization opportunities! If your son or daughter is currently earning money from you, receiving a weekly or monthly allowance, or being given money for food, clothes, etc., the money you are already providing to your kids could be tax-deductible to you!

How? Hire your kids!

THE FAMILY EQUATION
1 high school child + 1 middle school child
Each working 10 hours/week for your business @ $15/hour

= $7,800 per child in wages annually x 2 children
= $15,600 tax deduction for your business

= $3,600 in annual tax savings for YOU*

*based on an estimated parental tax bracket of 32% and child tax bracket of 10%

Important note here: Be sure that you or your child are properly documenting time worked for the business, that your kids are being paid from your business account, and are on payroll — it’s worth it to minimize your taxes!

BONUS PLANNING IDEA: Establish a tax-free Roth IRA account for your child, and have them fund it with their earnings. Contributions to Roth IRAs, while not tax deductible, grow and are withdrawn tax free. The earlier one starts investing, the more time that money has to compound.

Travel Smart

Planning to take a trip? Make it a business trip and minimize your taxes by writing off your travel, airfare and transportation costs!

All travel, airfare, and transportation are fully tax-deductible, and meals are 50% tax-deductible, as long as the “primary” purpose of the trip is business.

“Primarily Business” = 50% or more of the trip days are business days (travel days count as business days!)

IMPORTANT NOTE: For full tax-deductibility, be sure you keep good records of your airfare, lodging, transportation, and meals, that they are not “lavish or extravagant,” and ensure you plan out and schedule your business activities in advance so it is clear that at least 50% of the trip is intended to conduct business.

The double dip

Why rental real estate income is so lightly taxed

A key reason why real estate investing is so appealing from a tax minimization standpoint is because you’re paying taxes on far less income than you actually receive in your pocket. This is due primarily to the IRS-allowed depreciation expense.

What is depreciation? Depreciation helps you to minimize your taxes because it allows for an annual income tax deduction to “recover” the original cost, or purchase price, of your investment property. The IRS requires that depreciation to be amortized, or applied over the entire time you own the property, known as the “useful life” of the property. For residential rental property, the IRS has determined the maximum “useful life” to be 27.5 years.

As you can see in the example below, you receive $14,000 in your pocket in cash flow, but only about $2,000 of the $14,000 is subject to tax in the current year.

Essentially, because of how a mortgage payment is amortized (a majority of the mortgage payment in the early years of a mortgage consists of interest), and because the IRS usually allows a tax deduction for both depreciation AND mortgage interest, it feels like you are getting a double deduction or “double-dipping”, in the early years after the purchase of investment real estate.

The long game

Avoiding ordinary AND capital gains tax for flippers.

Typically, when an investment property is sold, or “flipped” for a gain, the gain on the sale is taxable at higher ordinary income tax rates — up to 37% at the federal level. Yikes!

What if you could completely avoid paying taxes on your flip? Here’s where focusing on the long game comes in by utilizing the IRS Section 121 Primary Residence Gain Exclusion rules. Here is how it works:

1. Purchase the property you’d like to flip as your primary residence — you can often do this with a 5% down payment or less — another win!
   
2. Live in the property for at least 2 years while completing your renovations.
   
3. Sell the property after living in it as your primary residence for at least two years.
   
4. Exclude up to $500,000 of gain from taxation* (this $500,000 capital gain exclusion applies to married filing joint taxpayers; the exclusion is $250,000 for single filers).

* Please consult your tax advisor or CPA regarding your specific circumstances

The teeny downpayment

Purchasing investment properties with as little as 3.5% down.

While not tax-specific, this is a favorite strategy for those who might not be flush with cash, but who still want to acquire a portfolio of rental real estate. Conventionally, purchasing an investment property as a rental that you do not intend to occupy requires a 20% or 25% down payment, BUT if you…

1. Acquire the property as your primary residence AND
   
2. Live in the home for at least 1 year
   
3. THEN, move out and turn the property into a rental after 1 year…

You are typically able to purchase the property with far less down, as little as 0% on a VA loan or 3.5% with an FHA loan!

This greatly lowers barriers to entry, AND potentially increases your cash-on-cash return once the property is turned into a rental. ALSO, owner-occupied properties typically qualify for lower mortgage interest rates as compared to rental properties. If you don’t want to go the VA or FHA route, there are also conventional loans available starting at 5% down. Let’s run through an example:

*Not including lender and escrow closing costs
**PITI = principal, interest, taxes, property insurance + private mortgage insurance (PMI) required for < 20% down

Additionally, once the equity in your owner-occupied home increases to at least 20%, you can eliminate the monthly mortgage insurance payment of ~ $240 (PMI averages 0.2%-2% of the loan) and further increase your total monthly cashflow!

JUST “1031” IT

One of the Last Substantial Tax “Loopholes” – the Section 1031 Exchange.

A section 1031 exchange is also known as a “like-kind” or tax-deferred exchange. Around since 1921, section 1031 exchanges are a common and well-known strategy that allows real estate investors to sell, or “relinquish,” an investment property, and defer any capital gains taxes on the profit by reinvesting the entire proceeds into a new “replacement” investment property of equal or greater value.

Officially, Section 1031 of the Internal Revenue Code says:

A 1031 exchange offers real estate investors the opportunity to defer paying taxes by reinvesting 100% of the proceeds and their equity into one or more investment properties. The money that would have been paid in taxes instead remains invested, generating more income and wealth.

Many real estate investors have accumulated significant wealth over their lifetimes by completing 1031 exchanges every time they sell, keeping more of their money at work, allowing for greater compounding of growth. Additionally, with proper estate planning, the taxes deferred through 1031 exchanges can be eliminated when properties are passed ultimately to an investor’s heirs if they so choose.

IMPORTANT NOTE: Delaware Statutory Trusts (DST) can be an excellent “back-up” replacement property to identify as a part of your exchange. If your purchase escrow on a real replacement property were to fall through for any number of reasons, identifying a DST as a backup will ensure you do not lose your ability to continue on with your 1031 and defer the capital gains tax on the sale of the “relinquished” property. DSTs are also perfect for investors with “leftover” funds from purchasing other properties in a 1031 exchange. See more on DSTs below.

YOUR TRASH, TOILETS, AND TENANTS ALTERNATIVE — THE DST

Using Delaware Statutory Trusts (DSTs) as “replacement” property in a 1031 exchange.

It can be difficult to find a high-quality replacement property for a 1031 exchange in the IRS- imposed 45-day identification period, which creates anxiety, and can result in poor investment decisions. A solution to this constrained time period can be the DST, or Delaware Statutory Trust. A DST affords an individual investor a fractional ownership of a commercial grade, professionally managed real property (or properties), while also meeting the requirements of IRS Section 1031 to qualify as a “replacement” property for a tax-deferred exchange.

DSTs provide access to commercial real estate ownership that may otherwise be out of reach for individual investors, allowing for investment in an institutional-quality property that may otherwise be economically unattainable. DST opportunities open and close regularly, vary based on the sponsor, and typically hold 1-3 properties in a single class of investment real estate such as student housing, multi-family housing, self-storage, warehouse space, office buildings, hospitals, government buildings, etc. Many investors feel a sense of “graduation” into the world of commercial real estate ownership when considering fractional ownership of a Delaware Statutory Trust.

