Remember when you were starting your adult life with your first apartment and job, earning money, and paying your bills? At the time, you may have wondered how you would save enough money for retirement. You may have felt that you could barely afford what you needed then, let alone have much left to put into savings. And for many years, you likely had to make some tough choices about spending whatever money you were making.
And then, with time, perseverance, self-discipline, and maybe a bit of luck, your situation changed; you arrived at a point in life where you realized you have more than you need to fund a comfortable lifestyle and prepare financially for retirement; however you may define that. What a great feeling!
Now, you face new decisions. What do you want to do with the “extra” wealth you created? Some people spend it all on stuff. More commonly, people leave the majority to their loved ones, sometimes in a trust. Others may give a substantial portion to specific charities or causes they want to support. There is no “wrong” answer, as it’s your money to do what you want, but we offer the following two thoughts based on our experience.
First, you don’t have to wait until after you die to transfer some of your wealth to your children, other heirs, or charitable causes, and there are both significant financial and intangible reasons not to wait. Second, whether you give to loved ones or charities, the less you pay in taxes, the more powerful the positive impact your money can have. Of course, paying taxes does have a positive impact in the grand scheme of things. Tax dollars generally support our country and local communities, but it’s not the impact you can point to and say, “I made that happen.” It’s also universally understood that it’s not an efficient way to make a positive impact.
Regardless of how you make financial gifts and to whom, remember that giving should not undermine your financial security. None of us can accurately predict things like how long we will live or what expensive medical bills we may face someday. A competent financial advisor can run scenario analyses to help you decide how much you can safely give away without potentially creating a problem for yourself down the road.
Money Doesn’t Buy Happiness, but It Can Help
Many people enjoy giving money to their children and grandchildren while they are still alive so they can watch their loved ones enjoy the benefits this money provides. This strategy could mean contributing to a down payment on a house, helping to reduce a grandchild’s student loan debt, or providing a loved one with some extra cash in tough times.
Currently (in 2023), you can give up to $17,000 per person per year to anyone you choose, with no tax implications. Suppose you give more than $17,000 to any individual. In that case, the excess simply counts against your lifetime estate and gift tax exemption, currently about $13 million, and must be reported on your tax return (these limits can change, as tax laws do). So, a married couple could give $34K to each child ($17K from each spouse) and provide an additional $34K to the child’s spouse. That’s $68K per married child. Note: before making such a gift to your child’s spouse, it’s a good idea to understand how they, as a couple, handle financial decisions. You can make these gifts yearly or every few years if you like. Furthermore, a quality advisor can make additional recommendations that may have never occurred to you, such as gifting appreciated investments to those in lower tax brackets, as outlined later in this post.
Think of this as distributing part of your children’s inheritance to them while you’re still here to see and savor the positive effects. Many of our clients have expressed that by the time they got an inheritance, they didn’t need it anymore and that money could have had a significant impact if they received it earlier in their career. As noted above, this assumes you have more than enough financial resources, including pension, social security, and investment income, to meet your needs, even if the market takes a big tumble. If so, gifting can be a great way to reduce the size of your taxable estate.
The Family That Plays Together Stays Together
Another way to give some of your wealth to your family while you are still around is by paying for a family trip. From a tax perspective, this reduces the size of your estate and should not count toward your annual gifting limit. More importantly, the value of the shared experiences and time spent together will more than offset the cost of the trip. Think of it as an investment that pays dividends in the form of uninterrupted time with your family, shared memories, and inter-generational bonding opportunities that include you. For example, a family trip with ten or more people (you and your spouse, your adult children and their spouses, and your grandkids) could cost $10K-$50K or even more, depending upon where you go and how you travel. A trip could be as extravagant as an African safari, as casual as a camping weekend at the closest national park, or anything in between. The memories will be priceless wherever you choose to go.
