Strategies for Using Inheritance Dollars Now
Key Takeaways:
A good Estate Plan will go a long way to ensure your wishes are honored after your death.
Roth IRAs are a wonderful asset you can leave to your heirs.
Legacy does not have to be dollars and cents; a Legacy Project can be an interesting idea for future generations.
Gifting during your lifetime instead of passing a significant Legacy at the end of your life may be more rewarding to you and your heirs and is worth exploring.
Charitable giving can benefit causes you support in your community and may also yield tax benefits.
Donor Advised Funds (DAFs) can be a great tool to offset an unusually high-income tax liability in a given tax year. If incorporated into your Estate Plan, it can continue to support your favorite charities or religious organization long after you pass away.
Suppose you have a detailed financial plan and a strong projection that you will have a significant amount of money left after you depart this realm of existence. In that case, you may think of the best ways to use that wealth now and even after your departure. In this article, we will explore ideas and methods to use your wealth that you may not need after all.
This article marks the conclusion of our Retirement Income Series and is entry #8. To learn about the entire retirement income process from A-Z, we suggest going to our main resource page and starting from the beginning.
LEAVING A LEGACY TO YOUR HEIRS
Once you know what you want to accomplish with your wealth, your next step should be updating your estate planning documents to reflect those wishes. A good estate attorney will hear you out and draft a plan to ensure your assets are handled as you intended after you leave. If you only want to ensure that your wealth is passed on to your intended heirs, a "Will" usually does the trick just fine. If you want to control how your heirs use their inheritance, a Trust allows you to spell out how funds are accessed and spent.
Under the right circumstances, Roth Conversions can be a powerful tool to build up Roth IRA balance and pass tax-free assets to your heirs. We take a deeper dive into this concept in our article titled Roth Conversions When It Makes Sense and When It Does Not.
It is said that each person dies three times: when we die physically, when our body is laid to rest, and the third time when our name is spoken the last time. "Legacy" is defined as "the long-lasting impact of particular events, actions, etc. that took place in the past, or of a person's life." In other words, your legacy does not have to be limited to passing money on to your descendants but instead might include discussing the values you'd like to impart to your heirs; or crafting a family narrative that encompasses more than simply real estate or cash assets. We can all reflect on our family trees and quickly realize that while we may know a bit about our great-grandparents, almost nothing is known about our great-great-grandparents or older generations.
Suppose your legacy focus is on something other than transferring wealth. In that case, you may consider starting a family tradition where members gather every couple of years to discuss and honor family members who have already passed away and update family history record with important events to be used by later generations. If you are interested in this, there are a lot of free resources online, and all you have to do is search for "Legacy Project" ideas.
GIFTING DURING YOUR LIFETIME
Setting up beneficiaries and inking your wishes into a well-written etate plan is a great start, but you could go a step further. Instead of waiting to share the wealth you may not need, you could start giving it away now if you would rather watch your heir enjoy your gifts to them. Family trips and creating new memories with your children and grandchildren is likely far more meaningful than a 6-figure check. The added benefit of giving early is that it can serve as a litmus test to see how someone would manage a larger inheritance in the future.
Gifting during your lifetime could also help reduce the size of your estate and lower your estate tax bill, which is important if your estate is large enough to trigger lifetime exclusion limits. Each person can gift up to an annual exclusion amount of $17,000 per person, per year, without filing IRS Form 709. Taking it a step further, married couples may gift $34,000 to any one person per year and qualify for the exclusion limit. Fortunately, under current law, triggering gift and estate taxes is not an issue for most – the Lifetime Exemption amount is $12.92M per grantor ($25.84M if the surviving spouse properly elects the marital deduction).
One common misconception is that either you or the recipient would have to pay taxes on dollars gifted – not true. Since these rules do not limit whom you can gift assets to, you can give $1,017,000 to your favorite neighbor. While this amount is far in excess of the annual exclusion amount of $17,000, all you would have to do is file a gift tax return.
On the other hand, some assets should never be gifted, especially highly appreciated assets of any kind. While one may think it is a great way to avoid paying capital gains taxes, it is the worst thing you could do because your highly appreciated assets receive a step-up in cost basis upon your death. A step-up in cost-basis allows your heirs to receive those assets with minimal tax consequences compared to gifting the highly appreciated asset to them during your lifetime.
Let's use a common mistake to illustrate how the step-up in cost basis works and can benefit your heirs. A parent decides to list a child as a joint owner of their residence, or even worse, they "deed over the house" completely. Unfortunately, in this situation capital gains taxes are calculated on the appreciation of an asset realized upon sale. For example, if you buy a house for $500,000 and sell it a year later for $1,000,000 – congratulations, you made $500,000, but you must pay taxes on this gain. However, if you buy a house for $500,000 and you die a year later when it is worth $1,000,000, and your child inherits the house – the IRS considers the value on the date of passing as the new purchase price for the child who inherited the home.
