There is an old joke in my office that goes like this: Everybody can retire in 15 years starting with nothing. I can prove it. Most people overspend until their birthday has a 5 in front of it. Then they panic. OMG! I have only 15 years until retirement! And then they get serious and get it done.
Of course it isn’t that simple. Many people do save early. Yet all too many suffer a diminished retirement due to financial habits in the years leading to retirement. A heavy debt load can move the starting block to negative territory, making the drive for retirement all the more challenging.
No matter your age or financial condition, you can always improve your situation. We will focus on tools for those 50 and older in this post, but make no mistake, each tool listed here has potential for people of all ages.
Using the story above, people who get serious about retirement can reach that goal by age 35 and even younger. The FIRE (financial independence, retire early) community is a prime example of people moving the urgency of retirement from age 50 to an earlier age. Which leads us to a simple concept: Decide when you want to retire by picking the year you will get serious about planning for retirement. Start at 25, retire by 40; start at 40, retire by 55; start at 50, retire by 65; never start, never retire.
The closer you are to retirement the more important it is to make financial decisions that will keep you on course. A major financial setback in the final run to retirement can be devastating. Today we will deal with those risks and work to mitigate them.
1.) You Need a Budget
When I was a wee tyke I was already budgeting. It was a simple ledger listing income and expenditures. If I wanted a new Wrist Rocket slingshot I needed to save for the purchase. (This is a true story.) That required a plan.
A budget is not about deprivation! A budget is about knowing where you are financially and managing income and spending.
A simple spreadsheet can do the trick. This is something I have used since I was in middle school. Back then I used paper and pencil. Later I graduated to Excel and similar spreadsheet software. It doesn’t have to be fancy; it just has to work! If you want bells and whistles you can try You Need a Budget. Fancy or something simple, all works as long as you start and remain consistent.
Budgeting is more than limiting expenses in each category. A budget shows you where you are spending and this allows you to eliminate waste without any sacrifice. Sometimes you will notice an expense that is out of line and it will become a conscious choice to reduce spending in that area.
The point is budgeting gives you control of your finances. You can’t manage what you don’t understand. As much as you think you know where your money is going, there is no way to really know and manage money properly unless you can see it. That is what a budget does. It works for anyone at any age, but is vital if you are reaching the end of your working years. This frees up money so you can pay-yourself-first.
2.) Eliminate Debt
It is hard to enjoy retirement when you are managing debt payments. A mortgage would be bad enough, but credit cards, auto loans and student loans are things you want wiped off the slate before you enter retirement.
Remember: Paying off debt is a form of investing. It is a backward way of thinking about allocation of excess funds. Investing is straightforward. Yet, paying off debt also has a return. High interest debt is a cancer to a budget. Paying off the debt reduces the interest expense. That lowers expenses and makes budgeting a world better.
Getting into debt is easy; getting out can be a serious challenge for many. There is help. If you have reached the crisis level consider contacting the National Foundation for Credit Counseling.
Most people can reduce and eliminate their debt by tracking their income and spending on a spreadsheet. Budgeting is the place to start so you can visualize your finances. This should reveal the low hanging fruit. Modest tweaks to your finances can yield a significant boost to your free cash flow.
Dave Ramsey has made a career out of helping people get out of debt. His baby steps and debt snowball programs have helps thousands of people get out of debt and stay debt-free. I have witnessed many clients over the years benefit from Dave’s system. If you have debt you might want to consider looking into Dave’s programs. You can check out his books from the library if you don’t want to spend a penny. Financial Peace University is a good program. Or you can own his book The Total Money Makeover for under $12 at the time of this writing from Amazon. (Note: Many years back I was a Dave Ramsey Endorsed Local Provider in the tax field. Dave Ramsey is not an affiliate, but the Amazon link is.)
3.) Take the IRS Up on Catch-up Contributions
Once you reach age 50 the IRS allows you to supercharge your retirement savings. Congress made these rules because they stood behind me when I was working and quickly realized I was not joking when I say people get serious about retirement when the calendar stamps 50 candles on their birthday cake.
Of course, you can start before age 50, too. You can stash away serious money with a 401(k) or other retirement program. Once you are 50 and older you can top off your annual retirement contributions with an additional $6,500 in a 401(k), 403(b), 457 or SARSEP; $3,000 for SIMPLE plans; $1,000 for traditional and Roth IRAs (these are all 2021 numbers).
