When each asset in your portfolio is well-aligned with its intended purpose, it helps to unlock opportunities to increase your after-tax wealth potential. (UBS)

If you and your financial advisor have determined that some of your assets won’t be needed during your lifetime and can, therefore, afford to give them away—whether it’s deliberately through lifetime gifts, or simply the residual balance remaining at the time of your passing—you'll also need to decide which assets you’ll use for inheritance and philanthropy objectives.

Tax efficiency and liquidity are particularly important considerations when building a strategy to efficiently fund each of your goals.

For example, some assets and accounts—such as Roth IRAs—are tax-efficient for funding lifetime spending and inheritance goals because you’ve already paid income tax on the contributions and distributions are generally tax-free. By the same token, these assets aren’t as attractive for funding charitable goals because charities don’t generally pay income taxes and thus the tax-free income would be “wasted” on them.

When identifying which of your assets are best suited for funding your lifetime spending versus other goals, here are a few important considerations (this list is subjectively ranked, based on tax and liquidity considerations, from best to worst for funding your lifetime spending needs):

  • Health Savings Accounts: Triple tax-free for funding lifetime qualified medical expenses. Loses income tax-free status if inherited by non-spouse beneficiary, so the second-to-die spouse should leave to a charity or a beneficiary in a lower income tax bracket.
  • Disability insurance: Useful as human capital insurance (Income replacement in case of disability) during working years. Not a resource for retirement spending.
  • Long-term care (LTC) insurance: Protects against the risk of significant lifetime LTC expenses. Hybrid LTC/life insurance solutions may help with inheritance goals.
  • Annuities: Income is usually taxable, but useful for funding lifetime spending and giving. Death benefits are generally taxable income for beneficiaries. Certain annuity structures are useful for lifetime philanthropic giving.
  • Traditional retirement accounts (401(k)s, IRAs, etc.): Especially useful for early retirement spending, when taxable income is low. Qualified Charitable Distributions allow for tax-efficient lifetime donations. Unlike heirs, charities don't pay income taxes on bequests.
  • Roth retirement accounts (401(k)s, IRAs, etc.): Income tax-free Roth distributions are useful for lifetime spending or inheritance, but less useful for charities.
  • 529 accounts: Tax-free growth to fund your family's educational expenses across generations.
  • Life insurance: Useful as human capital insurance (Income replacement in case of death) during working years. Can help to defer taxes on investment earnings. Cash value can be tapped for retirement spending. Death benefits are income tax-free.
  • Taxable accounts: Unrestricted access to funds. Appreciated securities can be effective for charitable donations or as gifts to family in a low tax bracket. Beneficiaries can benefit from step-up in cost basis.
  • Estate planning vehicles (e.g., irrevocable trusts): Move growth out of your estate, use lifetime gift tax exemption, control/direct the use of funds by your beneficiaries.
  • Small business stock: Giving small business equity to family helps to retain control of the family business beyond your lifetime. As an illiquid asset, it may not be as valuable to beneficiaries as other assets. Can give non-voting shares to charity.
  • Private market / illiquid investments: Illiquid investments can help to boost return potential. Can be a hassle for charities and beneficiaries to manage.
  • Real estate & Real assets: Can be a hassle to manage and costly to liquidate. Income tax-free (due to step-up in cost basis) if inherited.
  • Philanthropic vehicles (e.g., Donor Advised Funds): Fund with appreciated securities. These strategies can help you to boost the impact of lifetime gifts and establish charitable funds that last beyond your lifetime.

When each asset in your portfolio is well-aligned with its intended purpose, it helps to unlock opportunities to increase your after-tax wealth potential, efficiently support your retirement spending, manage the tax cost of transferring wealth across generations, and maximize your potential philanthropic impact. To segment your wealth by purpose, we recommend following this simple process:

  1. Prioritize the assets that should be earmarked for your lifetime spending needs.
  2. Earmark specific assets that will help you fund your specific lifetime giving goals (charitable donations as well as lifetime gifts to family).
  3. Work with your financial advisor to confirm that you have earmarked enough resources to achieve all of your lifetime goals with a high level of confidence.

After these steps, you will be able to view the other assets on your balance sheet as excess wealth. If you’re not happy with the level of your excess wealth, you may want to revisit your goals and the steps above before finalizing your wealth segmentation plan. Once you are happy with the balance that you’ve found, you can begin to unlock hidden opportunities that will help you to get the most out of each part of your net worth.

For example, you may find opportunities to enhance your investment strategy, such as adding annuities to your lifetime spending assets to reduce the risk from market volatility, or revisiting life insurance to meet specific inheritance goals.

During this process, you may also decide to accelerate some of your gifting so that you can enjoy seeing the impact that it will have on your family and your community.

This framework may also help you to identify better ways to meet your inheritance and philanthropic objectives, and reflect these intentions by updating your will, trust documents, beneficiary designations, and other important documents.

Main contributor: Justin Waring

Learn more: