Taxes With Wealth Transfer?

One of the biggest parts of estate planning is trying to figure out what is the best way to minimize taxes when assets are passed to your beneficiaries.  To accomplish this, there are so many variables to consider, there is not just one answer or method to minimizing Uncle Sam’s cut.  If you absolutely want to zero out taxes for your beneficiaries, put all your money under your mattress or dig some holes in your backyard.

All joking aside, there are some things you can potentially do to soften the blow of taxes on the assets you are passing to your beneficiaries.  At the end of your life, your assets will end up being distributed amongst three different categories – taxes, charities, and your loved ones.  Let’s take a look at a few strategies that can direct more of your assets to the latter two.

1. Gifting – gifting is the simple act of simply giving your money to somebody, most often children or other relatives.  For the year 2021, an individual can gift up to $15,000 without any Federal gift tax consequences.  A person can gift $15,000 to as many people as they want in 2021.  For a married couple, each person can gift up to $15,000 to the same person for a total of $30,000.  So, if you are looking at how to maximize gifting money to all of your children, in 2021, you can give $30,000 to each child and spouse (if married).  You can see how a couple can gift a fair amount of money away each year if they wanted to.

Now add another level of family member to the equation, the grandchildren, and it’s possible to gift up to $15,000 per year to all family members, and double that number if both mom and dad are gifting all family members.So, if one of your children is married with three kids, you can gift the entire family $150,000 in one year without any tax consequences to your child’s family.***If you are wondering if you can gift your IRA money, the answer is NO.You have to take a distribution first, pay the taxes, then you can gift the “after-tax” money to whomever you want.

How much can a person gift over their lifetime? For 2021, the maximum limit increased to $11.7 million dollars per individual, meaning a married couple can gift $23.4 million dollars over their life to loved ones.This generous rate will expire in 2026.There has also been talk that the new Biden administration wants to lower that level back to $1 million dollars.

2. Direct payments – these are exactly what they sound like.  The IRS allows a person to pay on behalf of a loved one for qualified medical care or educational expenses, in ANY amount, as long as that payment is made directly to the institution and not the person.  As an example, grandma or grandpa writes a $18,000 check to the university to cover the annual tuition and dorm expenses.  Or if your own child has a tragic car accident that requires months of in-patient therapy and rehabilitation, mom and dad can write a $45,000 check directly to the healthcare facility to pay the bills, NOT write a check to the child and let them pay the bills themselves.  That would be seen by the IRS as a gift over the annual gifting limits and would incur a tax bill.
3. Roth conversions – If you have the vast majority of your wealth in IRA accounts, if your children inherit the accounts upon your passing, they will have the option of cashing it all out or stretching the withdrawals over a 10-year period.  Either way, all of the IRA money they pull out will fall into their income for the year and will be taxed at whatever tax bracket those additional funds place them into.

To avoid your children having to pay taxes on the IRA funds you’re passing along to them, you can start to do a series of Roth conversions while you’re alive.This will result in you paying the taxes on the amount converted each year, and they will inherit a Roth-IRA that can essentially be received tax-free.There are various rules to be aware of like the 5-year rule, different time frames for withdrawal strategies, and are you taking out contributions or earnings?

4. Trusts – There are entire 300-page books that try to explain all the nuances of the different types of trusts that exist and in which circumstances certain trusts are best suited for.  When it comes to wealth transfer and trying to decrease the tax burden to those people inheriting your assets, there are certain trusts you can utilize.

• Irrevocable trusts – the IRS treats property in an irrevocable trust as being completely separate from the estate of the decedent. As a result, anything your beneficiaries inherit from the trust won’t be subject to estate or gift taxes.
• Irrevocable Life Insurance Trust (ILIT) – an ILIT is where you set up a trust and place the ownership of the life insurance into the name of the trust.  This way the life insurance proceeds will not be counted as part of your estate and exposed to potential estate or gift taxes.  To complete an ownership transfer, you can’t be the trustee of the trust and you may not retain any rights to revoke the trust.
• Qualified Personal Residence Trust (QPRT) – With a QPRT, you’re transferring the ownership of your home into an irrevocable trust. During the trust’s term, you can continue living in your home without paying rent. After that term ends, your beneficiaries can take over your property.  However, if you die before the term of the trust expires, your home will still be considered part of your estate and susceptible to taxes.  There is no limit on how long a QPRT can last, but trying to time it to the exact lifespan of a person can be a tricky undertaking.

This is not by any means an all-inclusive list of ways one can try to reduce the tax burden on your loved ones as you pass your wealth to them upon your demise.  There are many other methods, but these are some of the more common ones available.  One thing you must do is educate your family members and/or other beneficiaries on how you want to transfer your wealth to them.  Many mistakes can occur and completely undo what you have put together as a stellar wealth transfer strategy.  Money magazine published a report back in 2015 that stated 70% of families lose all of the inherited money with the second generation of family and 90% with the third generation (https://money.com/rich-families-lose-wealth/)

My disclaimer for this topic is that I am not a tax professional, so I’m keeping the above ideas at a high level so you will know what some potential options are for your own estate planning.  And we also know that laws relating to wealth transfer are constantly changing, so make sure you check with your tax person to get a bit more specific with these ideas and to get additional tax help.

This blog is created and authored by Chuck Henrich (Content Creator) and is published and provided for informational and entertainment purposes only. The information in the Blog constitutes the Content Creators own opinions and it should not be regarded as a description of services provided by Southwest Michigan Financial, LLC. The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.  It is only intended to provide education about the financial industry.  The views reflected in the commentary are subject to change at any time without notice.

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