This purchase value increase upon death is called a "step-up" in cost basis. So, if the person who inherited the house turns around and sells it right after it was inherited – the capital gain would be $0, and there would be no taxes due. The IRS uses the home's value on the date of your passing as the "purchase price" for your child, so from the IRS perspective, your child got the house for $1,000,000 and sold it for $1,000,000 – no gains to tax. However, if you gift or "deed over" the house – there is no step up in cost basis, and IRS still considers the original $500,000 purchase price as the actual cost of the house, and if the child sold the house for $1,000,000 – there would still be capital gains taxes to pay on the $500,000 gain.
CHARITABLE GIVING
Some consider giving to those in need a moral obligation, while others do so simply because it makes them feel good. Whatever your motivation is, some ways to give are better than others from an estate planning perspective. It is crucial to be aware of a few core concepts.
First and foremost, to qualify for tax deductions, you must give to a legitimate 501(c)(3) organization. This designation means the IRS recognizes the organization you are helping as being tax exempt – which means it is not in the business to make a profit but instead operates as a non-profit entity. If you donate to an organization that does NOT have this designation, while your gift will be appreciated, you will not receive a tax deduction.
Tax Deductions
How much you give to a cause is another important consideration if the tax deduction is a significant factor in why you are giving. Therefore, knowing the rules may determine if you decide to donate or not. Suppose your cumulative deductions are within your standard deduction amount ($13,850 for single filers or $27,700 for those married filing jointly); in that case, your donation will not reduce your taxes. The standard deduction amount is a "default" reduction of your taxable income and is meant to simplify the tax filing process. If you would like to receive the tax deduction for your charitable donation, then the goal is to exceed the standard deduction amount.
Qualified Charitable Distributions (QCD)
You may have heard the term "QCD" used when discussing withdrawals from your IRA, which stands for "Qualified Charitable Distributions." This type of withdrawal denotes a way to take out funds from your Traditional IRAs and pay NO taxes if the distribution goes directly to a charity or a church. We go into more detail about this in the following blog article: How Making a Qualified Charitable Distribution From Your IRA Can Help You.
Donor Advised Funds (DAF)
A less common method of gifting is via a "Donor Advised Fund," often abbreviated as "DAF." An easy way to understand how a DAF works is to think of it as an investment account you can open at a Charity. Once the investment account is opened, you can donate to the DAF and receive a tax deduction for the amount contributed. After funds are in the DAF account, you can assign the charity or charities that eventually receive the proceeds in the account. You can even get as specific as dictating the particular causes you want the DAF funds to go towards and by how much.
The flexibility of a DAF is why they are growing in popularity. In other words, you do not have to distribute the entire balance of this account in any given year, and you can use this account to donate as little or as much as you want during your lifetime. Deferring your donation until later allows the balance of the DAF to be invested and grow over time.
DAFs fit well when someone who is charitably inclined faces a year with substantial income tax liability. In such a year, you can contribute a significant sum to a DAF to offset part of the income tax liability and then spread out the gifts to charities over a number of years. Another way to use a DAF is to incorporate it into your Estate Plan and direct transfers to charities after your passing – continuing to support things you care about well after you are gone.
VOLUNTEERING
Charitable giving does not have to be denominated in dollars or shares of stock. Volunteering your time and expertise to a cause you support may not lower your taxes. Still, it is very important to organizations involved, and knowing you impacted your community feels great. If you are seeking to engage a charity and participate in a hands-on way, go to www.volunteermatch.org to search for your favorite causes.
COORDINATING YOUR ESTATE WITH A PROFESSIONAL
While the legacy and gifting concepts discussed today will give you a good starting point towards optimizing the financial aspects of your estate, a good estate plan requires an in-depth understanding of the legal nuances and IRS regulations that may trigger other unintended consequences. It is best to discuss these strategies with a qualified professional, so that your legacy and gifting goals are coordinated seamlessly with your overall financial plan, estate plan, and ongoing tax planning efforts. Feel free to get in touch with PARAGON if you need an introduction to a well-qualified estate planning attorney.
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Paragon Wealth Strategies, LLC [“Paragon”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Paragon. Please remember that if you are a Paragon client, it remains your responsibility to advise Paragon, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Paragon is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Paragon’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.wealthguards.com. Please Note: Paragon does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Paragon’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please Also Note: IF you are a Paragon client, Please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.