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When you think of estate planning or legacy planning, most of us think about our kids but did you think about your spouse?  What happens if you’re a surviving spouse?  Are you prepared for the financial implications that a death of a spouse may have?  Well, joining us today is Jason Smith, Founder and CEO of Clarity 2 Prosperity, Prosperity Capital Advisors and the JL Smith Group, to discuss with us the dangers a surviving spouse faces with taxes and legacy planning.  Welcome, Jason.



Thanks for having me, Jim.



One of the biggest concerns facing Americans today is when one spouse dies, you have a widow or widower and I think a lot of them aren’t even aware of some of the dangers that affect them.  Talk about that a little bit for us.



Yeah, Jim.  You wouldn’t believe what I’ve seen over the years.  I have a tax practice and last year we did over 1000 tax returns, almost all of them individual tax returns.  Unfortunately, we have a lot of people pass away every year.  When that happens, the effects that I see on the taxes going up and just overall from an estate and legacy planning standpoint, income dropping, taxes going up and increased liabilities.  They didn’t have those same challenges as a married couple that they do as a surviving spouse filing alone.



I’ve always heard it saying, I talk to couples all the time and the things they don’t realize is if they have a house, property taxes don’t get cut in half.  The heating oil bill doesn’t get cut in half so one can’t live half as cheap as two.  You talk about the taxes.  There are a lot of different issues facing a widow or widower so what can they do about it?  Let’s start with the taxes.  What can they do to mitigate that risk?



Well, one of the things they need to do is they really need to get a base education, a little bit of a foundation of education of what is the difference of married versus single?  As a married couple, you have a standard deduction that’s almost double what it is as a single.  What does that mean?  It means that that’s income you normally don’t have to pay tax on.  Also, you get two personal exemptions on your tax return as a married couple.  It goes down to only one so that gets cut in half for a surviving spouse.  What’s a personal exemption?  It exempts you from a certain amount of income that you have to pay tax on so what happens is your taxes go up exponentially as going from a married person filing to a single person so some of the things that you can do.  First of all, you need to educate yourself on that.  You need to meet with your advisor and understand the effects of the difference in the two.  Second to that, there are a lot of different strategies you can implement.  One, a real simple thing you can do, is Roth IRAs.  Now there was a lot of hubbub a couple years ago in 2010 about Roth IRAs and people were wondering oh should I convert, should I convert because they changed a law where they released the $100,000 income limit so that way a lot of people could do the conversions and it was all over the newspapers.  Most no one converted.  Why didn’t they convert, Jim?



Well, they just don’t want to pay that tax.



They don’t want to pay the tax.  Exactly but what a lot of people don’t realize is there are two ways to get money into Roth IRAs because Roth IRAs are the best thing, in my opinion, since sliced bread.  I mean it’s money you can put in and it never gets taxed again.  It grows tax free but the first way to put money into a Roth is a conversion.  A conversion means you take your existing IRA or 401(k) and you convert it over into a Roth and you owe a ton of taxes if you do that.  That’s what most people don’t want to do but there is a second way that you can go about it to get money into a Roth and it’s a contribution.  Now a contribution means you’re just taking some money in the bank or from one of your other accounts, not an IRA account, and putting it into a Roth IRA.  That shelters it from all future taxation going forward into the future so a contribution is a very easy way that people can get money into a Roth tax status without trying to pay a bunch of tax on a Roth conversion.



That’s fantastic because of course with those tax advantages, the more time you have to preplan before you lose your spouse and build wealth within that tax advantage container, you’ve given your surviving spouse incredible leverage for the future because as you said, most of the time, you’ve seen in your tax practice, surviving spouse’s tax rates increase.  What about just addressing for a minute, Jason, the reality or the history of taxation.  We all try to educate our clients that taxes are actually at a historical low and I don’t think a lot of people have felt those highs of the past or can really perceive what those highs might return to in the future.  Just address that for a moment.



