The current economic environment has resulted in very low interest rates and deflated portfolio values, as well as decreased valuations of many businesses. Though silver linings in the COVID-19 pandemic seem few and far between, one such positive side effect is that these circumstances create an opportune time to transfer lifetime accumulated wealth to the next generation in a tax advantageous way. For example, business owners can satisfy succession planning goals now by taking advantage of the current low values and/or interest rates to transfer their businesses to heirs.
There are several other wealth management strategies to consider at this time.
Intrafamily loans are a simple and tax effective way to transfer wealth to family members. Individuals can make loans to heirs or to a trust for their benefit at significantly low interest rates right now, lower than they can get through a bank. To illustrate, the minimum interest rate the IRS requires be charged on a long-term loan (i.e. mortgage) to avoid gift treatment is 1.01 percent for June 2020. Maybe a child wants to buy a home or start a business — parents could provide the financing to help them. They could also refinance prior loans, whether they are prior intrafamily loans or a child’s commercial mortgage. Note that when providing the financing for a mortgage, the mortgage must be secured by the home for the interest to be deductible.
Enhanced gifting leverage
The federal estate and gift tax exclusion is currently $11.58M ($23.16M for a married couple), but the law is scheduled to revert to lower levels on December 31, 2025. In this uncertain economic environment and time of high federal spending, it is possible that this exclusion level could be reevaluated by the current or future administration sooner than anticipated. Therefore, anyone considering utilizing this elevated exclusion should be proactive.
Gifting assets now when they are likely at a low value means that less of the estate and gift tax exclusion will be used to accomplish the same result or even more assets can be transferred. Additionally, as New York does not have a gift tax, gifting now to reduce your estate can also save New York estate taxes later (note: you have to live at least 3 years after the gift).
Roth IRA conversions
With deflated values, lower tax rates and possibly reduced income, now may be a good time to convert your traditional IRA to a Roth IRA. Let the rebound happen in a tax-free Roth IRA. For younger people, conversion can make sense for income tax purposes and to avoid future mandatory distributions that are required from a traditional IRA.
A Roth IRA conversion can be especially advantageous for those with excess wealth. For example, if someone realizes after retirement planning projections that they won’t need all those retirement assets during their lifetime, a Roth IRA can be an effective vehicle to pass that wealth to heirs. These individuals can accumulate more tax-free wealth in the Roth IRA since there are no minimum distribution requirements. On conversion of the IRA to a Roth IRA, that IRA asset’s value is essentially frozen for income tax purposes by paying the income tax on it on conversion. From that point forward, any future growth escapes income taxation, even for heirs. By paying the income tax heirs otherwise would’ve had to pay, it’s essentially a gift, free of gift tax. Additionally, any income tax paid on the conversion reduces the taxable estate.
The tax-free treatment of qualified distributions from Roth IRAs are even more valuable after the recent passage of the SECURE Act. The new law requires retirement accounts to be fully distributed to heirs within 10 years. That can wreak havoc on their income taxes; that wouldn’t happen with a Roth IRA.
Not only is charitable planning a great estate tax strategy, but it also has obvious benefits in supporting the community and providing financial support to those suffering during the COVID-19 crisis. Charitable trusts create an opportunity for assets to pass to either beneficiaries or a charity, depending on the type of trust established. The current low-interest-rate environment means less of the estate and gift tax exclusion is used when setting up certain types of these trusts.
Another factor at play in charitable planning is the CARES Act. The law relaxes the limits of deducting cash contributions. Up until now, only cash contributions made to a charity of up to 60 percent of adjusted gross income were deductible. Under the CARES Act, Americans can deduct a full 100 percent of their adjusted gross income for 2020 (with certain limitations). There is also a $300 above-the-line deduction for individuals that do not itemize in 2020.
Refer to the experts
Expert advice is necessary as laws and personal finances grow more complex. In addition to those noted here, there are many different types of estate planning vehicles and strategies that can be customized to suit the needs and goals of each family’s situation. Those interested in understanding and implementing the best wealth management solutions in the current environment should contact a CPA financial planner to help design a plan that is right for them.
Cindi Turoski, CPA/PFS, CFP®, is the managing partner of Bonadio Wealth Advisors LLC, the statewide financial planning division of The Bonadio Group. With over 30 years of deep tax and financial planning experience, she provides consultative services to a wide variety of clients, further specializing in closely-held business owners.l