The Real Death Tax

The IRS tax code is favorable to married couples and unfavorable to single people in a relative sense.  The IRS doesn’t distinguish between happily or unhappily married couples.  Married is married and better tax treatment is a benefit of marriage.

The IRS doesn’t care why you are single.  You’re single because you don’t “believe in marriage,” you’re single.  You got divorced, even from a destructive relationship, you’re single.  You lost your spouse to cancer, you’re single.  Unmarried is single-PERIOD.

There are countless life scenarios, belief and value systems, and disparate financial circumstances.  I love what I do professionally, in part, because of this.  The impact my work has on the life satisfaction of others is tremendous, and the variety of challenges to solve feeds my creative self.

I will describe one of the most common situations in which consumers may not be well served by what they think they know or the financial industry.  Since IRAs were created in 1974 and 401K plans began in 1979, many Americans began accumulating money primarily through pre-tax contributions.  The lure was and is, tax-deferred savings for a long-term retirement objective.

This approach is neither good or bad, but like most things in life there are benefits and limitations to the strategy.  However, it is rare to read anything negative about this approach to serving your retirement objective.  We do hear and read “Maximize your Pre-tax Contributions;” “You’ll be in a Lower Tax Bracket later;” “Protect your Principle;” “Only Withdraw the Required Minimum” and other phrases my industry expects you to accept without critical thinking.

This propaganda works for my industry, but does it work for you? 

My industry, one way or another, is paid to use your money.  The more money you save and invest (Maximize your Contributions), the more profitable it is for my industry.  This doesn’t mean it is a “zero sum game,” but it is true that more money equals more profit for the financial industry.

If you don’t spend and enjoy your money (Protect your Principle), then who are you saving your principle for?  You cannot take your money with you, so someone else will spend and enjoy your money.  This is also not good or bad, but it is your choice.  While you protect your principle, the financial industry earns higher fees on larger account values that go unused.

If you continue to defer taxes on your Traditional IRA and 401K money, it might feel good in the short-term, but you are not avoiding anything.  You are congress!  By deferring taxes as much and long as you can, you are simply “kicking the can” down the road where the tax burden is very likely to be much higher.  The more successful you are at saving and investing while working, the less likely you are to be in a lower tax bracket when you withdraw your IRA/401k money!

Here is the dirty little secret in the IRS tax code!

If you are married, what are the odds either you or your spouse will die first?  Answer: 100%  If you arrived at a different answer, read the question again.  After you or your spouse dies first, the survivor will file as a single tax payor. 

You are likely unaware that the tax bracket for a single person with $50,000 of taxable income, is over 83% higher than the same $50,000 tax bracket for a married couple!

It may not be possible to predict investment performance, but death and taxes are certain.  If you and your spouse have each other as beneficiary of IRA and 401K accounts, then there is no immediate taxable event at the first death.

However, now the RMD and all withdrawals from your combined IRAs and 401Ks will be subject to the IRS Single filing status.  The tax consequences for leaving your IRA and 401K money to your children may be worse, depending on their tax bracket and your children’s spending behavior (with your inheritance).

What is your IRA Exit Strategy?  Great questions are better than easy answers.  As a Fiduciary on behalf of my clients, I trust but verify every phrase or platitude put out there by brokers and in advertising.  Critical and Strategic thinking seeks to profit from known facts, not speculative opinion.

The tax bracket applied to your IRA and 401K money is a moving target every year based on your specific situation.  Follow the herd at your peril or partner with a good Fiduciary Shepherd.