Other highlights from this webcast
- The latest tax laws—What’s different?
- The new rules’ effect on estate and gift taxes
- What tax reform means for your investment portfolio
- Roth conversions under the recent rules
Talli Sperry: Hello, I’m Talli Sperry. Welcome to this evening’s live webcast on tax and estate planning in a changing environment. We’ll cover an overview of the current environment, what you need to know, and how you can plan for the long term.
Joining us today to discuss these important topics are two Senior Wealth Planning Strategists, Jacklin Youssef and Alisa Shin, and one of our Senior Financial Advisors, Tony Giordano, all with Personal Advisor Services. Welcome Jackie, Alisa, and Tony.
Jacklin Youssef: Hello.
Alisa Shin: Thank you.
Tony Giordano: Hi, Talli.
Talli Sperry: We’ll spend most of our time today answering your questions. Two items I’d like to point out, there’s a widget at the bottom of your screen for accessing technical help. It’s the blue widget, and that one’s on your left. And if you’d like to read some of Vanguard’s thought leadership material that relates to today’s topic or view replays of past webcasts, click on the green Resource List widget; and that’s on the far right of your player. Sound good?
Alisa Shin: Um-hmm.
Tony Giordano: Sounds good.
Talli Sperry: All right, well great. But before we get started, I’d like to ask our audience a question. So on your screen now you’ll see our first poll question which is what concerns you most about the recent tax legislation? Is it AMT, cost basis, income tax, or estate and gift taxes? Please respond now, and we’ll share your answers in just a few minutes.
So, Jackie, while we’re waiting, why don’t we answer one of our presubmitted questions.
Jacklin Youssef: Sure.
Talli Sperry: Great. So this one is from Gail in Carmichael, California. Thank you, Gail. And she’s asking, “What’s different this year?”
Jacklin Youssef: That’s a great question to start. We definitely had a lot of changes based on the new tax rules that were passed on December 22. This is essentially considered more of the far-reaching rules that we’ve had in changes over the last 30 years because it does cover a lot of changes to the individual income tax side, to trust and estate, to small business owners, as well as the corporate tax side. So because of the magnitude of the changes, that’s why we believe, again, that this is considered to be sweeping changes.
If we look and focus on the provisions that are pretty much related to the individual taxpayers, we’ll recognize that a number of those are set to expire at the end of 2025. And what that, in a sense, really means, it means that those will essentially revert back to what the tax rules looked like before the rules were effective in 2018. So we’ll, essentially, just see some sort of changes, unless, of course, Congress were to go back and extend these tax rules.
Talli Sperry: So it would look like 2017 did?
Jacklin Youssef: Exactly, right.
Talli Sperry: Okay, important to know.
Jacklin Youssef: We want to maybe point to specific areas as to what were some of the changes, and we’re looking at the individual income tax side of things. So we’ll recognize that the marginal tax brackets were lowered, so we do have a chart up on the screen that will essentially just go back and take a look at what the tax brackets look like for individual investors. Those, essentially, will be progressing from 10 all the way up to the highest bracket of 37%.
Other changes really include looking at the standard deduction and how those were expanded and almost doubled, so that’s a little different than what we had before the tax rules. There’s been a repeal of the personal exemptions, which, in a combination of these two areas, will drive a lot of our clients to making decisions around whether it would behoove them to itemize their deductions or not itemize their deductions. And I also have another chart that we can probably bring up on the screen as well that will highlight the number of the different rules around some of those itemized deductions that we’ll probably converse about a little bit more throughout the rest of the webcast.
The last area I want to bring up is one area that I focused on earlier, which is small business owners; and there’s a new tax deduction for flow-through entity and business owners in that situation, that they certainly can look at whether they certainly will qualify for this and how much potential deduction they would be looking at. So those are some highlights.
Talli Sperry: Wow! Well, I’m already really thankful you’re here with us because it sounds like a lot has changed. I do see that we have your poll results in, so let’s take a moment to look at those and see how our audience responded.
So it looks like when we ask, “What concerns you most about tax reform legislation?,” we actually see that 14% of you are most concerned about the AMT; 6% of you are concerned about cost basis; 50% of you are concerned about income tax, so I have a feeling we’ll discuss that a lot tonight; and 28% of you are concerned about estate tax. So it seems like we’ve got a good panel gathered together. Does any of that surprise you?
Jacklin Youssef: No, I would say that that does not surprise me at all.
Alisa Shin: Yes, I think that’s pretty consistent. I think with the changes in the estate tax laws, I think some people are no longer affected by the estate tax; but others will not know what to do because they’re right in the middle, so I’m not surprised at all by that.
Tony Giordano: Yes, that’s consistent with what we talked about earlier. We thought income tax and estate tax would be the biggest area where people were confused and wanted more information.
Talli Sperry: So you’re very consistent with what we’re hearing from all of our clients, so it makes total sense.
So let’s ask our audience a second poll question. So with this one, which of the following have you used as a tax efficiency tool? So systematic giving for annual exclusion gifts, life insurance trusts, techniques using your lifetime exemption, so those are dynasty trusts, IDGTs, QPRTs, CLTs, GRATs, valuation discounts, etc., all of the above, or none of the above? So please respond now, and we’ll get to your answers in just a few minutes.
Okay, so let’s take another one of our presubmitted questions while we’re waiting for our audience. So this one comes from Robert in Hillsborough, California, and he’s asking, “Is there a change in the annual gifting amount?” So, Alisa, you were just kind of getting to that, so I think I’m going to turn this one to you because he’s asking, “Does the change in the estate tax exemption alter the change in the cost basis of estate assets?”
