*This post highlights Chapter 9 from Mike’s book, Achieving Financial Fulfillment.
What do you want your legacy to be? Along with your value system, family traditions, and great genetics, you will undoubtedly leave a financial legacy to the next generation. As you move through life, it may become important to you to pass on your frugalness and investment savvy, or even share some mistakes you have made in order to show how they can be avoided. Organizing your finances for your heirs can take a big burden off of your mind and an even bigger one off of their plates with some simple planning and communication.
Charitable Giving
If you have accumulated a significant net worth over your lifetime and are unlikely to spend it all, you may want to consider some form of gifting. You may also benefit through the form of federal tax deductions, capital gains avoidance, and reduced inheritance taxes. This is not intended to be a comprehensive list, but it is evidence that not all gifting or estate reduction strategies need to be complicated.
Gift Appreciated Investments
As you plan your charitable gifting for the year, don’t forget that you can avoid the tax on appreciated securities by gifting them instead of selling them. You also may get to take a charitable deduction for the gift, saving you money in two ways! More details on this in the Donor-Advised Fund section below.
Donor-Advised Funds (DAFs)
Most large financial institutions like Schwab, Vanguard, Fidelity, etc. offer these accounts which are like a charitable savings or investing vehicle. You simply make a gift to the account (usually a $5,000 –$10,000 minimum) and it should qualify for an immediate tax deduction in the year of the gift. The funds are invested in a way you select, and as often as you want you can distribute money in the fund to the charities of your choice. By involving your kids or grandkids in the process of giving, these methods can also be a great way to encourage philanthropy in future generations.
According to the National Philanthropic Trust, these accounts were created way back in the 1930s and were not officially recognized in the tax code until the 2006 Pension Protection Act. Donor-Advised Funds can receive a variety of assets including cash, stocks, real estate, and life insurance proceeds. The DAF itself can even be the beneficiary of an IRA or trust. Donor-Advised Funds can also be very useful if the charity you want to benefit is small and doesn’t have the means to accept something like a gift of stock. The stock could be gifted into the DAF followed by a grant of cash made to the charity. Also, a single transfer to an account can be split among multiple 501(c)(3) organizations.
Another benefit is that these accounts can be a great tool for someone expecting a big spike in income. The donor can make an off-setting charitable donation (for an income tax deduction) to the DAF in the year it is most effective and still have time to figure out which charities to support. This could be useful in the case of a business sale, stock option exercise, or a big bonus.
There can be a few negatives of DAFs, including large account minimums, administrative fees, irrevocable contributions, and the fact that the charity may not get all of the money right away.
Family Gifting Strategies
While many popular gifting strategies involve charities, gifting to family members can be equally rewarding. Here are a few easy approaches that can reduce or avoid taxes and are also effective wealth-transfer techniques.
Cash
Perhaps the most often practiced method, you can simply give cash, write a check, or Venmo your favorite person or grandchild. In 2023, you can gift up to $17,000 (called the annual exclusion) to an unlimited number of individuals without reporting or tax filing requirements. If you are married, you can take advantage of gift splitting, which allows for you and your spouse to gift up to $34,000 to any individual. If you give more than $17,000 in a year to any one person, you need to file a gift tax return. That doesn’t mean you have to pay a gift tax, it just means you need to file IRS Form 709 to disclose the gift. Gifts between spouses and to charity are unlimited, and the recipient of a gift generally pays no tax either.
Pay College Tuition or Medical Bills Directly
There are two exceptions to the annual gifting limit. If you pay medical expenses or college tuition directly, the $17,000 limit does not apply.
Start a Roth IRA
If you are starting small with gifting to a teenage grandchild, this may be a good fit. For example, if your grandson earned $1,000 mowing lawns and would otherwise qualify, he could put $1,000 into a Roth IRA. If he saved half of what he made or $500, you could gift a matching contribution of the other half to allow him to put the full $1,000 into the account. This could be a great way to encourage saving and investing at an early age.
Gift Appreciated Assets to Lower Income Tax Brackets
You can gift stocks or other securities to someone else who will pay less tax than you upon an investment sale. Just beware of the ‘Kiddie Tax,’ which is levied on unearned income (interest, dividends, and capital gains) earned by children under the age of 19 and college students under 24. The first $1,250 is offset by the standard deduction, and the next $1,250 will be taxed at the child’s tax rate. All of the child’s unearned income in excess of $2,500 is taxed at the parent’s tax rate.
State Income Tax Deduction for 529 Plan Contributions
Several states allow income tax deductions for these contributions subject to certain limits. You can be the donor for a 529 plan managed by your child where your grandchild is the beneficiary. So you may be able to help yourself with a state income tax deduction at the same time!
Estate Planning
Planning for the end of your life is a topic most people understandably want to avoid. However, without basic planning, there could be unpleasant outcomes. I have been asked several times by clients if they really need a will, and it is typically followed by a statement such as “I’m sure everything will be taken care of by my kids” or “My situation is pretty straightforward.” So how basic does your situation have to be to NOT need a will? If you truly have no heirs and no worldly possessions, then you get a pass; otherwise you should probably have one.
If for no other reason, you need a will to name an executor (or executrix). This is the person responsible for handling your affairs after you pass on. If you do not have a will, the probate court will appoint one. Anyone with good reason can petition the court to be appointed so, in my opinion, there is no reason to leave this to chance. The executor or court appointed administrator performs many important functions, including gathering all of the assets of the estate, paying any debts or taxes owed by the deceased, and distributing the remaining property to the named beneficiaries.
If you die without a will, your state of residence will decide who gets what through what are called intestacy laws. These rules vary from state to state, and assets generally go to immediate family first, such as a spouse, parents, or children. If you are single with no children or surviving parents, then the state will decide who is the most important of your remaining relatives. In Pennsylvania, this is generally 1) siblings and their children, followed by 2) grandparents 3) uncles, aunts and their children and grandchildren and finally 4) the Commonwealth of Pennsylvania. Yes, if no one else is named in Pennsylvania, assets go to the state. That may be a crying shame if you had a best friend or favorite charity that was more deserving. It would be a good idea to check with a local attorney about the laws in your state and to see about getting this simple, important estate planning document in place.
The other primary estate planning documents everyone should have are a Durable Financial Power of Attorney (DPOA), Health Care Power of Attorney (HCPOA), and Living Will. Unlike a Last Will and Testament, these could all be used while you are living because you may not have full capacity to make your own decisions.
A Durable Financial Power of Attorney gives a trusted individual, called your agent, the legal authority to act on your behalf in financial matters. You can designate specific powers for the agent, and they generally include things like paying your bills, managing your real estate assets and financial accounts, and gifting assets to others including charity. Once you execute the DPOA and your agent acknowledges it in writing, it is in force. The agent is required to act in your best interests, so it is of the utmost importance that you name someone with the skillset to handle these financial tasks properly and the integrity to do so in your best interests.
A Health Care Power of Attorney is similar to a Financial Power of Attorney, but there are two main differences. The power is given to make medical decisions, as opposed to financial decisions. And the power is only in force when you are incapacitated and not at any other time.
The Living Will is used to guide the HCPOA in making health care decisions. Here you outline the treatment options you want if you are unable to make decisions or communicate those decisions. It’s a way to make your wishes known in advance regarding possible end-of-life care and treatments. In your Health Care Power of Attorney, you designate whether your agent is required to follow your Living Will or simply use it as a guide. The HCPOA and the Living Will are often combined into one document called an Advanced Medical Directive. You need to plan ahead for uncertainties in life, and as your situation changes, you may need to update these documents.
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