Since its enactment in 1932, families with significant assets have utilized the annual gift tax exclusion as a tool for both transferring wealth to the next generations and also reducing the size of the taxable estate. In 2024, an individual may give away as much as $18,000 to any individual without incurring tax liability. For married couples, the amount is doubled, so if a married couple has two children and five grandchildren, they could gift up to $90,000 to family members in 2024, tax-free. (And the provision is not limited to family members, by the way. Gifts to qualified charitable organizations, of course, provide a deduction from taxable income, which falls under a different section of the Internal Revenue Code.)
But there are other ways to provide these important benefits to heirs beyond simply gifting cash or other assets. And especially in light of the “sunset” provision of the 2017 Tax Cuts and Jobs Act (TCJA), which provides that certain currently higher exemptions from estate taxes will revert to their pre-2017 levels (adjusted for inflation) on December 31, 2025—unless extended by new legislation—it’s more important than ever to review your gifting strategies to make sure you’re taking maximum advantage. Here are some steps you can take to make sure your gifting and other wealth transfer plans are working for you in the best way possible.
- Assess the optimal transfer vehicle. Most people automatically assume that a properly drawn will is the best way to guarantee a smooth transfer of assets upon death, but this is not always the case. In some situations, a revocable trust may be more advantageous. As you begin forming your plans, this decision should be foundational to all other arrangements. This means that you should stay in close touch with your estate planning or legal experts to make sure that your documents are optimized for your individual needs and priorities.
- Insure that assets are titled in a non-contradictory way. If the planning strategy determines that assets should be held in a trust, ownership of assets should be in a form that takes this into consideration. For example, an investment portfolio held in a joint tenancy account with rights of survivorship will pass to the surviving joint tenant, no matter what the will or trust document says. If the intention is to use a trust to insure the client’s wishes are carried out, then assets in the trust must conform.
- Take advantage of the annual gift exemption. As mentioned above, the annual gift exemption was increased for 2024, from $17,000 per individual up to $18,000. And that applies to each individual recipient. By fully utilizing this provision, a married couple may be able to significantly reduce the size of their taxable estate in each instance. A program of planned annual gifting is an important wealth transfer tool that is often overlooked.
- Review all documents annually. One of the most common estate planning mistakes that we encounter is the use of out-of-date documents. We strongly urge clients to make an appointment with their financial planners and/or tax consultants each year. Estate planning documents should be reviewed in light of any changes in the client’s marital, health, or business circumstances. Births, deaths, divorces, and other major life changes in the client’s immediate family should be considered. Purchase or sale of businesses or new roles in a business for members of the family should be reviewed. The client’s philanthropic priorities should be re-assessed, with any changes or updates reflected in the documents.
Gift Funding to a Roth IRA
Roth IRAs can also serve as a way to transfer wealth from one generation to another. Because no RMDs are required, Roth IRAs can continue to grow, tax-free, for the entire lifespan of the owner. And if the owner chooses to name a child or grandchild as the beneficiary of the account, the Roth IRA will pass to that person upon the death of the owner, continuing to grow tax-free as long as the funds remain in the account.
In fact, many parents and grandparents have discovered that one of the secrets to teaching kids about money is giving them a chance to handle it responsibly, which includes saving a portion and watching it grow. Roth IRAs are actually a great vehicle to drive home this vital lesson, and there’s more than one way to incorporate the benefits of a Roth IRA into your gifting plans. Because qualified deposits into a Roth IRA grow tax-free, and because there are no required minimum distributions (RMDs) for Roth IRAs, these accounts are an excellent way to show the next generation the real-world benefits of smart, disciplined saving and investing.
One way to do this is simply by contributing to a Roth IRA held in the child’s name. Even if the parent or grandparent doesn’t qualify for a Roth IRA of their own because of income restrictions (individuals earning above $139,000 and couples earning above $206,000 annually cannot make qualified contributions to a Roth IRA), they can contribute to a child or grandchild’s Roth IRA, as long as the child has earned income equal to or greater than the amount of the contribution. So, if a child earned $6,000 at a summer or part-time job, the parent or grandparent can gift $6,000 (the maximum annual contribution) and deposit it in a Roth IRA in the child’s name.
Obviously, for a young person, the potential future value of the account after compounded growth can be impressive. And with the ability to make qualified, penalty-free withdrawals from the Roth IRA account for expenses like higher education or the purchase of a first home, it’s a perfect way to nurture a lifelong habit of saving and investing.
It’s important to note, however, that the rules have recently changed for when RMDs must be taken for inherited Roth IRAs (accounts that pass to anyone other than the spouse of the deceased owner). Under the SECURE Act of 2019, a non-spouse who inherits a Roth IRA must take distribution of the account balance over a span of ten years from the death of the original account holder. This applies only to Roth IRAs that were inherited after January 1, 2020.
Estate Taxes and the SECURE Act
One of the most heralded changes wrought by TCJA was the dramatic rise in the exemption from estate taxes. By some estimates, the number of estates subject to tax fell by more than half, from some 5,500 in 2017 to around 2,000 in 2018. By basically doubling the size of estates exempt from the wealth transfer tax, the TCJA created a flurry of activity for estate planners, grantors, and others.
But the December 31, 2025 sunset provision appears likely to stimulate another flurry, perhaps in the opposite direction. In preparation for the drastic reduction in the exemption indicated for 2026, it may be advisable for estates near or above the prior threshold ($5 million, adjusted annually for inflation) to give increased attention to their annual gifting plans, since the IRS has indicated that clawback provisions for conforming gifts made prior to the sunsetting provisions are unlikely. In 2024, estates still enjoy a lifetime exemption equal to the estate tax exemption, $13.61 million ($27.22 million for couples). But, unless Congress and the president act to extend them, these higher thresholds are set to expire at the end of 2025. If that happens, estates of around $7.5 million ($14.5 million for couples) could again become subject to taxation of the estate upon its transfer to heirs. Persons with estates in or near this range should probably consult with their estate planning experts to begin formulating plans for tax-efficient strategies that incorporate the new, lower limits.
At The Planning Center, we want you to be well informed about ways to make your estate planning more tax-efficient. And we also know that many clients are very interested in providing financial advantages to future generations. To learn more, visit our website to read our article, “The Inheritance Talk: Tips for Those on Both Sides of the Table.”