4.) Start a Health Savings Account (HSA) if Allowed
The HSA is one of the best financial tools in the tax code. If your health insurance is HSA qualified, be sure to contribute to an HSA savings account. Contributions are deductible. Withdrawals are tax-free if used for qualified medical expenses. You can’t use HSA funds to pay for health insurance premiums, but you can use them to pay Medicare Premiums. That means if your medical expenses are low your HSA becomes a wonderful tax-free tool as you prepare for retirement.
For 2021, you get a $1,000 contribution limit increase if you are 55 or older.
Consider Fidelity or other low-cost investment house for managing your HSA funds.
5.) Consult a Tax Professional
Most people reading this are not concerned about starting their financial plan; they already started and want to manage their finances to maximize benefits while reducing taxes.
Even in retirement taxes are still a major expense. Consulting with a tax professional is a high-value investment.
In my office I make it clear to clients I am not interested in saving them money for one tax year only. My goal is to get the lowest tax possible for all years involved combined!
Retirement is different than your working years. The rules change and the tax code is different once you push into the traditional retirement years. You spent your entire life looking at income and the slice you will dedicate towards retirement investments.
Now you need to balance Social Security income, retirement income, tax brackets, tax credits and more. Social Security benefits can be tax-free, but it is getting harder to accomplish that. This is where a good tax pro comes in. Required Minimum Distributions play a role. Pension income and capital gains, too. Tax professionals who can navigate the moving parts are worth their weight in gold.
Steps you take today will affect your taxes in future years. I consult with many clients approaching retirement and in retirement each year. It is always a profitable consulting session for the client. The moving parts are numerous. A seasoned tax pro can help you navigate the options. Your facts and circumstances determine your optimal path. One size does not fit all.
Insurance is a strange animal. Each person’s situation is unique. Your health will determine the health insurance policy best for you. Some people might need life insurance, many will not. What about long-term care?
Insurance has a built in profit for the insurance company. Insurance should not be considered a good financial investment. Instead, it is a tool to help manage and protect your wealth.
As your financial resources increase you might wish to increase the deductible on your policies. Depending on the value of your vehicle, you may wish to forgo collision completely.
Insurance gets expensive as you get older, especially health insurance. It might be a wise choice to have disability insurance or long-term care coverage. Your personal situation will determine the proper course.
Discuss the issues with your insurance agent and then have a disinterested third-party (someone not getting paid a commission for the sale of the insurance policies) to review the choices provided. A financially knowledgeable family member or trusted friend might be a good choice. Or, you can discuss the options provided by the insurance agent with a tax professional or attorney that is versed in these matters.
7.) Legal Matters
All the bad party jokes have attorneys as the butt of the joke. While attorneys get a bad rap, they are the most powerful tool out there in protecting your wealth as your nest egg grows.
Estate planning requires a legal professional. Do you need a trust? Will? Durable Power of Attorney?
Attorneys are also trained in asset protection. When you have only a small net worth there is less to worry about. Once you build serious retirement assets you need to take steps protecting those assets.
Finding a qualified attorney is the challenge. I use Legal Shield (not an affiliate) in my office. They can answer simple legal questions and refer you to an attorney specializing in the area of practice you need.
The biggest risk is not starting or starting too late. The second biggest risk is a financial disaster as your approach your retirement date.
You do not want a financial surprise after 50. There just isn’t enough time to recover as you get older. And who want to work forever anyway? (You might enjoy working, but you don’t want to be required to work over poor financial planning.)
Tax planning and legal help are vital. The key is to review each facet of your life annually once you reach 50: investments, health, tax, legal, et cetera. Several tools have been provided above. I encourage you to use them.
Retirement isn’t out of reach. You can do this. If you are looking forward to an early retirement you can use most of the tools in this post; if you are over 50 you can lock and load on powerful programs that supercharge your net worth.
It all boils down to a plan. With a proper plan retirement will be the blessing you dreamed it would be.
It is never too late to start.
More Wealth Building Resources
Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?
Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.
QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.
A cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.
As children we dream. We dream unfettered. We dream of traveling to the stars; we dream of life as a policeman, fireman or even a doctor. Some fall in love with numbers and can’t think of anything else. We dream of great discoveries as scientists or helping people reach their dreams and goals financially.
Then we grow up.
Society tells us we must prepare for retirement as soon as possible. The financial services industry breathes and dies by our willingness to buy into their story.
The news feeds are filled with stories of people who started early, saved hard and retired early. As someone living inside said community I notice a pattern. A large majority of people who take a knee at an early age—any age, in fact—go through a predictable pattern. Travel dreams are realized. Some want to golf or fish. After a while golfing or fishing all day becomes the job. Travel turns into a drag. Living on the road looks far more appealing from the outside.
