Ready For Retirement
Ready For Retirement
Tax-Smart Strategies for Wealth Transfer: Secure Your Family's Future
James responds to listener Jerry’s question about the optimal time to distribute inheritance or charitable gifts: before or after passing away.
James walks listeners through four important things to consider when it comes to gifting and inheritance: your gifting goal, whether you have a strong desire to see the assets gifted within your lifetime, the tax implications of various types of gifts, and what to do with assets you plan to retain for now but are intended for future generations.
Questions Answered:
Should I give my children and grandchildren their inheritance before or after I die?
What are the tax implications to my children when I gift them my assets?
Timestamps:
0:00 - Jerry’s question
2:20 - What is your gifting goal?
3:38 - Gift during your lifetime?
6:51 - Timing and priorities
9:17 - Different tax implications
12:08 - Exemption amounts
14:13 - Tax implications to child
15:33 - Proper beneficiary designations
21:41 - The right time horizon
24:45 - Summary
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The primary goal of most people's financial plan is to ensure they're going to be okay for the rest of our lives. Practically speaking, what that means is do they have enough income to maintain their lifestyle, and then do they have enough excess or margin left over for those unexpected expenses that will never really come up? But even beyond that, once you've accomplished that goal of ensuring you're going to be okay for the rest of your life, there are still other goals. One such goal is how can we, in the most effective way, take care of children and even grandchildren Whether that means gifting during our lifetimes or passing down assets in the most effective way after our lifetimes? Many people have a desire to take care of family, take care of kids and grandchildren. So in today's episode of Ready for Retirement, what we're going to do is discuss how you can think about that and what steps you can take to most effectively pass assets down or to take care of children and grandchildren. This is another episode of Ready for Retirement. I'm your host, james Cannell, and I'm here to teach you how to get the most out of life with your money. And now on to the episode To do so.
Speaker 1:We're going to be addressing a listener question and this question comes from Jerry. The question is kind of written in bullet points, but I think the gist of it is going to come out as we go through this. Jerry writes this Parents in last year of life but they want to start giving some wealth away to see their kids and grandkids enjoy it. Blessed to have more than they can spend. Should they wait till they are passed or start giving money to kids and grandkids? Same parent is getting $500,000 in sale of a house, not certain what to do with money. Invest for my kids and gift when they pass. What would you invest it in? Parents are in their mid-career or would you give them money for kids now and watch them spend or advise them to spend it? It is like getting a windfall in your 80s. What should you do if you don't need the money? So that's the question, jerry, thanks for writing that in.
Speaker 1:I know that's kind of a choppy, a little bit bullet point-esque, but what Jerry is effectively saying is his parents I'm assuming someone's parents, I'm assuming Jerry's parents. They're in what maybe appears to be the final year of their life. They want to take care of their kids and grandkids. They have, it sounds like, more money than they necessarily need to be okay for the rest of their lives, which maybe isn't that much longer. How should they pass that, though? Should they invest it now and then let the kids inherit it? Should they start gifting it now? Should they do something differently and that's really what we're going to be talking about today is, assuming that is a goal of yours, to take care of kids and grandkids, take care of family.
Speaker 1:How do you structure your plan to best support that? And there's really four key elements that you should be addressing that you should be looking at as you go through this, so let's jump right in. The first thing that you should really start with is what's your goal if you're going to gift? Now, that might sound a little vague. You might say well, the goal is to gift. Well, sure, but is the goal to, for example, pay for children's education or grandchildren's education? Is the goal to pay off a mortgage? Is the goal to give them money to do whatever they want with it? So start with that, as simple as it sounds.
Speaker 1:What do you want this money to do for them? In some cases, it truly is. I just want to give them money. They can do whatever they want with it. They want to go out and buy a new car. They can buy a new car If they want to go out and invest it. They can invest it If they want to go out and use it to help send kids to college. They can do that.
Speaker 1:But think through that, because sometimes people think through that and say, no, you know, I want to make sure they're mortgage free, so I'm going to help to write a check and pay off a chunk or all their mortgage. Or I want to help to send grandchildren to college. Well, in that case, maybe you put some money specifically into a college savings plan, as opposed to just transfer money, in which case the grandchild could do whatever they want with it. So really start with that, as simple as it might sound, because, based upon the goal, that's going to then lead us as we work backwards into what should you be thinking about or what should you be doing to best support that goal. So that's step one.