Advantages of DSTs:

1. FAVORABLE TAX TREATMENT
   
   – Deferral of federal and state capital gains taxes AND depreciation recapture taxes.
   – Income distributed is taxable but offset with depreciation and other real estate expense deductions passed through to the investor typically on a form 1099 or 1098.
   
   
2. NO MANAGEMENT RESPONSIBILITIES
   
   – DSTs are a truly passive strategy — step away from the Terrible Ts — tenants, trash & toilets.
   – The DST sponsor manages and utilizes professional property management.
   
   
3. ACCESS TO INSTITUTIONAL QUALITY PROPERTY
   
   – Invest in property typically not available to individual investors.
   – DSTs own large institutional grade properties in a wide variety of markets.
   
   
4. LOWER PERSONAL LIABILITY
   
   – No individual financial qualification — the DST is the borrower on any loan. 
   – Non-recourse financing to the individual investor.
   
   
5. CUSTOMIZABLE INVESTMENT AMOUNT
   
   – If you need to invest a very specific amount of funds to fully exclude the gain on your 1031 sale, DSTs offer fully customizable investment amounts.
   
   – DSTs come in a variety of loan to value options to meet your exact loan to value on the property relinquished to avoid having to add additional cash, take out a new loan or pay tax on the boot. Boot is the additional taxable gain if the replacement property price is less than the sales price of the relinquished property.
   
   
6. DIVERSIFICATION
   
   – Can decrease overall risk in your real estate portfolio by offering additional geographic locations.
   
   – Wide variety of property types (multi-family, student housing, senior housing, self-storage, industrial, etc.).
   
   – Can divide proceeds amongst multiple DST investments.

Potential limitations of DSTs:

1. ACCREDITED INVESTORS ONLY
   
   – > $1M of net worth excluding primary residence, OR
   
   – $200,000 of annual income for single investors and $300,000 with spouse or partner in the 2 years prior.
   
   
2. LIQUIDITY CONSIDERATIONS
   
   Usually, there is an investment “lock-up” period, until the property is sold (called “going full- cycle”), which typically is between 4-8 years.
   
   
3. ADDITIONAL POTENTIAL STATE TAX RETURN FILINGS
   
   Depending on the location of the investment(s) held inside of the DST, investment in a DST may required additional state income tax return filings.
   
   
4. VARIABLE QUALITY OF SPONSORS
   
   Many companies offer DSTs, but not all have the same reputation, capitalization, and market recognition.
   

DSTs offer the potential for stable, long-term income without landlord duties, appreciation in property value, and fit almost any size exchange, as a DST investor owns a proportionate share of the property.

Additionally, the income that a DST generates is tax advantaged as an investor is able to deduct their proportionate share of mortgage interest and depreciation. But remember, it is always important to consider the limitations as well in considering whether a DST is right for you as a real estate investor.

QUALIFIED OPPORTUNITY ZONE FUNDS

Do you have a capital gain in excess of the $500,000 primary residence sale exclusion? Or perhaps a large taxable stock sale?

A new addition to the IRS tax code that was introduced under the 2017 Tax Cuts and Jobs Act, Qualified Opportunity Zone Funds (“QOFs”) are an economic development tool that allow people to invest in distressed areas in the United States while taking advantage of major tax benefits. Capital gains that are generated from the sale of other assets can be invested into a QOF, and the recognition of either part of or all capital gains taxes associated with the sale will be deferred until December 31, 2026. This provides a number of powerful and unique financial planning opportunities:

• Ability to spread tax liability over multiple periods to reduce annual tax liability and marginal tax rate paid.
• Allow for time to engage in strategies like tax loss harvesting to offset capital gains. ADDITIONALLY, if the investor holds their interest in the fund for at least 10 years, their basis is stepped-up to fair market value and the growth of the investment upon exit is free of taxation! (assuming exit prior to 12/31/2047).
• Retroactive tax planning
  – An investor has 180 days from the date of the sale that gave rise to the capital gain to invest the realized part of it into a QOF.
• ANY appreciated asset qualifies including assets like a business, stocks, bonds, collectibles and primary residences that DO NOT otherwise qualify for 1031 exchanges.
  

How Can We Help?

At Towerpoint Wealth, we are a legal fiduciary to you, and embrace the responsibility we have to act in our clients’ best interests 100% of the time. We also understand that “talking taxes” can be intimidating, and that applying capital toward “retirement investing” instead of additional real estate investing might feel awkward and different from your “normal” wealth-building philosophy.

However, it is essential to educate yourself on the myriad of different and non-conventional planning opportunities as outlined in this white paper, as each of us will carve a unique path as we strive forward in our wealth building and wealth protecting journey.

Start on your plan today — call 916-405-8168 or email mmiller@towerpointwealth.com or schedule an appointment to get the ball rolling and open an objective dialogue.

Towerpoint Wealth, LLC is a Registered Investment Adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth, LLC unless a client service agreement is in place. 

Navigating the Tax Laws to Maximize | Your Beneficiary’s Inheritance | Comprehensive Estate Planning

When most individuals are establishing an estate plan, they generally only think about the tax consequences to themselves. But a truly comprehensive estate plan is one that takes planning a step further and considers the tax consequences the beneficiaries of the estate may face. When creating an estate plan, having a clear understanding of, and properly planning for these taxes will help ensure your beneficiaries get the largest inheritance possible.

Need more information on what estate planning documents do I need?

When one inherits money as a beneficiary of an estate, there are three different taxes that oftentimes need to be understood and accounted for:

Let’s take a look at these individually:

Estate and Gift Tax

• The 2021 federal estate tax exemption (commonly known as the unified tax credit) amount is $11,700,000 per individual.
• Only the deceased taxpayer is subject to the estate tax when the estate value is greater than the unused exemption.
• Even if the decedent did not have a taxable estate, the estate of the decedent survived by a spouse should file Form 706, Estate Tax Return, to pass any remaining/unused unified tax credit exemption to the surviving spouse.
• When someone dies, their assets become property of their estate. Any income those assets generate is also part of the estate, and may trigger a requirement to file Form 1041, Income Tax Return for Estates and Trusts.
• An inheritance is not considered taxable income to the beneficiary.
• Currently, in addition to estate taxes assessed at the Federal level, 12 states and the District of Columbia also collect an estate tax. California does not currently have an estate tax.

Inheritance Tax

• Only six states currently collect this tax (Iowa, Kentucky,Maryland, Nebraska, New Jersey, and Pennsylvania).
• Property passing to a surviving spouse is exempt from inheritance taxes in all six of these states.

Income Tax

• Inherited retirement account distributions are subject to ordinary income taxes.
• If you sell or dispose of inherited property that is a capital asset, you will be subject to either a long-term capital gain or loss, regardless of how long you, as the beneficiary, have held the asset.

Additional considerations

Inherited Pre-Tax Retirement Accounts

• Eligible Designated Beneficiaries and Non-Eligible Designated Beneficiaries are subject to different required distribution rules.
• Consider Roth conversions to allow the beneficiaries to take tax-free distributions.

Lowering the Value of Your Estate – Gifting

• Make annual cash gifts to your children, grandchildren, other family members, and even friends. You can also contribute cash to a 529 plan to help pay for future school to any individual you would like. The receipt of cash is non-taxable to the recipient, and, if the gift is below the $18,000 annual exclusion amount, you will not eat into your above-mentioned $11,700,000 lifetime estate and gift tax exemption amount.

