A recent client experience served as a great example of how we add value to our clients. In this specific example, our strategy saved them over $100,000 in taxes. Here are the details:
We had been working with a client for several years. Based on a good experience, they asked us to begin advising their Father (Dad). Dad was retired and had various financial planning needs, including the need for ongoing financial planning, retirement income planning, tax planning, estate planning, insurance review, charitable planning and investment management. After reviewing Dad’s financial statements, we realized one of his portfolios had $500,000 of blue chip stocks inherited in the 1960’s when his parents died. The cost basis on the securities was virtually zero, which meant if we sold them, he would pay substantial capital gains taxes.
Financial Goals
Dad’s living expenses were $75,000/year, which he wanted to maintain, even if it meant selling securities and paying higher taxes. He wanted to continue gifting to the charities he had supported over the years, and leave assets to the kids when he passed. There were several components that we analyzed in crafting solutions to save him taxes.
Tax Planning
Like many retirees, Dad’s taxable income was relatively modest. He had Social Security Income, the dividend income from his portfolio, and a modest Required Minimum Distribution (RMD) from his IRA. Factoring in his various tax deductions, Dad was in the middle of the 15% federal income tax bracket. The capital gains rate for someone in the 15% tax bracket is 0%… that’s not a typo. We were able to sell approximately $15,000/year of Dad’s appreciated securities, and keep him in the upper limit of the 15% tax bracket, and pay zero capital gains tax. The proceeds from the sale of these securities were used to supplement Dad’s income.
Liquidity & Cash Flow in Tax Planning
Dad’s Social Security check was over $2,500/month, but covered only a portion of his annual living expenses. The Blue Chip securities in his brokerage account were generating over $12,000 year in dividends, which we used to further supplement his income. Not unlike many retirees, Dad had over $75,000 in cash in the bank. It was earning less than 1%, and was not earmarked for any current or future expenditure. We decided to begin using these low yielding funds to supplement his Social Security and dividend income, and limit the extent of selling his securities.
Charitable Planning for Tax Purposes
Dad was charitably inclined and enjoyed gifting to a few non-profits, including his church and the local food pantry. Rather than writing a check from his checking account to each charity, we advised Dad to gift shares of appreciated securities directly to his charities. In doing so, Dad satisfied his charitable desires, received the full amount of the Charitable Tax Deduction, kept his cash liquid for paying bills, and avoided generating capital gains in selling securities.
Appreciation
The added benefit of this strategy is that the securities continued to appreciate, and did so at a faster rate than he was spending them, via partial sales and charitable gifts.
Estate Planning
One of Dad’s primary goals was to leave assets to his kids. After many years of good health and a fulfilling retirement, Dad died early this year. His portfolio, which he used to maintain his lifestyle and satisfy his charitable desires, was still above $500,000. On Dad’s death, his children received a step-up in basis to the securities that Dad had owned for over 50 years. The tax liability to the children on their inheritance was $0. Had Dad sold these securities, he would have paid approximately 20% in federal and state capital gains taxes, equivalent to $100,000.
Dad’s Legacy
The children are using these securities to maintain Dad’s beloved cabin up north; and they are using the dividend income to pay for their children’s college education. In doing so, Dad’s legacy lives on through his children and grandchildren.