With the federal lifetime gift and estate tax exemption still at a record high, fewer estates will receive an estate tax bill from the federal government. Yet estate planning remains critical as investors seek to manage the distribution of assets as well as meet any state tax requirements.
Indeed, more than a dozen states have death or inheritance tax laws.
In addition, tax provisions of the Tax Cuts and Jobs Act (TCJA) are set to expire in 2025. Key tax figures may change unless Congress acts. And these changes may impact taxes and strategies for wealth transfer.
As year-end approaches, here are several strategies for investors to consider as they review their tax and estate planning.
Use it or lose it – The annual gift tax exclusion
Year-end provides an opportunity to review existing estate plans and consider gifting strategies. The annual gift tax exclusion for individuals in 2022 is $16,000. To avoid utilizing a portion of the lifetime gift and estate tax exclusion (roughly $12 million for 2022), annual gifts can be made to as many recipients as desired as long as each gift doesn’t exceed $16,000.
Consider large lifetime gifts
The drastic increase in the lifetime gift and estate tax exclusion since the passage of the TCJA in 2017 means higher-net-worth individuals and families should review existing trusts and other documents with their attorney to see if any modifications are necessary. Also, there may be opportunities for large lifetime gifts, considering the historically high level of the exclusion amount, which is scheduled to be reduced by roughly a half at the end of 2025 unless Congress takes action.
Use 529 plans to fund education for family members
Before the end of the year, consider gifts into 529 plans utilizing the annual gift tax exclusion of $16,000. There is also a special 529-plan exclusion that allows five years’ worth of gifts — up to $80,000 or $160,000 for married couples — to be contributed at once, provided that no other gifts are made within the next five-year period. For financial aid purposes, funding a 529 plan may make sense. The federal financial aid calculation treats 529 plans owned by parents more favorably than assets owned by the student (e.g., in a custodial minor account for ex.). There is an added benefit for non-parents such as grandparents who own 529s: These assets are not currently factored as assets for determining federal financial aid under the FAFSA process. However, distributions from these accounts may be counted as part of the income test portion of the financial aid calculation. Lastly, recent tax law changes allow 529 account owners to withdraw $10,000 for K–12 tuition expenses and $10,000 to repay student loans, and allow distributions for qualified apprenticeship programs.*
*Distributions for K–12 expenses are free from federal income taxes (taken after December 31, 2017). Earnings may be subject to state income taxes in certain states.
Plan for the “10-year rule”
In late 2019, Congress passed the SECURE Act, which eliminates the “stretch” option on distributions from inherited retirement accounts. Under the new rules, most non-spouse beneficiaries are required to fully distribute inherited account balances by the end of the 10th year following the year the account owner dies. As a result, from a tax perspective, retirement accounts are not as beneficial in passing wealth to heirs. Those with large 401(k)s or IRAs may want to review their overall estate plan and consider leaving a greater share of non-retirement assets to higher-income heirs. For example, consider proceeds from a life insurance trust or real estate that may benefit from a step-up in cost basis at death when transferred. See our recent post, "Distribution planning under the SECURE Act."
Review gift and estate plans with an advisor
When considering making changes to estate or gift plans, it is important to discuss these ideas with a financial advisor. Individuals considering advanced strategies should work with a qualified estate planning attorney who has knowledge of their financial situation and goals. Investors can benefit by reviewing their current financial plan with an advisor to make sure they are taking advantage of tax-efficient strategies under the current tax rules. Consider the impact of potential tax changes on estate and gift planning. Read Putnam’s “A closer look at the current estate and gifting tax rules,” to begin a review.
Financial professionals: Join our November 17 webinar (1 p.m. ET) for a discussion of the post-election landscape and year-end planning. Register here.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.