Lowering the Value of Your Estate – Philanthropy

• If you are charitably inclined, you can make gifts of any size at any time while alive directly to charities or to a Donor Advised Fund. The donation of appreciated securities provides not only an immediate deduction of the fair market value of the stock at the time of contribution, but also avoids capital gains tax upon sale.
• Charitable contributions due to the death of the taxpayer result in a dollar for dollar reduction of the taxable estate.
• Additional vehicles available include Charitable Remainder Trusts or Charitable Lead Trusts.

Life Insurance

• If you are considering buying life insurance to either pay for the estate tax liability or provide more for your beneficiaries, set up a life insurance trust and have it purchase the policy so the death benefit isn’t included in your taxable estate.

Step-Up in Cost Basis – Take Advantage!

If you have appreciated stock or property and gift it to someone, the recipient gets the carried over basis and will have to pay capital gains when he or she sells the asset. Instead of gifting before your death, have them inherit it after your passing so they get a “step up” in basis and recognize a smaller gain on future disposition.

The Future of Estate Taxes Under the Biden Administration

• During his campaign, President Biden discussed the possibility of decreasing an individual’s federal estate tax exemption amount either to $5 million per individual (and $10 million for a married couple) or to the pre-Tax Cuts and Jobs Act amount of$3.5 million per individual (and $7 million for a married couple). This decrease in lifetime exemption could be paired with an increased top tax rate of 45 percent.
• President Biden also proposed eliminating stepped-up basis on death and possibly taxing unrealized capital gains at death at the proposed increased capital gains tax rates.

How Can We Help?

At Towerpoint Wealth, we are a legal fiduciary to you, and embrace the professional obligation we have to work 100% in your best interests. If you would like to learn more about Towerpoint Wealth and how we can help you achieve your financial goals, we encourage you to call (916-405-9166) or email (spitchford@towerpointwealth.com) to open an objective dialogue.

Estate planning documents specify how you want your assets distributed upon incapacity or death. The collection of these documents together is called an Estate Plan. Some people don’t believe they have an “estate,” and therefore, don’t need to create a plan. They see estate planning and wills as things reserved for the wealthy. In fact, no matter your net worth, once you die, everything you own is considered part of the estate you leave behind. 

Many other individuals recognize that everyone needs some kind of estate plan, but avoid establishing one. Perhaps estate planning and wills evoke uncomfortable thoughts of incapacity or death, and this is simply too much to contemplate. Or maybe it’s because the legal jargon incorporated into estate planning documents can be difficult to understand. 

However, to be clear, if you have a financial plan, you have an estate. Establishing and then maintaining a proper estate plan is an essential aspect of a cohesive, well-thought-out financial plan. Preparing estate planning documents is not just about distributing assets. It is about ensuring that your wishes are respected, your loved ones are taken care of, uncertainty is removed, and potential conflicts are avoided. By assembling the proper estate planning documents, you can minimize the burden on your family during an already difficult time, and provide them with a clear roadmap for how to properly handle your financial affairs.

Why is estate planning important for everyone? There are six primary reasons, including the fact that probate is a nightmare and expensive, you and your children need more protection than just a will—although a will is one of the most important estate planning documents—and you probably would like to reduce and minimize your taxes. You can find a link to an article on the topic of why it’s important to have an up-to-date and properly coordinated estate plan at the bottom of this page.

Below are descriptions of the most fundamental estate planning documents, as well as other important estate planning considerations. 

Estate Planning and Wills
Estate Planning | Trust
An Advance Health Care Directive
A Financial Power of Attorney
Beneficiary Forms
Life Insurance
Owning a Business
Four Ways to Maximize Your Beneficiary’s Inheritance
Keeping Your Estate Planning Documents Organized
How can we help?

Estate Planning and Wills 

A will is the most well-known and widely used estate planning document. A will is a legally binding blueprint that dictates how an individual would like their assets to be handled upon their death. 

Specifically, a will can direct

• who the beneficiaries of an estate should be
• who to leave property to (property may include bank accounts, investment accounts, real estate, or any other assets you own at the time of your death)
• who should be named a guardian for minor children
• who should be chosen as an executor of the estate
• who should plan personal affairs (such as burial arrangements, gifts, and donations) and hurdle other legal challenges. 

Should everyone have a will? Yes. We believe everyone should have a will. A will is essential even for individuals with a very simple estate, or who have already established a revocable trust (see next section). 

What if someone dies without a will? If an individual dies without a will, they have died “intestate.” When this occurs, the law of their state of residence determines how their property is distributed upon death. Dying intestate virtually guarantees a costlier, longer, and more stressful probate process, especially when compared to an individual who had a properly drafted will. 

Probate is the legal process through which a deceased person’s estate is distributed to heirs and designated beneficiaries and any debt owed to creditors is paid off. In general, probate property is distributed according to the decedent’s will (if there is one) or according to state law if no will exists. 

You can visit the following website to review the intestate rules for California.

Does a will have any shortcomings? A will, unlike a properly funded revocable trust, will still be subject to probate. It is almost always preferable to avoid probate given the costs associated with the process (which include attorney’s fees, court costs, and appraiser’s fees). Also, the probate process is public record, which limits the privacy surrounding an individual’s estate and heirs. 

Even with its limitations, a properly drafted and administered will is an essential estate planning document for almost all individuals. And, any shortcomings of a will can be mitigated by adding a revocable trust. 

Estate Planning | Trust

A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts are extremely flexible, with the ability to specify how and under exactly what conditions the assets held “in trust” pass to beneficiaries. 

The most common and widely applicable form is a revocable trust (also known as an inter vivos, or, living trust). Revocable trusts are funded during the lifetime of the grantor—the individual that creates the trust—and can be altered, changed, modified, or revoked entirely during the grantor’s life. Revocable trusts are unique in that the grantor and the trustee are the same person. 

What are some advantages of a revocable trust? Advantages of a revocable trust include: flexibility, avoiding the cost, delay, and publicity of probate, protection from court challenges, and the ability to control one’s assets after they have died.

Why do I need a will if I have a revocable trust? A revocable trust only deals with the specific assets titled or held within the trust, such as life insurance, real property, and investment portfolios. Even with a revocable trust, most attorneys still recommend a pour-over will to account for those items not specifically placed, or titled, in the name of the trust. 

Should everyone have a revocable trust? Not necessarily. Individuals (or couples with no children) who have a very simple estate and/or do not have significant assets may only need a will. 

An Advance Health Care Directive

An Advance Health Care Directive is a document that allows an individual to select a person or persons they trust to make decisions regarding their health care in the event they are mentally or physically unable to make decisions for themselves. An Advance Health Care Directive allows for specificity by identifying many different mental and physical impairments and the desired actions for each. 

An Advance Health Care Directive is the terminology used in California. In other states, the same document may be known as a durable power of attorney for health care, a medical power of attorney, or a health care proxy. 

Do I need an Advance Health Care Directive if I am in good health? Though an Advance Health Care Directive is particularly essential for someone with a family history of poor mental or physical health, or for someone whose health is rapidly declining, we believe everyone should have one. 

A Financial Power of Attorney

A Financial Power of Attorney allows an individual to give a trusted person authority to handle their financial affairs if they become unable or unwilling to do so by incapacitation or other means. A financial power of attorney can be as simple as allowing this trusted person to pay the incapacitated individual’s bills, or can be as involved as operating their business. 

When creating a financial power of attorney, we recommend making the power durable. 

