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2020 Tax Planning: Minimize Taxes on your Estate and Inherited Retirement Accounts

2020 Tax Planning: Minimize Taxes on your Estate and Inherited Retirement Accounts

December 15, 2020

There is still time to potentially reduce your 2020 federal income taxes, but you'll need to act soon. There are several tax minimization strategies for individuals including timing your income and deductions, making the most of your retirement and health savings accounts, being smart about charitable donations, keeping taxes to a minimum on the investments in your taxable accounts, and minimizing taxes on your estate and inherited retirement accounts. Many of these strategies need to be completed by the end of the year to be effective, and not all of the strategies may be appropriate for you. Let’s review how to minimize taxes on your estate and inherited retirement accounts.

Use your annual gift tax exclusion

If you think that your estate will be subject to estate taxes, consider giving some of it away tax-free during your lifetime using the annual gift tax exclusion.

The annual exclusion, which is set at $15,000 for 2020, makes it possible for you to give any number of people up to $15,000 each in 2020 without your gifts triggering the federal gift tax or reducing the amount that can be excluded from federal gift and estate taxes later on.

Take advantage of the temporarily high lifetime exclusion

In addition to an annual gift tax exclusion, you also have a lifetime exclusion for federal gift and estate taxes. It is set at $11.58 million, up from $11.4 million in 2019. This means that you can currently give away up to $11.58 million during or after your lifetime without your gifts being subject to federal gift and estate taxes. And if you are married, you can jointly shelter up to $23.16 million from those taxes.

The thing to keep in mind about the lifetime exclusion is that it is scheduled to decrease to $5 million, adjusted for inflation, after 2025 unless Congress changes the law in the interim. Wealthy individuals may want to use the exclusion to make tax-free gifts to their heirs now in case the exclusion amount decreases in the future. Please consult your estate planning professional for advice.

NEW: Inherited a retirement account this year? Check your distribution period.

Washington recently shortened the distribution period for inherited IRAs, 401(k) plans, and other defined contribution retirement plans to 10 years for most non-spouse beneficiaries. Previously, non-spouse beneficiaries had the option to stretch the annual distributions over their life expectancy. Now, if the account owner passes away after 2019, the entire account must be distributed within 10 years.

If you are required to empty an inherited account within 10 years, talk to your financial professional before the end of the year about how to manage your distributions. If you inherited a tax-deferred account, such as a traditional IRA, all or part of the distributions you receive will be subject to income tax. In some cases, it may be a good idea to take distributions every year in order to avoid a single, large distribution at the end of 10 years, which could push you into a higher tax bracket where you’ll pay tax at a higher rate than you otherwise would have.

Not all beneficiaries are subject to the new 10-year distribution requirement. The requirement does not apply to surviving spouses, the account owner’s minor children, disabled or chronically ill individuals, and individuals who are not more than 10 years younger than the deceased account owner. It also does not apply to beneficiaries who inherited an account from someone who died prior to 2020.

We can help

If you have questions about minimizing taxes on your estate or any of our other 2020 tax planning topics, please contact us.