Speaker 1:Step number one is understand what the goal is when you're gifting. What specifically would you like to see done? Step number two is to ask yourself do you have a desire to see that gift made during your lifetime? Here's why that matters. I'm going to take a big step back. Let's assume that you bought Amazon stock for $5,000 and you did so years and years and years ago and that Amazon stock that you purchased for $5,000 is now worth $100,000. So that's just growth. You didn't add any more. That's just the growth on the stock.
Speaker 1:Now let's also assume that you're starting to get up there in age and you look at your portfolio and you look at your income sources and you say you know what this Amazon stock, it's nice, but I'm going to be totally fine without this. In fact, I'd rather see this stock given to my children so they can start to use it to plan for their retirement and plan for their needs. So as you start to think through that, there's two options Do I gift this today or do I gift it once I pass in the form of an inheritance? Let's look at both options. If you gift it today so you're getting up there in age and you have this $100,000 in Amazon stock and you gift it to your child today, you can do so and we'll talk about gift tax exclusions and all those other things in just a second. But you could gift it today, at no tax consequence to your child and the cost basis transfers with it. So you give $100,000 or you gifted $100,000. Child now has $100,000 and the cost basis is still $5,000.
Speaker 1:Well, let's assume your child is going to use this to prepare for retirement. Your child's maybe in their 50s or 60s. They say great $100,000. We're going to allocate this into our retirement portfolio in a more diversified way to support our ability to retire. Well, let's assume that your child is a higher earner and let's assume that they live in the same state that I do, which is California. They might be in the 20% federal capital gains tax bracket and, let's say, 11.3% state capital gains tax bracket and because their income, there might be an additional 3.8% net investment income tax on top of this. So combined they are in called a 35% tax bracket.
Speaker 1:So now let's take a look at what happens if they're in that tax bracket and they then sell this Amazon stock to diversify into their portfolio. Well, the unrealized gains on that are $95,000. So that $95,000 would be subject to a 35% tax when they sell. So at the end of the day, after your child sells, diversifies, they would only end up with $66,750 after taxes, because taxes would have been $33,250. So that's one option. You gift the $100,000 today. Your child, or whoever gets it, sells, they pay taxes and then they invest more in line with their financial plan, but a good chunk comes out for taxes.
Speaker 1:Now the other option is, let's say you say you know what? No, I'm going to keep this Amazon stock and I'm going to hold on to it until I pass away and then my child is going to inherit it. Under that circumstance, when you pass away, there's what's called a step up and basis, so that Amazon stock that today has a cost basis of $5,000 and is worth $100,000. So you passed away today. The cost basis steps up to the market value today, to the date, to the value on the date of your passing. So now, all of a sudden, the cost basis is $100,000 and the value is $100,000. So now, if your child inherits that well, they could sell it immediately and not pay anything in taxes, because there's no difference between the cost basis in the market value in this example.
Speaker 1:So those are the two options and this is really important to consider because let's assume in this case, you know for a certain you only have one more month to live. Well, maybe it makes sense, it probably makes sense to hold on to that for one more month, because once you pass away, then your child can sell it at no taxes and save several thousand dollars, tens of thousands of dollars in taxes just by waiting a month to do so. But now let's assume, if I have one more month to live, maybe a five years to live, 10 years to live, 15 years to live in a big part of you says I don't want to just leave this money to my children when I die. I would love to see them be able to use it today. I would love them to be able to use this to help them retire, to buy a home, to send kids to college, to do the things that they want to do. That's where it becomes a little bit more tricky. So that's why I say the second goal, the second step in this process is, once you understand what you want the funds to be used for, then ask yourself is this the gift that I want to make during my lifetime, or is this a gift that I want to make after I pass?