A durable power of attorney will last for the entire individual’s life. So, if the individual becomes incapacitated more than once in their life, the durable power of attorney will continue to serve its purpose. If durability is not added, the trusted person’s power will lapse when/if the individual recovers from an incapacitation. 

Should everyone have an Advance Health Care Directive and Financial Power of Attorney in their estate planning documents? We believe everyone over the age of 18 should have a properly executed Advance Health Care Directive and Financial Power of Attorney. 

Beneficiary Forms

For certain assets, an individual can designate a beneficiary or beneficiaries to automatically receive the property upon their death. For example, an individual can establish a Transfer on Death (TOD) account or a Payable on Death (POD) account, titled outside of their trust, designating specific beneficiaries for these types of accounts. All retirement accounts such as IRAs, 401(k)s, 403(b), 457s, TSPs, and even annuities are subject to beneficiary designation rules as well. 

Naming a beneficiary for these types of accounts is often very easy to do and should not be overlooked. If you do not name a beneficiary for these accounts, the assets may go through probate and/or be subject to problematic tax consequences. The intestate rules then dictate the beneficiary to receive these assets and this may be inconsistent with your intended wishes. 

Life Insurance 

One way to ensure that all of your debts are paid in the event of your death (or disability) is through having adequate life insurance coverage. A life insurance trust can purchase a life insurance policy so the death benefit that is paid isn’t included in your taxable estate. 

While a detailed discussion on life insurance is outside the scope of this checklist for estate planning, the two most common types are term and whole life. 

Owning a Business

If an individual also owns a business, their estate planning and trust becomes more complicated and more important. Not only do they need to consider their family’s best interests, but also their business partners, co-owners, heirs, and employees, and customers’ best interests. Here are some tools to help business owners address the interests of these other people: 

Management succession plans specify who will take over their role. 

Buy/sell agreements help to assure business continuation for the surviving partner(s) or co-owner(s). 

Family limited partnerships help directly engage heirs and survivors. 

Four Ways to Maximize Your Beneficiary’s Inheritance 

When most individuals are thinking about estate planning and wills and assembling their estate planning documents, they generally only think about the tax consequences to themselves. But a truly comprehensive estate plan takes estate planning a step further and considers the tax consequences the beneficiaries of the estate may face. When creating an estate plan, it is important to understand and properly plan for these taxes. This will help to reduce your obligation to Uncle Sam, and ensure your beneficiaries get the largest inheritance possible. 

1. Consider the taxes on Inherited Pre-Tax Retirement Accounts. Understand the different distribution rules for eligible beneficiaries and non-eligible beneficiaries. 

2. Consider Gifts to family and friends as a way to lower the value of your estate. Give less than $18,000 annually to your children and grandchildren, or contribute to a tax-free Section 529 plan. They won’t pay taxes on the cash gift. 

3. Consider philanthropy as a way to lower the value of your estate. If you are charitably inclined, you can make gifts of any size at any time while alive directly to qualifying 501(c)(3) charities, or to a Donor Advised Fund.

4. Take advantage of a step-up in cost basis. Instead of gifting appreciated stock or property before your death, have your beneficiaries inherit it after your death, so they won’t have to pay capital gains when he or she sells the asset.

We discuss minimizing taxes to maximize your beneficiary’s inheritance, in our comprehensive estate planning article.

Keeping Your Estate Planning Documents Organized 

We believe estate planning documents should be kept in three separate places: the individual(s) should maintain the originals, their attorney should also have a copy, and their wealth manager should have a copy as well. 

For personal safekeeping, while we continue to recommend keeping a physical copy of your documents, you should also consider utilizing a website to store these documents in the cloud. Reputable websites to store these documents include: 

Everplans | The Torch

We also recommend visiting the following webpage to read a complete guide to keeping and maintaining your personal financial records.

For every American adult, it’s never too early to start thinking about estate planning and trust creation. 

If you’re still not convinced all this is necessary, please read our article, Six Reasons Why Estate Planning is Important.

How can we help? 

The Towerpoint Wealth team collaborates closely and in tandem with our clients’ estate planning attorneys and tax advisors, and supports our clients as their estates grow and evolve. To help you with estate planning, our financial and wealth advisors can counsel you on legacy planning and coordination. 

Download your estate planning checklist today!

Learn more about estate planning and estate planning documents on our YouTube Channel: 

• Estate planning with a 401 k and other retirement accounts 
• Estate planning young families
• Term life insurance

Towerpoint Wealth, LLC is a Registered Investment Adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth, LLC unless a client service agreement is in place. 

By: Steve Pitchford, CPA, CFP^®, Director of Tax and Financial Planning

Dreading a Required Minimum Distribution, or RMD, from a retirement account? No doubt, it’s because of T-A-X-E-S.

RMDs can be an unwanted by-product of contributing to and investing in retirement accounts such as 401(k)s, IRAs, 403(b)s, etc. And there are impactful and proactive tax planning strategies that can materially lessen the tax sting of an RMD.

What is a Required Minimum Distributions, RMD?
Why are Investors Subject to RMDs?
How are RMDs Calculated?
Form 5329
How to Effectively Plan to Decrease RMD Taxes

What are RMDs, and how should an individual plan for them within the context of a tax-efficient retirement strategy? Read on to learn more about RMDs, and specifically, three actionable RMD strategies worth evaluating reduce taxes on RMDs withdrawals.

What is a Required Minimum Distributions, RMD?

The Internal Revenue Service (IRS) requires that individuals begin taking annual distributions (read: withdrawals) from pre-tax qualified retirement accounts[1] when they reach age 73. These withdrawals are referred to as required minimum distributions (RMDs).

RMDs from pre-tax qualified retirement accounts are subject to ordinary income tax rates in the year in which they are taken.

Examples of pre-tax qualified retirement accounts include:

• Regular/Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k) plans[2]
• 403(b) plans
• 457(b) plans
• Profit sharing plans
• Other defined contributions plans  
• Inherited IRAs (subject to special rules, see page six)
• Annuities, but only when held within another qualified retirement plan

Generally, Roth IRAs are the only type of qualified retirement plan not subject to RMDs. Withdrawals from Roth IRAs are tax-free, and the IRS does not mandate distributions from these accounts, as no tax revenue is generated when taking a Roth distribution.

Why are Investors Subject to RMDs?

Pre-tax contributions to a qualified retirement account provide two important and major tax advantages:

1. A dollar-for-dollar reduction in taxable income (read: an income tax deduction) for the contribution in the year it was made
2. Investment earnings (interest, dividends, and capital gains) are not taxed until withdrawn from the plan[3]. The power of tax-deferred compounding is tremendous, FYI:

If RMDs did not exist and an individual had sufficient supplemental financial means[4] to meet their retirement spending goals and objectives, they would probably avoid distributions from a pre-tax qualified retirement plan in the interests of avoiding paying the concurrent ordinary income taxes on those distributions. Requiring these distributions ensures that the government will not lose out on valuable tax revenue, on top of the lost tax revenue from the upfront tax deduction and tax-deferred growth that retirement accounts already provide.

How are RMDs Calculated?

For most individuals, the annual RMD calculation is as follows:

1. The individual determines the account balance as of December 31 of the year before the RMD is to be taken.[5]
2. The account owner determines his or her “life expectancy factor” using the life expectancy tables published by the IRS.
3. The account balance is divided by the life expectancy factor to determine that year’s RMD.

