Summertime can mean a lot of things: kids being home from school, warm weather, fun vacations, and many more. Reviewing certain areas of your financial plan is probably not on that list for 99.9% of us. Most individuals cover any planning issues in the spring while their taxes are getting done, or in the fall when we close in on the end of the calendar year. That doesn't mean your plan should go completely untouched in between those periods. Since many of our clients do not have major adjustments being made over the summer, it is a great time to catch up on areas that may not feel as "urgent". The most common planning topic to get pushed off due to its perceived lack of present-day significance is Estate Planning. While reviewing or changing your estate plan might not yield any current-year benefits (although it sometimes could), that does not make the value of it any less important. Below, we'd like to highlight a few aspects of your estate plan that might be worth thinking about during these slower months of the year.
Review Beneficiaries
On every investment account or bank account that you own, you have the ability to designate a beneficiary. By doing so, you are informing the institution of who should receive the assets in that specific account when you pass. This is an essential part of the estate planning process, and designating a beneficiary in this manner is referred to as a "will substitute". The reason is that once your beneficiary has been named, that designation will supersede any specific language within your will. Therefore, there is no need to go through the time and cost of Probate for any accounts that have already been assigned beneficiaries.
Reviewing these designations periodically serves two purposes. First, it is inevitable that the number of open accounts in your name will increase throughout your lifetime. From moving to a new location, a new job, or a new advisor, there are a multitude of life events that generally coincide with at least one new bank or investment account. As that number increases, so do the odds that you might accidentally open an account and forget to add beneficiaries on. Due to the fact that many institutions do not even require you to name a beneficiary on an account, this can happen more easily than one might assume. Ensuring that all of your accounts can pass directly on to your beneficiaries without verifying any other estate documents is an essential first step in the process.
Reviewing beneficiaries can also be a valuable task simply because our goals change throughout our lives. You might have listed certain individuals on previous accounts who have since passed. There could also be a number of tax reasons why passing assets to certain beneficiaries makes more sense, and those tax situations can change year-to-year. Even events like creating a trust can mean that you need to update many (or sometimes all) of your accounts to reflect the language laid out in your trust document(s). That leads us directly to our next estate planning task:
Consider a Trust, or Update an Existing One
There are times when naming one or two individuals as a beneficiary can be sufficient. If your goal is truly to have certain individuals take over your assets as soon as you pass, designating a beneficiary will do just that. However, there are also plenty of times when your situation might not be that simple. From conflicts with other beneficiaries and their families, to tax sheltering, or even creating income for others, there can be dozens of reasons why simply passing assets directly to someone else might not be your desire. These cases are where a trust can come in to help. We like to refer to trusts as giving you the ability to have a proverbial "hand from the grave". While designating beneficiaries essentially means that those individuals are in complete control at your passing, a trust is the opposite. There can be language to allow for all sorts of distributions, with specifics on who, when, and for what reason they are being taken.
While there are many different types of trusts, there are a few things that they all share. First, there is a Grantor. This is the individual who is responsible for funding the trust itself. They are generally the ones who initiate the setup of a trust to begin with. Next is the beneficiary, which is the individual who will receive some or all of the assets and/or income from the trust. Last is the trustee, who is the one responsible for managing the trust based on the rules outlined originally by the Grantor. Keep in mind that there can be multiple Grantors, Trustees, or Beneficiaries. Additionally, they do not all have to be separate individuals. In the case of a Revocable Living Trust, for example, the trustee and grantor are many times the same person. Of course, there are a variety of tax and estate considerations when determining who to name for these roles, and that is where getting with an experienced estate attorney to draft your own specific document can be valuable. If you already have a trust, ensuring that your goals are still properly outlined in the document is an essential part of ensuring the effectiveness of your estate plan. As mentioned earlier, there are many types of trusts out there, and we will cover that in a later post.
Evaluate the Goals of Your Tax-Deferred Assets
Over our working years, we accumulate assets in a variety of different accounts. Regardless of your background or occupation, a majority of that accumulation almost always ends up finding its way to your tax-deferred accounts. One reason why this occurs is that employers have traditionally set up a standard 401(k) plan, so both your contributions and any matching that your employer does will be tax-deferred. The Roth 401(k) has risen in popularity over the last few years, but is still far less common in an employer plan than the traditional 401(k). An additional reason why so much of our retirement savings end up being tax-deferred is that we are told throughout our working years that this will be better for us in the long run. By deferring taxes while you have earned income, you are avoiding higher tax rates. Once you retire, you can withdrawal that money and pay taxes when your rates are lower. We will have another article coming out about why this is far from a reality for many individuals, but that statement sounds logical enough on the surface that it is accepted as the truth by the majority of workers contributing to their retirement accounts.
If you retire before the age of 73, you do not have to start taking money out of your tax-deferred assets yet. Once you reach age 73, you will be subject to Required Minimum Distributions, which are calculated at the end of each calendar year. The exact amount needed for a specific year's distribution is based on that end-of-year balance, and that balance is then divided by your life expectancy factor as determined by the IRS. It is not uncommon for individuals to wait until their Required Minimum Distributions (RMDs) begin to start taking money out of their tax-deferred accounts. The logic behind this choice is simple: most individuals would rather not pay more taxes right now if given the choice. However, the flaw in this logic is that most individuals are not doing the math on how that deferral impacts their future distributions. If you are an individual who retires at 65 and starts taking withdrawals each year prior to 73, your RMDs will be much smaller than another individual's who retired at the same age and with the same assets who never made any withdrawals. Given how much extra that second individual's RMD is, they are at a greater risk for increasing their tax brackets or raising their Medicare premiums. For this reason, doing the math on what your required withdrawals and expected taxes would be is a crucial step in determining when to start tapping into tax-deferred money.
