Milestone 9: Total Financial Independence

Milestone 9: The End of The Road – Total Financial Independence

At this point you’ve completed all of the previous milestones on our Next Dollar Roadmap:

You made it. You’re on easy street now my friend. This is the financial place you’ve been aiming for all your life: TOTAL FINANCIAL INDEPENDENCE!!!

Congratulations! You’ve done great and now your worries can shift from accumulating enough to keeping it safe, giving strategically, and preparing to leave it to your heirs.

Unfortunately, decisions at this stage can become even more complex. It’s time for estate planning, giving strategies, tax planning, unique insurance needs, etc.

Let’s hit a few of these at a high level to get your cognitive juices flowing, but a lot of things on this post may require professional help from a financial planner/advisor or legal counsel.

Giving Strategically

Why Give?

Giving makes you a kinder and all-around better person. Most people get a lot of joy out of it too.

Although not previously listed on the Next Dollar Roadmap, giving is something we’d recommend that you do all along your journey, even way back at Milestone 1, even if it is only a small portion of your income.

The reason is the way giving to others reminds you that it’s not all about you.

Ultimately, your life needs to mean something more than a daily grind to see how much cash you can accumulate right up until it all comes to an end.

And then what? As they say, you can’t take it with you.

So, instead of giving your executor or trustee the pleasure of blessing your decedents and charities with whatever fortune you manage to accumulate, why not enjoy giving it away yourself, while you’re still alive to see it?

Odds are if you are charitably inclined, you’ll also want to be sure the dollars you donate are making a maximum impact.

First, you need to vet your charity or recipient to make sure they’re trustworthy. We’re not going to spend any time on that here.

Next, just like you try to manage your income in a tax-efficient manner, you’ll want to ensure your giving dollars are handled in such as way as to avoid taxes as much as possible.

After all, Uncle Sam will get his share no matter what. You might as well minimize the bite.

Donate Appreciated Assets

I’ll never forget the day I stumbled upon this little idea. It kind of blew my mind, but at the same time, I was annoyed I hadn’t thought of it myself.

At the time, we did all of our giving straight out of our checking account. So, the flow of cash and taxes looked something like this:

Income -> Income Taxes -> Paycheck -> Check to Charity -> Tax Deduction

My wife and I were at Milestones 6 & 7 and had opened a taxable brokerage account a year or two earlier.

The rub with those taxable accounts is incurring a tax hit every time you sell an appreciated asset (an ETF in our case). For the most part, we made contributions and just left them there to grow.

But what if you donate shares from your brokerage account to the charity and instead of sending them a check you deposit those funds into your brokerage account? The flow of cash and taxes would now look like this:

Income -> Income Taxes -> Paycheck -> Deposit to Brokerage ->Purchase New Shares -> Donate Appreciated Shares to Charity -> Tax Deduction & Free Stepped Up Basis

Let’s walk through an example. Suppose Phil Philanthroper donates $2,000 a year to the local art museum. By writing a check, Phil gets a nice little deduction for his gift by reducing his AGI by $2,000.

But if Phil donates $2,000 of ABC ETF instead, the art museum still gets the full value of the donation, Phil still gets the tax deduction, but Phil can redirect the $2,000 he normally gave out of his checking account to buy more ABC ETF.

The result is Phil receives a free step-up in the price basis of the shares he owns while still owning $2,000 of ABC ETF.

To carry this example further let’s assume ABC ETF was worth $80/share when Phil bought it but had appreciated to $100/share when Phil donated it.

Since Phil donated 20 shares ($2,000 at $100/share) he avoids capital gains tax on $400 of appreciation (20 shares at $20 of gains/share). If Phil is in the 15% capital gains bracket, this means Phil just saved $60 simply by making his gift a little differently.

This is a simple example with small dollars. The more you donate and the more regularly you give, the more valuable this technique becomes.

Some things to bear in mind using this strategy:

It only works for long-term holdings, which means you need to own the donated security for at least one year to claim a deduction.
If you donate shares owned less than one year, only the basis is deductible.
You wouldn’t want to do this with shares that have lost value (depreciated). You should look into tax loss harvesting those instead.
Donate shares with the largest unrealized gains to maximize the value of the step-up.
Stock donations are limited annually to 30% of the donor’s AGI.
Get a receipt from the charity for your records.