The life expectancy table used for most individuals is the following:

*Individuals should speak with their financial advisor or tax professional to ensure that they are not subject to a different life expectancy factor, as exceptions to the above table do exist.

Investment custodians such as Charles Schwab, Fidelity, and Vanguard typically calculate RMDs on behalf of the retirement account owner. However, it is the responsibility of the owner to ensure the RMD is satisfied before year-end.[6]

Towerpoint Tip:

Withholding taxes directly from qualified retirement plan distributions is generally the most convenient way to pay the RMD taxes. However, using after-tax dollars instead to pay estimated tax payments to cover the RMD taxes may be a more tax-efficient approach.

Form 5329 | What If an Investor Misses Taking Some or All of Their RMD?

If a retirement account owner who is subject to an RMD misses taking it by December 31, the penalty is steep: 50% of the RMD shortfall.

If this happens to occur, the individual should immediately: Form 532

1. Take corrective action and distribute the shortfall from their qualified retirement account as quickly as possible.
2. File a Tax Form 5329.
3. Attach a letter to the Form 5329 explaining the steps taken to correct this and why it was missed in the first place. While there is no formal guidance from the IRS regarding an error that would qualify for the penalty to be waived, three common positions taken are a change in address resulting in not getting the RMD notification, a death in the family, or an illness.

How to Effectively Plan to Decrease RMD Taxes

There are three strategies that we regularly employ for our Towerpoint Wealth clients to mitigate RMD taxes.

Strategy One: Accelerate IRA Withdrawals

Subject to certain exceptions, age 59 ½ is the first year in which an individual is able to take a distribution from a qualified retirement plan without being subject to a 10% early withdrawal tax penalty.

Consequently, the window of time between age 59 ½ and age 73 becomes an important one for proactive RMD tax planning. By strategically taking distributions from pre-tax qualified retirement accounts between these ages, an individual may be able to lessen theiroverall lifetime tax liability by reducing future RMDs (and the risk that RMDs may push them into a higher tax bracket) by reducing the retirement account balance.

This strategy becomes particularly opportune for an individual who has retired before age 73, as it often affords the individual the ability to take these taxable distributions in a uniquely low income (and lower income tax) period of time.

At Towerpoint Wealth, we utilize BNA Income Tax Planner, a robust piece of tax planning software, to evaluate these types of tax planning opportunities, helping our clients optimize this decision-making process.

Towerpoint Tip:

Don’t forget Social Security! Leveraging distributions taken from qualified retirement accounts to serve as a retirement income “bridge” is an important consideration when strategically planning how and when to receive Social Security benefits. Oftentimes, it is advisable to take distributions from qualified retirement accounts to meet retirement spending goals and objectives and delay filing for Social Security benefits until age 68, 69, or even 70.

Why? Each year Social Security benefits are deferred, starting at the first eligible filing year of age 62, until age 70, the monthly benefit amount increases by a guaranteed 8%! 

Strategy Two: Execute a Roth Conversion

A Roth conversion is a retirement and tax planning strategy whereby an individual transfers, or “converts,” some or all of their pre-tax qualified retirement plan assets from a Traditional IRA into a tax-free Roth IRA.

While ordinary income taxes are owed on any amounts of tax-deferred contributions and earnings that are converted, a Roth conversion, when utilized properly, is a powerful tax planning strategy to reduce a future IRA RMD, as Roth assets are not subject to RMDs. Further, Roth conversions ¹⁾ maximize the tax-free growth within a taxpayer’s investment portfolio, ²⁾ provide a hedge against possible future tax-rate increases (as Roth retirement accounts are tax-free), and ³⁾ leave a greater tax-free financial legacy to heirs.

For both strategies #1 and #2: Consider executing these strategies for the older spouse first, as this individual will be subject to an IRA RMD earlier. For this same reason, it is often advisable to contribute to the younger spouse’s pre-tax qualified retirement plan first.

Towerpoint Tip:

At Towerpoint Wealth, pairing a Roth conversion with the “frontloading” of a Donor-Advised Fund (DAF) has been a powerful tax planning strategy, allowing our clients to convert additional assets “over” to tax-free Roth assets at lower tax rates, while also allowing taxpayers who would not ordinarily itemize deductions to “hurdle” the standard deduction. This ensures that they receive at least a partial tax deduction for their charitable contribution to a DAF.

Strategy Three: Use the IRA RMD to Make Qualified Charitable Distributions

When an individual becomes subject to an IRA RMD, in lieu of having the IRA distributions go to them, they may consider facilitating a direct transfer from their IRA to one, or more, 501(c)3 charitable organizations (up to $105K annually). This is known as a Qualified Charitable Distribution (QCD).

As long as these distributions are made directly to the charity, they ¹⁾ satisfy the RMD and ²⁾ are excluded from taxable income.

This strategy, when executed property, results in a dollar-for-dollar income reduction compared to a “normal” RMD.

What Is an Inherited IRA, and Are They Subject to RMDs?

An Inherited IRA, also commonly known as a Beneficiary IRA, is a qualified retirement account that is opened on behalf of the beneficiary(ies) of the original owner’s qualified retirement account after the death of this owner. While the rules surrounding RMDs for Inherited IRAs can be complicated, Inherited IRAs are subject to mandatory distribution schedules.

For most individuals, the RMD on Inherited IRAs is levied as follows:

            RMD on Inherited IRA for an owner who passed before December 31, 2019

Subject to a life expectancy table similar to those for regular RMDs. These RMDs begin the year following the death of the owner.

            RMD on Inherited IRA for an owner who passed after December 31, 2019

Subject to the “10-Year Rule” where all funds need to be distributed ten years after the year of the owner’s death. How and when funds are distributed within this ten-year time horizon is up to the owner of the Inherited IRA.

Towerpoint Tip:

The “10-Year Rule” is making Inherited IRA tax planning more important than ever. Although the flexibility of how and when to withdraw funds within this period may be helpful, the window of distribution is more compressed (for most individuals) compared to the “old” rules.

Individuals should consider a Roth conversion if they are concerned about their inheritors paying taxes on future distributions. While Inherited Roth IRAs are subject to the same RMD rules as Inherited IRAs, the distributions are tax-free. A Roth conversion, within this context, is an estate planning strategy to transfer tax liability to the original account owner and away from the future inheritor(s).

How Can We Help?

Towerpoint Wealth’s certified financial planners serve as legal fiduciaries to our clients near Roseville, Rocklin, Granite Bay, Folsom, Gold River, El Dorado Hills, East Sacramento, Curtis Park, Land Park, Elk Grove, and Rancho Murietta. At Towerpoint Wealth, we are a fiduciary to you, and embrace the legal obligation we have to work 100% in your best interests. We are here to serve you and will work with you to formulate a comprehensive and tax-efficient retirement strategy.

Are you searching “certified financial planner near me?” You’ve found Sacramento independent financial planner Joseph Eschleman, as well as certified financial planner Steve Pitchford, CPA, CFP^®, and our entire independent wealth management team.

We serve clients primarily in the Northern California region. Glad you’re here! Please contact us with any questions you have about our wealth management process.

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[1] A retirement plan that provides tax advantages relative to nonqualified plans. Most employer-sponsored plans are qualified retirement plans.

[2] Less than 5% owners can defer RMDs until they leave the company or retire.

[3] Taxable investment accounts, such as a brokerage account or trust account, are subject to taxes based on annual earnings. Investors receive a Form 1099 each year showing the income to be reported on tax returns.

