This article originally appeared in the November 2009 issue of Smart Business Philadelphia magazine.

As executives approach retirement, they need to be comfortable that their team of professional advisers can focus on all of their needs.

"Advisory teams should include their investment, tax and legal advisers and at least one of these should have a specialty in estate planning," says David E. Shaffer, director in the Auditing and Accounting group of Kreischer Miller. "If net worth and cash flow are greater than what is required to meet the family’s core needs, the investment adviser also should be knowledgeable regarding wealth transfer strategies."

Smart Business spoke with Shaffer about how executives can develop a secure plan as they prepare for this new life phase.

What should the focus be when first considering a retirement plan?

A retirement plan should first address cash flow needs. The plan should be routinely revisited to make sure the core assumptions have not changed and new strategies are considered.

A key consideration is the amount of liquid net worth needed to maintain the family’s current lifestyle. This is determined by the estimated spending at retirement, the ages of the family members and significant financial needs prior to retirement, such as education for grandchildren, etc. Any unique circumstances — for example, handicapped children — must also be evaluated, and future windfall liquidity proceeds expected, such as inheritance or sale of a business, must also be considered.

Based on these considerations, the advisory team should be able to calculate how much net worth is required and the estimated annual needs of the family.

Historically, these factors have been based on a ‘typical’ portfolio of 60 percent stocks and 40 percent bonds, but this mix has not proven to be a long-term strategy. Today’s market considerations may indicate a different mix.

What are the key points that the advisers will consider?

  • Life expectancy: As of 2000, a couple that reaches the age of 65 has a 50 percent chance of at least one surviving past the age of 92 and a 25 percent chance of at least one living beyond 97. Planning for a retirement of 20 years is no longer sufficient, and for early retirees, four decades are possible.
  • Spending rate: How much per year can the retirees spend from the beginning principal? Typically, we see advisers using annual spending rates regarding principal per year ranging from 3 to 6 percent. Data shows that at a 3 percent spending rate, a retiree has a greater than 90 percent probability that funds will last at least 43 years. If the rate is increased to 6 percent, the amount of time is reduced to 16 years. Prior to the decline in stock values, many questioned a spending rate of only 3 percent when their portfolios were getting at least a 6 percent return per year. Now, after the most recent declines, many are wishing they had planned using the 3 percent rate.
  • Tax rates/mix of investments regarding retirement: Will the retirees be subject to tax on the proceeds that are being set aside for retirement, and what tax rate should be used for any taxable distributions, other taxable income, and/or capital gains transactions? At this point, income tax rates are likely going to increase, but no one has the crystal ball to determine what the final outcome may be. Assumptions should be based on a worst-case scenario since we are talking about how much ‘core capital’ is needed to maintain the family’s lifestyle. We are proposing a rate of 39 percent for ordinary income and a 20 percent capital gain rate, at a minimum.

How much is the current estate tax?

There is a 45 percent estate tax on all estates that have net assets in excess of $3.5 million, the exemption amount. In 2010, this tax rate is repealed to zero and, in 2011, the exemption amount is scheduled to be reduced to $1 million and the tax rate is scheduled to increase to 55 percent. Almost all advisers believe that prior to Dec. 31, 2009, Congress will amend the law to at least keep the 2009 exemption equivalent of $3.5 million and the 45 percent rate. There is also a generation-skipping tax (GST) for gifts made to individuals two generations or more below the retiree, such as grandchildren or nonrelatives more than 37.5 years younger than the retiree. The GST tax exemption is approximately $2 million.

What are some ways to minimize GST, gift and estate taxes?

  • Credit shelter trusts: For married couples that have net assets in excess of the exemption amounts, the retiree can create a trust at the first spouse’s death up to the exemption amount, effectively doubling the exemption for married individuals if assets of the respective spouses are properly titled. Typically, an attorney can draft these documents to satisfy the technical requirements.
  • Annual gifting: Both a husband and wife can gift up to $13,000 each without reducing the estate tax exemption amount. At a minimum, families with high net worth should be making gifts annually to children/grandchildren to reduce the amounts of estate tax that may be due in the future. These gifts should be assets with the greatest future appreciation value, for example, interests in closely held businesses that may be eligible for valuation discounts.
  • Pay tuition and medical expenses for another individual: The retiree may pay these expenses gift-tax-free without using the exemption equivalent amount, as long as the retiree makes the payment directly to the school or medical provider.
  • Other potential strategies: Qualified domestic trusts, qualified terminable interest property trusts, irrevocable life insurance trusts, grantor retained interest trusts and dynasty trusts should all be considered. These are complex alternatives, but, when properly used under the right circumstances, can significantly reduce the estate tax burden.●