Delays in the starting age for Required Minimum Distributions (RMDs)

Through 2022, individuals were required to begin taking RMDs from workplace retirement plans and traditional IRAs by April 1 of the year after the year in which they turned 72. Effect Jan. 1, 2023, the threshold age to begin RMDs shifts to 73. It will move to age 75 on Jan. 1, 2033. While this will delay required distributions, delaying the tax liability associated with distributions, it will result in larger payouts over a shorter lifespan, which could have negative tax consequences in future years.

Automatic enrollment in workplace retirement plans

Beginning in 2025, many newly-created 401(k) and 403(b) plan sponsors will be required to automatically enroll workers in their plans, with pre-tax contributions of 3% to 10%. Such contributions will reduce taxable income, and current tax liability.

Larger “catch-up” contributions

Individuals 50 and older were allowed to make catch-up contributions to workplace retirement plans (above standard maximum contribution amounts) of up to $6,500 in 2022. That figure increases to $7,500 effective on Jan. 1, 2023. Special provisions that take effect on Jan. 1, 2025 will allow workers age 60 to 63 to make catch-up contributions of up to $11,250 per year. Since these are pre-tax contributions, they reduce current tax liability.

Additional penalty-free distributions

Provisions were included in the bill allowing for some early withdrawals (prior to age 59-1/2) for terminally-ill individuals, victims of domestic abuse, and to cover the costs of certain long-term care premiums. Those affected by a federally-declared disaster will be allowed to take up to $22,000 penalty-free, with the option to stretch out payments on the income tax due on the distribution over three years.

529 Plan “Roll-Ups”

Individuals with unused balances in 529 education savings plans will be allowed to shift those dollars, up to $35,000, to a Roth IRA. This opportunity only applies to 529 plans with a lifespan of at least 15 years. Transfers to Roth IRAs can be done to the extent they do not exceed Roth IRA contribution limits in a given year (currently, $6,500 per year, $7,500 for those age 50 and older). Such transfers avoid taxes and a 10% penalty that would apply to earnings accumulated in the 529 plan if the money was taken as a non-qualified distribution.

Expanded flexibility for Qualified Charitable Distributions (QCDs)

Effective Jan. 1, 2023, individuals 70-1/2 or older can make a one-time gift of up to $50,000 (adjusted annually for inflation) directly from an IRA to a charitable remainder unitrust, a charitable remainder annuity trust or a charitable gift annuity. The amount directed into such a trust or annuity would apply toward the $100,000 annual total QCD gift that is already allowed for qualified 501(c)(3) charitable organizations. This is an effective way to reduce RMDs and avoid the added tax liability that may result from it.

Existing tax laws that are set to expire

In some cases, tax law changes are already built into the calendar. This is true with many of the provisions included in the Tax Cut and Jobs Act (TCJA) that passed in 2017. A number of the changes designed to be beneficial to taxpayers are scheduled to “sunset” (or no longer apply), by Dec. 31, 2025.

With that date drawing nearer, planning ahead is critical to leverage current tax laws and to mitigate the potential impact of the changes that are scheduled to occur without further Congressional action. Here are some specific changes that will occur after 2025 unless Congress acts to amend their sunset status, and strategies to consider to offset these changes:

Adjustments to 2023 tax brackets

Under current law, the top tax bracket for individual taxpayers, estates and trust income is 37%. It reverts to 39.6% after 2025. In addition, income thresholds that apply to the top tax bracket will decline significantly. Adjusted gross income of single tax filers in excess of $418,400 and married tax filers (joint return of $470,700 would be subject to the 39.6% bracket. By comparison, the top income thresholds for 2023 (for the 37% bracket) are much higher, at $578,125 for single tax filers and $693,750 for married couples filing a joint return.

Other tax brackets will move higher after Dec. 31, 2025 as well, including:

• The current 12% rate rising to 15%
• The current 22% rate rising to 25
• The current 24% rate rising to 28%

Strategies to consider

To the extent you’re able, you may want to consider accelerating income into years prior to 2026 to take advantage of lower tax rates. You also will want to determine the potential benefits of maximizing pre-tax contributions to your retirement plan, if feasible. In addition, if Roth IRA conversions are part of your long-term strategy, it may be advantageous to begin executing those conversions as soon as possible in a strategic manner to capitalize on the current reduced tax brackets.

