Do you want to leave a lasting legacy that spans generations to come? If you’re like most of our clients, the answer is a resounding yes! And while this is a noble goal to have, transferring wealth to the next generation can come with its own set of challenges. For example, you might be preserving your assets in the best possible way now, but what happens after it’s transferred? How much could you lose to taxes? Your estate may be protected when it’s in your hands, but will that continue once in your heirs’ possession?
It can be a complicated process, but there are strategies to keep things simple while leaving a legacy you can be proud of. Here are some ways to transfer wealth to the next generation in a tax-efficient way. Keep in mind that changes to tax rules are currently in consideration in Washington. Small changes are likely, but we don’t anticipate any major adjustments around today’s topic.
1. Make Direct Payments
Simply making direct payments for your children or grandchildren’s expenses is one of the easiest ways to transfer your wealth without the hassle of taxes. Many institutions will allow you to pay your grandchildren’s tuition directly from your account. You can also conveniently take care of other important expenses, such as medical costs, by automating payments to their healthcare provider.
When you make this sort of payment to an organization or institution, it helps you bypass the burden of gift tax, which can be a hefty price to pay on your assets. However, if you gift the money directly to the recipient, you might still be subject to gift taxes.
2. Give Annual Gifts
You could also decide to gift some of your assets to your loved ones. Giving gifts helps you reduce the taxed portion of your estate, and you can gift up to $15,000 (1) per year to a loved one before any gift taxes are incurred. If you are splitting the gift with your spouse, you can give up to $30,000 combined. To effectively transfer wealth to the next generation, you can ensure that you give the maximum amount every year.
It’s worth noting that once you gift more than $15,000 (or $30,000 if gift-splitting), the excess amount spills into the “lifetime exclusion bucket.” You must use this entire amount before the IRS requires you to pay gift tax. For 2021, the current lifetime exclusion is $11.7 million for individuals and $23.4 million for couples. (2) You will be required to file a gift tax form for any amounts that exceed the annual gifting limits of $15,000 individually or $30,000 jointly. This is how the IRS will track your lifetime exclusion amount. Gifts are not typically taxed until the lifetime exclusion amount has been surpassed.
Another great way to transfer wealth to your children and grandchildren is through the use of 529 college savings plans. There is a special provision that allows donors to contribute 5 years’ worth of gifts as a lump sum. This means an individual can gift up to $75,000 and a married couple could gift up to $150,000, without incurring gift taxes! (3) Also no more gifting can be made to the same beneficiary during that same 5 year period. The beneficiary can then withdraw the funds and the investment growth tax-free to pay for qualified education expenses.
3. Use Irrevocable Trusts
Creating a trust is another way to transfer wealth to the next generation. To oversee the use of your assets, you can create a trust with specific guidelines for passing your wealth to beneficiaries. This is not an approach that makes sense for many people, but it can be a great option to explore for families with large taxable estates.
When your estate is significant, an irrevocable trust comes in quite handy. You transfer all your assets from your estate to your trust, thereby bypassing estate tax. Additionally, when you accrue income on the assets you hold in your trust, you are not personally responsible for paying taxes since the trust is considered a separate entity. As such, the trust will be taxed directly on any retained income and beneficiaries will be taxed on any distributions of income. This is an effective wealth transfer strategy since beneficiaries are often in lower tax brackets.
It’s also important to note that irrevocable trusts are permanently binding; you cannot change any of the terms nor beneficiaries. Once you have handed over your wealth to the trustees, they manage and transfer it according to your specific wishes.
Start Gifting Today!
At Colorado West Investments, we have ample experience in managing family legacies and estate planning, and we would love to help you leave a lasting legacy. Reach out to us at 970-249-9882 or email firstname.lastname@example.org to get started.
Michael Murphy is an associate wealth advisor at Colorado West Investments Inc., a wealth management firm committed to providing exceptional, comprehensive financial services to highnet-worth individuals, business owners, and retirees. Michael is known for building strong relationships with his clients, helping them clarify their goals and values, and partnering with them to design a financial road map that will help them work toward their ideal life. He is passionate about walking his clients through the financial planning process and seeing the confidence and relief on his clients’ faces as a result. Michael has a bachelor’s degree in finance from the University of Northern Colorado and an MBA from the University of Colorado Denver. When he’s not in the office, you can find him outside, likely hiking or mountain biking, or digging into a book. Michael and his wife, Becca, have 6 dogs at home. Becca runs a dog training and boarding facility. To learn more about Michael, connect with him onLinkedIn.
*Advisors associated with Colorado West Investments, Inc. may be either (1) registered representatives with, and securities offered through LPL Financial, MemberFINRA/SIPC, and investment advisor representatives of Colorado West Investments, Inc. or (2) solely investment advisor representatives of Colorado West Investments Inc., and not affiliated with LPL Financial. Investment advice offered through Colorado West Investments Inc., a registered investment advisor and separate entity from LPL Financial.
This material was created for educational and informational purposes only and is not intended as tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation. LPL Financial does not provide tax or legal advice.
This material was prepared for Michael Murphy’s use.