Ed Slott: OK, welcome back. Well earlier we talked about that the government has a plan and you don’t. And we realized that we would like to have a plan because our plan will be much better than the government plan. We talked about the ship. Remember I talked about the SHIP hitting the fan, causing financial disaster. Not being the person who dropped the ball because we want to have a plan. So that’s what we’re going to talk about right now.
How to use the tax code. What I call the three biggest benefits in the tax code, to create a plan that can actually leave you more money for you now, and maybe millions more than you ever had for your family later on, and much of that can be tax free.
I’m going to give you a dramatization of a problem, because first you really have to see how this unfolds. I’m going to use a big number, $10 million IRA. Now you might say who has 10 million in an IRA. First you never know. Second if you can lose 10 million you can lose whatever you have. And the less you have the more important it is to protect what you have. So I’m going to do this in slow motion.
What you will see the unraveling of the taxes. Let’s say you have a $10 million IRA. It’s the only asset in the estate. You die. What happens in nine months? You have estate taxes. Because we’re going to assume there’s going be some kind of tax.
What else happens in nine months? That’s right you have a baby. [laughter] Is it different here? [laughter] If you think about it, life’s like a Bell curve, they give you nine months to get into the world and nine months to get out. [laughter] A little tax history there. That’s where they got the nine month’s on the estate tax.
All right you have a $10 million IRA it’s the only asset in the estate, you die. What happens in nine months? Let’s make the numbers easy you have to come up with five million in estate tax. Where you going to get it from? That IRA I said it was the only asset, but you take five million out of an IRA that’s five million of taxable income, on one return, in one tax year.
So let’s see how this plays out in our dramatization. You die, $10 million IRA, your family has to come up with five million. They take it out of the IRA. They take five million out of the IRA, their walking it over here to Uncle Sam the estate tax guy. But, what step did I skip? Income tax, I crossed over a street right up the middle here I call income tax avenue, where Uncle Sam, Jr. His son, the income tax guy is standing there, and he says great you landed on my space, 40 percent. Forty percent of what, well you took five million out, I get $2 million.
So you give him $2 million. You continue on to Uncle Sam, Sr., the estate tax guy, and say, “Look, I was on my way over here. I had all five million. I didn’t talk to anybody, you know. I’m from New York. I got mugged. The guy grabbed me for two million bucks, so I’m short two million bucks. Don’t worry about that guy, he’s my son Uncle Sam, Jr. He does income tax I do estate tax. We work together.” Good, you guys settle it up. No, he gets his and I get mine. You’re short two million bucks. Better go back and get it, nine months. No problem, still a few crumbs left back in this account. You started with 10 million. How much do you have left? Five. What do you need now?
Ed: You have to pull out $2 million. You pull out $2 million. Your walking it over here to Uncle Sam the estate tax guy, minding your own business. You hit income tax avenue there’s Uncle Sam, Jr., and he says great! You landed on my space again. Now I have 12 hotels, 40 percent. Forty percent of what? I just gave you all that money. $800,000, 40 percent of the two million you took out. So you give him $800,000.
You continue on to Uncle Sam Sr. the estate tax guy, say look I was on my way over here with the two million I was short. I didn’t talk to anybody, I didn’t look at anybody, bang, same greedy guy hits me over the head. I’m short $800,000. Well better go back and get it in nine months. This goes on and on and on.
Actually, I did it in slow motion but it happens instantaneously. In this book of mine, “The Retirement savings time bomb” I actually did the walk on page 152. It didn’t even take me the whole page. I stopped when I got down to the last 12 cents, and I felt the point was made.
That’s what I call the retirement savings time bomb. You lose it. See the point is you have to understand there’s a problem. Why would you be interested in the solution? This is why most people don’t play in the second half of the game. Why would you be interested in a solution if you didn’t think you had a problem?
I’m telling you, you have a problem. What advice would I have given that $10 million guy if I was able to consult with him before he became the croakee. That’s a legal term. [laughter] “Croakee.”
I would have told him, you have to have a plan. The IRA is not sacred. The reason most people loose their retirement money is because they just look at it. It comes down to one word. That’s the big problem. Admiration.
People just like to look and admire their work. For example, I have people that love to show me their IRA statements and they say, “Oh, look. I have a million, too, in my IRA.” And I say that’s not your money. You’re not keeping any of that. It’s just temporarily on your letter head. Don’t you get it? [laughter]
But they love to look at it. I’m telling you the IRA is not sacred. Either, you use it–you leverage it–or you loose it. This is where we use the three figures benefits in the tax code. Here they are. Number one–the single biggest benefit in the tax code is the tax exemption for a life insurance.
Now just so you know where I’m coming from, I do not sell life insurance. I do not sell stocks, bonds, funds, annuity–no products. But I believe in this concept. I’m just a tax adviser. But I believe in this concept and you should too.
In fact, I have millions of dollars of life insurance myself. I have so much life insurance, that’s why I can’t eat at home at night. [laughter] I’m a big believer in this. What would I have told this guy, if I was able to consult with him with the $10 million?
That’s $10 million in an IRA. Take $5 million out now. What do I care? It’s going in the garbage anyway. I can do better things with it now. The last thing on earth you want is for taxes and post-death expenses to be paid from an IRA.
Remember, if most of your money is sitting in a retirement account that hasn’t been taxed yet–the last thing you want is to leave your beneficiaries the mess of having to pay those taxes–and we’re going to assume there’s going to be taxes and post-death expenses from retirement money.
Because if you do that you get into this cycle of taxation–this tax on tax that eats away at the account until it’s gone. Better to have other money. See life insurance money comes out income tax-free. If you’re working with an adviser who really knows their stuff–they can make it estate tax-free as well.
We want tax-free. So what would I have told this guy? “Take out the $5 million–we can do better things with it now. Even if the income tax was 50 percent. That still leaves you $2.5 million to buy enough life insurance to replace this entire estate and then some–and have it come out all tax-free. ”
See, you have to look at the long-term big picture. Most people don’t do that. When you talk about life insurance, the first thing people say, “Well, it costs too much.” I’m telling you what does it cost not to do it? Look at the score at the end of the game–you loose it all.
Here’s the way I do planning with people. I like to use a yellow legal pad like this. Using my football analogy we talked about earlier, the score at the end of the game–the reason I like the legal pad–because it kind of looks like a football grid. It has all the lines there. The last line is the goal line. Not a good goal for estate planning, which is what we’re talking about. It’s death. Whenever I say that I’m reminded of this attorney friend of mine who says, “Oh, I never like to use the death when I talk to clients.” I say, “What do you call it?” He says, “I like to use the term, when the will matures.” [laughter] [applause]
I call it what it is. When you’re dead, you’re dead. Here’s what I say to people. See, I don’t care what happens in the middle of the game. You get beat up, you get tackled–may be you pay some insurance premiums. I only care about the score at the end of the game. How much you keep.
So I would say to you, “If I could create a plan that after you and your spouse crossed over into the great beyond, you’re family gets your entire net worth–every thing you had or much more. Would that be a good plan? [applause]
See with the life insurance, you’re leveraging IRA money now. Yes, you pay tax now, but look at the score at the end of the game–what you get tax-free later. It’s many times the amount you take out now plus it’s tax-free later. You’re turning small amounts of money into may be millions tax-free and many people can do this.
The key is the IRA is not sacred. You don’t just sit there and look at it. You use it, you leverage it or you loose it. The second biggest benefit in the tax code–I mentioned it before briefly.