Alisa Shin: Sure, and so I actually think we have a chart that we can pull up, the estate and gift tax chart. But to answer his first question, the amount that each person can give each year, which is commonly called the annual exclusion gift, did change, not because of the tax law change, but just by inflation adjustment. So instead of it being $14,000 a year per person, per donor or per donee, it is now $15,000 a year. So there was a slight increase in that amount.
Before I answer the question about the basis, it might be worth it just to talk a little bit more about how the estate tax laws changed. We used to be in a world, pre this new tax law, where you could give up to $5.49 million free of the federal estate tax; and the top estate tax rate was 40%. As a result of the new law, Congress actually doubled the exemption. Now I need to make one quick correction on our chart because it was a very recent change and everything had been uploaded already so we could not make the change quick enough.
The new exemption for 2018 is not $11,200,000. It’s actually $11,180,000.
Talli Sperry: Thanks for clarifying. That’s important.
Alisa Shin: That is important. It’s a little bit of a difference. A lot of people were saying the $11.2 million number, that was based on the old way the CPI was calculated. The new tax law changed how we apply the CPI to what they call cha—
Talli Sperry: CPI, just for our viewers who aren’t familiar—
Alisa Shin: Is the Consumer Price Index, which is used to adjust the numbers based on inflation. And so now they’re using what they call chained CPI. So as a result of the new calculation, literally in the last probably 24, 48 hours or so, we were told that the exemption will now be $11,180,000. The tax rate stayed the same. The top tax rate is still 40%. And with this new law, they actually did not do anything with the basis rules, meaning that if you die owning assets, your beneficiaries will receive what they call a step-up in basis so that your beneficiaries’ basis becomes the value of that asset on the date of your death, so there’s still a win there. That was not taken away.
Talli Sperry: That’s great. And I just want to clarify, when you say $14,000 or $15,000 and you say the $11,180,000, did I get that right?
Alisa Shin: Right, yes.
Talli Sperry: When you say that, that’s per person, not per couple, right?
Alisa Shin: That’s correct.
Talli Sperry: Okay, so that’s an important clarification.
Alisa Shin: Right, right. So between the two, a married couple, they can now give over $22,000,000 free of federal estate tax to their beneficiaries.
Talli Sperry: And I would guess that’s probably exciting for some of our clients and concerning for others, is that correct?
Alisa Shin: Absolutely. Yes, absolutely. And the other thing, just really important to note, is that when clients give that annual exclusion gift, that $15,000 gift, that does not impact their $11,180,000 exemption. So you can give $15,000 every year to any number of individuals, and you still have your full $11,180,000 exemption.
Talli Sperry: So that can be very helpful.
Alisa Shin: It can be very helpful, yes.
Talli Sperry: Okay, great. So I think our results are ready. I’m just hearing that from our producer, and so let’s check those. When we look at which of the following our audiences used as a tax efficiency tool, it looks like the majority of our audience has used the systematic gift giving, those annual exclusion gifts, so that’s about 38% of you. Life insurance trust was around 4%. Techniques, the alphabet soup, the IDGTs, the QPRTs, the CLTs, the GRATs, those were about 6%. All of the above, 7%, and none of the above, 44%. So it’s really interesting that we see the split into the annual exclusion gifts or none of the above. So it looks like we might want to spend some time discussing some of these things and how we can apply them for your benefit.
Alisa Shin: Absolutely.
Talli Sperry: Okay, great. So while we wait for some live questions to come in, and please feel free to start submitting those, we’d love to hear what’s on your mind; and this is for you, so we want to speak mostly to your questions.
In the meantime, we’ll go back to one of our presubmitted questions; and I’m going to take this one from David. And, Tony, I’m going to ask you this, which is, “What portfolio changes should investors be considering in light of the new tax structure?” because I’m sure that’s exactly on your mind right now.
Tony Giordano: It’s a great question. And unlike the tax in the estate planning front, I don’t see things changing all that much from Vanguard’s perspective in terms of our investment advice—
Talli Sperry: That’s comforting.
Tony Giordano: Yes. I do see a tremendous opportunity for clients to take a look. Jackie had put up a slide earlier that talked about the rates, the marginal tax brackets. And just about everybody’s going to be in a different marginal tax bracket going forward; albeit, they’ll probably be in probably a close marginal tax bracket than what they are today or what they were in 2017. It will be different, so I think it’s a great opportunity for investors to look primarily at the bond portion of their portfolio.
We continue to be in a very low interest rate environment, so it’s important to really maximize your after-tax returns. So, again, I think it’s a good opportunity to do an apples-to-apples comparison of what does it look like, where are you at in the tax bracket, where do you fall in the new marginal tax bracket, and then do an apples-to-apples comparison to see does municipal bonds provide a greater after-tax value for you or does being in a taxable bond portfolio provide that greater value?
Talli Sperry: That’s a really important question we should probably be assessing sooner rather than later, right?
Tony Giordano: Yes, being at the beginning of the year, you want to be able to maximize that. So, you know, the way our bond funds work, they pay a dividend on the last business day of each year, so we’re already kind of midway through January, so the sooner that decision is made the better.
And some of our core principles, some of the things that we believe in like broad diversification, not only just U.S. but global diversification, low cost investing, those things still hold. We’re not making any changes from that perspective. We still think that that’s, obviously, really going to be even more important going forward because a lot of firms are projecting that returns could be a little bit lower than historical averages going forward.
