In the spirit of not waiting until the last minute, in this case New Year’s Eve, tax experts at Wilmington Trust have compiled a checklist for advisors with tips that can help clients come closer to preserving or enhancing their assets.
“If 2020 has taught us anything, it’s that the future is unpredictable,” says Wilmington Trust, which provides wealth and institutional services for M&T Bank.
It’s important to put wealth plans, liquidity solutions and investment portfolios to the test to determine whether they can withstand the stress of scenarios different from ones that were anticipated.
Everyone can make tax-free annual exclusion gifts up to $15,000 ($30,000 for a married couple) to as many people as he or she desires, without counting toward the taxpayer’s lifetime exemption from estate and gift tax. One possible gift is a 529 plan for a child or grandchild. Special rules allow for a transfer of five times this amount, meaning a married couple could make one gift of $15,000 per beneficiary (but no additional gift for the next four years).
Pretax contributions to employer-sponsored 401(k) plans in 2020 are limited to $19,500 per individual, with an additional $6,500 “catch up” allowed for taxpayers over 50. Health savings accounts are available to taxpayers with high-deductible health insurance plans and allow for contribution of pretax dollars. Growth within the HSA is income tax free, as are withdrawals if used for qualifying health care expenses. Contributions in 2020 are limited to $3,550 for an individual, $7,100 for a family and a “catch up” contribution of $1,000 for individuals over 55.
3. Look at opportunities for education payments.
Payments may be made directly to qualifying educational institutions for a student’s tuition expenses without counting toward annual gifting limits or the lifetime exemption from estate and gift tax. Tuition for primary, secondary, university and college is included, but not other expenses, such as room and board, or books and supplies. To qualify, the payment must go directly to the institution, not to the student or the student’s parents.
Long-term care insurance helps manage financial risk to protect life savings and assets, and may allow payment for costs of care without exhausting these assets. In some cases, it’s possible to structure a plan where no money can be lost, allowing heirs to receive premiums back plus a small debt benefit if a long-term care claim benefit was never paid. By doing so, these types of policies become a nearly cost-free hedge against possible future care expenses, potentially providing double-digit returns with little or no downside risk.
Having a solid cash flow plan for any unexpected cash needs, such as tax payments, medical or other family expenses, or even to pursue a lifestyle purchase may be an important component of an overall wealth plan. Ask whether a cash offer for a costly item could proceed without disrupting the current investment portfolio. Using securities as collateral for a line of credit allows one to have access to liquidity without disrupting one’s portfolio, and potentially incurring capital gains.
Business and personal balance sheets often intersect for wealthy individuals. In reviewing balance sheets, consider the borrowing power of assets, such as investor real estate, yachts or aircraft, and how leverage may affect the overall tax picture. Also review floating rates for existing loans on significant lifestyle assets, and evaluate whether an interest rate swap would be appropriate given the lower rate environment. Also, identify any Libor-based loans, as the London Interbank Offered Rate will be phased out by the end of 2021.
Taxpayers who itemize can deduct 20% to 60% of adjusted gross income, depending on the type of asset gifted and whether the gift is made to a public charity or private foundation, with the limit of up to 60% of AGI for cash gifts to public charities. For 2020 only, the CARES act increased this limit to 100% of AGI for itemizers, and also allowed a $300 “above the line” deduction for non-itemizers. Be sure to time gifts appropriately so that they may be received and recorded by the charity by Dec. 31, keeping in mind that gifts of assets other than cash take more time for charities to process.
Gifting appreciated stock that has been held more than one year can benefit both the recipient charity and the taxpayer. A taxpayer making a gift of the stock receives a deduction for the fair market value of the shares at the date of the gift, but doesn’t incur the capital gains tax that would apply if he or she first sold the stock the donated the proceeds.
It is important to understand the unrealized capital gains and losses in a portfolio, and take advantage of any opportunities to minimize taxes by selling assets at a loss and upgrading clients’ strategies to investments that may benefit them more in the current market environment. One typically never wants to sell an investment solely for tax reasons, but could make the decision as part of rebalancing and stress-testing one’s portfolio.
Funds typically make capital gain distributions toward year-end. The distribution represents the proceeds of the sale of stock or other assets by the funds’ managers throughout the course of the tax year. These distributions can come when one doesn’t have an overall gain in the fund itself, or even if one is holding a fund at a loss. Analyzing when and how much a fund is going to pay out as a capital gain distribution can indicate whether it makes sense to continue to “hold”, or “fold” and swap the fund for a more tax-efficient vehicle in a timely manner.