4 Financial Assets That Will Cost You If You Don’t Hold Until Death

The following four assets may or may not interest you, but if you decide to “purchase” them, you had best be comfortable holding them until death—or it is going to cost you plenty of money to get out of them.

#1 Marriage — ‘Until Death Do You Part'

The original “until death do you part” asset is marriage. Divorce is financially devastating, and it's challenging to insure against, even with a pre-nuptial agreement. Most physicians getting divorced lose half of their assets and half of their income. They also lose some serious economies of scale as the ex-family goes from owning one house to two. Alimony is even more expensive than it used to be, now that the payments are not tax-deductible. But wait, there's more. The attorney fees can be outrageous, especially if the divorce drags out for years. Plus, there is that period of time before the divorce is finalized when both spouses are spending with abandon because “I'm only paying for half of what I buy.”

How to Minimize the Cost

Stay married. Date night is the best asset protection move. Pre-nuptial agreements can help as well, and they should be considered mandatory for second marriages, blended families, and later marriages when income and assets are dramatically different. Trusts can also have a role in protecting pre-marital assets in the event of divorce.

• What Physician Specialties Have the Happiest Marriages?
• Financial Conversations to Set Your Marriage Up for Success

#2 Whole Life Insurance

Like marriage, whole life insurance tends not to work out very well unless held until death. That doesn't mean someone who has bought a policy should never dump it. Sometimes it's best to cut your losses as early as possible. Whole life policies often take 5-15+ years to break even as an “investment.” But to get any sort of a reasonable return out of it, you'll need to hold it for decades.

Guaranteed returns are typically in the 2% range long-term, with projected returns more in the 5% range and likely returns somewhere in between. But if you dump it early, you're almost surely getting nowhere near 5%. Plus, if you do have gains, the taxation on them for a fully surrendered policy involves ordinary income tax rates. A high earner might lose as much as 40%-50% of the gains, not even considering the effects of inflation. The unique tax benefits of whole life insurance, limited as they are, don't really exist unless the policy is held until death. Those benefits (tax-free death benefit and the ability to do partial surrenders and take out “principal” first) don't really matter if you don't own the policy when you go.

How to Minimize the Cost

The easiest way is to simply never buy a whole life insurance policy. They're rarely mandatory, and most physicians who understand how they work neither need nor want them for any purpose. If you do own a policy and have held it long enough that it no longer makes sense to surrender, you have a few options.

1. Exchange the cash value into an annuity you do want (SPIA? MYGA?).
2. Exchange the cash value into a long-term care policy you do want.
3. Do a partial surrender up to basis, allow cash value to pay premiums, and hold until death, leaving it to heirs as part of your estate plan.

#3 Investment Properties

Investment real estate is certainly a viable pathway to wealth. However, the most tax-efficient way to invest in real estate is to follow this formula:

1. Buy
2. Depreciate
3. Exchange
4. Depreciate
5. Exchange
6. Depreciate
7. Die (and let your heirs get the step up in basis at death)

If you sell the property prior to death, that step up in basis goes away, and you end up paying all of the depreciation recapture and capital gains taxes due. This eliminates a huge percentage of the overall pre-tax return on your investment.

How to Minimize the Cost

You can avoid this massive tax bill with the following.

1. Own the properties until death (even if it means hiring out all management and/or borrowing out the equity to spend).
2. Gift the properties to charity.
3. Gift the properties to heirs in a lower tax bracket and have them sell them.
4. Do a 721 exchange.
5. Use a deferred sales trust.
6. Sell the property, and invest the proceeds into an Opportunity Zone fund.

• The 7 Ways to Get Out of a Real Estate Investment
• The 7 Worst Ways to Invest in Real Estate

#4 Direct Indexing

Direct indexing is where a relatively wealthy person who can really put additional capital losses to use hires someone to run their own index fund in a taxable investment account. Done well and at low cost, pre-tax returns are similar to index fund returns, but there are also hundreds of more opportunities to tax-loss harvest, dramatically increasing the amount of usable capital losses from the portfolio.

Costs for this service have been coming down ever since the idea was introduced a few years ago, and they are now in a somewhat reasonable 0.1% range. So, what's the catch? The catch is if you want to stop doing this prior to death—which seems pretty likely, given that pretty much all of the losses come in just the first few years after you put money into the strategy. Once you want to move away from a direct indexing strategy and back to a mutual fund/ETF strategy, the direct indexing provider gives you all of the now highly appreciated individual stock shares left over. Instead of owning one or two ETFs, you now own 500 or more individual stocks. And you will have to deal with them.

How to Minimize the Cost

While direct indexing can be useful for a well-to-do person expecting significant realization of capital gains in the future (sale of a practice, a home sale, a small business sale, an extensive sale of securities to fund retirement, etc.), most people don't need to consider the technique. Those who do and then regret it have limited options to get rid of the large number of legacy investments they will be left with after stopping.

1. Stop reinvesting dividends (DRIP).
2. Hold the shares until death when they can be sold with a step up in basis.
3. Sucker your ex-spouse into taking those shares in a divorce (see #1 above for more details).
4. Sell any shares with losses or minimal gains.
5. Use previously acquired losses to offset gains from shares sold with gains.
6. Use appreciated shares instead of cash for charitable giving.
7. Gift appreciated shares to people in lower tax brackets (especially the 0% capital gains bracket) that you care about and let them sell them.
8. Sell the shares and invest in an Opportunity Zone fund.
9. Use a swap/exchange fund to diversify holdings.

One of the great benefits of investing in retirement and other tax-protected accounts is that you can revamp your investing strategy without consequences. Once you start investing in a taxable account, decisions become a lot more serious. Choose carefully!

What do you think? Which of these have you had to deal with? What did you choose to do?