Before You Wish 2020 Away, Consider These Planning Strategies
The end of the year is fast approaching, and it’s probably fair to say that everyone is looking forward to saying goodbye to 2020 and hoping for a better 2021. The presidential campaign provided insight into potential tax legislation from both candidates, and although any meaningful tax reform may be off the table absent a Democratic Senate, it is very clear that taxes will have to be increased at some point to pay for the mounting debt that the US has incurred due to the pandemic. For that reason, the current estate tax exemption amount and volatility in the financial markets make 2020 an opportune time to explore ways to reduce your tax bill or otherwise improve your financial situation. Below are some of the more common actions to consider in the next few weeks before the end of the year.
By now you have likely heard or read about the possibility of the estate tax exemption being reduced in 2021. Joe Biden has expressed his preference for a reduction in the exemption from the current amount, as well as changes to other laws affecting estate planning. While that may be less likely to occur if the Republicans maintain control of the Senate (which won’t be decided until January), the increased exemption amount (currently $11,580,000) is scheduled to automatically phase out at the end of 2025 so you may want to consider potential gifting strategies including the following:
- Spousal Lifetime Access Trusts – Some say that this strategy allows you to “have your cake and eat it too” because you can potentially access the gifted assets (via your spouse as the beneficiary) if necessary while still removing the assets from your taxable estate.
- Dynasty Trust – This is perhaps the simplest way of removing assets from your estate and benefitting your descendants for generations - by making a gift to an irrevocable trust. If the beneficiaries or proposed trustee live in a state with a significant income tax (e.g., California or New York) a Delaware trustee should be considered to avoid that state income tax.
- Grantor Retained Annuity Trust – With this “heads you win/tails you tie” strategy, the grantor transfers assets to a trust and retains an annuity stream for a term at least two years. Any growth of the trust assets above an IRS-prescribed rate (the “7520 rate” – which is currently only 0.4%) is transferred tax-free, making it particularly appealing for transferring an interest in a closely held business expected to appreciate substantially in the near term.
- Annual gifts – These gifts (up to $15,000 per donee, or $30,000 if the donor is married) are a powerful tool for reducing the value of your taxable estate and will likely benefit your descendants as well.
While there are also other planning techniques that provide for significant transfers of wealth on a tax-free basis, the overriding message is to review your estate plan now and consider making additional gifts to utilize your increased exemption before the end of the year. We encourage you to contact your advisor soon if you want to act prior to year-end – lawyers and accountants are very busy between now and year-end given the amount of gifting occurring this year.
Income Tax Planning
There hasn’t been much legislation in 2020 affecting income taxes and it is difficult to see significant changes being made in the next couple years if we have a divided government. That said, the volatility in the capital markets may have provided opportunities to reduce your income tax liability, and year-end is always a good time to review your income tax situation to make any adjustments that may reduce your taxes. The following are some of the more common areas where savings may be found:
- Portfolio Management – Note that we are currently reviewing all of our client portfolios and paying close attention to the following:
- Rebalancing – Year-end is a good time to rebalance your portfolio to maintain the appropriate asset allocation for your desired level of risk, especially since global markets and various asset classes have diverged significantly this year.
- Tax-loss harvesting – Consider selling any holdings held at a loss now (while buying a similar asset to maintain the appropriate equity exposure). This will allow you to offset gains generated elsewhere in the portfolio or carry over the losses to future years.
- Capital gain distributions – Many mutual funds have capital gain distributions in December. You should check with your mutual fund to determine the extent of any capital gain distributions, and consider selling the fund before the distribution date, then investing in an ETF temporarily and buying the fund back after 30 days.
- Capital Gains – Joe Biden has proposed an increase in the capital gains tax rate for those making over $1 million annually to 39.6%. You should discuss with your advisor and accountant the possibility of accelerating capital gains into 2020 to take advantage of the current capital gains rate of 20%
- Income acceleration/deferral - If you have flexibility in the timing of income, you may want to accelerate income from 2021 to 2020 in the event that marginal tax rates (and potentially payroll taxes) increase. Conversely, if you expect your marginal rate to remain the same, you may want to defer as much income as possible to 2021.
- Timing of expenses that may qualify as itemized deductions - The standard deduction in 2020 is $24,800 for joint filers. If your deductions exceed that, you might want to pull medical expenses and charitable contributions into this year.
- Charitable contributions - Consider making donations before year-end. Thanks to the CARES Act, the deduction for cash contributions to public charities is now up to 100% (up from 60%) of your adjusted gross income. Gifting appreciated securities rather than cash can also help to reduce your tax burden while still achieving your charitable goals.
- Gifting of Qualified Plan Assets — Consider making charitable donations from your IRA directly to the charity. These distributions will not be included in your gross income but will count as part of your required minimum distribution. This strategy works particularly well if you can’t otherwise itemize deductions.
- Health Savings Accounts - Maximize your contributions to an HSA account. The contribution limit in 2020 is $7,100 for a family. These accounts can be a terrific source of funding for medical expenses in retirement since they can be rolled over year-to-year.
The Secure Act of 2019 became effective in December and significantly changed the administration of retirement accounts. Below are a few tips for retirement planning as year-end approaches:
- Required minimum distributions - The CARES Act suspended minimum distributions for 2020 so you do not need to take them at this time. You will want to pay attention to minimum distributions in future years as the Secure Act now requires non-spouse beneficiaries to take distributions over 10 years instead of over their life expectancy.
- Maximize retirement savings - Review and maximize your contributions to tax-deferred accounts such as 401(k)s and IRAs (or SEP-IRAs or SIMPLEI IRAs if self-employed), especially to receive any matched contributions by an employer. Note that the Secure Act of 2019 allows taxpayers still working to continue making IRA contributions past age 70 ½.
- Consider Roth-IRA conversion - Given the poor performance of many securities this year, it may make sense to convert IRA assets with depressed valuations into a Roth IRA. Remember that such a conversion will increase adjusted gross income (“AGI”) for 2020, which may affect tax breaks based on AGI or modified AGI.
This year has been difficult in many ways and while you might prefer to ignore the rest of 2020 and hope for a better 2021, it is important to review options available to you from an estate and income tax perspective and take appropriate action prior to year-end. While not all of the tips noted here may be appropriate for you, now is a good time to reach out to your advisor and begin proactive planning.
This information is provided by Tiedemann Advisors, LLC (“Tiedemann”) and is not intended to be, nor should it be construed or used as, investment, tax, accounting, legal or financial advice. Tiedemann’s services may not be suitable for all clients. This information is provided to discuss general market activity, industry or sector trends, or other broad-based economic, market or political conditions. Economic and market forecasts presented herein reflect our judgment as of the date of this presentation and are subject to change without notice. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change.