As the saying goes, “you can’t take it with you.” So where do you want your wealth to go when you’re gone?
There are three places your assets can end up after your death: taxes, charity, or to loved ones as an inheritance. For those who are subject to high estate taxes, proactive planning can help direct more wealth to the latter two buckets and less to the government.
Seventy percent of the time, family assets are lost from one generation to the next. Often it’s because heirs aren’t financially literate on money matters.
The first step in a successful wealth transfer plan is to identify legacy goals and objectives. If a top priority is retaining wealth during transfer to the next generation, consider utilizing these tax-efficient techniques.
Annual gifting
The annual gift tax exclusion for 2022 is $16,000 (or $32,000 for spouses splitting gifts), per donee. Up to this amount can be gifted to any number of people, per year, without having to pay gift tax. Anything above this limit will reduce the individual’s federal lifetime exemption and require the filing of a gift tax return. Giving away the maximum amount every year can be a meaningful way to shift wealth to the next generation.
Direct payments
Making direct payments for qualified medical care or educational expenses on behalf of a loved one is a simple and straightforward gifting strategy. For example, if a grandparent wants to give more than the annual gifting limit to a college-aged grandchild, many schools will allow the grandparent to pay tuition directly and avoid any gift tax consequences. There are no limits on the amount of these gifts, but they must be paid directly to the institution (rather than the recipient), otherwise it could be subject to gift taxes.
Roth IRA conversions
Depending on your income tax bracket and overall financial situation, it could make sense to convert some or all traditional IRA assets to Roth IRAs. In the year the conversion takes place, the account owner will pay income taxes on the amount converted. As a result, the assets in the Roth IRA can grow tax-free and eventually be distributed tax-free to the beneficiaries, which can be a spouse, children, grandchildren, and others.
Intra-family lending
The IRS has established special interest rates, called applicable federal rates (AFR), for intra-family loans, and these rates are typically lower than commercial lending rates. This can be an effective family wealth planning strategy for individuals wanting to give for a specific use (home purchase, business startup, and similar purposes). It can be an especially appealing option in the current low interest rate environment. Just be sure to properly document and structure the loan according to the IRS rules.
Irrevocable grantor trusts
Selling appreciating assets to an irrevocable grantor trust (IGT) held for the benefit of heirs is another potentially attractive planning strategy in a low interest rate environment. Doing so removes the transferred assets (plus any future appreciation) out of the grantor’s estate while retaining access to a certain level of cash flow. Common types of IGTs include the grantor retained annuity trust (GRAT) and intentionally defective grantor trust (IDGT).
Plan and educate heirs
Transferring wealth is only half the battle. Before any plan is implemented, you need to verify those on the receiving end are prepared for it. A study reported in Money magazine found that 70 percent of the time, family assets are lost from one generation to the next. Often it’s because heirs aren’t financially literate on money matters, in part because parents and grandparents are uncomfortable discussing it. Many simply don’t believe their children or grandchildren are responsible enough to handle an inheritance. It’s up to you to change that by having open and honest conversations with those who will be the recipients. Talk about the desired long-term objectives for the wealth and help them to understand the role they play.
How we can help
Determining which wealth transfer strategies to employ depends upon your goals and personal financial situation. Timing is likely to make a difference, too. The sooner you begin, the more likely you are to see your plan implemented the way you wish. It may be helpful to collaborate with a team of financial planning, tax, and estate planning professionals to help guide decisions for you, your family, and your legacy.