The estate
tax, also called the death tax, is a tax on transferring assets from a deceased
person to their heirs or beneficiaries. One significant component of our
current estate tax law is the sunset provision, which implies that specific
policies within the law have a set expiration date after which they cease to
exist. The impending estate tax sunset on December 31st. 2025,
may significantly impact high-net-worth individuals transferring their estate
to heirs and those who inherit these assets.
In this
article, we review the current estate tax exemption, the step-up basis rule,
and how proactive estate planning and the implementation of strategies may help
lighten the tax burden on heirs.
Today’s
Federal estate tax exemption
Currently,
the estate tax exemption limit in the U.S. is $13.61 million per benefactor,
implying that any estate valued less than this amount will most likely not be
subjected to federal estate tax. Nonetheless, these parameters are subject to
change following the sunset provision, which will expire at the end of 2025.
As the sunset date approaches, the federal estate tax exemption could be
decreased by nearly half. This reduction would mean more estates fall into the
taxable category, substantially impacting heirs. Investors who initially
thought their estate or heirs would not be liable to pay the estate tax due to
the value under the exemption threshold may need to reevaluate their estate
plan due to the lower limit.
Though the
exact changes following the sunset provision are subject to legislative
decisions, being prepared for different scenarios may help investors better
preserve their investments and their heirs’ inheritances from adverse tax
consequences.
The stepped-up basis rule
Another
aspect of the estate tax sunset that could impact investors relates to the
step-up basis rule. Under the current law, when an investor inherits an asset,
its cost basis is adjusted (stepped up) to the market value at the time of the
previous owner's death. It allows the inheriting investor to sell the asset
immediately without incurring capital gains taxes or to hold onto the asset
with a managed potential future tax liability.
Eliminating
or modifying the stepped-up basis rule could result in higher capital gains
taxes for heirs inheriting assets. In such cases, the inherited assets' cost
basis would remain the same as when initially purchased by the original owner,
leading to higher capital gains when these assets are sold.
Proactive
estate planning needed
The
uncertainty surrounding these impending changes urges investors to consider
proactive estate planning strategies; some examples include:
· Intervivos
gifts—Intervivos
gifts are the transfers of assets made during the giver's lifetime. Such gifts
can strategically help manage an estate's value to fall within the exemption
limit.
· Life
Insurance Trusts (LITs)—
A life insurance trust (LIT) is a legal agreement that allows a third party to
manage a life insurance policy's death benefit and help mitigate the tax
liability to heirs on assets held in the trust. Trusts can help control how and
when assets are distributed to beneficiaries, offering protection against
future estate tax changes.
The sunset of
the estate tax may also impact investment strategies. If the estate tax reverts
to its old rules, more estates may be subject to the tax, encouraging investors
to consider tax-efficient investing more seriously. This could lead to
increased investments in assets such as dividend-paying stocks, municipal
bonds, and real estate properties that provide rental income.
It is essential to remember that the sunset of the Federal estate tax is
not a certainty. Future Congresses could decide to extend the increased
exemptions or even make them permanent. Alternatively, there could be further
restrictions or increases to the estate tax. Given the fluctuating nature of
this scenario, it is recommended that investors continually revisit their
estate plan with their financial, legal, and tax professionals to ensure it
still aligns with their financial goals and wishes.
Planning for retirement can be overwhelming, but it becomes much easier if you start early. If you plan to retire next year, there are specific things you must consider and implement now as you prepare for an independent retirement.
Here are seven tips to help you prepare to retire.
#1- Pay off debt.
Before you retire, it's essential to eliminate as much debt as possible. Whether credit card debt, mortgage loans, or student debt, any outstanding financial obligations may affect your retirement savings. Eliminating these debts can help you manage your monthly expenses and have more cash for your golden years.
#2- Estimate your retirement income needs.
The first step in retirement planning is estimating how much money you need to retire. A common rule of thumb suggests that you may need about 75—80% of your pre-retirement income to maintain a similar lifestyle throughout retirement.
The amount varies depending on health, lifestyle, debts, travel plans, etc. A financial or insurance professional can help determine if this percentage is appropriate for you.
#3- Fully fund an emergency fund.
An emergency fund is crucial to safeguard against unexpected financial emergencies that could derail your retirement plan. Your emergency fund should be large enough to cover six to twelve months of living expenses.
#4- Purchase for long-term care.
Many need to pay more attention to the cost of healthcare in retirement as they plan for their future. You're more likely to require extended medical or nursing home care as you age. Long-term care insurance provides care in a long-term care facility, at home, assisted living, or other care arrangements, depending on the policy and riders.
Without adequate financial resources or insurance for long-term care costs, your retirement assets may face early liquidation. Visit with a long-term care specialist or financial professional to understand how these policies work and what is covered.
#5- Evaluate your retirement savings portfolio.
As you approach retirement, you must revise your investment strategy and adjust your portfolio to manage risk. Moving away from aggressive investments and toward conservative, income-generating assets may be appropriate to your situation.
#6- Create a retirement savings spend-down plan.
As retirement approaches, it's essential to start thinking about how you will draw down your retirement savings. You may opt for systematic withdrawal plans from your retirement accounts or consider annuities that provide a steady income stream in retirement.
Also, consider the taxes on your retirement income, determining the order in which you want to draw down assets from pre-tax, taxable, and tax-free accounts.
#7- Take advantage of catch-up contributions.
