As the year-end approaches, it offers a strategic opportunity for individuals to review their wealth and estate planning strategies. This is the perfect time to reflect on your financial objectives and align them with your current and future financial commitments. Whether you’re inclined toward philanthropy, planning a business transition, or unsure about your surplus wealth goals, effective year-end planning can help you optimize your financial outlook.
Year-End Gift and Estate Tax Planning:
Gift/Estate Tax Exemption: Starting in 2023, each U.S. citizen can take advantage of a lifetime exemption of $12.92 million to protect transfers from estate and gift tax. The tax rate for these transfers is 40%. For married couples, the exemption is doubled to $25.84 million. These amounts are adjusted for inflation and are projected to increase to $13.61 million per individual and $27.22 million per couple in 2024. The same exemption amounts apply to the generation-skipping transfer (GST) tax.
- Lifetime Gifting: Making gifts during one’s lifetime can be a strategic move to remove the future appreciation of assets from the taxable estate. These gifts can take different forms, such as outright gifts, funding trusts, or adding to existing trusts using various assets like cash, securities, or complex assets such as interests in private businesses or family partnerships. It is also possible to leverage gifts through valuation discounts, especially for assets that are not easily marketable or where the donor lacks control.
- Spousal Lifetime Access Trusts (SLATs): SLATs are particularly beneficial for those who are cautious about gifting too much. They allow one spouse to access the trust if needed, providing a safety net while still taking advantage of the tax exemption.
- Tax Cuts and Jobs Act: The gift and estate tax exemption was doubled in 2018, but it is set to decrease in 2026 unless Congress takes action. Individuals who have the means to make significant gifts are advised to do so before the potential decrease.
- Annual Exclusion: In 2023, each person can gift up to $17,000 annually to another person without affecting their lifetime exemption ($34,000 for married couples). This amount is expected to increase to $18,000 ($36,000 for couples) in 2024. These gifts can be made directly or into trusts, custodial accounts, or 529 college savings plans. The latter option allows for frontloading up to five years’ worth of annual exclusions.
- Direct Payment of Tuition and Medical Expenses: This strategy involves making direct payments for tuition and medical expenses, which are not considered taxable gifts and do not use any portion of the exemption amount, regardless of the beneficiary’s relationship to the payer.
Year-End Income Tax Planning:
- Tax Loss Harvesting: This strategy involves selling investments at a loss to offset capital gains, which can be advantageous for reducing taxable income. If losses exceed gains, you can use up to $3,000 to offset ordinary income, and any remaining losses can be carried forward to future years.
- Roth IRA Conversion: Transitioning from a traditional or employer-sponsored IRA to a Roth IRA can be highly beneficial, especially during a market downturn. This conversion requires paying taxes upfront on the tax-deferred amount, but it offers the advantage of tax-free withdrawals in the future, without any required minimum distributions (RMDs). It is crucial to carefully consider the tax implications of this conversion, ideally with the assistance of an accountant.
- Charitable Planning: Making end-of-year charitable contributions can provide significant tax benefits. Donating appreciated securities is particularly tax-efficient as it allows you to avoid capital gains tax. You can contribute directly to a charity or choose to utilize Donor-Advised Funds (DAFs), private foundations, or charitable trusts. It is important to note that the method of giving can impact the tax deductibility limits. Cash gifts to public charities and DAFs are typically deductible up to 60% of your Adjusted Gross Income (AGI), while gifts of non-cash assets held for over a year are deductible up to 30% of your AGI. Consolidating contributions into a single year can help exceed the standard deduction, resulting in higher overall tax savings. Collaborating with an accountant can help you maximize these deductions effectively.
Year-End Required Minimum Distributions (RMDs) and Contribution Limit Planning:
1. Required Minimum Distributions (RMDs):
- Most retirement accounts require RMDs to begin at age 73, except for Roth IRAs.
- The rules regarding inherited IRAs are intricate, and beneficiaries should seek advice from wealth planners for accurate guidance.
- RMDs are classified as ordinary income, which may push individuals into a higher tax bracket.
- Individuals who don’t rely on RMDs for income can choose a Qualified Charitable Distribution (QCD) from their IRA, allowing them to direct up to $100,000 to a public charity. This can reduce their taxable income by the amount of the RMD.