Experiencing new destinations is what people really want. The actual traveling is sheer pain. I’ve never heard anyone say she can’t wait to be sealed inside an aluminum tube with her 260 closest friends for several hours.
Even with travel dreams alive, it is as common as weeds in a garden for people to pick up a side gig (some call it a side hustle) after the gloss of retirement wears off.
Then, there are people who find their calling early and live their side gig from day one. We call these people entrepreneurs or business owners.
Never Ending Story
Whether you find your calling early or after you retire from a “traditional” career, life is best when you discover what provides you the greatest joy. Once you find the activity you enjoy most you begin to build a life and habits around said activity.
Starting a business or side gig requires planning. The one issue rarely addressed is the exit plan. As I look down the barrel of my fast approaching 54th birthday I have to ask serious questions about my tax practice. What if I were injured or got sick? Either event could destroy what I spent a lifetime building.
As we age and accumulate wealth we quickly discover the need for a living will. I propose a significant percentage of people also need to consider an occupational living will.
Vision of the Future
Of all the employees I ever had, Bev is the only one still asked about every tax season. Bev hasn’t worked for me in seven years!
Bev was my first employee. Her skills and work ethic assured my efforts to build a firm were successful. Bev wasn’t the fastest, but she was consistent. And for the record, fast isn’t always better in taxes and accounting.
When I let Bev go it broke my heart. I wrestled with the decision a long time. Her abilities were more than adequate, but bitter Wisconsin winters were taking their toll. Cold air took her breath away. There were times Bev would need several minutes to catch her breath walking from the car to the office door. Her health was more important than a few more years of service.
Bev still comes to the office every tax season to get her return done. It’s a continuing fringe benefit for a rockstar employee. It’s always a good day when Bev walks in the door.
But there was another reason I asked Bev to retire.
When winter turns nasty and the hours long Bev felt the effects. She lost a step as tax season wore on. If the weather added to the stress I could chart the increase in errors.
I review virtually every return in my office. Some get a minor once-over and other returns get a proctology exam. Bev started to lose a step in her 60s when the workload increased and weather added stress. If only I found the fountain of youth to keep Bev at her post.
Dementia is an insidious disease. It approaches gradually. People around you may notice, but we have self-defense mechanism to delude ourselves. We are the last to know our quality is no longer up to par.
Bev is still mentally sound. Stress and health were the real deciding factors.
Lifetime of Love
I was lucky. I found the work I enjoy early in life. As a business owner I can choose my hours and workload within reason. This is a lifelong occupation. If I were to sell my practice I’d probably be doing taxes and consulting on the side within months. (Either that or Mrs. Accountant would hit me with a rolling pin as I started to bounce off walls.)
As much as I love my work I must accept the day may come when I’m no longer proficient at it. Worse, a car accident or cancer could end my ability to serve my clients. In the past the issue wasn’t as acute. The returns I handled back then were more traditional. Now I manage accounts from around the nation, all with advanced issues. Finding qualified staff has been a challenge. Dementia in unwelcome.
I’m not alone in this. The Washington Post had an excellent article dealing with these issues and it’s where I got the idea for this post.
The more you love your calling the less likely you want to retire from it. Unfortunately, the day comes when we no longer serve our clients adequately. That is where an action plan set into place well in advance can protect you, your family and your clients.
Occupational Living Will
Your facts and circumstances will determine the necessary steps in your occupational living will. Below are steps I’ve taken over the last several years in preparation for my demise.
- Create a business bible. Around the time Bev took the long walk I had a come to Jesus moment. I knew the day would come when my body couldn’t cash the checks my mind was writing. Every member of my office team was a part of building the office bible. Every task was outlined step-by-step. Should any employee be on vacation, quit, retire or become incapacitated, there was a guide for each process our company performs. We discovered the office bible is an excellent tool when we get in a bind and it gets regular use. It is also a part of the training process for new employees.
- Create redundancy. Certain people handle certain tasks. In a small office it is hard to have several people working on every project. While it is natural for one person to handle most issues around certain tasks, it is wise to train staff to have at least a working knowledge of other tasks. The increased payroll expenses should be minimal.
- Create a succession plan of ownership. This is hard for business owners. In my office if I’m ever unable to perform my duties I would lose the right to vote my shares. In effect I would lose control of my company to someone already in place and able to make the decisions necessary to keep clients serviced and the company alive.
- Train and train some more. It is almost impossible to over-train your team. Cross train so more than one person is competent in all areas of practice.
