What is Total Net Legacy?

Total Net Legacy is the ending portfolio balance, less the taxes due upon the lump sum distribution of each account, to a 50-year-old couple. Therefore, taxable accounts receive a step-up in basis, Roth accounts are not taxed, and tax-deferred accounts are taxed as ordinary income. The ending portfolio balance reflects the average expected portfolio return for the plan (with planned withdrawals applied over time), rather than a particular simulated outcome from the plan test.

Below is an example and some talking points to help explain the net legacy difference between the 2 plans.

Example

Let's say we have two plans, A and B. Plan A has a higher estimated net-of-tax income and lower taxes, but Plan B has a higher net-of-tax estimated legacy at the end of the plan.

How would I interpret this? 

It means that Plan A is more tax-efficient for retirees while they are alive, but less tax-efficient for their heirs.

The reasons may be complex, but they typically revolve around the asset levels and types at the end of the plan. Net legacy is calculated by having the heirs make a full lump-sum distribution of all the portfolio assets. That means that amounts in taxable accounts and Roth accounts are received tax-free (taxable accounts get a step-up in cost basis). Tax-deferred qualified assets get taxed at ordinary rates, as do the gains on non-qualified annuities. These tax calculations walk through ordinary tax brackets, but do not include any other income in the calculation. So, if the heirs also have $1 million in wages in the year they inherit the funds, the net legacy calculations are overestimates because we're not including those wages in the calculations.

It's essential to note that the taxes due on this final legacy amount will vary, as will the pre-tax amounts in the portfolio. For example, a plan with a significant amount of IRA funds at the end could still have a higher net legacy if this higher amount offsets the higher taxes due.