Talli Sperry: So it’s nice to know that amidst a lot of change, some things remain very consistent. That’s great.
Tony, I have a follow-up question for you, and it’s a live question. So Bruce is asking, “In a taxable account, what is the strategy for rebalancing asset allocations when the tax basis of your assets is essentially zero and one has substantial gains in all asset classes?” So maybe if you were going to start out by defining tax basis and then walk us into that so all of our viewers can be with us.
Tony Giordano: Sure, so it’s a great question. It’s coming up quite often with a lot of my clients. As the equity markets have drifted higher, we’re asking a lot of people to consider rebalancing at this time, you know, selling some of their stocks and going into bonds.
But to answer your question, in terms of establishing cost basis in a taxable account, that’s essentially what you paid for the security or the underlying mutual fund or individual security. So just as an example, if you put $10,000 into one of our mutual funds, and that $10,000 has now grown to $100,000, you now have that established cost basis of $10,000; and now the question is if I’m going to rebalance the portfolio, I’ve got that delta, that $90,000 differential, and I’ve got to probably pay some capital gains to do that.
So one of the ways that we recommend doing that, it doesn’t move the dial all that much, but we could redirect dividends.
Talli Sperry: Interesting.
Tony Giordano: So you could take the dividends from the stock funds, you could start redirecting them into the bond portion of the portfolio. That’s a way to do it. You’re going to pay taxes on the dividend regardless, whether you reinvest it back into the mutual fund or whether you distribute it to a new fund or if you take it in cash. You’re going to pay taxes on it anyway.
So that’s one way again; albeit, it’s not going to move the dial all that much, but it will start to gradually shift that investor a little bit more conservative without having to necessarily incur the capital gains tax.
Having said that, the capital gain rates are pretty low, so we’re historically, whenyou look at capital gain rates—Jackie could probably talk to this even more historically—but if you’re not in the top marginal tax bracket, your federal rate is 15%. So it’s not the end of the world to pay a little bit of taxes. You did make money along the way, so and we do think that the overall asset allocation is really the driving force behind the investment strategy. So we do think that clients should rebalance, and if they have to pay a little bit of taxes, so be it.
Talli Sperry: And I think your mind is thinking just like our viewers because we actually have another live question; and Tom is asking Jackie, “Are there changes in the tax treatment of capital gains?” So I think that’s a perfect streamline.
Jacklin Youssef: It’s a great segue. So capital gain rates were not changed. So the rates progressed from 0 to 15 to 20%. The one change is now under the new rules, the rates are actually aligned to specific income thresholds and not tax brackets like the case was in 2017 and prior. So in that case, it’s not clearly and cleanly as aligned as it was. For instance, if a taxpayer is below the 25% bracket, the case was a portion of their capital gain would actually be at 0%. And as Tony had mentioned, in that case if that person is in the 25% bracket all the way up to the one right before the top bracket, then their capital gain is at 15%.
So the rates are the same, but the income thresholds are a little different. It’s a good news story at the end of the day because, to Tony’s point, the tax rules really should not be driving a conversation around should I rebalance or not. It’s the investment merit, first and foremost. So despite me liking to talk about the tax aspect, I’d say that that really is one area to be aware of but not to drive the decision.
Talli Sperry: That’s helpful because I think we want to start to understand what angles should we think from amidst all of these changes because I would imagine many of you are feeling like you have to think about multiple things at the same time, so that’s really helpful insight.
Alisa, we have a live question for you; and William is asking, “Is it still possible to pay for children’s education without affecting the annual $15,000 allowable amount?”
Alisa Shin: Yes, absolutely, that was not changed. So taxpayers have the ability, as long as they pay the tuition directly to the school; and in this case, it is any level of schooling. It is not just college, so it is primary, secondary, and postsecondary education. It is only tuition; and as long as payments are made directly to the provider, meaning the school, the IRS actually does not consider that to be a gift. You might consider it to be a gift, you might, but the IRS does not. And, again, it does not impact your ability to do the $15,000; and it does not impact your $11.18 million exemption.
A very similar exception to the gift tax rule is medical expenses. So very similar to paying tuition, clients can pay medical expenses on behalf of another individual to help them out. As long as they make those payments directly to the provider, the IRS, again, does not consider that to be a gift.
Talli Sperry: That’s wonderful, so it’s ways we can make a difference and help with this space as well, right?
Alisa Shin: Absolutely, yes.
Talli Sperry: Okay, good. Well, while we wait for more live questions, let’s go back to some of our presubmitted questions; and feel free to keep sending them in. These are great questions, and they’re perfectly aligned with where we’re going in the discussion, so thank you.
So this one is from Marie Jose, and it’s from Lovingston, Virginia; and she’s asking, “How does the new legislation affect the utility of GSTs? If one’s assets are within the expanded exemption amount, does a GST still make sense?” And, Alisa, I might move this to you; and if you could define GST for us, that would be helpful.
Alisa Shin: Sure. So GST most often means the generation-skipping transfer tax. This is an additional tax to the estate tax and the gift tax, and it’s a tax that’s imposed when somebody makes a gift or a bequest to somebody who is at least two generations below them, so meaning a grandchild or some further descendant.
So people have to remember that this is additional, as I said before. And what’s even more troubling about the generation-skipping tax is that it is a flat tax at the highest state tax rate. So it’s an additional 40%.