Giving the Wonderful Gift of Education
If you would like to help pay for college expenses, you can contribute up to $17K per year to a 529 Plan without incurring any gift taxes. Since the returns earned in 529 Plans are not taxed when used for qualified educational purposes, some people front-load contributions, making up five years’ worth of annual gifting at once. This strategy allows the money in the Plan to grow tax-free for longer. There is no federal limit on how much you can contribute, but every state limits total 529 account contributions.
As a bonus, 30 states, including the District of Columbia, give a state income tax deduction or tax credit for 529 plan contributions. In most cases, this applies only to contributions made to the Plan for your state, although nine states allow a state income tax deduction for contributions to any 529 plan. A couple with four grandchildren could contribute $136,000 ($17,000 each for both of you) in addition to annual gifting to others, reducing the size of your taxable estate by a non-trivial amount with no taxes owed.
Helping Those That Need It Most
Do you want to help a loved one with low or no income? Chances are good that this person is in the 0% long-term capital gains tax bracket. If you own appreciated investments, typically stock or mutual funds, that would generate a significant capital gain if you sold it, you might consider transferring up to $17,000 of the investment to a brokerage account in the person's name. From your perspective, this is a tax-free gift since it eliminates the capital gains taxes you would have owed if you had exited the investment to give cash instead. We recommend having the recipient sell the holdings immediately for numerous reasons. Of course, this strategy assumes you trust that the giftee will adhere to this plan, as once the stock leaves your account, you no longer control what happens.
Funds for Current Expenses vs. Legacy Assets
When you die, money left to your heirs is taxed differently, or not at all, depending upon whether it is held in a Traditional IRA, a Roth IRA, or a taxable brokerage account. Money inherited in a Traditional IRA must be withdrawn within ten years of your death and ordinary income taxes are owed on those withdrawals at the inheritor’s tax rate. With an inherited Roth IRA, withdrawals are tax-free (although the money must be withdrawn within 10 years for non-spouses). With a brokerage account, the asset values “step up” tax basis as of your death, wiping out any capital gains up to that date. This fact leads many people to conclude that they should live off their Traditional IRA, to minimize what is left in that “tax-burdened” account, leaving more in the accounts with more favorable tax treatment.
That strategy often makes sense, but only sometimes. Remember that there are often different rules for spouses, tax laws change from time to time, and a variety of taxable account types can impact the transfer of wealth and associated taxation. You should talk to a professional with tax expertise who can determine which accounts you should use to minimize the tax drag for you and your heirs. This review is critical if you have an adult child with special needs. You don’t want them to completely drive the decision, but taxes can be a big deal and should factor into which accounts you live on and which you leave for your heirs.
Maximize Your Charitable Giving
Many people choose to donate some of their wealth to charity, and in a separate article, we discuss ways to approach charitable giving. Here, we want to briefly note that you can use your RMD from a traditional IRA to make qualified charitable distributions, thus reducing the amount that counts toward taxable income. Remember, contributions to a Donor-Advised Fund do not qualify, so don’t transfer in assets from your IRA. If you gift shares to a charity from your taxable brokerage account, it may be possible to specify the tax lots with the lowest cost basis. It is a huge perk that you don’t have to use the average cost when gifting to charity!
Bottom line: How much of your net worth to give away during your lifetime and after your passing is up to you. As you evaluate your options, don’t forget to appreciate and feel proud that you are in a position to make such choices and strongly consider a trusted financial planner on how best to approach your specific situation.
Disclosure: Information presented is believed to be factual and up to date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Discussions and answers to questions do not involve the rendering of personalized investment advice but are limited to the dissemination of general information. Consult with a professional advisor before implementing any of the options presented. Third party posts are for informational purposes only and are not intended to be a solicitation or substitute for individualized investment advice. Information provided is believed to be from reliable sources, but no liability is accepted for any inaccuracies. Information found on this site is for informational purposes only and is not intended to be a substitute for specific, individualized tax or legal advice. Always consult with an attorney or tax professional regarding your specific legal or tax situation. Past performance is no guarantee of future results. Advisory services offered through Gold Medal Waters, a Registered Investment Advisor.
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