Speaker 1:The benefit, of course, of making a gift during your lifetime, as you get to see the fruits of that. You get to see your child or grandchild or the recipient of that gift put it to use and you feel good about it as the reality, you get to see the impact that that has, whereas if you continue holding that and you gift it once you pass, they're gonna be blessed by it. They're gonna receive it, but it might not be for several years into the future, depending upon your life expectancy, and you'll also never really see that. So understand and ask yourself to what extent is it important to you that you get to see the impact that it's going to make and do you wanna prioritize that or do you want to prioritize tax efficiency of the gift? Now, in some cases you don't have to choose.
Speaker 1:In some cases you can gift today and see the impact today and there's no tax efficiency to be had for waiting. For example, if you've got a chunk of cash that you wanted to gift, well, you could gift that cash, ensure there's some gift in estate exclusion stuff that we wanna talk about. There's no gains on that. If you gifted that money to your kids or grandkids, they just receive it. They're not paying taxes. You're not necessarily paying taxes, assuming it's within certain dollar amounts.
Speaker 1:So that's the second step, and so what we've done so far is number one we've asked ourselves what's the goal with these dollars that I want to gift. Is it serving a specific purpose or just a general wealth transfer? Number two we've asked ourselves is this something that I wanna do during my lifetime or is this something that I want to do upon my passing? Number three the third thing that we need to do is understand the different tax implications. Depending on the type of an account, depending upon the way that you're doing it, depending upon the amount that you're giving, there are going to be certain tax implications. So, in no particular order, let's start exploring what some of those look like.
Speaker 1:Number one and I already referenced this is what's called a step-up and basis. Step-up and basis does not apply to things like retirement accounts or 401ks or Roth IRAs. What it does apply to is assets that you hold, assets that are, say, in a brokerage account, or this could be piece of property, or really any asset that you own that's not in a retirement account that has a gain on it. So anything that you buy and sell at a gain, your paying taxes on that gain or that gain, is at least subject to taxes, depending upon your actual tax bracket Upon your passing. There's a step-up and basis, though it's really important to realize. This is oftentimes relevant if you have real estate, for example, maybe you bought a home 40 years ago and it's appreciated several hundred thousand dollars or even millions of dollars. Well, you may not want to sell that home because it's gonna trigger a pretty significant tax hit not just property taxes and those potentially changing, but actual capital gains tax hit. Well, if you pass and then kids or surviving spouse or whoever inherits, that there's a step-up and basis there. So that can be a really important planning point.
Speaker 1:There's also estate tax exemption amounts. So at the federal level some states have separate estate taxes, but at the federal level there's a 40% estate tax. So when you pass, the government will look at your net worth, they'll look at your estate and there's a 40% tax on that after the exemption. Now the exemptions today are really high, to the point that a small percentage of that population is actually subject to estate taxes. So for perspective, the individual exemption amount is $13.61 million for 2024, and for married couples the exemption amount is $27.22 million. So if you're married and you pass away with a $30 million estate, what that means is that $27.22 million that is exempt from federal estate taxes. It's the remaining. What is that $2.78 million that would be subject to a 40% tax at the federal level.
Speaker 1:So understand those exemption amounts is important because it's not just a death tax, it's a lifetime exclusion amount. So you don't have to wait until you pass to gift that money. Let's assume these exemption amounts do apply to you because your assets and your net worth is above them. Well, you could gift this money while you're living. You could gift this money some today, some in five years, some in 10 years, some upon your passing. It's really a lifetime exemption amount. It's not just what you have left over upon your passing. So here's what you need to know about those exemption amounts, because some people might be thinking okay, that's a lifetime exemption amount. So let's say I'm gonna gift I don't know a couple thousand dollars to my grandchild. It's 5.29 plan. This year I'm gonna gift my kids a few thousand bucks. Do I need to be keeping track of that? Do I need to be reporting that every single time I make a gift? Yes and no? No if the annual gift is below certain amounts.
Speaker 1:So for 2024, the annual gift exclusion is $18,000 per person per recipient. For married couples, that's $36,000 per recipient. What do I mean by that? Well, let's assume you have 10 children. You don't have $18,000 that you could split evenly between them in that salimit you could gift $18,000 to each of them, so $180,000 total. It doesn't even have to be children. Let's assume you have 100 really close friends and you want to gift $18,000 to each of them. Well, that's $18,000 to each of them that you could gift. That's $1.8 million, and that's all within the annual exclusion amount.