2. Contribution Limits for Retirement Plans:
- The contribution limit for employer-sponsored plans in 2023 is $22,500, with a catch-up option of $7,500 for individuals aged 50 and above. This limit will increase to $23,000 in 2024.
- For IRAs, the contribution limit in 2023 is $6,500, with a catch-up option of $1,000 for individuals aged 50 and above. This limit will rise to $7,000 in 2024.
- The deadline to make IRA contributions for the year 2023 is April 15, 2024.
Year-End Planning in this High-Interest-Rate Environment:
- Impact on Estate Planning: Estate planning strategies are influenced by inflation and rising interest rates, which are driven by Federal Reserve policies. These rate increases affect estate planning vehicles such as Applicable Federal Rates (AFRs) and the 7520 rate (GRAT hurdle rate).
- Rate Changes: Over the past two years, there has been a consistent upward trend in AFRs and the 7520 rate, which holds significant implications for estate planning mechanisms.
- Estate Planning Techniques in High-Interest Environments: The valuation of split-interest gifts in estate planning, such as QPRTs, CRTs, and GRATs, is impacted by higher interest rates. When interest rates are higher, the value of the taxable gift is reduced, allowing for a more favorable utilization of the gift tax exemption.
QPRTs and CRTs:
- QPRTs enable the transfer of a home into a trust, with the grantor retaining the right to live there for a designated period before gifting it to beneficiaries. Higher interest rates may result in a reduced taxable value, enhancing the benefits of this strategy.
- CRTs provide an income stream for beneficiaries, with the remainder going to charity. With higher interest rates, the charitable deduction increases, making CRTs advantageous. Funding CRTs with low-basis assets maximizes the deduction without triggering a gain.
Intra-Family Loans and GRATs:
- Despite high AFRs, intra-family loans can still be advantageous as they may offer lower rates than commercial options, providing family members with access to liquidity.
- GRATs allow for the transfer of asset appreciation to beneficiaries without incurring gift tax, provided the appreciation exceeds the hurdle rate  . While they may be less appealing in a high-rate environment, GRATs remain useful, particularly for those who have already utilized their exemption limits.
Despite the challenges posed by a high-interest-rate environment, there are planning opportunities that can benefit tax and estate considerations. It is advisable to discuss these opportunities with a wealth planner to optimize strategies for year-end planning.
Checklist for Year-End Tax and Estate Planning Based on Various Personal Objectives:
Maximizing Wealth Transfer:
- Strategically utilize your remaining estate tax exemption through effective planning techniques.
- Ensure the complete implementation and compliance of your estate plan.
- Establish a communication plan to ensure all parties understand the intent behind your estate decisions.
- Create flexible trusts that can adapt to evolving goals over time.
Strong Philanthropic Inclination:
- Maximize cash contributions to charities, potentially up to 100% of your income.
- Utilize IRA funds for charitable giving, either through minimum distributions or by designating charities as beneficiaries upon death.
- Involve the next generation in philanthropic efforts to instill the value of giving.
Selling/Holding a Business:
- Gift interests in the business to a trust before a sale to minimize taxes.
- Consider donating a business interest to a donor-advised fund (DAF) or public charity prior to selling.
- Clearly outline and communicate a succession plan to ensure smooth transitions.
Uncertain about Excess Wealth Goals:
- Collaborate with a wealth planner for values-based planning to clarify your objectives.
- Once values are identified, strategically align your resource allocation with these priorities.
- Consider establishing versatile trust structures that can be tailored as your objectives become clearer.
Year-end planning is a crucial exercise that can significantly enhance your financial health, provide clarity on wealth utilization, and ensure a smooth transition of assets. It’s never too late to start planning, and with the right approach and resources, you can make the most of your financial capabilities to secure your present and future. Remember, proactive planning today can yield significant benefits tomorrow.
 In this context, the hurdle rate is the annuity payout rate. So if assets are growing at 5% but the annuity is paying out at 10%, the GRAT will fail and not appreciation will pass to the remainder beneficiaries.
Spectrum Wealth Management, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Additional information about Spectrum’s investment advisory services is found in Form ADV Part 2, which is available upon request. The information presented is for educational and illustrative purposes only and does not constitute tax, legal, or investment advice. Tax and legal counsel should be engaged before taking any action. The opinions expressed and material provided are for general information and should not be considered a solicitation for purchasing or selling any security.