As I arrived at 40, I realized toys would not carry me through retirement. Nor would they ensure the future of those coming after me. The problem is, toys are usually disposable, neither accruing interest nor retaining their purchase value. Forty came quickly, and I realized 60 was probably lurking far closer than I realized. Hence, a financial plan was needed including retirement and estate planning.

Protect Your Resources
In order to protect your resources from heavy taxation, it is essential to understand that all aspects of financial planning go hand in hand. The reason is simple. Once you get past the jitters of shopping withdrawal, saving money is relatively easy. Growing it while protecting it from the tax department, however, fails the simplicity test.

Retirement and estate planning options are endless and varied in practicality. A sampling includes savings accounts, annuities, mutual funds, trusts, and, if worse comes to worse, a pickle jar buried in the backyard. The merit of each of these depends on the ultimate goal. One thing is certain, however: while we all know that we can not take it with us, we do not want Uncle Sam to carry it away either.

I know all about saving corporate tax dollars, but as a small business owner I, like many entrepreneurs, had not put a lot of thought into anything but growing my business. Entrepreneurs are often the least prepared for retirement because time is at a premium when it comes to the day-to-day activities of the corporation.

We also tend to put the business first because it ensures our continued financial health, and we tend to think of it as our retirement fund. Yet, is that the best use of resources if we want to benefit from tax savings? Probably not. So let us briefly review the above options.

Savings Accounts
Now, I like my bank president - a charming, helpful man who gives sound advice - but not enough to leave my money in the bank's savings accounts. With today's low interest rates, savings accounts are great for teaching children to save, but not practical when it comes to building wealth. At best they can be used to accumulate funds for a short time while you decide how to better invest your cash.

Annuities
A favorite way of investing that cash is the purchase of annuities, which are basically mutual funds wrapped in tax-deferred insurance company accounts. Before buying them, however, consider both the benefits and drawbacks of this investment.

When saving for retirement, buying annuities to defer taxes can help save more than taxable investments such as mutual funds. After retirement, annuities can generate life-long monthly income, a real benefit considering increased life expectancy.

Finally, the death benefits associated with annuities are excellent. At the annuity owner's death, the estate receives the original investment and a guaranteed minimum return on it. While annuities are purchased with after-tax dollars, the earnings compound tax-deferred until retirement. The gains are then taxed at the higher rate of ordinary income instead of as lower taxed capital gains.

Annuities also carry steep mortality and expense risk and administrative fees. Add limited financial flexibility and prohibitive early surrender charges should you break the contract, and other types of investments may be more attractive.

Mutual Funds
In order to get the best tax break on the investment dollar, financial planners recommend a maximum contribution to a 401(k) or a Roth IRA plan and diversifying the rest. Mutual funds are a favorite way to diversify.

A mutual fund pools investors' money and invests that money as per objectives stated in the fund's prospectus. This provides built-in diversification, which spreads the risk and reduces the effects of the stock market's ups and downs.

Keep in mind that while no-load funds do not cost you sales commissions, they carry charges such as yearly marketing fees. A great benefit of mutual funds is that the income is usually taxed as a low-tax capital gain thereby providing a way to save for your retirement without a heavy tax burden.

Trusts
Unfortunately tax burdens do not end with death. Since we are mortal, we must pass our wealth to family members or the cat shelter. Business Week magazine recently wrote that, "Trusts are becoming the estate-planning tool of choice for Middle America". This is in part due to the fact that you can set up a trust, revocable or irrevocable, in place of a will, because trusts typically minimize estate taxes.

For this reason, financial planners suggest transferring all assets, including 401(k) s and insurance policies, into the trust. In turn the trust will provide continued income for the remaining spouse and minor children, fund your favorite charity, and offer long-term protection of assets. Trust funds come with unique problems such as fighting heirs and lax trustees, so be sure to structure the fund with care.

Another aspect of trusts benefits small business owners who are often the only family member able to run the firm. Once a trust is set up, entrepreneurs can choose a trustee who will sell the business and add the monies to the trust. Properly liquidating the business helps recoup the built up equity, while transferring the money made from the liquidation to a trust fund provides added protection against succession taxes.

Still, the best protection from the tax department remains the passing of money to your heirs while you are still alive. If you do this, instead of leaving the money to them in your estate, they will pay fewer taxes on the same amount.

The current rules allow you to give each person up to $10,000 per year, and allows a lifetime credit by which you can transfer a total of $675,000, all without paying gift or estate taxes. Blending these two gift-tax advantages can save your heirs thousands of dollars in taxes thereby keeping the wealth in the family instead of with the IRS.

Now if none of the above options appeal to you, there remains the pickle jar in the backyard. Few IRS officers would be inclined to dig up the yard to find it so it is a great tax shelter. But one has to wonder if you are prepared to dig up the yard when you forget where you planted it?

First published on June 5, 2000.