Speaker 1:So when you look at this, if you're making gifts and it's under that exclusion amount on an annual basis, and every year that resets and most years that actually goes up a little bit, then you don't have to report that. Now let's say that you are single and you're making, say, a $38,000 gift to your child. Well, if you make a $38,000 gift this year, $18,000 of it is excluded. $20,000 of it must be reported Doesn't mean you pay taxes on it right now. It means, though, that that $20,000 excess above the annual exclusion amount that does count against your $13.61 million lifetime exemption.
Speaker 1:So, in most cases, for most people listening, this isn't something that you need to do serious planning around, because, for most people, their estates aren't going to exceed $13.6 million if they're single or $27.2 million if they're married. But this is something that you should know you can gift this amount without even having to go through the process of filing the tax form that indicates that you made a gift. Another thing to note on that is if you're making a gift, it's not taxable to your child. So if you're making a cash gift, or if you're gifting a vehicle, if you're gifting something, it's not taxable to them. Now, if you look back at that previous example, if you gift stock that you purchased for a very low amount and now it's appreciated quite a bit, you could gift them that stock and that gift itself isn't taxable. But if they then sell it, the gains on that are taxable, because they're essentially taking your cost basis and that, and when they sell at their tax rate, they're going to be taxed. So that's something that's important to note.
Speaker 1:Now another thing, just because it sometimes can't get confusing you can't gift IRAs, you cannot gift Roth IRAs, you can't gift retirement accounts, but what you can gift is personal property. This can be stocks, this can be vehicles, this can be homes, this can really be anything. All those are subject to the same gift exclusion amounts and when you do that, there's no tax to the recipient and it's the gifter, the person who's making the gift, that is subject to that $18,000 exclusion amount or $36,000 exclusion amount. They're married and if the gift exceeds that, then the person giving the gift must disclose that through the appropriate tax form. Now here's another thing that you want to keep in mind when it comes to saying how can I most effectively gift my assets or pass on my assets to the next generation or to family or to charity or whoever might be.
Speaker 1:If you intend to gift any part of your assets to a charity, then this is an important thing to know. You really want to use proper beneficiary designations. Let's assume that you have $500,000 in an IRA and you have $500,000 in a brokerage account, and let's assume that you're gonna leave half of your assets to your son. You have an only child and let's assume that you're gonna leave half of your assets to the charity. Well, if you leave half of your IRA to your son and half of your brokerage account to your son, and then you leave half the IRA to the charity and half of the brokerage account to the charity, let's see what happens there. So it seems like the right thing to do if you just want to split your estate evenly, split the inheritance evenly. But let's assume your son's in a high tax bracket and let's assume that between federal and state taxes he is in a 40% tax bracket. Well, he inherits $250,000 from the IRA, but that's taxable to him. He has 10 years to fully distribute it. That's just for simplicity. Say he takes it all out right now. Well, he pays 40% taxes and he ends up with $150,000 on that after taxes. Then he gets a $250,000 in trust that is not taxable to him at all upon your pass and there's a step up in basis. So he receives a total of $400,000 after tax.
Speaker 1:Upon your passing the charity. Then the charity gets a full $500,000. They get the $250,000 from the IRA because it's a charity and they don't pay taxes, they receive that full $250,000. They could sell it, cash it out and walk away with $250,000. They also receive the brokerage account, or half the brokerage account, which is another $250,000, so they get a combined $500,000. So your son walks away with $400,000, the charity walks away with $500,000. $100,000 goes to taxes.
Speaker 1:Well, what if you just switched things? What if you said and obviously using a very simple example here. But what if you said okay, how about? The charity is the 100% beneficiary of my IRA and my son is the 100% beneficiary of my brokerage account? Well, when you pass away, there's a step up and basis on the entirety of your brokerage account. So your son would get $500,000 free and clear, no tax implications on that brokerage money. The charity they're getting more of the IRA, they're getting all the IRA, in fact, but because they don't pay any taxes on that, they could sell it, distribute it and they don't have any tax consequences. So they also receive $500,000. So in this case now, both your son and the charity are receiving $500,000. There's not that $100,000 that was paid in taxes just due to I don't even want to say wrong beneficiary designations, but not having strategic beneficiary designations.