The last point we will cover on tax-deferred assets is the importance of identifying who will be using those specific assets. For example, let's say your goal is to withdrawal all of that money while you are living and spend it on yourself so that you can enjoy your retirement. That means we need to base the investment risk and income on your own time horizon and your own tax rates to make sure we are optimizing the efficiency of that account. However, let's say that your goal is to pass all of the money in a specific IRA to your grandson. If that is the case, our plan for the account has to look completely different. The risk and income of the investments are now both based on your grandson's time horizon, and with the knowledge that the funds will have to be distributed within 10 years of him inheriting the account, the tax implications will look completely different. If your grandson is in a much lower tax bracket than you, your goal will likely be to draw as little as possible so that he can take it out over 10 years at a lower rate than you. However, if his tax rate is much higher, he could receive a much larger net amount by you taking the funds out during your lifetime at lower rates. This could be either through regular distributions, or even converting to a Roth IRA. As always, these tax strategies only make sense in certain cases, so it is always best to consult with a tax advisor before making these choices.
Consider Gifting
It is not uncommon to have a gifting plan that basically looks like this: whatever I have left when I pass will go to my beneficiaries. While that sounds nice and simple, there are many times where that does not lead to optimal outcomes for you or your beneficiaries. As we discussed above, reviewing the tax rates of your beneficiaries and comparing them to your own is a key aspect of helping your beneficiaries receive more money as opposed to the IRS. We discussed the considerations when gifting/inheriting tax-deferred assets, but what about investments not in an IRA? One common strategy we use would be having an individual gift a stock to their children/grandchildren up to the gift tax annual exclusion ($18,000 in 2024), and then those individuals can realize any capital gains at a lower rate. For example, say you gift $18,000 of stock to your granddaughter. If your taxable income is anywhere from $94,050-$583,750 in 2024 and you file taxes as Married Filing Jointly, your capital gains rate is 15%. If you gift it to your granddaughter who is just starting out her career and has taxable income underneath that, her capital gains rate is 0%. If your gain on that $18,000 of stock was $10,000, that means that your granddaughter nets the full $18,000 instead of $15,300 if you realized the gains yourself.
What if you have assets that you would like to gift to charity rather than family members? If that is the case, you can unlock even more tax benefits. On a tax-deferred account, you can begin donating the funds at age 70.5 using a Qualified Charitable Distribution (QCD). Prior to 70.5, you could still make a withdrawal and eventually give that money to a charity, but the withdrawal would be taxed as ordinary income just like any other IRA withdrawal. By utilizing a QCD and gifting that withdrawal directly to a charity, you can transfer up to $105,000 in 2024 totally tax-free to any 501(c)(3) organization. If you utilize these at age 73 when RMDs begin, the amount taken out as a QCD will actually go towards satisfying the RMD for that year.
Another advantageous charitable account is a Donor Advised Fund (DAF). A DAF is set up through a sponsoring 501(c)(3) organization so that when you contribute to your DAF, it counts as a charitable contribution for that year. For non-cash contributions such as stock, you can deduct up to 30% of your adjusted gross income (AGI) for the year. For cash contributions, that number increases to 60% of your AGI. One important note is that non-cash contributions tend to be more popular due to the fact that you do not need to realize any capital gains on those contributions. So if you had a stock worth $50,000 and $25,000 of that is made up of unrealized gains, you could donate the full $50,000 to your DAF without paying the capital gains on that $25,000.
Once your contributions have been made, they will continue to grow tax-free in your DAF. Remember, you already received your deduction in the year that you made your contribution, so there is no timeline to actually move the proceeds out of your DAF. Once you are ready to donate to the charity of your choosing, you can choose the amount that you would like to give. You may even nominate a successor on the account so that your charitable donations continue to grow beyond your lifetime.
Conclusion
The intention of this article is to simply scratch the surface of how you can optimize your estate plan. It is important to note that we are not estate planning attorneys, and we are not here to take their place. As your advisor, it is our job to review your financial plan to identify your goals and needs, and this often times goes beyond just your own income or your own assets. As we identify opportunities for wills, trusts, or power of attorneys within your plan, we will loop in the appropriate professionals to get these documents taken care of. It is nearly impossible to separate your estate plan from your financial plan, so it is always important to have your advisor and your estate planning attorney working hand-in-hand. As life inevitably changes in ways that we could not have predicted, the opportunities to optimize your wealth building or income generation will of course change as well.
As you spend this summer taking vacations, spending time outside, or just simply relaxing with your family, you might also want to take a few minutes and ask yourself if you truly have an optimized estate plan. If the answer is anything other than "Yes", then please feel free to contact us so that we can discuss your questions and concerns in more detail. Some of the above information could be applicable to your situation, and more importantly, there could be other planning implications for you to consider that we did not get a chance to touch on in this article. As always, thank you for taking the time to read our insights, and we hope you have a safe and happy summer!
Matt J Black,CFP®, AAMS®
mblack@larsonfs.com
913-428-2233
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