Global equities delivered a mixed performance in the third quarter, with large U.S. stocks inching higher and foreign stocks treading water. Employment growth continues to improve coming out of the post-pandemic world, but businesses in numerous industries face painful labor shortages and disrupted supply chains, causing inventory delays and price fluctuations. Real estate held onto its strong performance for the year as interest rates remained very low, keeping financing costs attractive. Other notable market events during the quarter included:
Asset class returns for the quarter and year-to-date were as follows:
Third Quarter 2021
|Barclays U.S. Govt./Credit—Int.||Fixed Income||0.0%||-0.9%|
|S&P 500||Large U.S. Stocks||0.6%||15.9%|
|Russell 2500||Small/Mid U.S. Stocks||-2.7%||13.8%|
|MSCI ACWI ex-USA||Foreign Stocks||-3.0%||5.9%|
|S&P Global REIT||Real Estate Securities||-0.1%||16.9%|
It is hard to believe that the end of 2021 is just a few months away. With continued government spending in response to the global COVID-19 pandemic and trillion-dollar legislative proposals making their way through Congress, many are anticipating some combination of higher income and estate taxes in the future. While we always look to take advantage of year-end planning opportunities, income tax and estate planning may be particularly important this year. Strategic personal income tax and estate planning considerations for year-end 2021 are summarized below.
The current federal lifetime gift and estate tax exemption amounts are $11.7 million per person ($23.4 million per married couple) in 2021. Estates exceeding the federal exemption amount are currently subject to a 40% estate tax. The current exemption amounts were established under the Tax Cuts and Jobs Act of 2017, which are scheduled to sunset and revert to half the current exemption amounts at the end of 2025, if new tax legislation doesn’t change them prior.
Review estate planning documents, including wills, trusts, and beneficiary designations to ensure they reflect current objectives and family legacy goals.
Consider annual gifts of up to a limit of $15,000 per year per person without utilizing any lifetime gift or estate tax exemptions.
529 accounts may be “superfunded” in a single year, allowing up to 5 years of annual exclusion gifts ($75,000) per account beneficiary. The “superfunded” gift is averaged over five years to avoid utilizing any gift tax exemption.
Individuals can make unlimited gifts for tuition and medical expenses, as long as the payments are made directly to the providers of those services (e.g., pay tuition directly to school), without counting against some lifetime exclusion amounts.
Assuming sufficient assets are available to fund lifetime spending needs, consider making gifts up to the available gift/estate tax exemption amount to utilize the current exemption amount before it is reduced.
Various other trust structures, such as Spousal Lifetime Access Trusts and Intentionally Defective Grantor Trusts, could be utilized to facilitate passing along assets to beneficiaries while offering some flexibility and maintaining tax efficiency.
The strategies referenced above are not comprehensive and should be considered in the context of each client’s financial plan, goals, and long-term objectives. Clients should consult with their legal and tax advisors before implementing any strategies described herein. Additionally, tax changes may be on the near-term horizon, such as the Build Back Better Act, which is outlined below.
In mid-September, the House Ways and Means Committee unveiled new tax proposals in the Build Back Better Act. Proposals by the Ways and Means Committee have a reasonable chance of surviving the Budget Committee process and making their way into Congress for amendments and ultimate voting. If the proposed tax law makes it through the reconciliation process (which may require only a simple majority of the Democrat-controlled Senate to approve), then the proposed changes would become law.
Below are four key proposals that could affect income and estate planning in the near term if the current bill is enacted.
The bill would not only increase the top ordinary income tax bracket, but also lower the income thresholds in this new, highest ordinary income tax bracket. Single filers with taxable income over $400,000 and married filers with taxable income over $450,000 would fall into the highest income tax bracket. Additionally, the current 35% ordinary income tax bracket would become narrower, causing more taxpayers to potentially drift into higher marginal income tax brackets.
The current lifetime unified gift and estate tax exemption of $11.7M per person ($23.4M per married couple) would be essentially cut in half to approximately $6M per person ($12M per couple), adjusted for inflation. Under current law, this reduction is scheduled to take place on January 1, 2026, so the BBBA proposal would simply accelerate the planned reduction. Notably, in the current proposal the 40% estate tax would remain intact, and the stepped-up cost basis rules, which “step up” the cost basis of assets to market value at the decedent’s death, wouldn’t be changed.
For high earners (single filers with taxable income over $400,000 and married filers with taxable income over $450,000), Roth conversions would be prohibited, but not until the year 2032. For IRAs and employer-sponsored plans, any conversions of after-tax dollars would be disallowed beginning next year, in 2022. As a result, this could potentially close the “Backdoor Roth IRA” strategy, and later prohibit Roth conversions altogether for higher-income taxpayers.
The highest long-term capital gains rate would increase to 25% for single filers with over $400,000 in taxable income and married filers with over $450,000 in taxable income. This would mean that the same threshold for the highest marginal tax bracket would align with the threshold for the highest capital gains tax. The new 25% capital gains tax would be the highest since 1997, when it was then lowered from a maximum of 28% down to a maximum of 20%. The proposal contains transition rules that would generally apply the increased rate to capital gains recognized retroactively, any time after September 14, 2021.
The above are still proposals at the time of this writing—and may change before signed into law. We will continue to monitor the progress and negotiations of the Build Back Better Act and how it could impact your investment portfolio, financial plan, and estate planning.
Lastly, as we enter the final months of the year, we would like to remind our clients of a few timely administrative items related to taxes. If we have not already, we may be consulting with those of you who are obligated to take required minimum distributions (RMD) from IRAs and other retirement accounts by December 31. Please inform us of any IRAs you own that are not managed by our firm so we can take them into account when calculating your RMD. If you plan to make charitable donations of appreciated stocks or other securities in 2021, please notify us as soon as possible — ideally no later than the first week in December. Finally, if we are not currently reporting tax information directly to your tax preparer and you would like us to do so, please provide us with his or her name and contact information (including email address) by the end of the year.
We appreciate the trust you have placed in us to guide you through these ever-changing times. We encourage you to call or e-mail anytime you would like to discuss your portfolio or your financial plan.
DOWLING & YAHNKE WEALTH ADVISORS