Speaker 1:You can also use this to get a lot more complex and most of the time I don't recommend doing this. But let's assume you have several children or several beneficiaries and they're all in different tax brackets. And let's assume you have a Roth IRA and a brokerage account and a traditional IRA. Well, for the people, your beneficiaries that are in much higher tax brackets, if you just split everything evenly, they're going to walk away with much less of the IRA after tax just because they're in a higher tax bracket versus your beneficiaries that are in much lower tax brackets. They're going to end up with much more of the IRA because they're not paying as much taxes when you fully distribute it. So there's actually a way that you can rearrange who's getting which assets so that everyone ends up with more.
Speaker 1:Than just simply doing an even distribution. What you're effectively doing is you're saying, okay, my beneficiaries that are in a lower tax bracket are essentially trading assets that they're going to give up more of their rights, for example, to the brokerage account or the Roth IRA, to the beneficiaries that are in higher tax brackets. In exchange for that, the beneficiaries in the higher tax brackets are going to give an even greater share of, say, the IRA beneficiary designations to those and lower tax brackets. It's just a way of shifting assets. It probably sounds a little too complex. In most cases it is too complex, but there are a lot of cases where, with some serious planning, the higher your net worth in, the higher the discrepancy between the tax brackets of your beneficiaries, the more it makes sense to implement a strategy where you're not just evenly splitting everything. You are more intentional about who is getting which assets. So at the end of the day, whatever the tax savings are on that, that can be spread evenly across all of your beneficiaries. But just something to keep in mind is you're trying to say how do I not just ensure I'm okay for the rest of my life with my assets but I can most effectively pass these on to future generations, either during my lifetime or after my lifetime? Having the right beneficiary designations in place is a crucial aspect to doing so the most effective way. But just to start to recap this understanding tax implications is going to go a long way into helping you understand should you gift something during your lifetime or should you gift it upon your passing into.
Speaker 1:Quickly go back to Jerry's question. He said my parent is getting $500,000 in the sale of a house. Well, Jerry, when that happens, the parent is going to pay whatever tax consequences there are. That's going to be at the parent's level. That can't be passed on to children or grandchildren unless the parent first transferred the home to the child or grandchild. But once that $500,000 is received, let's just assume it's tax free, and it very well could be tax free, especially if they've lived there for some period of time.
Speaker 1:Well, that $500,000, if it's just going to stay in cash, that's money that could be gifted now. So that could start being gifted to children and grandchildren within the exclusion amounts and there's no tax implications, or it could be gifted upon their passing. So there's really no benefit to delaying, unless this is money that, of course, the parent wanted to keep holding on to just for their own needs. But if it just comes down to hey, is there any tax benefit to gifting this while living or after passing? The answer is no. In a case like that, the taxes have been paid. The money's now in cash. Assuming it's just going to stay in cash, you could gift that money now. You could gift it upon your passing. There's not going to be different tax implications from that, assuming you're staying under the annual gift exclusion amounts. And even if you exceed the gift exclusion amounts, it just means that's something that has to be disclosed. There's a tax form that has to be filed, because that would count against the lifetime exclusion amount that I just went over.
Speaker 1:And then, finally, there's another section of Jerry's question that leads to the fourth point that I want to make, and it says something along the lines of the parents aren't sure what to do with the money. Should they invest for the kids and then gift that invested money when they pass, or should they transfer it down now? So that's where the fourth thing that you want to look at if your goal or part of your goal is to say how can I effectively transfer money is use the right time horizon. So let's take a look at an example of this what's the right investment allocation for a 90 year old? Well, your first thought and there's probably some argument to be made here, within varying degrees, but probably something pretty conservative right? That 90 year old doesn't have a super long time horizon. Most likely they're going to need that money to be pretty stable, pretty conservative, pretty liquid so that they can use it to live on. So conventionalism probably rightfully so in this case would say probably something pretty conservative. But what if I told you that that same 90 year old had a strong pension and a strong social security benefit that covered all of their monthly income needs? What if I also told you that that very same 90 year old had a fully paid for home and had a long term care insurance policy in place that would cover any needs for any long term care events? And finally, what if I told you that 90 year old is more concerned about gifting that money to their grandchildren than they were using it to spend for themselves? What would you do? Well, maybe they keep it in their estate, maybe they keep ownership of it in case something happens? Sure, but what would you do to the investment allocation If they're 90, and let's assume their grandchild is 30.