[4] Pension income, Social Security benefits, taxable investment assets, etc.

[5] For example, a 2021 RMD is calculated using the account balance as of December 31, 2020.

[6] RMDs may be taken all at once or throughout the year.

Written by : Steven Pitchford, Sacramento Certified Public Accountant, CPA®, Sacramento Certified Financial Planner, CFP®

Manage Costs and Investment Expenses
Investment costs and fees add up, but can be minimized
Utilize Tax Minimization Strategies

You can count on steady headwinds from investment costs and fees – and of course income tax bills from Uncle Sam. You’ll inevitably face these necessary evils as you work to build and protect your net worth, but with intelligent and proactive planning, you to have a degree of control over them. In other words, we can select our vessels, and, to finish the metaphor, we can control the sail.  

The markets go up and down. The economy is uncontrollable and unpredictable. We can’t guess about the next political headline and how it will affect our bottom line, and above all, we can’t control them. There’s an old sailing metaphor that begins: We can’t control the wind.

What’s ultimately important for your financial peace of mind is not what you make but what you keep. Identifying and controlling these necessary evils is crucial for wealth management.

What can you do to minimize their impact as you grow net worth? How can you keep sailing in the right direction?

Manage Costs and Investment Expenses

We consider costs and investment expenses to be one of the two things that impede the growth of a client’s net worth and portfolio. Studies have repeatedly shown that reducing costs can drastically increase the probability of success in one’s portfolio. At the same time, we believe that picking funds simply by lowest fee can sometimes be short-sighted.  One must consider the expenses of an investment within the larger spectrum of its overall merit. You can get better “mileage” out of a portfolio by managing and reducing the drag of costs and expenses.

Investment costs and fees add up, but can be minimized

Because fund investors don’t receive a bill in the mail to physically write a check to pay the internal costs and expenses of their diversified investment funds—these are paid directly out its returns—a large number of investors don’t even know how much they are paying in fees and investment costs. This is money you earn but never see! Since one of the easiest ways to bolster your returns and to better grow and protect your net worth is through expense, fee, and cost reductions, it pays to be aware.

Consider expenses, control costs:  

1. Low-cost index funds and ETFs have fewer fees and lower costs than actively managed funds. The more trades you execute, the more fees or commissions you might have to pay. Empirical data suggests that funds with lower costs have actually outperformed more expensive ones.

2.  Account custodial fees and trading commissions/costs can be reduced and in some cases eliminated completely. Use a custodian or brokerage firm that doesn’t charge for these things. For example, Towerpoint Wealth partners with Charles Schwab as our custodian, and our clients do not pay any account custodial fees, nor any stock/ETF trading commissions.

3.  Institutional funds and no-commission (no-load) funds are out there. Make sure your financial advisor recommends them to you over commission or high-load funds, assuming all else is equal. 

4.  Company-sponsored retirement plans may have hidden fees. You can ask to see the summary plan description, also known as the plan document. If your menu of investment choices is a limited selection of high-expense/high-fee funds, ask your plan administrator what lower-cost options are available to you.

5. Fiduciary financial advisors are legally responsible for putting their clients’ personal and financial interests before their own, and always acting in their clients’ best interests, 100% of the time. This means they won’t sell you something that is simply suitable for your needs and will pay them a large commission. A fiduciary financial advisor is compensated generally via an annual, asset-based fee that is computed based on a percentage of the client’s assets the advisor manages.

A financial advisor who is not a fiduciary can receive compensation via hidden compensation derived from products that can have higher fees and expenses. In fact, the White House Council on Economic Advisers has discovered that non-fiduciary advice leads investors to pay higher fees and expenses to the tune of $17 billion a year!

Utilize Tax Minimization Strategies

Taxes are the second of the two inevitable headwinds mentioned above, and can severely impact investment returns if not monitored and controlled. You want to keep the tax impact of investments and portfolios minimized, while not allowing tax implications to be the sole criterion. Utilizing careful fund screening, intentional asset location, and tax-loss harvesting decisions, through diligence it’s possible to minimize your obligation to Uncle Sam.

Taxes are inevitable, but controllable

Income taxes can drag down the real return of an investment. While financial, investment, or personal decisions should not be made entirely based on taxes, it’s wise to evaluate opportunities to reduce and minimize the income tax drag on your portfolio. You don’t want surprises when it comes time to retire.

Learn and consider ways to reduce taxes:

1. You may have a taxable account and also a tax-deferred retirement account. Knowing how to leverage, and what to hold, inside of IRA and 401(k) accounts can have a significant influence on your net, after-tax returns.

2. Speaking of retirement accounts, when setting up your 401(k) beneficiaries, you want to be aware of beneficiary distribution rules, as that will affect the taxes you and your beneficiaries may end up paying.

3. Should you buy and sell in your tax-deferred IRA or 401(k) account, or would it be better to take advantage of the long-term capital gain and/or return of principal opportunities that a “regular” taxable account offers?

4. Certain funds trade less and have lower turnover, tending to be inherently more tax efficient, as compared to funds that do a lot of active buying and selling, which can generate unwanted income and capital gain distributions. Exchange-traded funds, or ETFs, inherently trade less and almost always have a lower tax burden than do regular mutual funds.

5. Tax-loss harvesting and the strategic realization of capital gains can make a huge difference when reducing the overall tax drag of your portfolio. Short-term gains are taxed Federally at higher ordinary income rates, and long-term gains are usually taxed at the lower 15% Federal capital gains tax rate.

6. When taking money from your portfolio, be mindful of the type of account you decide to draw from matters, as does your personal income tax bracket at the time these withdrawals occur.

7. And while we’re on the subject of withdrawals, Required Minimum Distributions (RMD), which you must take after you retire, are also important to consider as you plan. Taxes on RMD will affect what you get to keep.

8.  If you get Restricted Stock Units from your employer, consider your RSU selling strategy. Will you have to sell to cover taxes? The same goes for an employee stock purchase plan. ESPP taxation is a unique opportunity to look for tax planning and minimization.

9. Do you own or are you considering real estate or a short-term rental property? You know rentals are good tax return and deduction opportunities. But VRBO taxes and Airbnb taxes are a necessary part of the equation. Also, knowing the intricacies of section 1031 exchanges can help avoid a big tax hit when selling these properties.

10. Tax reduction strategies and modeling are important to look at periodically with a financial advisor and a tax advisor. Is a tax-optimized investment account liquidation, drawdown, and withdrawal analysis part of your wealth management process? A question to ask a financial advisor, for sure.

By: Steve Pitchford, Director of Tax and Financial Planning and Matt Regan, Wealth Advisor
Published: April 13, 2021 updated October 22, 2021

Most individuals who are philanthropically inclined usually just take the path of least resistance and write a check directly to a charity. Of course, this is a straightforward approach and can qualify for an income tax deduction, but when being charitable, there are many different (and often economically more advantageous) options and strategies available to you. Indeed, with strategic and thoughtful planning, a taxpayer may be able to optimize their gifting strategy, meeting multiple objectives by maximizing the economic benefits ^1.) to themselves, ^2.) to their favorite charities, and even ^3.) to their loved ones.

Are you optimizing your philanthropy and gifting strategy? Below you will find a myriad of different charitable strategies we regularly employ for Towerpoint Wealth clients, designed to help you better understand your options.

Cash/Direct to Charity

A cash gift is the simplest and (by far) most popular form of charitable giving.