There are exceptions to the generation-skipping tax. We could spend this whole hour and then some talking about this. But really quickly, annual exclusion gifts, the $15,000 gifts to grandchildren or further descendants is not subject to the generation-skipping tax as a general rule. Payment of medical or tuition expenses for grandchildren are also not subject to the generation-skipping tax. And if we look at the chart that had the estate tax rules in it, you’ll also see there’s a third column there for the generation-skipping tax. So each person also has an $11,180,000 lifetime/death time exception that they can give tax free. So that’s really quickly what the GST is.
But to answer her question, I think that a lot of clients would think that on its face, if they are now well below the $11 million threshold or the $22 million if they’re married, that they don’t have to worry about generational tax planning. But I actually think that what this new tax law does for us, and what we really want clients to understand, is that it is now probably as important, if not more important today, for clients to be really strategic about what they’re doing and thinking through not only what the purpose of their wealth is but also what they’re trying to accomplish and to look beyond just them and their children.
So a couple things, one, this estate tax law is set to sunset on December 31, 2025.
Talli Sperry: That’s great because we actually had a question on that, and Harry was asking, “In light of the law changes, do we know if we’ll revert to old amounts?” So, yes.
Alisa Shin: Right, and we don’t know. I mean I think I could say historically we’ve not been a world where the estate tax exemption ever went down from where it was before, but I don’t know that we’ve ever been in a world where the exemption has doubled as quickly as this one has. So I don’t know that anyone knows whether this has any staying power or not.
Talli Sperry: Tony, do you hear clients concerned in this space?
Tony Giordano: I do and Alisa and I have lots of conversations with many clients on this topic, and the GST’s actually pretty confusing. I can see my client’s faces, and it’s a challenging topic to understand. But I think what’s nice, Alisa, is for the clients to understand that it’s not just them getting assets out of their estate; it’s also getting assets to their children, the next generation, and then, if done properly, it’s excluded from their estate. Those assets are then excluded from their estate. I agree with Alisa; there’s tremendous benefits, and I’ve got a feeling we’re going to, with the expanded exemption amount, we’re going to spend a lot of time over the next several years through 2025 talking to clients about this very topic.
Alisa Shin: Absolutely. I mean I think just to tag onto what Tony said just by way of example is even if you are below the exemption thresholds, right, and you have children who are doing relatively well financially, they can at least take care of themselves. They might even be able to save money for their own retirement, if not support themselves.
Talli Sperry: So we really need to think about the space quite carefully. We really do, yes.
I think it’s interesting because we’ve got a lot of questions around capital gains coming in. I think we’re kicking off a topic. So, Jackie, maybe I’ll kick this to you. So Marianne is asking, “What about the 3.8% capital gains addition?”
Jacklin Youssef: Yes, so the Medicare surtax is still intact, which means if you do have net investment income above a certain threshold and your income is above a certain threshold, you still have the 3.8%, again, that you’ll be subject to.
So it was one of the areas that we hoped initially would go away earlier in 2017, but when we saw ultimately some of the different versions of the tax bill, we noticed again that that’s still pretty much staying with us.
Talli Sperry: Okay, great. So this one’s interesting. So Karen is asking, “While most people won’t be impacted by estate tax, aren’t inheritance taxes in most states unavoidable?” So this is meaty. Who wants to dive in here?
Alisa Shin: I’ll take the first stab.
Talli Sperry: All right.
Alisa Shin: So I think it’s an interesting question. As of the end of 2017, I think there were maybe 13, 14 states that still had some kind of form of state inheritance tax or estate tax, and she is correct. The only way to, I don’t like to use the word “avoid,” but the only way to not be subject to estate inheritance or estate tax is to simply not reside there, to not be a resident there. That’s really the only way to do it.
Talli Sperry: And is that primary residence?
Alisa Shin: Yes, it would be your primary- So, right. Your primary residence, residence that you consider being a citizen of that state, where you vote, where you file your tax returns, and so forth, okay? So the only way to minimize that tax is to move out of those states, which is not always plausible because I personally, and I think at Vanguard, is I like to say we don’t like the tax tail to wag the dog.
Talli Sperry: Right.
Alisa Shin: Like you shouldn’t pick a place to live just to avoid paying taxes. Like you either like-
Talli Sperry: There’s a lot more to life.
Alisa Shin: That’s right, that’s right. Exactly. Exactly.
Jacklin Youssef: But if you were contemplating it, it may actually behoove you to maybe think about it seriously at this time.
Alisa Shin: It could. It could.
Talli Sperry: You’re choosing between a couple of really good states.
Alisa Shin: Right, right. There had been a trend with the states that still had estate tax or inheritance tax that they were slowly either repealing those taxes or they were at least making them in line with the federal exemption. We had several states, for instance, a state might have a $2 million estate tax exemption that would be free of state estate tax even though the federal exemption back then had been almost $5.5 million. And a lot of states have passed legislation to kind of, over time, start mirroring what the federal is. I think it’ll be interesting to see over the course of the next year or so what all these states do and if they’re still going to completely align with the federal or if they’re going to be a different demarcation.
Talli Sperry: Okay, that’s really helpful. Another layer to all of this.
Alisa Shin: Right.
Talli Sperry: So we’ve got a question from Della, and she’s asking, “What are the effects on RMDs and charitable giving?” So, Jackie, we’ll move this one to you.
Jacklin Youssef: Sure. So RMD is the short of required minimum distribution. So an individual who has a traditional IRA is required to take a minimum distribution once they reach 70-1/2. And, in general, that’s taxed at an ordinary income rate, so the rules really have not changed there. In general, of course, it is the tax rates that that person is in and what other planning that they could do.