Qualified Charitable Distributions

A qualified charitable distribution (QCD) is a strategy for redirecting annual required minimum distributions (RMDs) to a charity of your choice instead of receiving the RMD as income for yourself.

Once you reach age 72, the IRS requires that you begin taking an income in the form of an RMD from tax-deferred retirement accounts.

In many cases, retirees find that they no longer need the money in these tax-deferred vehicles and would prefer to allow the balances to grow instead of incurring income taxes for withdrawals. So, RMDs basically force their hand.

The RMD amount is calculated using a formula provided by the IRS which is designed to slowly force account owners to pay taxes on the money that has been building for years (about 4% the first year).

Fail to take an RMD and you’ll pay a 50% penalty on the undistributed amount. (this percentage is being reduced in 2024.)

No. They’re not messing around.

However, if you are charitably inclined, QCDs allow a direct donation to be made to a qualified charity. In exchange, you can reduce your RMD by the amount you’ve given away.

Since the funds are coming out of a tax-deferred account (meaning they’ve never been taxed) you don’t get a deduction, but you never had to pay any tax on the sum.

In summary, by making your gift through a QCD, your charity is relieving you of incurring that same amount in RMDs.

But couldn’t I claim a deduction if I just took the RMD, then wrote a check to the charity? Great question. Yes, you could still get a deduction, but you’ll have a higher MAGI as a result.

This could also potentially put you into a higher tax bracket, reduce your options for conversions, impact taxes on social security, and even increase your Medicare surtax.

Other important points:

The QCD must go directly from your account custodian to the charity. If it comes through you, you will owe income tax for the distribution.
Currently, you are limited to $100,000 in QCDs per year.
You can begin QCDs at age 70.5 even though RMDs don’t start until age 72.
Your RMD amount is calculated using your IRA balance from the end of the previous year. The IRS has tables corresponding to your age so you know what percentage to withdraw.
To count toward your RMD the QCD funds must leave your account by December 31 of the same year as the RMD.
You can’t make a QCD from a 401k, but odds are you’ll have long since rolled yours over to an IRA.

Donor Advised Funds

A donor-advised fund (DAF) is a fund managed by a custodian on behalf of a person, family, or organization.

Basically, it allows the contributor(s) to immediately recognize any tax deductions for the whole amount of the donation, but control its distribution over an extended period.

DAF owners can deduct up to 60% of their AGI for cash contributions and 30% of their AGI for donating appreciated securities.

Contributions are held by a 3^rd party custodian who then distributes the funds according to the instructions of the fund owner(s). Most of the larger investment houses have services for establishing DAFs.

Gifts can be made at one time or on a recurring basis. The donations are immediately tax deductible and irrevocable. Once the assets are in the account you maintain control over how they are invested and distributed.

The tax benefits are similar to just donating appreciated assets directly, but this route does allow you to concentrate the tax deduction in one year while distributing the assets across whatever period you prefer.

Let’s look at an example to see how this might be beneficial.

Terry Tither has been giving 10% of her income to her church for as long as she can remember, and intends to continue doing so until her last breath.

Over the years, Terry has accumulated quite a sum of assets in a taxable brokerage account and would like to begin donating appreciated shares to her church.

Terry’s annual AGI is $50,000 which puts her about $9,500 deep into the 22% tax bracket for a single filer.

Her annual tithe of $5,000 is technically deductible, but since it doesn’t get her down into the 12% bracket Terry still prefers to take the standard deduction of $12,950.

One day, Terry finds martinmoney.com and learns about DAFs.

After doing some math, Terry realizes she can donate $15,000 of mutual funds from her taxable brokerage this year to reduce her AGI and claim a larger deduction. This is 3 years of tithing claimed all in one tax year reducing her AGI to $35,000.