Yeah, that’s an excellent point, Tony, and a lot of people don’t realize.  If you go back to the very beginning of when income taxes started, we are at historical lows right now and people just don’t even realize that that’s the case.  If you look back to 1913 with Woodrow Wilson is the first time that income taxes were introduced into the system.  They were relatively low at first and then what happened is we got into the Great Depression into the 1920s through the 40s and believe it or not, basically after the Great Depression, the taxes in 1945 got as high as 94%, 94% in the highest bracket.  Just to give you an idea, right now our highest level of taxation is 39.6% so 94%.  What I believe is going to happen, what a lot of tax historians and people that we follow, is that if you look at the charts and you can Google this on the internet.  It’s real easy to get one of the charts going back to 1913 but there was only one period in time that the taxes were lower than they are right now currently and that was right before the Great Depression.  After the Great Depression, they got as high as 94%.  There were decades that they were in the 70s and 90s and then when Reagan came into office back in 1981, they started dropping down and got back to pretty much real close to where the levels are still today.  As we look at what’s going on in this economy and we look at the debt we’re accumulating and we look at where social security and Medicare and everything else, the state of the economy going forward into the future, what you have to ask yourself is do you believe taxes are going to be higher or lower in the future.  If you believe they’re going to be higher, they’re going to go back up to get our country out of the state that it’s in right now, then you really need to consider starting to utilize what the government gives you, which is an option to shelter your money from future taxation into Roth tax status.



As a financial advisor, a lot of times you’re talking about diversifying between stocks, bonds, real estate, all these different things.  You never hear anybody talk about diversifying how things might be taxed in the future and too many people as you talk about this take an all or nothing approach.  You don’t have to do all Roth or all traditional.  You can balance these things out by diversifying so if tax rates go up, you have the Roth to pull from.  If tax rates stay low, you’ve got the ability to take money out maybe at a lower bracket when you retire.  A lot of these things if you do the lunchroom advice, I constantly get people that come in and say well I talked to all the people at the office or I talked to all my family members.  I said did you go through your tax return, your brackets and how much you have saved compared to what they have saved?  Did you look at what social security benefits you’ll be eligible for?  Well no.  What good is that advice?  It’s not based on anything factual that’s specific to that individual so you really have to sit down with your team of advisors and figure out what’s going to be best for you and maybe you hedge the bets, so to speak, and just diversify and have a little bit in each.



That’s an excellent point, Jim.  It makes me think about a few minutes ago when I was talking about the difference.  If you want to get money into Roth tax status, there are two ways to do it.  You can either do contributions from the bank or a non-IRA account or you can do conversions from your IRA.  Well, one of the biggest misconceptions that I see out there is people think if you do a conversion, meaning your existing IRA or 401(k) and you want to convert it to a Roth, that it’s all or nothing and it absolutely is not all or nothing.  You can do partial conversions and that, in my opinion, is the best way to do it from a tax planning standpoint.  If you sit with your financial advisor, sit with your CPA, they do this every day.  They can show you how much room you have on your tax return as a married couple, where you have a lot more room and flexibility, where you can do a partial conversion.  Maybe only take $5000 or $10,000 or $15,000 or $20,000 from that big IRA or 401(k) and do a partial conversion over into the Roth by still staying in your current tax bracket.  People don’t realize you can do partial conversions.  It’s not all or nothing.  Keep yourself in the same tax bracket you’re in right now but wash out that tax liability for the future so that way, as a surviving spouse, you have that diversification in your portfolio because you have that block of Roth money that’s already been taxed grows tax free into the future.



You know, Jason, the reason that makes so much sense is with the historical that you just did on tax rates and again where our current economy is approaching $17 trillion in debt, back when we had those high tax rates, we didn’t have that kind of government debt so if you have to try and predict the future, which none of us can, and we see the trends of the past of taxation, if you’re able to, as you say, I love the term because I use the same, wash it through the tax system at today’s predictable and we certainly know low rates, at least you’re protecting it from what appears to be likely tax increases in the future.  Hey, we’ve got to take a short break and when we come back, let’s also transition now from the tax dangers to the legacy dangers.  Please stay tuned.



