Being in the financial business for decades, I’m acutely aware of the benefits of starting good financial habits early in life. Just ask my daughters, who get to listen to me dispense life’s lessons at will. And despite their dramatic eye-rolls and heavy sighs, I’m sure some of my nuggets of wisdom will stick. Not all of them of course . . . like when Jill and I were talking about our own estate plans recently. We periodically review them to keep them current, especially now that the girls are all technically “adults” – a new phase in our planning lives. As we chatted about some items the girls would inherit one day, Phoebe and Sophie started debating who gets the dog, Louie, if something happens to Jill and me. Bingo! Teaching moment about having your wishes spelled out in advance, especially for sentimental items – and pets.
My segue into estate planning wasn’t thrilling conversation for the girls, who snuck out of the kitchen to avoid a lecture. But for many folks, the topic is crucial even if it’s not exciting. You see, after working hard for decades to save for retirement and to leave a legacy, you must have a plan for your assets at your death. Otherwise, you risk not only family squabbles over personal items, but also the likelihood of giving up a larger cut of your legacy to those Washington Wizards who just keep spending, spending, and more spending. So this week with our time together, let’s take a closer look at some options for keeping your wealth intact for the next generation.
Now, despite the various proposals to lower federal transfer tax (estate, gift and GST taxes) exemptions and increase the tax rates, none of them were enacted in 2021. This means that the exemptions have increased for inflation in 2022, giving folks a “second bite at the apple” on locking in the advantageous rates and exemptions before they revert to $5 million in 2025, at the latest. In 2017, Congress doubled the exemption starting in 2018, and the amount will continue to rise with inflation through 2025. For 2021, the lifetime exemption for both gift and estate taxes was $11.7 million per individual, or $23.4 million per married couple. For 2022, an inflation adjustment has lifted it to $12.06 million per individual, or $24.12 million per couple. Above the exemption, the top rate on such transfers is 40%.
Although this increased exemption ends on December 31, 2025, the IRS and Treasury clarified in 2019 that the government will not “claw back” gifts given between 2018 and 2025, with respect to someone who dies in 2026 or beyond, that exceed $5 million, when the gift and estate tax exemptions return to the $5 million exemption under the 2012 Act.
That’s a wordy way of saying something like this – “Josh” gives assets of $11 million to a trust for his heirs in 2020. This transfer was free of gift tax because the exemption was $11.58 million for 2020.
Now, say that in 2022 Congress lowers the exemption to $5 million per person, and Josh dies in 2023 when that lower exemption is in effect. Under current Treasury rules, Josh’s estate won’t owe tax on any portion of his 2020 gift of $11 million, even if $6 million of it is above the $5 million lifetime limit in effect at the time of his death.
Another component is the gift tax exclusion. Currently the annual federal gift tax exclusion has increased from $15,000 to $16,000. The annual exclusion is the most you can give away to or for the benefit of a single person each year without needing to file a federal gift tax return. For 2022, the annual gift-tax exemption has risen to $16,000 per donor, per recipient. In 2021, this limit was $15,000. Using this tax break, you can give someone else—such as a relative, friend or even a stranger—assets up to the limit each year, free of federal gift taxes. And while annual gifts aren’t deductible for income-tax purposes, and they aren’t income to the recipient either.
Another benefit? Gifts to pay tuition or medical expenses, these are also free of gift tax. To qualify for this break, you must make the payment directly to the institution. Using another strategy, you can also “bunch” five years of annual $16,000 gifts to a 529 education-savings plan, typically for children or grandchildren. In this case, you’ll want to file a gift-tax return.
Now luckily most estate planning documents are drafted to be flexible, so their overall structure may be unaffected by the increased exemption amounts. There are, however, always specific areas where you will want to update your documents. One area is that, unlike the estate tax exemption, the Generational-Skipping Transfer (GST) tax exemption is not portable on a spouse’s death. States that have separate state estate tax regimes – and this includes Massachusetts – do not permit estate tax exemption portability. Use of a Bypass Trust at the first death of a married couple may be useful where these limits on portability are applicable.
Additionally, if you are a married couple and live in, or own real property in Massachusetts, there may be provisions that should be added to your documents which could save state estate taxes at the death of the first spouse. And as always, reach out to a qualified estate attorney to ensure accuracy and completeness.
These are just a few of many considerations when planning your legacy, but it’s key to have a plan – and then keep it current. Just like your investment and income plans, your estate plans need to be revisited as your life changes. This helps ensure you’re taking advantage of time-sensitive benefits, like the estate tax exemption, as well as seeking out new opportunities to maximize your legacy. It also makes sure the family dog has a good home, too!
So as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS, offers investment advisory services through Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at firstname.lastname@example.org.
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