In the following two years, Terry doesn’t get a deduction for her tithe since it has already been claimed. Instead, she uses the standard deduction of $12,950 each year to reduce her taxable income. So, for this three-year period, here is what Terry’s two options were:

	Non-DAF Route	DAF Route
Year 1 AGI	$37,050	$35,000
Year 2 AGI	$37,050	$37,050
Year 3 AGI	$37,050	$37,050

In this case, by using the DAF, Terry saves $2,050 in taxable income for one year. This amounts to $246.00 in the 12% bracket. It ain’t much, but it’s scalable. Besides, smaller numbers are easier to digest.

Imagine if Terry was on the line between the 24% and 32% brackets. There are bigger bucks at that level.

One day you will retire and you may see a significant drop in your income from one year to the next.

If you know retirement is coming and you’re going to make donations anyway, there’s a great chance that front-loading those donations in a DAF will save quite a sum of money from taxes.

Clearly, DAFs can provide great tax planning flexibility depending on your individual circumstances. Keep these in mind as you think about your charitable giving.

Other important points:

In addition to cash and securities, most DAFs can accept less common assets like insurance policies, bitcoin, restricted stock, or even S & C Corp stocks.
Some companies will charge a fee for managing your DAF.
The fund manager also technically has control over the distribution of money. You might want to do your homework to see how satisfied previous customers are with the service or start with a small donation and work up from there.
Did I mention the contributions are irrevocable? Seems important.
You’re probably getting tired of acronyms, but they’re incredibly helpful when writing a long post. Here comes some more.

Charitable Remainder Trusts

Charitable remainder trusts (CRTs) are complex. I’ll provide a high-level summary of how they work and what they do, but this isn’t something you can set up on a single trip to the bank.

CRTs allow individuals to meet certain philanthropic goals while still generating income from donated assets.

Per the name, a CRT is a trust. They are created via a donation from the grantor or “trustor” who receives a partial tax donation from their contribution.

The trust then distributes income to the grantor or other non-charitable individuals for a pre-determined period, after which the remaining assets are given to the designated charitable beneficiary.

Their primary purpose is to reduce taxes.

Like a DAF, contributions to a CRT are irrevocable. As a result, the assets are removed from the estate of the grantor, excluding them from the probate process, estate taxes, capital gains taxes, and gift taxes.

There are two types of CRTs: Charitable Remainder Unitrust Trusts (CRUTs) and Charitable Remainder Annuity Trusts (CRATs).

CRATs distribute a fixed amount of the trust assets and do not permit additional contributions.

CRUTs distribute a fixed percentage on the balance of the trust, revalued each year, and permit additional contributions.

In both cases, the distribution must be no less than 5% and no more than 50% of the trust assets.

CRTs have a maximum allowable lifespan of up to 20 years after which the assets go to the designated charity.

Like I said earlier, they are complex and can be expensive to set up, but they can be effective for avoiding large tax liabilities in a given year by offsetting a large portion of income or at least spreading it out over a longer period.

Estate Planning/Insurance

Truthfully, estate documents and insurance needs should have been covered before Milestone 1 on the Next Dollar Roadmap.

Estate planning can be very complex and insurance is about as exciting as fingernails on a chalkboard. We’ll post more about them down the road, but for now, let’s cover the high points.

The Will

A will is a document that records your wishes regarding the distribution of property to heirs and the care of your minor children.

If you die without a written will (also known as dying intestate) your default becomes some order of succession provided by the state in which you live.

This can also make your estate the subject of great frustration, anger, and even fighting among your decedents. It’s not uncommon for heirs to spend away the estate on legal fees while they fight over it.

You might think you don’t need a will until you have a high net worth or a family, but there are several reasons everyone with any assets should have a simple will:

It makes life easier for your heirs.
If you have kids, you can nominate someone to care for your children instead of leaving a judge to decide.
You can specifically decide who gets what and how much.
Perhaps most important, you can specifically decide who doesn’t get anything (and name them so it’s really clear).

For years, my wife and I have used a simple will .

It was pretty easy because we don’t have any unusual circumstances that call for complex planning. One day, we may upgrade to…

A Trust

A trust is a legal entity in which a third party (the trustee) agrees to hold assets on behalf of a trustor, beneficiary, or beneficiaries.

The trust is managed by a trustee upon the trustor’s death who then sees that the instructions of the trust are carried out.