The income tax deduction[1] for a cash gift is generally equal to the amount of cash donated less the value of any goods or services received in return. And while the benefit of a cash donation is its simplicity, as you will see below, it is not always optimal from a tax and gifting perspective.

Donor-Advised Fund

A Donor-Advised Fund (DAF) is a charitable fund, a 501(c)(3) entity in and of itself, that allows an individual to donate cash or appreciated securities, such as individual stocks, bonds, mutual funds, or exchange-traded funds (ETFs).[2]

Donating appreciated securities can be a more tax advantageous way to fund a DAF, as donating an investment that has gone up in value generally provides the exact same tax deduction as donating cash, while at the same time provides the extra benefit of eliminating the capital gains tax that a taxpayer would normally pay upon selling the security.

How does it work? The donor makes an irrevocable gift of cash or appreciated securities to a DAF. The donor is then able to decide, on their own timeline, when to grant funds out of the DAF and directly to a charity or charities of their choice. If the contribution is appreciated securities, the DAF is allowed to sell these positions tax-free. The DAF will typically then, at the donor’s discretion, invest the funds in a manner consistent with the donor’s charitable goals and objectives. Once the donor is ready to make a grant from the DAF, he or she simply informs and authorizes the DAF custodian (usually via the custodian’s online platform) to send a check directly to the charity on the donor’s behalf.

Typically, the funding and operational costs of DAFs are low, and our clients also love that they provide a year-end summary report, eliminating the hassle and stress of tracking each contribution/grant out of the DAF individually.

Towerpoint Tip:

At Towerpoint Wealth, we also evaluate “frontloading” a DAF with several years’ worth of potential charitable contributions, allowing a taxpayer to “hurdle” the standard deduction and thus, not only eliminate the future capital gains tax of the donated funds, but also provide them with at least a partial tax deduction for their charitable contributions in a particular tax year.

Private Foundation

A private foundation is a 501(c)(3) organization set up solely for charitable purposes.

A private foundation may be structured either as a corporation managed by a board of directors, or as a trust managed by trustees. Unlike a public charity, the funding for a private foundation typically comes from a single individual, family, or corporation.

The primary benefit of a private foundation is the enhanced control that it provides, as it is able to formulate its own customized charitable gifting approach and platform (and continue to gift directly to other charities as well). A donation to a private foundation is an irrevocable charitable gift, and qualifies for a potential income tax deduction that, for most individuals, will be the exact same as gifting directly to another 501(c)(3) charity.[3]

Importantly, private foundations have administrative and tax reporting requirements that may be costly, and speaking further with a financial advisor and tax professional regarding the benefits and drawbacks of establishing one is recommended.

IRA Qualified Charitable Distribution

Individuals who are over the age of 73 are subject to annual required minimum distributions (RMDs) from their pre-tax IRA(s). These distributions are included on an individual’s tax return as taxable income and are subject to ordinary income tax.

As an alternative to taking a “normal” RMD, an individual can instead execute a Qualified Charitable Distribution (QCD), which allows them to both satisfy their RMD and their charitable intention at the same time.

How does a QCD work? Instead of a “normal” RMD, which usually is deposited into an individual’s checking, savings, or brokerage account, a QCD is paid directly from the IRA to a qualified charity. This distribution not only offsets – or, depending on the amount, fully satisfies – an individual’s RMD, but it is also excluded from taxable income.[4]

And unlike other gifting strategies, a QCD’s net effect as an “above the line” dollar-for-dollar tax deduction can offer additional economic benefits when compared to a “typical” itemized charitable tax deduction.

Charitable Remainder Trust

A charitable remainder trust (CRT) allows a donor to make a future charitable gift, while at the same time, receive an income stream during their lifetime for their own spending goals and needs. There are two types of CRTs: Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs). The two main differences are how the annual distribution to the income beneficiary(ies) is calculated and how often assets can be contributed to the trusts.[5]

When the donor establishes and contributes to a CRT, they are entitled to a current income tax deduction that is equal to the future expected value of the trust assets that will ultimately pass to the charitable beneficiary(ies). The deduction calculation is based on a number of different factors, such as the annual income stream payout set by the CRT, the age(s) of the income beneficiary(ies), the trust’s specified term of years, and the published IRS monthly interest rate.

At either ^1.) the donor’s death, ^2.) the death of the beneficiary, or ^3.) the completion of the trust’s term, the trustee will distribute the balance of the trust assets directly to the chosen charity(ies).

The primary benefit of a CRT is that an individual may receive a substantial tax deduction in the year they open and fund the CRT, while at the same time, continue to receive income for themselves (or other income beneficiaries) during their lifetime. If the CRT is funded with cash, the donor can claim a deduction of up to 60% of adjusted gross income (AGI); if appreciated assets are used to fund the trust, up to 30% of their AGI may be deducted. In addition, if the trustee decides to sell contributed appreciated securities, he or she can do so tax-free.

Towerpoint Tip:

Opening, funding, and administrating a CRT is complicated and there are important ongoing tax filing obligations. As such, it is highly recommended to work with a trusted financial advisor and tax professional to ensure that a CRT is the right choice. Further, the tax deduction calculation may be audited, so it is important to hire a qualified professional to appraise this value.

Charitable Lead Trust

In the simplest sense, a charitable lead trust (CLT) is the reverse of a CRT. The income generated by the contributed assets is distributed to the chosen charity, and the beneficiaries receive the remainder interest. Like a CRT, a CLT can be an annuity trust (CLAT) or a unitrust (CLUT), but different distribution rules apply.

There are two main types of CLTs: a grantor CLT and a non-grantor CLT. A grantor CLT, like a CRT, is designed to give the donor an upfront charitable income tax deduction. However, to receive the charitable deduction, the donor must be willing to be taxed on all trust income. Since the gift is “for the use of” a charity instead of “to” a charity, cash contributions to a grantor CLT are subject to reduced deduction limits of 30% of AGI, and appreciated asset contributions are subject to deduction limits of 20% of AGI. For non-grantor CLTs, the grantor does not receive a charitable income tax deduction, nor are they taxed on the income of the trust. Instead, the trust pays tax on the income, and the trust claims a charitable deduction for the amounts it pays to the charity. It is very important to note that since they are not tax-exempt, neither type of CLT offers the ability to avoid or defer tax on the sale of appreciated assets like a CRT does.

A CLT may be a better option than a CRT if an individual has no need for current income and wants to ensure that, upon their death, their loved ones receive an inheritance.

Towerpoint Tip:

A charitable lead trust is often structured to provide gift-tax benefits, not necessarily a current income tax deduction. A donor is able to gift more to family members with a reduced gift-tax effect because the gift’s present value is discounted by the calculated income to be paid to the charity(ies). The tax deduction the individual receives is based on the annual amount provided to the charity.

Pooled-Income Fund

A Pooled-Income Fund (PIF) is a type of charitable trust that functions like a mutual fund.

A PIF is comprised of assets from many different donors, pooled and invested together. Each donor is assigned units in the fund that reflect his or her share of the fund’s total assets. Each year, the donors are paid their proportionate share of the net income earned by the fund – the distribution amount depends on the fund’s performance and, importantly, is taxable income to the beneficiary (which is typically the donor but may also be a family member, friend, etc.). At the death of each income beneficiary, the charity receives an amount equal to that donor’s share in the fund.

