Whether it’s the threat of taxes changing in the near future or recent changes impacting inherited retirement accounts, investors have a lot to consider when it comes to their personal financial situation.
Looking at the year ahead, individuals may want to explore opportunities to save more, reduce taxes, or transfer wealth more efficiently.
Review some of the key tax facts for 2023 and tax planning ideas to consider in “Ten income and estate tax planning strategies for 2023.”
Consider Roth IRA conversions
A thoughtful strategy utilizing Roth conversions can be an effective way to hedge against higher taxes in the future. In fact, tax rates are scheduled to increase after 2025 when most of the current tax law provisions expire. Lower tax rates now translate to a lower cost for converting.
Explore alternative ways to fund Roth accounts
Taxpayers at higher income levels are prohibited from contributing directly to Roth IRAs. One option is to consider funding a non-deductible (i.e., after-tax) IRA and then subsequently converting to a Roth IRA. It’s important to understand the tax reporting rules around this strategy since after-tax and pretax IRA funds must be converted to a Roth IRA on a pro rata basis.
Maximize deductions in years when itemizing
With the large increase in the standard deduction under recent tax law changes, and the scale back of many popular deductions, fewer taxpayers itemize deductions on their tax returns. Some taxpayers may benefit by alternating between claiming the standard deduction some years and itemizing deductions other years if possible.
Plan for the 10-year rule on inherited IRAs
Since most non-spouse beneficiaries will have to liquidate inherited IRAs within 10 years following the death of the account owner, they will likely pay taxes upon distribution. There may be strategies to transfer retirement savings in a tax-smart manner to the next generation. For example, consider leaving a greater share of retirement assets to heirs who are in lower tax brackets.
Review estate planning documents and strategies
The increase in the lifetime exclusion amount for gifts and estates ($12.92 million per individual in 2023) may have unintended consequences for some individuals and families with wealth under that threshold. They may think that they do not have to plan for their estates and fail to consider important documents such as a power of attorney or health care directive.
Plan for potential state death taxes
While much attention is focused on the federal estate tax, certain residents need to be aware of potential taxes at the state level. For example, some states will apply a tax on estates valued much lower than the federal lifetime exclusion ($12.92 million for 2023). And other states may impose a tax on heirs upon receiving assets.
Develop a strategy for low cost-basis assets
Ensure stepped-up cost basis is maintained when property is transferred at death. For example, careful consideration should be made around lifetime gifts that may jeopardize a step-up in cost basis on property at death. In the case of a lifetime gift, the cost basis of the property generally carries over to the person receiving the gift.
Expand use of 529 accounts for education savings
529 college savings plans retain existing tax advantages. Account earnings are free of federal income tax, and a special gift tax exclusion allows you to elect to treat up to $85,000 of contributions as though those contributions had been made ratably over a five-year period. Additionally, a recent tax law change allows up to $35,000 of unused 529 account funds to be transferred to a Roth IRA if certain conditions are met.
Consider the charitable rollover option if you are a retiree
IRA owners (age 70½ and older) may benefit from directing charitable gifts tax free from their IRA. Since most retirees claim the standard deduction, they will not benefit taxwise from making those charitable gifts unless they itemize deductions.
Maximize the 20% deduction for qualified business income
The Tax Cuts and Jobs Act introduced a new provision (Section 199A) that allows certain taxpayers to generally deduct 20% of qualified business income on their tax return. Business income from pass-through entities such as sole proprietorships, partnerships, LLCs, and S corps may qualify for this new deduction.
See “Ten income and estate tax planning strategies for 2023” for more detail on these strategies.
Seek professional advice
Individuals may want to consult a qualified tax or legal professional and a financial advisor to discuss these strategies to prepare for the risk of higher taxes in the future. Personal circumstances vary widely, so it is critical to work with a professional who has knowledge of your specific goals and situation.
Financial professionals: Join us for a webinar on "SECURE 2.0: Provisions and planning considerations" on February 7 at 1:00 p.m. ET. We will discuss opportunities presented by the new legislation.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.