Mike Starns, 66, and his wife Beth, 61, recently sat down with their Heritage planner to discuss his upcoming retirement.  Mike will be retiring from his position as COO at an apparel company at the end of next year.  Currently, their net worth exceeds $12MM, but much of the value is tied to Mike’s company in one form or another and bears substantial risk and tax liability.  Mike grudgingly concedes that their profit margin has been under pressure for the past 4 years.

Mr. Starns has yet to exercise his vested, non-qualified employer-sponsored stock options worth $3MM (pre-tax).  Mike’s 401k is worth more than $1.9MM but half of that value is in company stock as well.  Over the years, Mike has deferred compensation in accordance with the company plan and needs to determine the timing and payout structure to minimize taxation.  His pension is generous, but again, is contingent on the financial stability of the company.

Their joint investment portfolio exceeds $4.5MM but also includes over $800,000 of company stock.  Beth has IRA assets of $250,000.  Their residence is worth at least $1,750,000 and their mortgage has been eliminated.

Mike and Beth have simple wills, Living Trusts, and Powers of Attorney but they haven’t been reviewed for nearly two decades. Their two children, Michael and Stephanie, are successful professionals and while they don’t need any financial assistance, Mike and Beth would like to set up accounts for their three grandchildren.  Mike also owns $2 million of life insurance on his life with Beth named as the beneficiary.  They are open to charitable giving.

Concerns:

• While both Mike and Beth have sufficient resources to support their desired standard of living through age 90, a significant portion of their assets- the company stock options- have yet to be converted to spendable dollars.
• Their overall wealth is vulnerable to business risk given that the majority of their investments are tied to Mike’s company.
• Without coordinating deferred income, stock options, pension start date, social security and RMDs, they could lose all the expected benefits of tax deferral.
• They are vulnerable to state estate tax and potentially to future federal estate tax.
• Mike’s existing life insurance is included in the estate for estate tax purposes. Without proper planning, a substantial portion of the death benefit could be lost to taxation in the event of simultaneous death.
• In summary, while their retirement looks great on paper, a financial problem at Mike’s company could throw their plans in jeopardy.

Potential Solutions:

• Develop on optimal schedule for the various income streams that helps to keep taxes as low as possible under current law.
  • Establish a conversion strategy for the company options, considering both market timing and income tax issues with salary and bonus.
  • Coordinate deferred compensation payments with pension and Social Security initiation to minimize tax bracket.
• With regard to Mike’s 401k plan, company shares with a low basis may be good candidates for special federal tax rules like Net Unrealized Appreciation (NUA).
  • NUA could potentially provide the ability to reduce the stock concentration and pay capital gains rates instead of ordinary income tax rates.
  • The non-company portion could roll into a self-directed IRA to allow for more flexibility in investment choices.
  • Develop an overall investment allocation suitable to the cash flow needs and accounting for the concentration in the Mid-cap sector.
• Reduce the concentration in their investment account:
  • Establish a capital gains budget for the reducing the company stock over time;
  • Consider making charitable gifts of some low basis company stock. Charities won’t be subject to the capital gains tax.
• Consider large lump sum payments to Educational accounts (529 plans) for the grandchildren:
  • Mike and Beth can front-load each grandchild’s plan to the level of $150,000;
  • $10,000/year can be used for private school prior to college;
  • Earnings are tax-free when used for qualified education purposes.
• Consider naming a qualified charity as a beneficiary on retirement assets:
  • Charitable intent at death;
  • IRA gifts are typically the most optimal assets to give to charity for tax purposes.
• Consider the use of trusts in their estate plan:
  • Shelter from state estate taxes;
  • Preservation of elevated federal lifetime gifting ability, prior to sunset in 2026;
  • Health/Education trusts for grandchildren.
• Remove the existing $2 million in life insurance from the taxable estate by either transferring it to an Irrevocable Life Insurance Trust (ILIT) or, based on the economics of underwriting, surrender it and purchase a survivor life policy in an ILIT. An ILIT can reduce potential estate tax liability and provide the liquidity to pay the remaining estate taxes. In addition, the proceeds of the policy upon the death of Mike (or the second to die between Mike and Beth) may be protected from any creditors or divorce proceedings encumbering the heirs.

Please remember that all clients are different and individual suitability should be determined. These case studies are presented as information only; actual results may vary. It is not our position to offer legal or tax advice. Seek the advice of a professional advisor prior to making a tax-related investment and/or insurance decision.

CRN – 3141647-062620