But when we go back and focus on the charitable aspect of this, there is an option for those individuals who have a required distribution that they need to satisfy to avoid a significant penalty. They could direct a portion of the distribution from the IRA to go directly to a qualified charitable organization up to $100,000, and that would satisfy the minimum distribution. But the kicker is it’s not counted as ordinary income. So if the client is truly charitably inclined because this is one of the areas that they’d like to continue to do, it may behoove them to essentially use those qualified charitable distribution, which is QCD for short of that specific option.
Certainly, there are rules around it that the client would need to follow to make sure, again, that it ultimately qualifies; but the good news is under the new rules that we have here for whether you could use your itemized deduction versus standard deduction, it may become more advantageous to use the IRAs in that case to make those charitable distributions.
Talli Sperry: That’s really interesting. Tony, do you see clients doing this? You’re nodding, yes.
Tony Giordano: Yes, lots. I have lots of clients that take advantage of that provision. It was nice when it became permanent.
Talli Sperry: Yes.
Tony Giordano: It was in and out of the tax code for years. Clients were waiting till the end of the year to see if it was in. And, fortunately, it’s, well, permanent. I use that word like a grain of salt.
Talli Sperry: Loosely, exactly.
Tony Giordano: Loosely, exactly. But it’s permanent. I do have a lot of clients that take advantage of the QCD or qualified charitable distribution. Absolutely.
Talli Sperry: Okay, that’s great. It’s good to know the connection between some of these faces too. That can help us package it together and keep it in our mind, so thank you for drawing those.
Tony Giordano: Sure.
Talli Sperry: Great. Well, while we’re waiting for more questions to come in, let’s actually go to another one of our presubmitted questions. So this one is for you, Jackie, as well. And this is David from South Carolina, and he’s asking, “Are IRA to Roth IRA conversions impacted?”
Jacklin Youssef: So, yes they are. And, in general, I would say converting from a traditional to Roth IRA, which means, again, you take the funds out of the IRA and move them to Roth and have that considered as taxable income, that is still available. What’s unavailable and has been repealed is undoing that conversion after the fact.
Talli Sperry: Which got popular with many people, right?
Jacklin Youssef: Absolutely. So a lot of the clients, again, that we work with generally had the ability to complete a conversion during a calendar year and come back and reassess after the end of the calendar year well into mid-October of the following year. So that essentially equated with the tax return due date including extensions. The rules clearly say you can’t undo a conversion that you’ve completed already in that case.
One little nuance, again, that we were debating, a number of tax experts really were debating, which is what about 2017 conversions that were completed? There was a lot of debate as would that be impacted by those rules or not?
Talli Sperry: And that’s because things were signed right at the end of 2017, right?
Jacklin Youssef: Exactly. And the language of the provision itself was not clear as to what would be the ultimate effective date for this. So hot off the press, it looks like the IRS was gracious to update their Q&A on the website to ultimately clearly indicate that 2017 Roth conversions could still be undone through mid-October of 2018. So for a lot of our clients who have completed conversions in that case, they still do have the ability to go back and reassess. So it ultimately will come down to does it make sense again for them to undo and potentially come back and redo? I mean, keep in mind, tax brackets are lower; but, of course, the various itemized deductions look drastically different than what they looked like in 2017. So it’ll ultimately come down to crunching the numbers to see whether it would make sense for someone to undo this. Keep in mind also the markets have done tremendously well.
Tony Giordano: Well, I was just going to say, Jackie, too the reason to undo it or to redo it would be because a lot of people who convert from a traditional IRA into a Roth want to put that into stocks or very heavy to stocks because now that money, they’ve paid the taxes on it, it’s growing tax deferred and ultimately tax free for their beneficiaries. So that’s really the reason to undo it. And now we’ve had such a remarkable runup in the equity markets. We haven’t seen really a negative stock market since 2008. We had a couple flat years for 2011 and 2015, but I’m not predicting we’re going to see a crash, but we’re certainly due for a negative number at some point. And that would be the reason. So I think investors in 2018 have to proceed with caution on the conversions, even though their rates are going to be lower, because the reason to undo it would be because the value of your account goes down.
Jacklin Youssef: And that’s a very good point. So in 2018 and beyond, any conversion someone is contemplating, there’re really clearly two main questions that they need to ask themselves: is this truly appropriate for me? And the second one is, is the amount ultimately appropriate as well because there’s no way back out of it.
Talli Sperry: That’s helpful. So while we’re on the subject of IRAs, I’m going to get a question to Alisa. And it looks like we may be doing a little bit of a lightning round with you so watch out, questions are coming in for you. So please feel free to chime in, Tony and Jackie.
Tony Giordano: Sure.
Talli Sperry: So this one is from Shakandred who is asking, “If grandchildren are named as beneficiaries on traditional IRAs, are they subject to GST?”
Alisa Shin: They are. They are, so people have to be very careful about what assets they’re giving to whom and how much it is. So anything going to a grandchild will be subject to the generation-skipping tax, assuming that you’ve used up your $11,180,000 generation-skipping tax exemption.
Talli Sperry: And you said that’s 40%, right?
Alisa Shin: Forty percent and that’s in addition to whatever estate tax will be levied at the time.
Talli Sperry: So if we want our grandchildren to get assets, we have to think very carefully, right?
Alisa Shin: Correct. Correct, yes.
