2020 has been a difficult year for planning ahead. From canceled vacations, appointments, and celebrations to lowered expectations, adjusted business goals, and rescheduled graduations, it has truly been a year in which the best laid plans of mice and men have gone astray. And although Robert Burns could not have imagined the combined chaos of a pandemic and its effects on our modern society when he wrote his poem “The Mouse,” its words nevertheless ring true. Many things seem uncertain and out of our control, but as Founding Father Ben Franklin once noted, two things in life ARE certain, and one of them is taxes. The good news is that taxes are something we can plan for, so they can work in our favor. As this year draws to a close, there are a few tactics you can employ to optimize 2020 as a taxpayer.
The Gift(s) of a Lifetime
Lifetime Gifting is a strategy activated to maximize the value of one’s wealth and inheritance while minimizing its susceptibility to taxation. The Tax Cuts and Jobs Act of 2017 (TCJA) made it easier for people looking to improve their gift tax exemptions by doubling the Basic Exclusion Amount (BEA) from a base of $5 million to $10 million (indexed for inflation after 2011) for gifts and inheritances bestowed from 2017 through the end of 2025. With the TCJA in place, you can make substantial gifts now to enjoy exemptions today, and receive the added benefit that appreciation of the gifted amount will not be applied to the future value and taxation of your overall estate. Initially there were concerns about clawback and future tax liabilities on gifted amounts during the TCJA time period, but the United States Treasury Department and the IRS declared final regulations against this possibility. With the increased BEA currently slated to end at the close of 2025, it is important for eligible taxpayers to take advantage of this lifetime gifting strategy now, as it is a “use it or lose it” opportunity. But a caveat- it is crucial to work with experts to assess and calculate the amount of capital that you can irrevocably gift and still sustain your lifestyle for the duration of your life.
A smaller risk with big rewards is another use-it-or-lose-it opportunity known as Annual Exclusion Gifts. United States taxpayers seeking to reduce implications of their estate tax can give up to $15,000, (or $30,000 for married couples), per year to an unlimited number of recipients without paying a gift tax. Annual Exclusion Gifts should be bestowed as early in the year as possible, so you can transfer a few additional months of potential appreciation to your beneficiaries instead of it accruing on your estate. As a side note, gifts to children should be made in trust to avoid its inclusion in their taxable estate, and to best protect it later from divorcing spouses or creditors. It is an ideal time to start planning for gifting in the first few months of 2021, but it is also not too late to transfer wealth in 2020- especially with the holidays as a perfect occasion for sizeable gifts.
Another gifting opportunity that offers big benefits you AND your children or grandchildren is a 529 plan, which sets aside funds for education. Within the 529 plan, your contributions can grow tax-deferred and distributions are income-tax free as long as they are used for qualifying educational expenses of the account’s beneficiary. The dollars contributed to this would still be considered part of an annual exclusion gift but is a smart strategy that can still be taken advantage of in 2020.
Tax Benefits that Benefit Others, Too
Charitable planning and contributions are an exceptional means of optimizing tax exemptions, since they benefit both the taxpayer, and an organization in need. There are several strategies for this, including basic charitable deductions, charitable distributions that are completely excluded from the taxation of your income, bunching several years of donations into one year to help the you enjoy a more significant tax benefit by exceeding the standard deduction mark, and setting up a CLAT, or a Charitable Lead Annuity Trust, the last of which is a significantly tax-efficient means of reaching both charitable and tax savings goals. Now is the time to work these contributions into your wealth management plan to take advantage of opportunities that may change in the future.
Maximize Your Roth 401(k)
More and more employers are offering their employees a Roth 401(k) option. An often-under-used tactic among high-income earners, a taxpayer can attain a higher savings rate with a Roth 401(k) as compared to a traditional 401(k). Both options have the same contribution limits, which produce an income tax deduction, and a resulting tax benefit that can be invested. That said, with the traditional 401(k) option, once the maximum contribution limit is obtained, these tax benefits are then required to be invested in a taxable account. With a Roth 401(k), 100% of the contributions remain in the account, where it will grow tax-free. Even with a tax rate that is lower at distribution than contribution, a taxpayer with the Roth 401(k), who maximizes their contributions may still end up ahead due to a better tax efficiency of the whole overall portfolio.
In a year of many uncertainties, tax planning is a certain way to get ahead. You have worked hard for your money and want to preserve its integrity for years and generations to come. The advice from financial planning experts can be crucial to ensuring that your assets and family are well taken care of. At Sorensen Wealth, we work with our clients to understand their needs and goals, then devise and implement customized wealth-management solutions to achieve these benchmarks. It is not too late to plan for 2020, and to take advantage of early tax benefits for 2021. We encourage you to visit the Sorensen Wealth website and contact us today.