Tax Planning in an Election Year

1. IRAs: Contribute $6,000 to individual retirement accounts — $7,000 for those 50 and older. Maximizing these kinds of contributions lowers clients’ taxable income. Non-working spouses can take advantage of this provision as well, further reducing the tax burden for some married couples.

2. HSAs: Establish and fund a health savings account (HSA). To qualify, the taxpayer must participate in a high-deductible health plan, which is a deductible of at least $1,400 for individual coverage and $2,800 for family coverage.

HSA contributions max out at $3,550 for individuals and $7,100 for family coverage. The money in these accounts will grow and pay out tax-free if the withdrawals are used for qualified medical expenses, including payment of Medicare premiums and out-of-pocket costs.

3. Bunching itemized deductions: Because of changes in the treatment of itemized deductions, some clients, particularly those in higher income brackets, may be able to take advantage of “bunching” deductions.

For example, clients who regularly give to charities, but who will no longer benefit from charitable gift deductions due to the higher standard deduction, may choose to instead give a larger gift every few years and itemize during those years to maximize the impact and simply take the standard deduction in the years they don’t itemize.

4. Review the tax efficiency of clients’ investments: Financial professionals can add great value to clients by ensuring investments and income streams are tax-efficient from the start. Periodic reviews of an investor’s portfolio may unveil certain tax inefficiencies.

Unfortunately, most people don’t think about how taxes affect their investment goals. The tax drag will be greater for portfolios that are actively managed and have a high turnover ratio. This could result in a lot of short-term capital gains being distributed to the investor each year, which can face tax rates as high as 40.8%, including the 3.8% Medicare surtax.

To add insult to injury, especially during periods of high volatility like we have seen over the past year, many investors will receive a taxable distribution even though they experienced a market loss in their overall investment portfolio. Tax-efficient options include tax-managed mutual funds, tax-deferred investing with 401(k) plans, IRAs, non-qualified annuities, and cash value life insurance.

5. Review your clients’ estate plans: Clients should review their estate plans to make sure it is up to date, reflects their current legacy wishes and is consistent with the current estate tax laws. In addition, the plan should be reviewed with consideration of possible tax changes that have been proposed.

A reduction in the federal estate tax exemption amount along with a repeal of stepped-up basis for assets passing at death, as Joe Biden proposes, could have a profound impact on clients who don’t have a federal estate tax problem today, but would in the future with the enactment of these proposals.

A gifting plan may be attractive for clients whose estate is less than the current estate tax exemption but may not be once and if the TCJA sunsets or the exemption is lowered by other tax changes.

Making a gift to a trust or directly to beneficiaries will reduce their taxable estate as well as get the subsequent growth and income from the gifted asset out of their taxable estate.

An estate plan review should also include an audit of all their retirement plan and IRA beneficiary designation elections. Make sure the beneficiary designation form is completed and they have the right beneficiary designated.

Also, some of the recent changes to the “stretch” IRA rules under the Secure Act may have impacted some of your clients’ legacy plans for their retirement assets. The recent legislation requires beneficiaries to completely withdraw inherited IRAs and retirement plans within 10 years and pay the resulting tax liability.

This could result in a massive acceleration of tax liability, forcing beneficiaries into a higher tax bracket and resulting in more of the retirement assets lost to taxes.

The loss of “stretch” may encourage more Americans to spend their retirement assets on themselves in retirement and find other assets to leave as a legacy. Leveraging life insurance for this purpose would be a way to provide a tax-free legacy to their heirs.

While there may be future changes to tax policies, now is a good time to review strategies to reduce taxes and improve the tax efficiency of a financial, retirement and estate plan.

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Brandon Buckingham, JD, LLM, is vice president and national director, Prudential Individual Solutions Group.