Estate planning for retirees: changes to watch for and how to navigate them

When it comes to estate planning, there are many variables for retirees to consider, with one of the biggest being the effect of taxes on how much of their wealth they get to pass on.

Between several years of accommodative monetary policy and massive federal spending to offset the economic damage of the Covid-19 pandemic, the government has borrowed a lot of money that it will eventually have to be paid back, which inevitably means higher taxes.

At this point, there have been numerous proposals, but no clear indication of what changes to the tax code will make it into law, but Americans should be preparing now for bigger tax bills later.

There are several sections of the federal tax code that have an impact on estate planning, but there are three in particular that retirees should be looking at now.

The first to consider is the federal estate tax exemption.

The Tax Cut and Jobs Act of 2017 raised the exemption, which is $11.7 million per person, for 2021. However, among the early proposals floated by the Biden administration was to have the exemption revert to the pre-2018 level of around $5.5 million, and some Democrats in Congress have suggested going even further and cutting the exemption to as little as $3.5 million.

Even if Congress takes no action at this time on the exemption amount, that provision expires in 2026; and the exemption automatically drops down to around $6 million per person.

The reduction in estate tax exemption will mean many more people will be affected and by itself that change would be significant enough. It becomes much more onerous when you add in two additional proposed changes. The first is the increase in the capital gains tax. The second, which is closely related to the first, is the removal of the step up in basis provision for assets that have realized more than $1 million in capital gains.

During the 2020 campaign, President Joe Biden repeatedly promised that anyone making less than $400,000 a year would not see their taxes go up. But those with income in excess of that amount are likely to see their taxes go up considerably from the triple whammy I just outlined.

At this point, since these are all proposals, it’s hard to offer a concrete prescription for each situation, but there are some steps that can be taken today to lessen the potential blow from future changes to the estate tax laws.

The first thing to do is to re-engage with the estate planning process. A plan drawn up five years ago, or even last year, may no longer be relevant in light of the proposed changes. The first step is for the advisor and client to sit down and go through the existing plan and consider how changes to the exemption, step up in basis and capital gains could affect that plan.

Another way to preempt the tax man is to contemplate the value of “gifting,” either during lifetime or at death, to individuals or to charitable organizations.

This could be a direct charitable gift or through a donor-advised fund. Looking at it pragmatically, gifting also can help retirees protect their assets from changes to the step up in basis. If the asset is gifted during the holder’s lifetime, the recipient of the gift inherits the original basis. If they are in a lower tax bracket, they can sell that position and wind up with lower taxes on the gain than the grantor.

A third tactic would be to consider how wealth could be managed differently today given the possibility of these upcoming changes on the future estate.

Consider the holdings in brokerage accounts where capital gains have been produced over time. Right now, the maximum rate of capital gains is 20%, which, like it or not, most investors are willing to accept, but a return to the mid-70s rate of around 40% would dramatically reduce how much of those investment gains could be passed on to heirs. 

Each client’s situation will be different based on how they are currently invested, but it presents an excellent opportunity for the advisor to add more value to the relationship. The key is to reevaluate everything and make sure that what was a good idea yesterday may not be so tomorrow. So, you may have more individual stocks in the portfolio, and municipal bonds become more attractive.

One of the basic estate planning tools that many couples use is the funding of a marital trust on the death of the first spouse. Since such a trust needs to be set up in advance and drafted into legal documents, we suggest outlining in the estate planning documents the funding of that marital trust by a disclaimer. Depending on the estate tax at the time of the first spouse’s death, the surviving spouse has the option of disclaiming any assets above the exemption limit. Those assets would then transfer into the trust without being subject to estate taxes after the second passing. 

Another planning tool that will become more attractive as estate tax burdens increase is the option of setting up an Irrevocable Life Insurance Trusts, or ILITs, for their life insurance policies as a way to reduce the value of a taxable estate. It’s a good idea to buy well-priced term insurance “now” that can be converted to coverage that will last through a lifetime “later.”

 Retirees also should encourage their adult children to take their own financial planning to the next level. Encourage them to get their own estate planning documents in order, save for retirement and have adequate insurance and other protections. Younger adults that have a history of managing their own money tend to make much better decisions with gifted and inherited dollars.

Keep open lines of communication with all the members of your team of advisors: financial planner, investment advisor, accountant, insurance agent and estate planning attorney. For large estates, this team should meet formally at least once a year to provide the client with the best value.

Retirees also should be keeping an eye on what’s happening with estate and other taxes at the state level which will also have an impact on retirees’ financial futures.

In Washington state, this includes the new state capital gains tax and the new state long-term care tax. The state of Washington also has one of the country’s most onerous estate tax structures. All these structures, combined with the federal rules, should together define your planning parameters.

There’s still a lot of uncertainty around the future tax picture, but that doesn’t mean we should wait for the other shoe to drop before we take action. The more steps we take to protect ourselves from future tax exposure now, the easier it will be to adjust when the laws actually change. Preparation and proactive navigation are the themes of the day when it comes to estate and tax planning.

Michelle Clary, a certified financial planner, chartered financial consultant, chartered life underwriter and retirement income certified professional, is chief executive officer/senior wealth advisor with Piton Wealth in Kennewick and Kalispell, Montana. Piton Wealth is a part of Thrivent Advisor Network LLC, a registered investment adviser based in Minnesota.

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