Welcome back.  As we continue a very informative conversation today with Jason Smith, who is the Founder and CEO of Clarity 2 Prosperity, Prosperity Capital Advisors and the JL Smith Group.  You’re a seasoned advisor out there who also owns his own tax practice so you’ve seen right in front of you the impact and the dangers that a surviving spouse faces with taxation and legacy planning.  Before the break, we were focusing on some of the tools and tips and ideas to think about in preplanning for when a spouse passes and the impact to that surviving spouse with taxation.  Now let’s transition if we could, Jason, with the time we have left to the legacy issues.  Now most people think legacy planning means designing your plan to leave it to the heirs but quite frankly most of us don’t die simultaneously today.  Let’s talk about designing the plan first to take care of the spouse who survives.



Thanks, Tony.  That’s the other thing I run into so often is people think oh, legacy planning, estate planning, I don’t need to do that, whatever is left is left for the kids.  Legacy planning and estate planning is not just for the kids.  It’s for your surviving spouse and some of the biggest mistakes that I see people make from a legacy planning standpoint for the surviving spouse as well as for the kids but number one.  Going back to the tax because they really interrelate, I see people every single year that actually have room on their tax bracket where they could pull money out of IRA or convert it to a Roth and pay zero, zero dollars in taxes and people think that’s unheard of but as a married couple because of those additional personal exemption room by having double and the higher standard deduction, in many cases you’re able to actually wash out the tax liability at zero where as a single person surviving spouse, you’re absolutely going to have to pay tax if you pull that money out and you can bet that your kids will too.  The second big mistake that I see very often with a husband and wife is they don’t get their legal documents updated.  There was the Health Insurance Portability and Accountability Act, the HIPAA law that passed years back and many people got their legal documents drawn up prior to HIPAA and so many of those documents are outdated.  I recently had a client come through and tell me a horrible story.  They were taking care of their mother.  The legal documents were outdated and they literally could not get access to the medical records for a specialist to make an on the fly basically decision over the weekend that they needed to make, the fact that they didn’t have the right documents signed, they could not gain access and the medical professional in hindsight made the wrong decision and their mother passed away.  It was just a horrible story but I can’t tell you how many times I’ve heard, and I’m sure you guys have too, by not having the proper legal documents updated, you can really affect your surviving spouse by them not being able to access the medical records and give you the type of care that’s needed.  The third thing that I see from a legacy planning standpoint is I was preparing to come on the call with you guys and I knew we were going to talk a lot about taxes.  I pulled a return that we did this previous year for a client that was a single filer.  Her husband had passed away.  We did both of their returns the previous year.  The previous year compared to, I just couldn’t believe the drastic difference.  They needed about $60,000 to live and you know what, when he passed away, she found that she still needed about $60,000 to live.  Things really didn’t change much in regards to her income.  For her to get that same $60,000 to continue her lifestyle the way she was accustomed to, the taxes went up 63% from the married filing jointly her and her husband to what she had to pay as a surviving spouse.  Unbelievable huge increase, 63% increase in tax liability.  So many people do not realize the dramatic increase in tax liability the surviving spouse will take.  Lastly, I’d say the biggest other mistake or danger that people overlook is on top of a 63% tax increase, this woman also suffered a 33% drop in her social security income because they were receiving $1800 was his and $900 for hers.  It was actually a total of $2700.  When he passed away, she then lost her social security benefit and claimed on his because his was higher, you get the higher of the two, so she continued to receive the $1800 but lost her additional $900 so her income dropped by 33%.  If you can imagine as a surviving spouse, it’s enough of an emotional burden but to also face a 33% drop in income and 63% increase in tax liability.  So many spouses just don’t realize that that’s the truth of what happens.



A lot of people who aren’t into the social security realm, I ask do you know when social security becomes taxable so as you talk about higher brackets, you can make a lot more money as a couple versus a single individual because of a phase out of less deductions for a single person and you got the brackets are more compressed.  Then you have social security where it becomes taxable and up to 85% of your social security can be subject to your tax rate so if all of a sudden more of your social security is subject to a higher rate, that’s where you could have a 63% increase in what you’re paying in taxes and we see it all the time.  You talk about the Roth conversions.  I know Roths have been available since basically January 1, 1998.  The law was passed in 1997.  I’ve been in practice long enough that when that passed, we started taking advantage of couples’ situations where they had what we call negative taxable income.  They had enough deductions where they could maybe pull $10,000 or $15,000 or $20,000 out of their IRAs completely tax free, convert them to a Roth, and we’ve got clients that now have $150,000, $200,000, sometimes even $300,000 where they got the full deduction on the contribution all those years, were able to convert it with no tax, and now not only is it coming out potentially tax free for them, it’s going to come out tax free for the surviving spouse and be left to the heirs tax free.  It’s one of the most powerful planning tools there are and I know when we sit down with couples that have traditional-type retirement accounts, we ask them have you ever looked at a Roth conversion.  Have you ever really done an analysis and they may have done an analysis way back when and it was an all or nothing proposition and right way they made a decision it never makes sense but there are so many opportunities there that can happen that can make it very affordable and sometimes tax free to do those conversions.



