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Dear MarketWatch,
I’m 59 years old, and my wife is older (retired early). I will be retiring next year after 40 years of Naval service and government contracting.
After the recent market crash in 2022, we still have at least over $1.5 million in 401(k), Thrift Savings Plan and other investments that we think we may never have to use and want to pass that on to our adult kids. I have a monthly retirement pay and VA disability benefit of over $12,000. Our monthly cash flow covers our monthly expenses and more. No major credit card debts, just the one we use monthly and pay it off monthly. The mortgage for our retirement home is $1,987 a month including tax and insurance. We have no other debts except for our monthly life and property insurance, along with other necessities of life. We put money aside for vacation and we have over 12 months of emergency funds in our savings/checking accounts. Medical benefits are also covered with TRICARE and VA.
We are in the process of selling our primary residence and moving to our retirement home, which we still owe $182,000 toward the mortgage but don’t want to pay off since it will become our tax shelter as I call it. We plan to use the proceeds of the sale to upgrade our retirement home, pay off our loan, invest the remaining and use some for vacation next year.
I think we’ve done well preparing for our retirement but am unsure of what to do with our investment that we think we will never use. With that said, we wanted to stay aggressive but we don’t have a financial adviser to say otherwise. The other thing is that our investment will be left to our kids and I’m not smart enough on the consequences of tax once the investment is transferred to my two adult kids. Any advice is greatly appreciated.
Mr. Stay Aggressive
Dear Mr. Stay Aggressive,
I would say you’ve done well to plan for your retirement, too. You’ve clearly thought out your cash flow in retirement and the tax consequences of your decisions, as well as your healthcare and housing situation. The fact that you have $1.5 million in investments you don’t intend to use is another huge plus, of course.
There’s no one way to invest your money, especially when there’s no particular goal for the amount you want to have saved or the timeline you need to meet that mark, but your instinct to stay aggressive isn’t wrong. Advisers typically suggest investing your assets rather aggressively when they’re intended for the long-term, and considering you and your spouse are still young in retirement years, you could have decades to go until your kids actually get that money.
If you’re sure the money will be going to your children, it should be invested as if it was already theirs, said Larry Luxenberg, a certified financial planner and principal with Lexington Avenue Capital Management. “They should look at the time frame of the investments considering when the money will be spent. So if the money is going to younger people, it could be spent decades from now and should be invested accordingly.”
This should be balanced with your appetite for risk, said Mark Smith, a certified financial planner and president of Vision Wealth Planning. Even if you don’t intend to keep the money for yourselves, you might not be comfortable seeing the account balance drop too low. Ask yourselves at what point you’d be uncomfortable with investment losses, which will dictate just how aggressive you can be with this money. If you don’t agree – say one spouse is a little more comfortable with risk than another – you can always have two buckets, said David Haas, a certified financial planner and owner of Cereus Financial Advisors. One bucket can be used for aggressively investing while the other is a bit more conservative.
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I know you said you don’t intend to need the money, but regardless, you may not want to announce to your kids how much they’ll be getting… or at least be cautious about how you do so. There are a couple of reasons for this.
The first: you don’t want your kids planning around a specific number, especially considering the time horizon is so long and can leave you somewhat unsure of what to expect the account balance to eventually become. If you can have an open and healthy conversation with your children about this extra money, that’s amazing – talk to them about what you have in there, how and why it’s invested the way it is, what important information to know about accessing the money after you’re gone and so on.
More importantly, however, you might want to hold off on promising all of that money to your kids because you may end up needing at least some of it – even if you don’t think you will right now – and you should take care of yourself and your wife first. A lot of Americans do not take long-term care planning as seriously as they should, and that’s a financial and emotional disservice to themselves and their loved ones. This money can be a “last resort rainy day fund” for you two, and if you end up not needing it, your kids will still get it after all.
“Couples in this situation usually forget about long-term care,” said Wheeler Pulliam, a certified financial planner and founder of Xponify Financial. “It is the No. 1 killer of retirement plans. The reason it goes unaccounted for is that it is not fun to think about, and people tend to push it off until it is too late.”
In that scenario, you might not want to be too aggressive with your investments, said Mackenzie Richards, a certified financial planner at SK Wealth Management. Investing aggressively makes sense for accounts that are meant for inheritances, “but not if there’s any doubt about whether they will need the funds,” he said. “It may be helpful to separate the ‘excess’ into two portfolios.” The first can be for unexpected big expenses, like a vacation home or long-term care, while the other can be invested aggressively for kids and grandkids. If you end up truly never needing both, your loved ones still reap the benefits of your invested assets.
Still, if you can get through all of retirement without touching it and it comes time for your children to inherit it, there are a few tax considerations to make. The first is listing beneficiaries, because doing so will avoid any headaches as far as the probate process is concerned – listed beneficiaries on retirement accounts and life insurance policies supersede wills, so make sure the people you want the money going to are listed as such.
You might want to look into purchasing a permanent life insurance policy, which will provide a tax-free inheritance to your loved ones, said Greg Hammond, a certified financial planner and chief executive officer of Hammond Iles Wealth Advisors. You can also name a charity or multiple charities as beneficiaries for taxable retirement funds, which will could alleviate some of the tax burdens. “This will eliminate income taxes for the relatives, make a lasting legacy impact with the causes or organizations they care about, and allow them to stay invested to grow the retirement investments for the long-term while still having the ability to tap into the retirement funds if needed,” he said.
If you decide to pursue that route, you should consider working with a financial planner who can help you make sense of the right strategies and talk through the pros and cons for your specific situation. If not, that’s OK, there are still other tax aspects to account for when planning to leave behind an inheritance.
Also see: What can retirees do about inflation?
Non-spouse beneficiaries have to follow a 10-year rule for withdrawing money from an inherited 401(k), which means they must strategize when it is best to take their distributions so that they aren’t hit with hefty tax bills.
I would also suggest reaching out to your plan provider or human resources department to ensure you understand withdrawal rules for inheritances, and then write out a list of instructions that your children should know. Date the letter though – as you can imagine, anything can change over the span of 10, 20 or even more years.
Also, keep in mind you may very well have to tap into some of this money before you die, even if you don’t actually need it, thanks to required minimum distribution rules. Right now, accountholders who have not yet begun withdrawing from their employer-sponsored plans must take these RMDs beginning at age 72. RMDs are calculated using the account balance as of the end of the prior year and the person’s age, and they can push individuals into a higher tax bracket.
You might want to consider how and when you withdraw the money so that you have more control over the tax implications, such as converting some to a Roth IRA every year in an amount that does not place you in a higher tax bracket. A Roth is also a good idea for inheritances, Richards said. “Not only does this reduce or potentially eliminate the need for required minimum distributions, which sounds like the clients don’t need to live off of, it will also be much more beneficial for the kids to inherit,” he said. “They will still have to be depleted in a 10-year period, but it won’t be a ticking tax time bomb for the kids to have to plan around.”
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