Speaker 1:Whose time horizon should they use? Well, if this is an asset that definitely is going to be used for the third year old and they just want to pass it down and maybe they're not passing it down quite yet because of tax implications well, still, what they could do is start positioning it, investing it as if it's for the third year old, as if it is a more aggressive, growth-oriented investment allocation that the nine year old still has access to if needed. But they're aligning it with the intended purpose, which is to say, how can this be used for my third year old grandchild to be able to support their needs, as opposed to being something that needs to be super conservative, super liquid for the nine year old's needs? So that is certainly something that should be considered Now, don't get carried away with this, because you do absolutely want to make sure that your needs are, first and foremost, cared for.
Speaker 1:Don't do something that is so hyper-focused on providing for children and grandchildren to the detriment of your plan, to the detriment of oh well, what happens if you do have a long-term care event? What happens if you do have an emergency medical expense? What happens if you do need to move on and die into somewhere else and you need liquid funds to be able to do so? So don't sacrifice your ability to be okay and to live comfortably and to provide for those unexpected expenses. Prioritize that. But if that's pretty well dialed in and you have investments or you have other assets that you almost certainly don't need, well then maybe start to think about the time horizon and the investment allocation that's appropriate for that time horizon, for how those assets will actually be used. So, as we start to wrap up, these are the four things and, just to summarize, that I would think about If, once you've dialed in your plan and you say I'm going to be okay for the rest of my life, I'm now thinking about how most effectively to help kids, grandkids, family, friends, charity, whoever it is these are the four things that I want to look at.
Speaker 1:Number one start with what's your goal. Is there a specific purpose of the assets that you want to gift Like I said, paying off a mortgage, funding education, buying a home or is it just a general wealth transfer, a gift and money for them to do what they want with it? Start there. Then, number two do you have a strong desire to see that gift made during your lifetime so that you can see the blessing that it is, so that you can see the impact it has, or are you okay with that being something that you gift upon your passing? The reason for that ties into. Number three is understand tax implications of the various types of gifts or inheritances that you might leave, whether it's step up and basis, whether it's understanding the state tax exemption amounts, whether it's understanding annual gift exclusions, whether it's even understanding how to properly title beneficiary designations. Understanding those things is going to allow you to more effectively transfer more of your estate and net worth and have less of that subject to taxes in most cases. Then, number four use the right time horizon For assets that you are going to retain, but you know a certainty you're going to be used for future generations. Well, don't necessarily think about your age and time horizon when investing those assets. Think about the age or the time horizon or the purpose that they're ultimately going to be used for and take that into account when designing the right asset allocation for those investments.
Speaker 1:That is it for today, jerry. Thank you very much for the question. I hope that was helpful to go through that. If you're enjoying the show, I would really appreciate it if you would just share this with someone else. I think you might find value in it, whether it's this episode or other episodes. Want to make sure that as many people are possible or getting the information they need before they retired so they can ultimately get the most out of life with their money.
Speaker 1:Number two if you're looking to support the show, you can easily do so by subscribing on the YouTube channel. The channel name is James Cannell. Subscribe on Apple Podcasts or Spotify or Google Podcasts or wherever you listen. If you want to take a step further and leave a review. If you're an Apple podcast, great, that would be really helpful. It helps more people find the show. Or leave a comment If you're watching on YouTube and want to say, hey, this is great. Want more people to be able to find it. Whatever you do, wherever you're listening, really appreciate you taking some time each week to tune in. I hope you find value in this message. Thanks for listening and I'll see you all next time.
Speaker 1:Hey everyone, it's me again for the Disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. Thank you for listening to another episode of the Ready for Attachment podcast. If you want to see how root financial can help you implement the techniques I discussed in this podcast, then go to rootfinancialpartnerscom Click start here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.