Talli Sperry: Okay, great. So question number two, “Will an unused portion of one’s lifetime estate tax exemption at death still be transferable to a spouse?” And that one’s from Michael?
Alisa Shin: Yes, so that’s a great question. So what he’s referring to is the ability of spouses to basically leave their unused estate tax exemption to their surviving spouse. And Congress left that intact so you’re still able to do that.
Talli Sperry: So if your spouse has used 2 million, then you can use their 9 million plus your 11 million?
Alisa Shin: That’s correct. Yes, yes. And I think that what will happen if the exemption changes or goes down, I would suspect that you still get the 9. It’s just your 11 that might change as the law changes.
Talli Sperry: Oh, interesting. That’s helpful too.
Alisa Shin: I don’t know that for sure, but that would be the logical result, yes.
Talli Sperry: Okay, good. This gets to that uncertain environment ________. Doesn’t it?
Alisa Shin: Exactly.
Talli Sperry: All right, third question. So John is asking, “Did tax reform change life insurance trusts used in estate planning?”
Alisa Shin: So it didn’t change life insurance trust per se. It probably has, at least temporarily, might have lessened the need for some clients to have life insurance.
Talli Sperry: Interesting!
Alisa Shin: So a lot of clients would have life insurance to replace the wealth that their family would lose to estate tax. So with the exemptions doubling, there’s a lot less families who are subject to the estate tax so you don’t need that life insurance unless you have a liquidity issue or something like that. Okay? So I think it temporarily lessens the need.
But as I say, I say temporary because the law does sunset in 2025. And so it’s going to be a hard decision for some of our clients within certain net worths to decide do I pull the trigger now or not? And the risk of not pulling the trigger and buying the life insurance today when you’re at a certain age is that by the time 2025 comes around and we figure out that you need it, either because someone like Tony has done a fabulous job with your portfolio or the exemption law has changed adversely, you might have health issues or other things that might happen that might make you less insurable. And so I think it temporarily has lessened the need, but I don’t know that it has taken it away completely.
Talli Sperry: That’s helpful. A lot of these things feel like they’re so hard to predict because we don’t know which way life will flow. So any insights for our clients as they think through that uncertainty portion?
Tony Giordano: You know, I was just going to add with the life insurance trust, because I would say probably 75 to 80% of my clients have second-to-die life insurance policies, you know, and we talk about this with clients. Even if the estate tax exemptions change or the estate tax goes away altogether, if you had, for example, a $10 million second-to-die life insurance policy, it’s still going to funnel into a trust at the second death, and it’s going to be available for your beneficiaries. Now the beneficiaries just don’t necessarily have to go and pay a big federal tax bill with it, but they still have those funds. So I wouldn’t say—
Alisa Shin: Absolutely, yes. I think I was speaking more towards purchasing new ones.
Tony Giordano: Oh, right. Sure, sure. Already on them.
Alisa Shin: But I think, yes, I think our clients who already have life insurance or a life insurance trust, it’s worth the analysis to figure out do you need it, do you still keep it, is there a different product that you can use? But I think Tony’s right, for a lot of our clients, when we’ve done the analysis in the past, to surrender that policy and take the cash value and invest it, depending on the clients’ age, might not yield the death benefit that they would have gotten had they kept it. So the purpose of the insurance has changed a little, but them keeping it might not.
But to what you were saying, Talli, I think what you’re hearing is right. It’s a lot of “what ifs.” It’s a lot of “depends on the client.” It depends on what they want to try to accomplish, it depends on their risk tolerance, not just from a market standpoint, but also from a complexity standpoint; and I’ll even say from a political standpoint whether they think this law has any staying power and everyone’s going to look different, right? And it’s going to give different results as a result.
So the key, I think, for our clients to understand it is probably, as I said before, more important that you meet with your advisors, whether that’s your financial advisor, your accountant, your tax lawyer, your estate planning attorney. We actually think if you bring all of them together, at least figuratively around the table so that they could help you together and you get cohesive advice, that’s the best way to do it. But it’s really important to work with your team to do the analysis; not just the numbers, but also kind of the deep gut kind of what am I trying to do, what am I worried about, and how does—
Tony Giordano: Softer side of it.
Alisa Shin: Exactly. It’s really important to do that because just as I was taught, again, in 2010, 2011, 2012, and I think Tony and I are going to learn this lesson again in the next few years, is we could have two clients whose families look exactly the same on paper demographically—same age, same net worth, same number of children—and I can almost guarantee you that they will have two completely different plans.
Talli Sperry: Yes. I think this space is really interesting because we’re seeing the value of having experts around the table, so all of our experts and our team all at one time. So I can see why you’d recommend that to all of our clients.
And I think the other thing that’s striking me is it seems like making decisions like this goes back to our goals, it goes back to our risk tolerance. It feels very parallel to our investing decisions, right?
Alisa Shin: Yes, absolutely.
Talli Sperry: So that purpose is key.
Alisa Shin: Yes, absolutely.
Tony Giordano: Yes, absolutely.
Talli Sperry: Great. Tony, this is a question for you, and this question is, “Can the QCD be used for a contribution to donor-advised funds?”
Tony Giordano: Unfortunately, it cannot. So it’s got to go directly to a 501(c) charitable organization. I’ve had clients that have really pressed and wanted to put money into our donor-advised fund, but it’s not permittable.
Alisa Shin: And very similar to that, it’s also private foundations that the QCD cannot go to. It has to go to a public-
Talli Sperry: So directly to a 501(c)(3).
