VOICES FROM THE INDUSTRY: Taxes, school, health costs challenge affluent families

September 25, 2006

Affluent families face many threats to their wealth. But three forces eroding the legacies in almost all of them are taxes, education costs and post-retirement health care.

Fortunately, with proper planning, there are steps you can take to help ensure your wealth carries you through retirement comfortably with ample left over for your heirs.

Make taxes manageable

Taxes may be unavoidable but they can be managed in a way that makes them less destructive to your wealth. Specifically, the alternative minimum tax, or AMT, can be triggered or avoided by carefully evaluating certain taxable events.

For example, the spread between the market and exercise price of incentive stock options, interest on home-equity loans, and property and state income taxes are deductible from income for regular taxes, but not under the AMT.

Other items such as capital gains and compensation income from exercising nonqualified options alter reported income, which in turn affects exemptions and deductions with income phase-outs. Under certain circumstances it's actually possible to eliminate AMT liability by increasing taxable income.

What can you do? Every decision you make about investments and compensation must be considered in light of its tax ramifications. The best solution is to involve your tax accountant and financial advisor in your decisions.

Prep schools and beyond

Paying for tuition is by far the most common financial event for wealthy households. With steadily rising education costs, planning needs to start almost at the point of birth. Here are some options you should consider:

Financial aid and loans are available for private K-12 schools, college-prep boarding schools, and colleges, including merit awards and need-based scholarships.

529 College Savings Plans offer taxfree distributions if spent on qualified education expenses. You can also change the beneficiary at any time.

Coverdell Education Accounts are out of reach for many wealthy families, but may be an option for a grandparent who no longer generates a high income.

Education Assistance Programs allow business owners to help employees with education costs. Be careful here because there are very specific IRS regulations.

Health care: The big wild card

For most people, the cost of health care is the greatest potential threat to an estate. No one can control, or even predict, with any certainty, whether a spouse or other family member will experience a severe health condition that could eat up a major part of their wealth.

What can you do?

Understand Medicaid now and what you can do to qualify.

Explore long-term care insurance. Despite its high cost, many wealthy people purchase long-term care insurance to relieve their children of the burden, or to protect their assets, in the case of a chronic disability. For business owners, the premiums may even be tax deductible.

Calculate whether you can afford to fund your post-retirement health care costs from earnings on your investments.

Explore Health Savings Accounts, in which contributions are tax-deductible, earnings compound tax-deferred, and distributions are tax-free at any age if matched with approved medical expenses. The IRS does impose several restrictions.

Getting started

It takes time to accumulate wealth, so it makes sense to dedicate time to exploring ways to protect and preserve it. What can you do now? Start by managing taxes throughout the year and involve your tax accountant and financial advisor in all financial decisions.

Let grandparents sponsor a Coverdell Education Savings Account for your children. Use Health Savings Accounts or long-term care insurance wisely to prearrange your own elder care and relieve your loved ones of an unnecessary burden and expense.

And, most importantly, get your attorney, accountant, and financial advisor together at least once a year to review your financial situation and explore ways to save costs and preserve your legacy.

Nowak is vice president and Indiana regional manager for M&I Wealth Management in Indiananapolis. Views expressed here are the writer's.
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