Five tax-smart ways to plan your legacy

Planning your legacy is more than just drafting a will. It is a profound undertaking beyond the mere distribution of assets. Planning your legacy is about ensuring your assets and values endure for generations. It’s about shaping your impact on your family and the causes you love. Whether you are contemplating ensuring your loved ones are financially secure or looking to make a lasting charitable impact, strategic legacy planning can help you achieve these goals effectively. Here are five tax-smart strategies to consider when planning your legacy:

Sprout the Seeds of Success: 529 Plans

Investing in your children’s and grandchildren’s education is an enduring gift. A 529 plan is a tax-advantaged savings vehicle specifically designed for college expenses. The plan allows you to save for future educational expenses while enjoying tax benefits. Contributions grow tax-free. Furthermore, eligible tuition, fees, and room and board withdrawals are tax-exempt.

529 plan supports your family’s educational aspirations and provides a thoughtful way to invest in their long-term success.

Bunching contributions is a strategic approach to maximizing the tax benefits of 529 college savings plans. Account holders can take advantage of specific tax incentives more effectively by making lump-sum contributions in a single year rather than spreading them out annually. This technique leverages the gift tax exclusion, allowing individuals to contribute up to five times the annual limit in one year without incurring gift taxes, as long as you do not make additional gifts to the same beneficiary for the next four years. This approach can significantly enhance the growth potential of the 529 plan through compounded, tax-free earnings and may also help manage estate taxes for the contributor.

Lastly, starting in 2024, a new provision allows converting leftover 529 plan funds to a Roth IRA under specific conditions. This change offers flexibility in managing educational savings by providing an alternative use for excess funds.

Here are some of the requirements for 529 to Roth conversion

• the 529 plan must have been open for at least 15 years,
• contributions made within the last five years are not eligible for transfer.
• The annual transfer limit is subject to Roth IRA contribution limits,
• The lifetime maximum that can be converted is $35,000.

Converting residual 529 plans to Roth can be particularly beneficial for families whose children receive scholarships or choose not to attend college. This ensures that the leftover funds continue to grow tax-free for retirement.

Give the Gift of Growth: Fund Roth IRAs

Consider contributing to Roth IRAs for your children or grandchildren.   Setting up Roth IRAs for younger family members can be a powerful strategy for transferring wealth across generations. Roth IRAs grow tax-free. Moreover, withdrawals in retirement are also tax-free, making them a valuable tool for future financial security.

A Roth IRA offers a powerful way to supercharge your family member’s retirement savings. Starting contributions early allows for maximum potential growth through compounding, setting up your heirs for a stable financial future.

You can contribute to family members’ Roth IRAs if they earn and report annual income. The total contributions cannot exceed the lesser of their income or the annual contribution limit set by the IRS. Furthermore, Roth contributions must meet annual income limits. Higher earners are not typically eligible for direct Roth contributions, but they can still participate through Backdoor Roth conversions.

Share the Appreciation: Gift Appreciated Stocks

Giving appreciated stock to family members can be a tax-efficient way to share wealth and help your heirs financially. When you transfer appreciated stock as a gift, the recipient assumes your original cost basis and holding period. This means they can potentially sell the stock and pay capital gains taxes on their own, possibly at a lower tax rate.

This strategy is particularly beneficial if the recipient is in a lower tax bracket, as it minimizes the overall tax burden on the capital gains.

By thoughtfully gifting appreciated stock, you can support your family members financially while optimizing tax outcomes for both parties. Additionally, gifting appreciated stock allows you to reduce your taxable estate.

When giving assets, it is crucial to consider the annual gift tax exclusion limit. The yearly limits allow you to give up to a certain amount per recipient each year without incurring gift taxes.

For 2024, the annual gift tax exclusion is $18,000 per recipient. If you give more than this amount to an individual within a calendar year, the excess is treatable as a taxable gift. When this happens, you must file a gift tax return (Form 709) to report the gift to the IRS.

However, this does not necessarily mean you will owe gift tax immediately. Instead, the excess amount reduces your lifetime gift and estate tax exemption, which for 2024 is $13.61 million. This means you can give away up to $13.61 million in taxable gifts over your lifetime before you own any gift tax.

Step Up Your Legacy: Cost Basis Step-Up

The cost basis step-up is a significant tax advantage associated with inherited assets, such as stocks, real estate, and other investments. When you pass away, your assets receive a step-up in the cost basis. This rule requires their value to be adjusted to its fair market value on the original owner’s death date. Any appreciation in value before the passing is generally exempt from capital gains taxes for your heirs.

The step-up basis can be a significant tax advantage when passing through generations. It helps preserve family wealth by minimizing the tax impact on inherited assets.

What does it mean in practice? If an asset has appreciated over time, the inheritor’s capital gains tax liability is greatly reduced or even eliminated if they sell the asset shortly after inheriting it.

For example, if a parent buys stock for $1,000, which is worth $50,000 at the time of their death, the heir’s cost basis is stepped up to $50,000. If the heir sells the stock at $55,000, they only owe taxes on the $5,000 gain rather than $54,000, which is the difference between the sale price and the original cost basis.

Leave a Charitable Mark: Charitable Contributions

Contributing to charitable causes allows you to support organizations and causes dear to your heart and can also reduce your taxable estate. Donating leaves a meaningful impact on your community or causes and provides tax advantages that can benefit your estate and heirs.

You can donate cash, cars, real estate, stocks, and even Bitcoin.

Charitable giving allows you to support causes you are passionate about while potentially reducing your tax burden. Donating appreciated assets to eligible charities can be particularly tax-beneficial. You can avoid capital gains taxes and receive a tax deduction for the fair market value of your donation.

Setting up charitable trusts and foundations is a more advanced approach to charitable giving. These will allow you to support philanthropic activities and your heirs even after your lifetime.

A charitable trust, such as a charitable remainder trust (CRT) or a charitable lead trust (CLT), allows individuals to donate assets while retaining some benefits, such as income from the assets, for a specified period.

A private foundation, on the other hand, is a non-profit entity created to support charitable activities through grants. Establishing a foundation offers control over your wealth distribution and can help create a lasting legacy.

Planning your legacy.

Planning your legacy involves carefully considering your financial goals and personal values. By incorporating strategies such as setting up 529 plans and Roth IRAs, gifting appreciated assets, leveraging step-up in cost basis, and making charitable contributions, you can ensure that your legacy reflects your values and provides lasting benefits to future generations. Consulting with financial advisors and estate planning professionals can help tailor these strategies to your specific circumstances, ensuring your legacy plan is comprehensive and effective. By taking proactive steps now, you can leave a lasting and meaningful legacy that extends well beyond your lifetime.