Jim, have you ever noticed that financial advisors are typically better tax planners than the actual tax preparers typically are?



Absolutely.  We sometimes refer to that do you have a tax planner or tax preparer because the preparers just take your information and tell you what you owe.  The planner will say hey, based on this, here are some opportunities you might want to consider this year.



I always like to say there’s a difference between proactive tax approach and a reactive.  The reactive tax approach goes to H and R Block, goes to the accountant or CPA or whoever it is.  They punch in the numbers and they say this is what you owe.  The proactive tax approach is sitting down with your financial advisor, looking at your whole holistic and comprehensive plan, your tax, your insurance, your financial, your legacy planning, everything, and proactively doing the tax planning because it all ties directly together.  I heard a phrase one time and I really liked it.  It said there are two tax laws in America.  There’s one for the informed and one for the uninformed.  That’s the thing is you’ve got to get with your advisor.  You’ve got to get educated on these things because there are strategies out there that people don’t even realize that they’re completely overlooking.



Amen.  Well, listen, with the few moments we have left, let’s go ahead and touch on one legacy again planning issue, which is life insurance between the husband and wife.  Talk about that.



One of the things that I’ve noticed, life insurance for a lot of older people is almost like a dirty word.  They look at life insurance as something they did when they were younger as a necessary evil to pay off the mortgage when they passed away.  What a lot of people don’t realize is that you still have a mortgage right now but that mortgage is taking a different form.  That mortgage is the tax time bomb that you have with your IRA.  That tax time bomb eventually will go off on your surviving spouse or it will go off on your kids.  You want to look at life insurance as a way that you can purchase that in order to pay off the mortgage, basically pay off the liability that you have with the federal government because people don’t realize whether you know it or not, you are in a partnership with Uncle Sam and currently Barack Obama.  You are in a partnership with them and there’s only one way to get out of a partnership.  You’ve got to buy yourself out of it.  You’ve got to buy the partner out and you can buy the partner out by slowly doing partial conversions of your taxable IRA into a tax-free Roth IRA.  The other way is you may not be able to do that over your lifetime.  You might want to completely diffuse that bomb when you pass away and that’s purchasing a life insurance policy to pay off the government and get completely out of that IRA’s tax liability when you pass away.  The most beautiful thing that I have loved, the biggest innovation that the insurance industry has done over the last five or ten years is they now will allow you to use the death benefit of your life insurance policy for long-term care purposes.  They’re specific type of policies you’d have to ask your financial advisor about but how wonderful is that.  Let’s say at the end of your life, God forbid you end up in a nursing home or needing home healthcare or assisted living, you have that life insurance death benefit that is there to pay for all your long-term care expenses and then ultimately when you pass away, even if you didn’t use long-term care, that money is there to pay off the government and pay off that tax liability on the IRA.



All excellent points, Jason, and one other new innovation that’s just come out in addition to the long-term care rider is you now can have a critical illness rider that could pay the death benefit just upon diagnosis of things like a stroke or Alzheimer’s or cancer.  I’ve always heard people say well, what do I want life insurance for, I have to die to collect.  Well, no dead person has ever collected a check.  It’s for the people you love that you leave behind and sometimes having that money before the event happens can be important as you mentioned in long-term care or could be in critical illness.  Jason, we just want to say we really appreciate you taking this time with us and shedding light on a very important subject that I think most people fail to plan for and that’s what happens when one spouse dies.  Sit down with your financial advisor if you haven’t already and anticipate what that impact might be for your life and see if there are some opportunities that you can take advantage of to better prepare that surviving spouse to face life as they go forward.  Thanks, Jason.



Thank you for having me.



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