Alisa Shin: Yes, it has to go to a public charity, correct.
Talli Sperry: Okay, that’s good. So how should we think about donor-advised funds in this type of environment? If we don’t get an answer there, Jackie, any insights?
Jacklin Youssef: Sure, absolutely. In light of the new rules and the expansion of the standard deduction where if we go back and look at the numbers, we’ll recognize that a married couple now will have $24,000 of a standard deduction. So they have to have their total itemized deductions between state and local taxes, deductible medical expenses, any mortgage interest, and charitable contribution in total exceeding $24,000 for it to make sense. So this is where strategically thinking about what year would I be looking at combining a number of those different types of deductions and maybe bunching some of my charitable contributions would make it certainly advantageous for someone to take their itemized deductions. And in that case, let’s say again if I have a client who generally gave $15,000 each and every year to a local charity, just that $15,000 alone in charitable gift will not actually exceed the standard deduction. So perhaps this is probably where they could utilize a donor-advised fund to maybe bunch two or three years’ worth of gifting in that case. So now you get to $30,000 or $45,000 of gift that you get a charitable contribution deduction on. It’s going into your donor-advised fund, but what you could use the donor-advised fund for is to ultimately streamline your gifting to that same organization that you’ve supported all along.
Talli Sperry: So it stays consistent for them, but you get the itemization.
Jacklin Youssef: Exactly. So you don’t necessarily have to see that charitable organization essentially suffer, again, some of the consequences of maybe not getting the same $15,000 each year like they were used to.
Talli Sperry: That’s helpful. And on this note, we do have a presubmitted question from Martha from Spokane, Washington, and I want to get to that one because she’s saying, “Our itemized deductions have been less than $24,000. Is there a way to donate to take advantage of tax deductions”—I should know that one today—“every other year or more perhaps? And, also, should dividend-producing investments be in IRAs or brokerage accounts?”
So, Jackie, it feels like you spoke to the first half of that question. And then I’m wondering if we can speak to the second half, which is, “Should dividend-producing investments be in IRAs or brokerage accounts?”
Jacklin Youssef: So that’s a great question. I’ll start, and I’ll direct it to Tony. When you think about dividends in that case, dividends and the qualified dividend component is treated as long-term capital gains. So as I mentioned, those rates have not been impacted so it’s still the 0, 15, 20%, and so forth. So because those are preferred holdings, that’s why generally we would be looking into locating those within taxable accounts rather than tax-deferred. But I’ll kick it off to Tony.
Tony Giordano: So, yes, different types of taxable income. So if you’re looking at a bond, a taxable bond portfolio, we would generally recommend that the taxable bond portfolio be sheltered inside of an IRA because you’re going to be at a higher marginal tax rate. You’re not going to be at that preferred rate that Jackie just talked about. So it just depends on whether we’re talking about dividends that are coming from stocks preferred and then also coming from bonds taxable.
And then one other point I was going to just tie back to the donor-advised fund. We’re talking about kind of a smaller example. I think another thing that’s in play today is where you’ve got clients kind of on the flipside of that example that Jackie provided where you’ve got a client who has significant income, and they’re only going to have that income for a short window of time. So the donor-advised funds are a great way to be able to put large sums of money, make large gifts for somebody, let’s just say hypothetically it’s somebody who’s 60 years old, and they’re planning to make charitable donations for the rest of their life. So they may be looking to kind of frontload or put that large chunk of money into the donor-advised fund, get the tax deduction, and then kind of grant the money out over time.
Talli Sperry: That’s an exciting strategy. That’s fun. So, Jackie, we have a question, and this has been a hot topic. I know we’ve been discussing it the last few days. So Michael is asking, “Can you explain how the individual AMT was affected by the new tax act?”
Jacklin Youssef: Great question. So AMT is the short for alternative minimum tax. So bear with me, I’ll take a minute or two just to describe what AMT is. It’s exactly what the name says. It’s an alternative tax system that was put in place years ago to make sure that individual taxpayers are paying a minimum amount of tax and not necessarily avoiding tax by generating significant deductions and so forth.
If we look at the main triggers of what generally had really triggered AMT, I would say, again, a lot of it, or was, state and local deductions. Like I live in New Jersey—paying large income tax to the state of New Jersey, paying large real estate taxes. Miscellaneous deductions like tax prep fees, looking at investment portfolio management fees, and so forth, those generally were triggers that when you combine you ultimately have better odds of running into an alternative minimum tax.
But by virtue of what the rules that we have in place have done where you have a cap on your state and local deductions, so it’s a total of combined amount that can’t exceed $10,000. So that’s one area.
You have now the repeal of those miscellaneous deductions that I mentioned. You also have the repeal of the personal exemptions, as I mentioned earlier. So the combination of all those factors and also the fact that they’ve increased the exemption on AMT – and I do have a chart up that would show what the exemption numbers looked like in 2017 versus 2018 – this probably now may ultimately result in fewer taxpayers now being subject to AMT. I would say it ultimately comes down to still crunching the numbers. Do the math to see are you an AMT or not because what is unique about AMT is I look at the rates and the rates are 26 and 28%. So sometimes there are great planning opportunities that we do when we’re working with clients who are in AMT.
So examples would be, unlike traditionally where the idea of tax planning is always defer income and accelerate deduction, when your client is in AMT and when I’m running into those situations with a client, it’s completely opposite where it would make sense, again, for us to maybe look at accelerating the income in the year when you’re in AMT to take advantage of that maximum bracket of 28%.