- Keep your family informed. Planning for dementia, accident or other disease is not the highlight of the day. Still, keep a copy of the office bible available to family members with additional information on operating the business. Remember, your family will be under serious stress if something happens to you. Provide a guide to make it as easy as possible for your loved ones in your time of incapacity. Be sure to inform family of pass codes and where the money is, including working capital, online savings accounts and lines of credit.
Here are considerations I’ve had a difficult time handling, yet MUST be addressed.
- Find your replacement. It is so easy for me to fall into the trap of I’m so good at what I do nobody can measure up. That’s ego, not intelligence speaking. Once upon a time I had a much larger staff. As my practice transformed into serving fewer clients at a higher level it grew harder to find experienced tax professionals to compliment my talents. My primary goal this year is to find my replacement. Instead of sending me out to pasture I can have more free time during tax season and a seasoned pro to compliment my tax skills. A true win/win situation.
- Work with peer/competitors. At first blush this one sounds stupid. But think about it. You already work with other professionals and businesses in your field. Start a dialog to build bridges for unforeseen personal events. It could lead to a sale or merger of your business. Or, it could compliment both businesses, reducing stress and increasing profits for all.
Estate planning is often put off to the detriment of family. In business it is even more important to plan ahead. Having trusted friends and family in place to guide you through an illness or dementia might be uncomfortable, but it is necessary if you care about your clients, employees, friends and family.
There are alternatives to retiring. Your workload can shift, be reduced or more focused. When you love your work as much as much as I do it is hard to plan for the day it will be reduced or completely out of your life.
But it is still the right thing to do.
Recently I discussed my net worth and how I went from a poor farm boy to an eight figure net worth. To keep the discussion moving I glossed over a few issues, most notably some of the vehicles I use to invest and protect my net worth from taxation. My sole mention of using trust instruments to protect net worth and save taxes caused several requests to hit my email inbox. People wanted to know more about trusts and how they can be used to super-charge net worth, provide guaranteed income, reduce taxes and protect against lawsuits stealing your hard earned money.
To which I mentally replied, “Is that all?”
A tax discussion on trusts turns into hard core tax planning quickly. Discussing all trusts is beyond the scope of a simple blog post and even beyond the scope of an entire blog. Too many variables are involved. What we can do in a single blog post is cover one trust topic enough to help you decide if it is right for you and get you to the right people to facilitate the process.
Today we will discuss an animal called the net income makeup charitable remainder unitrust, or NIMCRUT. It sounds like a derogatory name you would call someone in the heat of battle. Instead, the NIMCRUT, or even her sister the CRUT, is the perfect tool to get a massive tax break now, avoid paying capital gains on highly appreciated assets, help the charity of your choice and get a nice income stream—some of which might be tax free—for your entire life or a set number of years. Sound like fun? Then read on.
Highly appreciated assets face a large capital gains tax rate, currently topping out at 20% for federal, plus more in many states. To make matters worse, the alternative minimum tax is calculated using a 22 ½% capital gains rate.
Moving money from a long-term, highly appreciated asset to a higher income producing asset requires a serious tax haircut. The reason for the transfer of investments frequently revolves around income. The old asset has appreciated several fold, but has a low or no current income distribution. To access your net worth requires sale of a portion of or the entire asset, triggering a taxable event.
Basics of a NIMCRUT
A NIMCRUT is really a charitable remainder trust with a unique income makeup feature.
Once a NIMCRUT is established, assets are transferred into the trust. The trust sells the asset/s and since it is a charitable trust pays no tax on the gain. You personally did not sell the asset so you also pay no tax on the gain, nor is there anything to report on your personal tax return.
Because you donated to a charitable trust (a qualified nonprofit organization (the beneficiary) gets the remainder at some point in the future) you also get a tax deduction on your personal tax return. The tax deduction has to be discounted for the present value of the future gift. In the old days we used tables provided by the IRS to calculate our deduction; today we have handy online calculators linked at the end of this post.
Example: A 53 year old donating $1 million of stock to a NIMCRUT with a basis of $100,000 would avoid paying capital gains tax on $900,000, plus get a current tax deduction on Schedule A (subject to limitations) of $239,894. Any unused charitable deduction is carried forward up to five years.
The tax avoided and the additional deduction is a great start. BUT, you also get an income stream from the trust. Remember, this is not a straight forward donation to a charity. The charity gets the remainder at some point in the future. You choose how much income per year you want before the charity takes possession of the gift. The Tax Code requires at least a 5% rate with higher amounts allowed (up to 50%). A common rate is 7% and is used for our example above.
You also choose the term, either life or up to 20 years. The longer the term the lower the tax deduction on Schedule A.
