By Allen Giese, CLU®, ChFC®, ChSNC®, and Gary Gonzalez
Over the next decade, the U.S. is expected to experience a historic transfer of wealth: Over $31 trillion will be passed down through inheritance. And over the next 20 years, that number more than doubles to something more than $72 trillion. If any of that might be coming your way, it’s worth asking: Does that change how you should be thinking about your FRS retirement plan? Let’s take a closer look.
The reality is, right now, despite being only 20% of our country’s population, baby boomers hold half of all the wealth in this country, according to Federal Reserve data. And they’ve done really well with it! It’s in real estate, retirement accounts, stocks, and mutual funds and small businesses. But the Boomers are also hitting life expectancy and starting to die off, and all that money is flowing down to the next generation, to millennials and Gen Xers—to you.
If you’re one of those next gens with boomer parents that have done well for themselves—and a lot of you are—then you need to consider how this money changes things. Because I promise you, it does. For starters, it can help solve one of the biggest problems you have with an FRS retirement, which is that everything, or nearly everything, you have coming in at retirement is going to be subject to some pretty serious taxes. So, if you’re on the fence about switching to the investment plan over the pension plan, then this might be the thing that makes the difference and makes that investment plan a whole lot more attractive. Or, if you're concerned about the future tax hit on your DROP account, this may be the thing that saves you a lot in future taxes. Here’s why.
If you know you’ll be receiving a sizable inheritance, even down the road a ways, and depending on the type of assets you’ll be receiving, it may give you the opportunity to draw your retirement income from an asset that has very little taxation—or at least, for part of your income. For example, assume Mom and Dad were good savers and had a nice brokerage account filled with stocks and maybe even some bonds. Even though Mom and Dad may have been paying a hefty capital gains tax on all that growth while they were alive, when they die, the tax basis gets stepped up. That means that, for tax purposes, all the gains you would have owed taxes on get erased, and you inherit the whole account, but it only gets taxed on capital gains from the realized growth from that day forward. Like I said, all the previous gains disappear from a tax perspective. It’s a huge loophole, and it’ll allow you to draw your income from that account, pay very little in realized gains, allowing your FRS Investment Plan or DROP to continue growing tax-deferred.
It also gives you the opportunity to rethink a little bit how you invest and what type of investments different kinds of accounts hold. For example, if you get penalized for higher growth in an IRA or investment plan with higher future taxes, then maybe you want your assets with the highest growth potential outside of the investment plan or IRA. And the things that pay high dividends and spin off higher income and thus taxes now, well, maybe you want to put those things in your IRA or investment plan, where that kind of taxation is protected.
In effect, you’ve done two things: You’ve transferred the future growth to a lower-taxed environment that focuses on lower capital gains taxes rather than higher ordinary income taxes. Plus, you’ve put the lower-growth items in an IRA, stifling its future growth, meaning you pay less later and have lower required minimum distribution amounts. It’s called having an asset location strategy, and it forces you to think of all of your accounts as a whole but to consider the different types of taxation that occur in each of them. It’s a little confusing, but when it’s done by somebody competent, it can be so powerful!
And if you really want to take it up another notch and further reduce future taxes which will one day have to be paid on that FRS investment account or DROP account, you can look at additional techniques of using Roth conversions now and even qualified charitable distributions later to strip out the taxes on future growth in your investment plan as well as use any charitable giving you might be doing, even if it’s just the regular donations you’d make to, like your church for example, to beat the tax on required minimum distributions that’ll come along in your 70s.
Like I said, there’s a lot going on here, and it takes someone with some experience and knowledge about how different things get taxed and how it all works. So if there’s a good chance you’ll be part of that big wealth transfer that’s occurring over the next 10 to 20 years, come in or set up a Zoom meet for a chat and talk to one of our fiduciary advisors. We’ve got nothing to sell you, so nobody’s going to suggest you buy an annuity or life insurance policy—just a good discussion on how money works and how to make better decisions around it and if we might be able to be an asset for you. Give us a call—I’ll bet you’ll be glad you did!
Thanks for watching, and be safe out there.
Sources
Federal Reserve DFA: generation-level wealth share charts https://www.federalreserve.gov/releases/z1/dataviz/dfa/distribute/chart/?utm_source=chatgpt.com#range:2010.1,2025.1;quarter:142;series:Net%20worth;demographic:generation;population:all;units:shares (click on the toggle “Distribute by” and make sure is says “Generation”)