Financial Fragmentation Series – Part 3: How to Avoid or Minimize Financial Fragmentation

July 14, 2021

This is the final post in our Financial Fragmentation blog series. To view the previous post in this series, please see here.

Reviewing your financial plans and goals on a regular basis is especially important for successful financial planning. To finish our Financial Fragmentation blog series, we would like to discuss a few important considerations to make when planning for retirement, your estate and college education expenses specifically. Keeping these considerations top of mind and reviewing your circumstances regularly will help you to avoid financial fragmentation.

Retirement Planning

How much can you comfortably spend in retirement? If you’ve accumulated an investment portfolio for retirement, how do you know how much you can safely withdraw without worrying about running out of money? Once you’ve made this determination you need to decide from which accounts you should withdraw the funds. Most retirees have tax deferred balances (401K or IRAs), on which withdrawals will be taxable (and are eventually required to be distributed). There are sources of income such as social security and, for a lucky few, pension benefits which are also taxable. Finally, other accounts may hold accumulated investments that pay dividends or interest and may result in capital gains if they are sold. There are a lot of moving parts and making the best tax effective decision is anything but simple.

Social Security Claiming Strategies:

When should you and your spouse claim your benefits? If you can wait until age 70, your benefits will be much higher, but for a shorter period of time. While we recommend deferring benefits until age 70, your circumstances matter. Your retirement needs and your life expectancy matter.

Tax Implications for Medicare Premiums: 

Most folks don’t realize that their Medicare premiums are affected by their taxable income. This may also be managed in the proper circumstances.

Estate planning

One of the most important considerations is to make sure you have the right people in the right places. This includes beneficiaries, executors and trustees, along with appointments for medical powers and powers of attorneys. A regular review of wills and other estate planning documents can serve to focus on the provisions in your documents and make sure that things haven’t changed since you originally prepared them. We often find outdated documents which require changes to meet clients’ current wishes.

For example, an appointed executor may be deceased or unable to carry out the required duties. Many times, we find that children, who were too young when earlier wills were signed, may now be capable of taking on the role.

Also, children may have matured since the last version of your planning and perhaps trusts are no longer necessary.

For older folks and their beneficiaries, it may be important to plan around existing assets with large capital gains. Under current law, assets held by a decedent’s estate receive a step up in basis to date of death values. So, it may be sensible to avoid selling highly appreciated securities for those later in life. One writer suggests that “this is the closest thing to a free lunch, in the tax world, that you can get.”

Planning for changes in tax laws is important. For example, the current lifetime exemption from estate and gift taxes is $11,580,000, but this law is scheduled to expire in 2025, when the exemption returns to $5 million. There are also several current proposals to make substantial changes to taxes in this area. It will be best to pay attention to this.

Taxpayers can make a big mistake by ignoring “portability” and not filing an estate tax return for the first deceased spouse. Any unused exemption (see above) from the estate of the first spouse to die can be carried over and added to the exemption for the second spouse to die. So, spouses can collectively pass along more than $23 million to their heirs without estate taxes.

For wealthy taxpayers who would like to reduce their estate, it may make sense to make annual gifts to their children and grandchildren, as annual gifts of $15,000 are not subject to gift taxes.

College Education Planning

Many parents and grandparents are interested in tax advantaged savings plans to provide for education for their children or grandchildren. These accounts, known as 529 accounts, provide tax free growth and tax free withdrawals for qualified expenses. Costs of higher education are daunting and this is a great tax efficient way to help. Education expenses can also be provided through annual or periodic gifts to children or grandchildren. We often suggest a combination of these two strategies.

So, that’s a lot to consider and it’s not everything, but it’s a good start. There is plenty of room for error if you miss something important, so thoughtful, comprehensive planning is very important.

As we’ve said before, the solution to financial fragmentation is to make a point of reviewing your financial plans and goals on a regular basis. Changes to your plan could be warranted if you’ve experienced a life-changing event such as the sale of a business, birth of a child, death of a loved one, inheritance, marriage, or divorce.

You can coordinate this review on your own, or with the help of a financial advisor. At Horizon Wealth Advisors, we make it a practice to meet with our clients on a regular basis to provide continuity and to make sure their financial plans are reviewed and revised in a timely manner and in accordance with their changing circumstances and changes in the tax or regulatory environment.

This sort of planning is fundamental to our services at Horizon Wealth Advisors. All of the examples we’ve discussed come from our actual experiences with clients and their families. Also, this list is not comprehensive. There are many solutions that are applicable to clients with particular circumstances and goals. As they say in that well-known insurance commercial, “We know a thing or two because we’ve seen a thing or two.”

If you’d like our help solving your particular financial puzzle, please call and we’ll be glad to explore how we can help.

Larry Maddox, CFP®, CPA

Larry founded Horizon Advisors, LLC in Houston, Texas in 1999 with fellow business partner Joe Thomson. He collaborates with our wealth management team and other external advisors to provide comprehensive wealth management services.