CRUT or NIMCRUT
There is a difference between the two. Generally, a NIMCRUT only pays you from income, excluding capital gains. A CRUT can dip into the corpus to fund payments. The NIM part of a NIMCRUT means you can catch up, if you will, the missed portion of past payments.
Since many investments do not throw off a 7% income available for distribution, two investments rise to the surface: real estate and annuities. The rent is available to distribute to the annuitant (you).
An annuity inside the NIMCRUT can control the flow of funds. Income must be distributed up to the rate listed in the trust document. Previously missed payments are “made up” in years when the income supports the payment.
Since tax is due on all or most distributions, your personal tax situation might require more control over when you get paid and hence pay tax. The annuity inside the NIMCRUT can delay paying out; therefore, no income is available for distribution. When you need the money you can take your distribution by having the annuity pay out income to the NIMCRUT. (Special thanks to Putnam Investments for presenting the annuity strategy at a H.D. Vest Financial Services conference during the mid 1990s.)
Assessing the Benefits
Let’s add up all the benefits of a NIMCRUT before disclosing a few negatives.
First, you avoid capital gains on a highly appreciated asset. Most taxpayers will avoid 15% to 20% long-term capital gains tax with a NIMCRUT, plus state capital gains taxes. In our example, $900,000 of avoided LTCG adds to a $180,000 tax reduction at the 20% LTCG rate.
Next, you get a present value charitable deduction on Schedule A subject to normal limitations for the future charitable contribution. Our example shows a $239,894 deduction.
Assuming a 7% rate and no increases in value of the NIMCRUT investments, you will receive 140% of the original investment over 20 years. If the investments inside the NIMCRUT increase, your payment will too. Our example should generate $1.4 million over 20 years.
Normally you are the trustee so you determine the investments inside the NIMCRUT.
You control in a limited fashion when and how much you get paid. Most income from a CRUT or NIMCRUT is taxable. A portion of a CRUT might be exempt.
At the end of the term your named charity receives the remainder.
To keep the kiddos happy you can purchase a single premium term life insurance policy for the amount of the charitable gift with the tax savings from avoiding the LTCG tax. This is done with an irrevocable life insurance trust (ILIT).
If you die while the NIMCRUT is in effect the remainder goes to the charity, is added to your estate, but your estate takes an equal amount as a charitable deduction.
In sum, you avoid LTCG taxes on unrealized asset appreciation, get a deduction up front, receive income over your lifetime (single or joint) or a set number of years up to twenty, support your preferred charitable causes and give the kiddos a healthy legacy to boot.
Every strategy has pros and cons. A NIMCRUT is irrevocable. This means you can’t later change your mind. Well, you can change your mind, but there is nothing you can do about it. You must plan in advance for a NIMCRUT. The issues and process is complex and set in stone once in effect.
There are annual reporting requirements. At minimum a Form 5227 is required. Sometimes a Form 1041 or other tax forms are required. Few tax professionals are versed or experienced in preparing complex trust tax returns. You will need to find one who is.
You must have an attorney to draft the trust documents. No shortcuts here. An experienced estate attorney will smooth the process and inform you of issues pertinent to you while avoiding IRS scrutiny.
Large investments are required and large unrealized LTCG increase the tax benefits of the NIMCRUT. Realistically, anything less than $100,000 of asset value or $50,000 of unrealized gain to transfer to the NIMCRUT is inadvisable. $1 million of highly appreciated assets and greater put into a NIMCRUT yield excellent advantages to many high net worth taxpayers.
A CRUT usually allows corpus to be used to pay the annuitant, but yields fewer tax benefits. A NIMCRUT must have income from which to pay the annuitant (you). Many NIMCRUTs exclude capital gains from income in the trust documents.
The Next Step
It’s not all roses when planning a trust. Trusts are nor for everyone. They are powerful estate planning tools to carry out your wishes and serve your needs. It takes time and there are legal fees.
I intentionally left out a massive amount of information to keep to this post’s story line brief. Additional research is required even before you contact your estate attorney.
Here is an interesting article on NIMCRUTs you might find valuable.
Here is a NIMCRUT calculator. You can play with the numbers to get an idea of the tax benefits available. The same site has excellent calculators for a variety of CRUTs and CRATs as well.
You can read a bit more from the IRS on the issues discussed.
Finding a qualified attorney is an issue for many readers. Here is an article by a company that helps people set up charitable trusts. (Not an affiliate.)
Finally, if you want to read extensively before committing to a discussion with an attorney, here is a good book on the subject from Amazon.