Robert Carlson
Bob Carlson is editor of the newsletter Retirement Watch. He is a managing member of Carlson Wealth Advisors and chairman of the board of trustees of the Fairfax County (Virginia) Employees’ Retirement System. RetirementWatch.com
How to Plan Now
Heads up! Higher taxes are coming, and the clock is ticking if you want to take steps to protect yourself.
Many components of the 2017 Tax Cuts and Jobs Act (TCJA) are set to expire at the end of 2025—that’s only 18 months away. The Trump-era law brought sweeping changes for millions of Americans, including lowering individual income tax rates…almost doubling the standard deduction…and raising limits on the estate-tax exemption. Unless Congress and the White House extend or revise the TCJA, these changes will be automatically reversed, boosting tax rates for people in almost every tax bracket.
Financial advisor Robert Carlson told Bottom Line Personal that retirees and near-retirees should understand the implications of these fast-approaching changes and rethink their traditional tax- and estate-planning strategies now…
It is tempting to assume that the TCJA tax cuts will be extended. We experienced a similar situation in 2010-2011 when the Bush tax cuts were set to expire. Former President Obama’s administration agreed to extend those tax cuts for two years and then made most of them permanent. But with federal debt levels now at more than $34 trillion, Congress is likely to allow some TCJA provisions to lapse, leading to higher estate-tax and income tax rates for wealthier taxpayers.
What’s likely to happen: Higher income tax rates. Income tax brackets will revert to pre-2017 levels. Even a marginal shift in percentage can translate into big changes in how much tax you owe.
The top marginal income tax rate—for married couples filing jointly with income over $731,200—will rise to 39.6% from the current rate of 37%.
The 32% bracket—$383,901 to $487,450—would rise to 33%.
The 24% bracket—$201,051 to $383,900—would rise to 28%.
The 22% bracket—$94,301 to $201,050—would rise to 25%.
The 12% bracket—$23,200 to $94,300—would rise to 15%.
Exceptions: The second-highest bracket—$487,450 to $731,200—will remain at 35%…and the bracket for the lowest earners—$23,200 or less—will be left at 10%.
What to do…
Convert to Roth IRAs. Roll over distributions from your traditional IRAs to Roth IRAs over the next two years and pay taxes now rather than at the future higher tax rates, especially if you are facing required minimum distributions (RMDs). Keep in mind: You can move your exchange-traded funds (ETFs), individual stocks and bonds “in kind” from a traditional to a Roth IRA without having to sell them so the investments will continue to appreciate. Annual Roth IRA contribution limits don’t apply to conversions. Caution: Don’t create so much income that you push yourself into a higher tax bracket in the year you take the distribution(s). Roth IRAs require no RMDs. Surviving spouses who have inherited a traditional IRA also can benefit from making a Roth conversion before the sunset if they rolled the inherited IRA into a spousal IRA. After your death, your heirs can take distributions tax-free from Roth IRAs that you leave to them.
Turn your traditional IRA into permanent life insurance. Taking distributions now and using the after-tax amount for life insurance premiums offers several advantages. The life insurance payout received by the beneficiaries after your death is income tax–free. The amount your loved ones inherit with life insurance can be either fixed by contract or increase over time, depending on the type of policy you take. But it won’t fluctuate with the markets the way an IRA portfolio of stocks and bonds can.
What’s likely to happen: Lower limits for estate and lifetime gift-tax exemptions. The federal estate tax applies to the transfer of assets at death. The gift tax applies to transfers made while a person is living. Federal estate taxes for assets above the exemption can run as high as 40%. The exemption limit was greatly increased in 2017 and stands at $13.61 million per person in 2024. After 2025, the exemption drops back to about $7 million per person (with expected adjustments for inflation). Depending on who controls Congress and the White House, there is a possibility that the exemption could decrease even more. Back in 2016, it was $5.45 million…in 2008, it was $2 million.
Also: Don’t forget state taxes. Eighteen states and the District of Columbia have some form of estate or inheritance tax…or both. The state exemption limits typically are much lower. Examples: Massachusetts has an estate-tax exemption of just $2 million…Oregon, $1 million. Both have state estate-tax rates as high as 16%. Helpful resource: TaxFoundation.org (search for “Does Your State Have an Estate or Inheritance Tax?”).
What to do…
Reduce the amount of assets potentially subject to estate taxes. The IRS has indicated that any gifts you make before the TCJA sunset that were not taxable at the time of the gift will not be subject to claw-back taxes, even if the exemption amount is lower when you die. Talk with your estate planner about which assets are most beneficial to transfer now and the best ways to do it.
Make direct gifts of cash, securities or real estate up to $18,000 per person per year to as many people as you want in 2024 (and an estimated $19,000 in 2025) without those gifts counting against your lifetime exemption. This removes not just the current value of the gift but any future appreciation from the value of your estate. Gifts can be made outright…transferred into a trust…or fund 529 plans for qualified educational purposes. Important: If you choose to gift long-held investments such as stocks or property, the recipient will owe capital gains taxes when he/she sells those investments based on the amount you originally paid for them. But if those same assets are left to beneficiaries when you die, they get a “stepped-up basis” when they are sold. In other words, capital gains taxes are based on the value of the assets on the date of your death.
Fund a SLAT. Some couples are reluctant to give up complete control of their assets until one or both spouses pass away, just in case their circumstances change in the future. A Spousal Lifetime Asset Trust (SLAT) enables one spouse to transfer assets into an irrevocable trust for the benefit of the other spouse, effectively eliminating these assets from the grantor’s estate and exempting them from estate taxes. If the value of the assets in the trust grows over time, those gains also are not subject to estate tax. The trust can be customized so that the non-grantor spouse (as well as other beneficiaries) still can have access to the assets via a distribution of income or capital gains. When the non-grantor spouse dies, the children or grandchildren can become beneficiaries.
What will change: Deductions for cash contributions to charities. Under the TCJA, you could deduct up to 60% of your adjusted gross income (AGI) for charitable cash contributions. At sunset, the threshold reverts to 50% of AGI.
What to do: Make any significant gifts now while the TCJA remains in effect, allowing you to deduct more of your contributions from your taxable income if you itemize expenses on Schedule A instead of taking the standard deduction.
What’s likely to happen: The standard deduction taxpayers can elect to take on their federal income taxes goes down. It reverts to about $6,350 for single filers and $12,700 for married couples filing jointly (adjusted for inflation). At the same time, personal exemptions will be reintroduced—$4,050 per taxpayer and qualified dependents in 2017—as will deductions for miscellaneous itemized expenses such as investment/advisory fees, legal fees, unreimbursed employee expenses exceeding 2% of AGI, job-relocation moving costs and personal casualty and theft losses. Also, the $10,000 cap on deducting state and local income and property taxes will be eliminated. Note: High-income taxpayers will have a reduction in itemized deductions.
What to do…
Hold off on purchases that qualify for deductible expenses for 2024 and 2025 if you are taking the standard deduction in those years. Then plan on “bunching” or consolidating those expenses in 2026 so you can itemize them on your IRS returns and maximize the tax breaks you get.
Plan to itemize deductions, instead of taking the standard deduction, if…
You own a home in areas and states with high income property tax rates, such as California, Illinois and New York. After 2025, you will be able to deduct an unlimited amount of your state and local income and property taxes on your federal tax returns.
You are buying a home. You might want to take out a larger mortgage in 2026 since mortgage interest deductions will revert to pre-TCJA levels, allowing interest to be deducted on the first $1 million in home mortgage debt instead of the first $750,000.