One of the biggest advantages of a trust is they avoid the probate process upon the trustor’s death. This saves the beneficiaries a lot of trouble in receiving the assets of the estate and keeps details of the estate out of the public record.

Trusts can be very simple or extravagantly complex. It all depends on how they’re set up.

They certainly require more time and effort to establish as compared to a will but can provide a lot of worthwhile benefits for your heirs. As of 2022, a typical trust costs between $3,000 and $5,000.

Here are some types of trusts and an explanation of each one listed. This is not an exhaustive list by any means. Bear in mind that all trusts will include characteristics of more than one type of trust from this list.

Living Trust is a trust set up by a person for their own use and benefit as long as they are alive. Once they die, the assets in the trust are transferred to the trustor’s heirs by a successor trustee.
Testamentary Trust is a trust established according to instructions provided in a will. The trust is created after the trustor has passed away so the trustee can distribute the trustor’s assets to his or her beneficiaries.
Revocable Trust is a trust that can be changed or closed by the trustor during their lifetime.
Irrevocable Trust is a trust that cannot be changed or closed by the trustor during their lifetime. Trusts created for tax planning purposes are usually irrevocable.
Funded Trust is a trust that has assets in it.
Unfunded Trust is a trust that has no assets but is normally funded upon the trustor’s death.

One of my favorite all-time books is “Beyond the Grave” by Jeffrey Condon. In addition to being quite entertaining, the book covers a litany of real-life scenarios in which the author (an estate attorney by trade) was serving clients who had a variety of estate needs.

It opened my eyes to some of the legal risks associated with dying and challenged me to think more carefully about estate planning.

Insurance

You should have insurance to protect yourself against the risk of loss for anything you can’t afford to replace yourself or don’t want to have to replace.

Common insurance examples include homeowner’s insurance, renter’s insurance, medical & dental insurance, automobile insurance (including liability), life insurance, and umbrella insurance.

Most insurance needs are pretty straightforward, but I do want to briefly touch on life insurance and umbrella policies.

Life insurance is necessary to replace income for one’s dependents if he or she dies. If you’re married and have significant debt or you have minor children, you probably need life insurance to protect them in case you die. Most of the time, simple term life insurance is adequate to meet this need.

Occasionally, there are situations in which someone may have a source of income that cannot be replaced after they die and their dependents have no other options to replace that income on their own.

For example, imagine a retired couple that receives pension income from one spouse with no survivor benefit. If the spouse who isn’t receiving the pension is unable to work due to a disability or age, a permanent life insurance policy may be necessary.

For the most part, we don’t like permanent policies because insurance companies can make them exceptionally difficult to understand and they are generally very expensive. If you find yourself in need of a permanent policy, do your homework.

Umbrella policies exist to cover personal assets, the value of which exceeds the coverage limits of existing policies.

In other words, when your net worth exceeds the coverage limits of your auto or homeowner’s insurance, an umbrella policy protects your wealth that is otherwise uncovered.

For example, assume your teenage son carelessly runs into the back of a priceless Ferrari while driving home from school. If the value of the vehicle exceeds the maximum coverage of the auto policy, you are personally on the hook for the difference. If you have an umbrella policy, the umbrella policy will step in and cover that difference.

Umbrellas exist to protect wealth. They are generally quite cheap and can be purchased to provide many millions of dollars in coverage.

We go into a deeper dive into insurance here and even deeper into life insurance here.

Conclusion

As I said before, proper insurance and estate planning should be an ongoing part of your financial plan. There’s not an exact spot anywhere on our Roadmap to insert them.

Once you make it to Milestone 6, you should begin looking into expanding your insurance and estate plans.

It does get more expensive to upgrade these plans, but considering the assets you’ve probably acquired by now, it is money well spent.

Financial Independence, Next Dollar Roadmap

Curt

Curt is a financial advisor (Series 65), expert, and coach. He created MartinMoney.com with his wife, Lisa in 2022. By day, he works in supply chain management for a utility in the southeastern United States. By night, he's a busy parent. By late night, he works on this website but wishes he was Batman.

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Hello. We’re Curt and Lisa. We started MartinMoney.com to educate you about personal finance so you can reach your own financial goals. Read more about us here.

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