Unified gift and estate tax deduction cut dramatically

The unified estate and gift tax deduction is valued at $12.06 million per individual in 2022 and $12.92 million in 2023 (effectively $24 million for a married couple in 2022 and nearly $26 million in 2023). Note that the amount is increased in line with the inflation rate, resulting in a significant jump in the exemption in 2023. However, this exemption amount will be cut approximately in half, with a projected inflation-adjusted exemption of $6.8 million per person applicable in 2026 after the current tax law sunsets.

The ability to utilize certain lifetime gifting strategies will be limited, because of a reduced lifetime gift tax exemption beginning on Jan. 1, 2026, if not earlier. The same limitations apply to certain estate planning and wealth transfer strategies at death, because of a reduced estate tax exemption.

Strategies to consider

Individuals with large estates may want to capture the benefits of the current enhanced exemption levels by stepping up the pace of lifetime gifting. For example, the individual lifetime gift and estate tax exemption is scheduled to drop to approximately $6.8 million in 2026, barring Congressional action. An individual could gift up to $12.9 million prior to 2026. That may exhaust their exemption by 2026, but it will reduce the size of their estate and potential future estate tax liability significantly before more limited exemption levels apply.

In addition, business owners have an opportunity of gifting an ownership position as part of a lifetime gift. Depending on the structure of the business and the share of the business assets being passed on, “illiquidity” and “lack of control” discounts can apply to the valuation of business interests. The business valuation discount is typically in the range of 20% to 40%. For instance, assuming a 30% discount, if passing on $1.4 million of business assets as a gift, the lifetime gift tax exemption that needs to be claimed is much lower (approximately $1 million), reflecting the illiquidity discount. Leveraging business valuation discounts in conjunction with current higher exemption amounts can result in significant wealth preservation and transfer, if the actions occur prior to January 1, 2026.

Be sure to consider any current gifting strategy in the context of your broader financial plan. You want to be certain that large gifts you make now don’t preclude you from pursuing other prioritized goals.

Tax-efficient planning in a changing economic landscape

The economic environment changed considerably in 2022. Along with persistently higher inflation, interest rates rose significantly. Interest rates are part of the calculation when establishing Charitable Remainder Trusts (CRTs). Today’s higher interest rate environment creates a potential tax advantage for those who establish these types of trusts.

A CRT is an irrevocable trust. You place assets into the trust. It will provide income for life or a term up to 20 years to the grantor or a beneficiary. At the end of that term, the remaining value goes to a qualified charitable organization. To determine the amount that qualifies for a charitable tax deduction, an assumed interest rate must be applied. This is the IRS’ so-called “7520 rate.” In December 2022, that rate reached 5.2% (compared to 1.6% in January).¹ With a higher applicable rate, the charitable remainder value of the trust increases, which may allow the grantor to claim a larger tax deduction in the year making the gift.

The 7520 rate is also part of the calculation for GRATs, another form of irrevocable trust that you may have. The 7520 rate has a potential impact on the amount to be received back by the grantor and ultimately what is available to the remainderman beneficiary. Consider discussing these strategies with your financial and tax professionals.

Be prepared for new and potential tax law changes

The Inflation Reduction Act and SECURE 2.0 Act make modest changes to the tax code that apply immediately. There seem to be limited possibilities of major tax legislation passing Congress in 2023 and 2024. But there is a high degree of certainty about the consequences if Congress does nothing and provisions outlined above expire at the end of 2025.

During the existing but narrowing window of opportunity for significant wealth preservation and transfer, it’s important to consider current tax laws and related sunset provisions, along with the new laws incorporated into the Inflation Reduction Act, and plan accordingly. We, as always, closely monitor events in Washington and will keep you apprised of any potential changes to the tax code that could affect your tax liability.