Wealth Management Group Newsletter — Spring 2016
Frank L. Washelesky

Estate Plans Come with Income Tax Strategies

Today, you generally do not need to be concerned about federal estate taxes unless your net worth approaches $5 million (about $10 million if you are married). For 2016, the federal estate tax exemption is $5.45million per taxpayer and the exemption is scheduled to be annually adjusted for inflation. The exemption is the amount, reduced by any taxable gifts you made during life, which can pass tax-free to your heirs upon your death.

As the higher, inflation-indexed estate tax exemption was permanently signed into law, the top ordinary income and long-term capital gains rates increased approximately five percentage points each, to 39.6% and 20%, respectively. In 2013, the 3.8% net investment income tax went into effect for higher-income taxpayers and at thresholds lower than those triggering the top income tax rates.

So, for higher-income taxpayers and people with higher-income heirs, income taxes are important to plan for. However, even middle-bracket taxpayers should factor income taxes into their estate planning to minimize tax liability for themselves and their heirs. After all, why pay, say, even a 15% federal tax on a capital gain if, with careful planning, your family could avoid incurring any federal taxes on that gain?

Two Valuable Income Tax Strategies

Several income-tax-saving strategies can be incorporated into an estate plan. However, the following are two of the most valuable that most taxpayers can take advantage of:

  1. Hold on to appreciated assets — unless you have loved ones eligible for the 0% rate. Inherited assets receive a step-up in basis to their fair market value on the owner’s date of death. The recipient can then sell the appreciated assets shortly after receiving them and owe little, if any, income tax on the sale. So, if estate taxes are not a concern, holding on to both assets that have already appreciated and assets that you expect to appreciate significantly in the future can be beneficial. However, if you would like to dispose of an appreciated asset and you have loved ones in the 10% or 15% bracket for ordinary-income taxes who thus are eligible for the 0% rate on long-term capital gains, consider gifting it to the loved one to sell. This might require a gift tax return to be filed.
  2. Make charitable donations during life. If you are charitably inclined, consider maximizing your lifetime donations rather than waiting to make large charitable bequests at your death. Properly substantiated lifetime gifts to qualified charities generally provide an income tax deduction (and reduce the value of your estate), while charitable bequests provide only an estate tax deduction, which you will not need if your estate is below the exemption amount.

Before making significant charitable gifts, be sure to consider your cash flow needs and the legacy you want to leave. Also, keep in mind that your annual income tax deduction for charitable donations is limited to a percentage of your adjusted gross income (AGI) — 50%, 30% or 20%, depending on the type of gift and charity. Contributions exceeding the applicable AGI limit can be carried forward for up to five years.

Stay Alert

As you consider — and perhaps implement — these income-tax-savings strategies for your estate plan, you also need to keep an eye on two things: 1) Your net worth, and 2) Congress. If you have a financial windfall or simply enjoy a steady increase in compensation or investment performance, your estate could be boosted to a size where federal estate taxes become a concern. And, while the high, inflation-adjusted estate tax exemption has no expiration date, Congress could pass legislation to reduce it at any time.

Whatever happens, be ready to revisit your estate plan and, if necessary, alter your strategies based on changing circumstances. Be sure to consult with appropriate financial, tax and legal professionals.

Checklist for Protecting Your Child’s Financial Future

Congratulations on your family’s new addition! The birth or adoption of a child is cause for celebration, but it also carries heavy responsibilities. In addition to protecting your child’s physical well-being, you need to ensure he or she will be financially secure. Here is what to do right now:

  • Make (or revise) your will. A will provides instructions on how your assets should be distributed and names a guardian for your child in the event that both you and your spouse die prematurely.  This is also a good time to establish a durable power of attorney, which allows your designee to make medical and financial decisions if you are incapacitated.  Also consider who you wish to take custody of your child, as they should be included in this process.
  • Buy life insurance. Even if your employer provides life insurance, it probably is not enough. According to many sources, raising a child born in 2015 to the age of 18 costs at least a quarter of a million dollars. Then, there is the cost of college, your home’s mortgage and your spouse’s living expenses. Remember that current stay-at-home parents may need life insurance to cover the possible cost of a full-time caregiver.  Per life insurance recommendations think DIME: Debt+Income+Mortgage+Education.
  • Update beneficiaries. The disposition of retirement plans upon death, such as 401(k) plans and IRAs, is guided by beneficiary designation forms rather than a will or trust agreement. Although you should not name your child as a beneficiary (minors cannot legally inherit assets), consider establishing a trust and naming a trustee to ensure your child’s financial needs will be met.
  • Apply for a Social Security number. You will need your child’s Social Security number to take advantage of tax benefits for parents with dependent children. Social Security numbers also are required to open a bank or investment account for your child.
  • Set up an education account. According to the College Board, a child born in 2015 can expect to spend as much as $324,000 just to attend a four-year college. As formidable as that might sound, 529 college savings plans can help parents and children reach their education goals.* Earnings on 529 plan contributions grow tax-deferred for federal income tax purposes and withdrawals used to pay for qualified higher education expenses (such as tuition and fees and, generally, room and board) avoid federal income tax, making the tax deferral permanent. Although there is no federal tax deduction, Illinois offers a deduction of up to $10,000 per taxpayer per year for contributions to certain IL plans.  Contributions to a 529 plan may be subject to gift tax, so consult with your CPA on laws.  Contributions to an education plan should be considered after you plan and save for your retirement.  Retirement saving comes first!  There are multiple ways to finance college; however, you are solely responsible for financing your retirement.
  • Establish an emergency fund. If you do not already have a “rainy day fund,” establish one. Aim to save at least three to six months’ worth of living expenses so that, if you lose your job or your child needs something you had not anticipated, the money will be there.  This money should be maintained in a cash account that is easily accessible and not subject to investment risk.

Prior to making an investment or insurance decisions speak with your CPA, or other qualified advisor.

* There is no guarantee that the plan will grow to cover college expenses. Depending on the laws of your home state or on your designated beneficiary, favorable state tax treatment or other benefits offered by your home state for investing in 529 college savings plans may be available only if you invest in the home state’s 529 college savings plan. Any state-based benefit offered with respect to a particular 529 college savings plan should be one of many factors considered in making an investment decision. Consult with your financial, tax or other advisor to learn more about how state-based benefits (including any limitations) would apply to your specific circumstances. You may also wish to contact your home state or any other state to learn about the features, benefits and limitations of that state’s 529 college savings plan.

Please consider the investment objectives, risks and charges and expenses associated with municipal fund securities, including 529 plans, before investing. This and more information is available in the issuer’s official statement. Please ask the issuer for an official statement and read it carefully prior to investing. You should consult with a tax advisor regarding the state tax consequences of any investment in a 529 plan.

If you have any questions, please feel free to contact your ORBA advisor or Frank Washelesky at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

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