Wealth transfer strategies could shift based on new policies

Planning ahead may keep investors ready for potential changes in the future.
Just when you may have felt you were understanding recent changes to tax laws, a possible change in Washington may signal a change again. How exactly they will be transformed won’t become apparent for quite some time, though, which gives investors a window of opportunity to sit down now with their financial advisory team and reassess their plans. 
“Clients want to be well-positioned regardless of what the outcome of the election is,” says Colleen Carcone, Director of Wealth Planning Strategies at TIAA. With tax increases possibly on the table, “we want to make sure that everyone, regardless of wealth, has a long-term plan in place. Each client’s situation is going to be different, so we suggest they meet with their advisors one-on-one to discuss their situations, their goals, and how potential outcomes may affect their long-term planning.”
In this piece, we’ll cover the following:
  • How the SECURE Act has changed wealth transfer—and how additional legislation could create more changes
  • What the potential end to the basis step-up means for investors and those passing on or inheriting assets
  • What a change in leadership could mean for the estate tax
  • Planning strategies to help you pursue your long-term goals

SECURE Act impact becomes greater if tax rates increase

A potentially higher income tax may have a more significant impact on legacy due to the Setting Every Community Up for Retirement Enhancement Act, also known as the SECURE Act, which became law in late 2019.
For years, a pillar of legacy planning, particularly for high-net-worth investors, had been the so-called stretch IRA. This estate-planning strategy allowed the growth in assets in Individual Retirement Accounts inherited by nonspouses to continue on a tax-advantaged basis, for multiple generations in some cases. Beneficiaries still had to take and pay taxes on Required Minimum Distributions from the inherited IRAs, but the younger the beneficiary, the longer the life expectancy, and the less money they had to withdraw in any given year on a percentage basis. This allowed the remainder of the inheritance to keep growing for longer without incurring a tax hit.
In late 2019, however, stretch IRAs were rendered obsolete for most when Congress passed the SECURE Act, which dictates that the inherited IRA now be emptied within 10 years for most non-spouse beneficiaries. A 50-year-old inheriting money from an 80-year-old parent, for example, will now have to draw down the inheritance within 10 years rather than over their remaining 34-year life expectancy. Because RMDs are taxed as ordinary income, someone in their prime earning years may end up paying more in taxes.
Add in the potential that tax rates on ordinary income may increase, either because of political will or in order to pay for coronavirus-related economic stimulus packages, and the SECURE Act has “fundamentally changed” legacy planning, says TIAA Wealth Management Advisor Daniel Soo.
“A lot of the strategies that made sense in the past don’t make sense anymore,” he says. “Some clients are significantly concerned about potentially higher tax rates on a go-forward basis and are taking steps to lock in today’s tax rates.”
In response to the SECURE Act, many people have looked to other strategies to enhance their legacy goals. For example, converting a traditional IRA to a Roth IRA shifts the income tax burden to you and away from your heirs. Alternatively, funding a life insurance policy is another way to pass on a sizeable income tax free death benefit to your beneficiaries. For more information about planning in a post-SECURE Act world, see the TIAA analysis of strategies.

Capital gains on inherited wealth and the estate tax

One proposal that has been floated by the campaign of Democratic presidential nominee Joe Biden has been to change the way that capital gains are treated on inherited assets. Currently, there is what’s called a “step-up in basis” when an asset is passed down. So, if someone purchased a stock at $5 a share and it was worth $50 per share when it was passed down at the person’s death, the inheritor’s cost basis would be $50 per share. That means if they later sold the stock at $60 per share, they would only pay capital gains on the $10 per share increase since they inherited it.
The Biden plan considers eliminating that, which means the heirs of assets that have greatly appreciated over time could have a larger tax bill to pay when they sell those assets.

Estate tax threshold has risen over time

The Tax Cuts and Jobs Act increased the exemption to more than $11 million for individuals.
Source: IRS
Another possibility is that the considerable increase in the estate-tax exemption that was part of the Tax Cuts and Jobs Act is either lowered or simply allowed to expire at the end of 2025, when it is currently scheduled to sunset.
For high-net-worth individuals, bringing the estate tax threshold back toward its “historical norm” or simply letting the Tax Cuts and Jobs Act sunset could have major ramifications on their legacy planning, says Jonathan Fishburn, Director of Wealth Planning Strategies at TIAA.
Fishburn recommends that high-net-worth clients talk with their estate-planning team, and while they’re at it, make sure to “coordinate their estate plan with the titling of assets and the beneficiary designations of TIAA retirement money, or you could defeat the whole purpose of having created the estate plan in the first place. The devil’s in the details.”

What’s at stake beyond wealth transfer

One other next-generation consideration in the election is the treatment of education, financing availability and loan forgiveness.
For those planning on funding their children’s education, the Biden campaign proposes to make community college free and also double the maximum Pell Grant award. He also proposes expanding Public Service Loan Forgiveness programs. President Trump, on the other hand, has proposed cuts to student financial aid programs and the elimination of subsidized student loans and Public Service Loan Forgiveness.

Plan now with an eye on the long term

TIAA retirement advisors caution investors not to do anything rash.
Don’t take “some type of extreme, drastic step until you’ve really worked it through with estate-planning professionals,” says Shelly Eweka, Director of Advice Strategy. David Ratzker, a Wealth Management Advisor, adds that for some of these investors, their time horizons can stretch out 70-100 years, and for that reason, “we try to help clients avoid making decisions based on short-term information.”

“Each client’s situation is going to be different, so we suggest they meet with their advisors one-on-one to discuss their situations, their goals, and how potential outcomes may affect their long-term planning.”

–Colleen Carcone, Director of Wealth Planning Strategies

Regardless of the outcome, Ratzker says, “if we start to see legislation that points to an increase in taxes, we’ll go back to the clients we’ve met with previously and say, ‘Here’s what tax rates were. Here’s what we expect them to be. How does this affect you?’ That’s the value of the planning process. We have a baseline, and when things change, we know what it effects. But it’s not going to be a November or December 2020 thing.”

Depending on how the election shakes out, taxes could rise in multiple ways and at different junctures. For example, income taxes could increase as early as next year, leaving that much less money for future inheritances.
Jim Daniello, a Wealth Management Director at TIAA Individual Advisory Services, says that investors wanting to leave a legacy would benefit from undergoing an Asset Location analysis, especially if taxes are on the rise. “It’s a very tax-sensitive approach to implementing different strategies for your financial plan,” he explains.
An asset location analysis typically breaks down where a client’s assets are invested in terms of timing the potential need. Money that might be needed soon is held in more-liquid accounts, and on the opposite end of the spectrum, assets that may be passed on to the next generation should be in the most tax-efficient instruments—for example, life insurance, which may never be taxed, or a hybrid life insurance/long-term care policy.
“A thorough asset location analysis, and implementation into various account types, will be more important than ever as we go into a very tax-sensitive future, regardless of who is president,” Daniello says.

Discover more

Financial planning

Perspectives for uncertain times

Get insights from TIAA experts.

What’s on tap for taxes?

Listen to TIAA experts discuss personal and estate taxes.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
The TIAA group of companies does not provide legal or tax advice. Please consult your legal or tax advisor.
Advisory services are provided by Advice & Planning Services, a division of TIAA-CREF Individual & Institutional Services, LLC, a registered investment index adviser.
This material is for informational or educational purposes only and does not constitute fiduciary investment advice under ERISA, a securities recommendation under all securities laws, or an insurance product recommendation under state insurance laws or regulations. This material does not take into account any specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on the investor’s own objectives and circumstances.