If you're 50 or older, the IRS allows catch-up contributions to retirement accounts like 401(k)s and IRAs. This 'catch-up' will enable you to save more in these accounts above the standard contribution limit, helping boost your retirement savings quickly before you retire.
In conclusion, planning for retirement involves several critical steps and requires diligent financial management. It’s essential to remember that everyone's financial situation is different. Therefore, working with financial, insurance, and tax professionals can help as you work toward your retirement goals.
Numerous factors can influence retirement savings and the longevity of one’s retirement nest egg. Among them are longevity, liquidity, inflation, mortality (the stock) market, and taxes (LLIMMT). Each plays a crucial role in shaping an individual's retirement outlook.
This article covers LLIMMT and a comprehensive understanding of how each may impact planning for retirement.
Longevity— Longevity pertains to life expectancy or the length of time that a retiree expects to live beyond the average retirement age. With advancements in healthcare, the average lifespan has been gradually increasing, which means that retirees need more money to cover their expenses for a more extended period.
If retirees underestimate their longevity, they might exhaust their retirement savings sooner than anticipated, leading to financial hardship in their golden years.
Liquidity—Another critical factor is liquidity, which refers to the ease with which an asset can convert to cash without significantly affecting its value. Retirees must have enough liquid assets to cover unexpected costs like medical expenses or home repairs without selling off long-term investments at a loss. The risk of not having enough liquidity may result in retirees depleting retirement savings more quickly than expected.
Inflation—Inflation is the general increase in prices over time, which mitigates the purchasing power of money. As prices rise, a fixed amount of money can buy less. Therefore, if retirement savings don't keep pace with inflation, retirees may find they can't afford the same standard of living they had anticipated.
A diversified retirement savings portfolio that includes inflation-hedging investments is crucial for mitigating inflation risk.
Mortality—Mortality risks are associated with the possibility of an individual's premature death. If the primary earner in a family dies before retirement age, it can severely disrupt the family's retirement savings plans.
Life insurance can mitigate the impact, but this also needs to be factored into retirement planning.
Market—The stock market is pivotal in accumulating retirement savings, as it may provide higher returns than other forms of investment over the long term. However, the stock market can also be volatile, and downturns can negatively impact retirement savings, mainly if they occur before a person retires and begins drawing on their savings.
Taxes— Taxes have a significant effect on retirement savings. Depending on the tax laws and an individual's income level, a portion of their retirement savings will go toward paying taxes. Some retirement savings vehicles offer tax advantages, whereby contributions are made with pre-tax dollars or withdrawals are tax-free. Understanding the tax implications can help individuals save more effectively for retirement.
In conclusion, longevity, liquidity, inflation, mortality, the stock market, and taxes are vital to retirement savings. By understanding these factors and working with financial, insurance, and tax professionals, pre-retirees can strategize and devise a plan to navigate the complexities of retirement savings as they work toward a financially independent retirement.
Financial planning, including tax planning, is vital to personal financial health and wealth accumulation. Financial professionals often specialize in tax planning, determining one's wealth growth trajectory and overall tax liability.
They frequently collaborate with tax professionals to provide proactive tax-planning services for their clients.
This focus on tax planning and other specialties can help clients work toward financial independence, knowing that their financial affairs—and taxes—are in capable hands. Here are some reasons why discussing taxes and tax planning is essential.
Tax laws- Tax laws evolve continually, and staying updated with these changes can be overwhelming for individuals unfamiliar with the intricacies of tax legislation. Financial professionals specializing in tax planning stay abreast of new tax laws, rulings, and court decisions about taxes. They interpret how these changes may affect their clients' financial circumstances regarding investments and strategies and identify the appropriate investments to help manage tax liabilities.
Personal and business tax planning- Financial professionals specializing in tax planning understand all tax-related issues. They can assist clients in income tax planning, estate tax planning, retirement tax planning, business tax planning, and other related areas. Financial advisors who are well-versed in tax planning can also structure investments, financial activities, and new business opportunities to help manage tax liability.
Tax education- Additionally, a financial professional’s help translating complex tax terminology into simple language enables clients to make informed decisions about their wealth. They can help clients understand their tax obligations, how different financial decisions impact their tax liability, and their estate's tax liability at death.
Tax-efficient investing- Financial professionals can provide guidance on tax-efficient investing. They can help clients select tax-efficient investment strategies and design a plan to optimize after-tax returns. By properly aligning investment strategies with tax planning, clients can enhance their overall wealth accumulation.
Help mitigate tax issues- Another advantage of working with a financial professional specializing in tax planning is their ability to help with long-term planning. They know how to plan for different tax scenarios and can help mitigate potential tax issues. This foresight helps safeguard their clients' financial independence, helping them navigate various financial stages in their lives or business cycles.
Ongoing tax and investment recommendations- Lastly, tax planning services offered through a financial professional extend beyond merely filing tax returns; they provide ongoing, year-round tax guidance about their client’s investments. Tax planning helps clients manage their taxes and adjust their financial plans as personal, professional, and regulatory changes occur.
Investment advisory services are offered through Wealth Watch Advisors, an SEC-registered investment advisor. Neither Wealth Watch Advisors or J. Martin Wealth Management, LLC are endorsed by the Social Security Administration or any other governmental organization. Note, registration with the SEC does not denote a certain skill level or guarantee the success of an investment strategy. Wealth Watch Advisors and J. Martin Wealth Management, LLC are independent of one another.