PIF contributions provide a tax deduction to the donor upon contribution and, like the other charitable gifting vehicles described previously, affords the donor the ability to avoid paying any capital gains taxes on the contributed appreciated securities.

A primary drawback of a PIF is that the donor has no control over how the assets are invested, as the investment of the fund is directed by a professional manager. As such, it is important that individuals speak with a financial advisor to ensure that a PIF is thoughtfully incorporated into their overall investment allocation and strategy, as well as philanthropic and charitable giving plan.

How can we help?

At Towerpoint Wealth, we are a legal fiduciary to you, and embrace the professional obligation we have to work 100% in your best interests. If you would like to learn more about charitable giving strategies, we encourage you to contact us to open an objective dialogue.

Have additional questions? Contact our Director of Tax and Financial Planning, Steve Pitchford, for a 20-minute “Ask Anything” meeting.

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[1] In order for an individual to receive a tax deduction, their combined itemized deductions must exceed their standard deduction.

[2] Appreciated securities may be donated directly to certain charities as well. However, doing so is typically an administrative hassle for both the individual and the receiving organization.

[3] Donations to a private foundation are tax deductible up to 30% of adjusted gross income (AGI) for cash, and up to 20% of AGI for appreciated securities, with a five-year carry forward

[4] Up to an annual maximum of $100,000, per taxpayer.

[5] A CRAT pays a fixed percentage (at least 5%) of the trust’s initial value every year until the trust terminates. The donor cannot make additional contributions to a CRAT after the initial contribution. A CRUT, by contrast, pays a fixed percentage (at least 5%) of the trust’s value as determined annually. A donor can make additional contributions to a CRUT.

As a small business owner, we know that you are an “around the clock” grinder, with a myriad of responsibilities that often supersede the core responsibilities you have to the growth of your business. And understanding that a regular review of your business’s retirement plan may not be a top priority of yours, at Towerpoint Wealth we have created this 401(k) “healthcheck” for your benefit. We regularly come across 401(k) and other company-sponsored retirement plans that, as currently structured, are in serious need of attention and improvement, and we are experienced in helping you, as a trustee and fiduciary to your company’s retirement plan, minimize the hassle of giving your plan the attention it needs.

Is your 401(k) plan structured and optimized properly to help you and your employees maximize the myriad of economic, investment, and tax benefits? Are you properly managing your fiduciary responsibility? Ask yourself the questions found below to quickly gauge whether your 401(k) needs adjusting or improving.

 Does my plan have a safe harbor structure?

You want to ensure that your 401K) retirement plan passes the annual non-discrimination testing conducted by the IRS. In its simplest sense, non-discrimination testing ensures that an employer is making contributions to each employee’s retirement account that equals the same percentage of salary for everyone. Importantly, if a plan fails a non-discrimination test, the 401(k) may lose its tax-qualified status.¹

[1]The most common reason a 401(k) plan fails this non-discrimination testing is when one or more of the business owners make much greater 401(k) contributions compared to their employees.

A safe harbor 401(k) plan structure ensures that you meet the non-discrimination regulatory requirements by following strict guidelines specific-to employer plan contributions, participant disclosures, and much more. 

Does my plan have a profit-sharing component and if so, am I optimizing its structure?

For a business owner to maximize the personal net worth building benefits associated with sponsoring a company retirement plan and receive the maximum 401(k) annual contribution amount of $58,000 in 2021^[1] (employee deferrals + employer contributions), pairing a profitsharing component in the plan’s design is essential.

All profit sharing plan structures – same dollar amount, comp–to–comp, new comparability, etc.^[2] – are not created equal. In particular, the new comparability strategy is becoming increasingly more common in modern 401(k) plans as this type of profit-sharing plan allows for unique flexibility in allocating the profits among the business owner(s) and employees.

Is my investment fund lineup optimized?

401(k) investment fund lineups vary from basic to advanced and passive to active. And with employees having better and more diverse investment options outside of 401(k) plans, annually reviewing your company’s fund lineup for improvements is critical to ensure that employees do not look to invest their hard-earned dollars elsewhere, and also to meet your fiduciary responsibility as plan trustee.

It is also a requirement that a business owner (usually with help from an investment professional) formulate, and review at least annually, an investment policy statement (IPS) for their 401(k).

Is my ERISA fidelity bond fund amount appropriate?  

The Employee Retirement Income Security Act (ERISA) requires 401(k) plans to hold a fidelity bond, which protects the plan from losses resulting from improper handling of the funds.

While fidelity bonds are generally inexpensive for the coverage offered, we often see the amount protected as either ^1.) inadequate or ^2.) overkill.  

[1] Increased to $64,500 for business owners 50 years of age or older.

[2] There are often several different terms that refer to the exact same type of profit-sharing structure.

Does my plan currently allow for after-tax Roth contributions?

While changing for the better, many 401(k) plans still do not allow after-tax Roth contributions. 

For business owners and employees that are in a temporarily low income tax bracket –  a business owner “winding down” and closing in on retirement or a younger employee at the beginning of their career and earning curve – offering an after-tax Roth contribution option, particularly given it typically costs nothing to do so, is a valuable and often overlooked plan benefit.

Is my vesting schedule appropriate?

In order to incentivize employees to stay with your company, having a vesting schedule for any  employer-matching profit sharing contributions that is not overly generous is important. For a number of Towerpoint Wealth’s clients who are business owners, a vesting schedule of six years (with 0% vesting in the first year of participation) is appropriate, but each business and retirement plan is unique.

Have I considered automatically distributing an employee’s 401(k) balance when they leave the company?

Many 401(k) plan administrators charge their fees based on the number of employees that the plan has. 

In order to keep fees to a minimum, it is advisable to consider automatically distributing account balances below a certain threshold when an employee separates from service.

Am I managing my fiduciary responsibility and minimizing my fiduciary liability?

All business owners who offer a 401(k) for themselves and their employees have a fiduciary responsibility to ensure that they are acting in the employees’ best interests, being prudent, diversifying plan investment assets, and adhering to all provisions of the retirement plan documents.

There are concrete steps that a business owner can take to uphold their fiduciary duty and at the same time, minimize their fiduciary liability.

Wealth management firms that specialize in helping business owners optimize their retirement plans, such as Towerpoint Wealth, are able to help guide you through these murky waters.

Am I doing everything I can to maximize my own personal net worth within my company’s retirement plan?

Even if a small business owner has a well-structured plan that meets everyone’s needs, is it important to remember that 401(k)s, and other types of company-sponsored retirement plans, are uniquely customizable. And often, there are overlooked plan features that may help the business owner maximize their ability to accumulate wealth within the plan. 

One of these particularly powerful features is allowing for after-tax deferrals (not the same as after-tax Roth deferrals), which then affords the business owner to take advantage of the “Mega Backdoor” Roth IRA strategy.

Some other questions that are worth your thoughtful attention: Do I allow for hardship distributions and if not, should I? What about allowing rollovers from other retirement plans? Is it risky to offer loans to employees? Are my plan’s expenses and fees reasonable?

How Can We Help?

At Towerpoint Wealth, we are a legal fiduciary to you, and specialize in optimizing retirement plan structures for business owners.. If you would like to speak with us regarding any other tax questions you may have, we encourage you to call (916-405-9166) or email (spitchford@towerpointwealth.com) to open an objective dialogue.

Towerpoint Wealth, LLC is a Registered Investment Adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth, LLC unless a client service agreement is in place.

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