Talli Sperry: That makes sense. So lots of strategy here for all of us.
All right, so Don’s asking, “For stocks that are in one’s estate at the time of death, does the heir pay capital gains tax on any gains? And what basis does the heir have in the inherited stock?” So, Alisa, could you speak to this?
Alisa Shin: Sure. If a beneficiary receives a stock or shares of stock as a result of someone passing away, their basis becomes the value of the asset of the stock on the decedent’s date of death as a general rule. There’s some other nuances that you can fall into, but that’s the general rule. So the only capital gains tax the beneficiary will pay is if the beneficiary liquidates the stock. Okay, doesn’t just take it in kind and hold it. And then, too, only if there is an increase in value in the stock between the date of death and when they actually sell it. So they do take it a higher step up from basis so it’s not as bad as if they had received the asset as a gift from the person because when a person receives a share of stocks as a result of a gift, they’re subject to what they call the carryover basis rules meaning—
Talli Sperry: So it’s two different sets of rules, gift or at death.
Alisa Shin: That’s correct. That’s right. So if someone gets something during their lifetime by way of gift, they take the donor’s basis. So if they bought it for a dollar and now it’s worth $100, the donee, the gift recipient’s basis is $1.
Talli Sperry: Okay. So this is interesting and it makes me think we should probably let heirs know what they might get at time of death or at least some advice around sell it or don’t sell it or consequences because that sounds like it’s a big decision someone could misstep on.
Alisa Shin: Absolutely.
Tony Giordano: Yes, and I would just add, you know, from a planning opportunity perspective, if you have like a child or a grandchild who’s in a low tax bracket, Jackie’s talked about there’s a place where you’re in a 0% capital gain rate. So we’ve seen clients who transfer shares of appreciated mutual funds or individual stocks over to a child or grandchild. Child then sells it and then they pay zero capital gains on it, so it’s another planning opportunity during lifetime.
Alisa Shin: Absolutely.
Talli Sperry: Okay, good. So we have another question for Jackie, and this one is a place we haven’t hit so I’m going to make sure we have time to go here. So this is from Lloyd. Thank you, Lloyd. And he’s asking, “Have the rules for 529 plans changed?”
Jacklin Youssef: Great question. So the rules expanded the use of 529 plans. Traditionally those plans were to pay for higher education expenses, so college and expenses beyond the college level. Right now those rules would allow for distributions of up to $10,000 per student for K through 12. So that really is a new expansion, again, that we have here.
There are a number of nuances as to what the estates are doing, how to handle something like this; but I would say from a federal perspective in that situation, it does pose to be a great opportunity for individuals that have large 529 plans and would like ways to be able to maybe spend down those types of accounts.
Talli Sperry: Well, great. Well, I really wish we could go on. This is a very engaging discussion, but it does look like we’re running out of time. So thank you so much for sharing all of your perspectives and thank you.
I want to ask each of you, do you have any final insights before we sign off? Alisa, you look like you’re about to say something.
Alisa Shin: The same thing I said at the beginning which is it’s really important now for clients to just take the time to talk with their advisors and just do some analysis. It doesn’t have to be painful, but it is wise to be strategic both from a softer side of what you’re trying to accomplish, what your goals are, what your concerns are. Are you trying to get as much wealth as you can to your family or is it something less than that? All those are really important questions, plus running the numbers. And don’t let the tax tail wag the dog, so to speak. There’s no right one answer. There’s no one right answer. There’s only the right answer for you and your family.
Talli Sperry: That’s a really important insight for us to keep considering. Jackie, Tony?
Jacklin Youssef: Sure. I’ll certainly add to Alisa’s comments. I believe the golden rule when it comes to tax planning it to ultimately make sure that you’re planning for now as well as for later. Now is probably even much more critical than it ever has been because of a number of the changes that we talked about today.
Tony Giordano: And I’ll tie into what Alisa said as well in terms of the estate planning because we work as a team quite a bit with our clients. And what me and my team, you know, discovers a lot is that there’s a lot of administrative, a lot of follow-up work, a lot of annual type of maintenance work that has to be done with a lot of these great estate planning strategies. So I think it’s important to not only go through the process and execute the strategy, but it’s also important to make sure you maintain the program and do all the necessary things to keep the estate plan current and make sure it’s set up the way that you wanted it to be intended.
Alisa Shin: Yes, absolutely.
Talli Sperry: Yes. We all too often hear of clients that get great wisdom but don’t implement it and then see consequences. So that is super important for all of this.
Alisa Shin: And if I could just add one last thing. Tony reminded me as he was talking, the other part that we’ve really learned the last five to ten years is it’s great to do the analysis, it’s great to do the implementation, but also make sure that you’re doing that last leg that’s often forgotten, which is thinking about how you’re preparing your heirs to inherit that wealth.
Tally Sperry: Yes.
Alisa Shin: Do they have the basic skillset to know what to do, how to be a good steward of that wealth? And that is a very important part that often gets overlooked.
Talli Sperry: I agree, especially when we think about decisions like you were directing us to, right? And this is just proof to me that having a team behind you and being able to sit with them all at once in some way, shape, or form is really important. So that’ll be my takeaway. So thank you all so much.
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Talli Sperry: Hi, I’m Talli Sperry, and you’re watching a replay of our recent webcast about tax and estate planning in a changing environment. We hope you enjoy it.
Talli Sperry: Hi, I’m Talli Sperry, and you’re watching a replay of our recent webcast about tax and estate planning in a changing environment. We hope you enjoy it.
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