Each year as we approach December, we review expectations for the coming year and outline planning strategies that may be beneficial to implement by year-end. There are some standards to consider every year: maximizing your 401(K) contributions ($19,500 in 2020 with an extra $6,500 catch-up contribution if you’re 50 or over), looking for losses to take if you have gains to offset, using your annual gift exclusion amount ($15,000 per recipient) to help move assets out of your taxable estate, and using appreciated stock where possible to do your year-end charitable giving.

Additionally, changes in the political, regulatory, and economic environment create potential opportunities above and beyond the annual standards. Not surprisingly, 2020 will be closing out with some uncertainty as to the political make-up of Congress in 2021. If the Democrats manage to gain control of the Senate, a Biden administration is expected to usher in a tax increase on households earning over $400,000/year and hasten the reduction of the estate tax exemption amount – or potentially do away with the exemption. If the Republicans maintain control of the Senate, it will be extremely difficult for Biden to get his tax proposal passed.

While we are still in limbo regarding what is likely to happen with income and estate taxes going forward, there are some things we do know. The current estate tax exemption amount is $11.58 million at the federal level. That is set to expire after 2025 and will drop back down to pre-Tax Cuts and Jobs Act (TCJA) limit as adjusted for inflation. Biden’s tax proposal would reduce the exemption amount to that level sooner.

For those with estates taxable at the federal level ($23 million for a married couple), it may make sense to give assets to heirs up to the exemption amount now, while the higher gift and estate tax exemption amount is still in effect. In addition, some businesses have valuations that are greatly suppressed right now, and owners may realize more bang for their exemption buck by transferring those assets while they’re worth less.

A grantor retained annuity trust (GRAT) is one option for transferring assets to your heirs that can work quite well in a low interest rate environment, as is a charitable lead trust (CLT). The latter is particularly appropriate if you’re interested in doing charitable giving now and leaving assets to heirs in the future.

Modeling a large gift in a financial plan can help determine the amount you can afford to give now without compromising your current standard of living and future financial independence. Talk with your advisor about what might make sense for you. Even if it’s too late to make a significant complex gift in 2020, the opportunity may still be there in 2021, and it will be helpful to have a jumpstart on planning.

Other Year-End Planning Considerations 

IRA Planning

Charitable Remainder Trust
Under the SECURE Act, a beneficiary other than a spouse may no longer stretch IRA distributions over their lifetime. A trust can hold an IRA but is also subject to the 10-year withdrawal limit. However, you can create a charitable remainder trust (CRT) and name it as the beneficiary of your IRA with a non-spousal income beneficiary(ies). The IRA can be distributed within the trust within 10 years, deferring immediate taxes on the recognition of income because of its charitable status. The IRA assets will be distributed and taxed to the trust income beneficiary during the term of the trust and, in that manner, the IRA assets can effectively be stretched over the lifetime of the beneficiary.

Roth Conversion
Converting assets in an IRA to a Roth IRA may result in more financial value being passed to future generations and less going to pay taxes, particularly if the original IRA owner is at a lower bracket than the beneficiary is likely to be when the original owner dies. The income tax on the IRA assets can be paid by the owner at a lower rate, and after conversion, there are no required minimum distributions during the life of the original owner, so the remaining assets stay in the account to grow. There will be a required withdrawal period of 10 years for the beneficiaries, but the income is tax-free. You can also split the conversion over several years, doing a portion by year-end 2020, and an additional amount in 2021, to spread out the tax impact.

CARES Act
Under the CARES Act, required minimum distributions from retirement plans, including 401(k)s and inherited IRAs, are waived for 2020. If you don’t need the money and if leaving it to grow tax-deferred in your IRA makes sense, you can leave your IRA untouched for the year.

Capital Gains

Biden has proposed that those earning over $1 million pay tax on capital gains as income instead of at the preferred capital gains rate. At that level of income, that would effectively be an increase from 23.8% to between 37% and 42.8% depending on whether income tax is also increased and the net investment income tax is included. Regardless of whether that happens, it seems unlikely that capital gains tax rates will go down. Depending on your situation, it may be more tax-efficient to take capital gains in 2020, under the tax structure we do know, than under a future and likely higher rate structure.

As always, your Fulcrum advisor is here to help clarify your options. Please reach out to your advisor if you have questions or would like help determining whether one of the strategies listed above may be right for you.