6 Tax-Efficient Ways to Transfer Wealth to the Next Generation

As the saying goes, “you can’t take it with you.” So, where do you want your wealth to go when you’re gone? There are three places your assets can end up after your death:

1. Taxes
2. Charity
3. Loved ones as an inheritance

If you find yourself in a taxable estate situation, there are several proactive planning strategies that can help reduce the amount of your wealth going to taxes and direct more funds to your loved ones and charitable organizations.

The first step in a successful wealth transfer plan is to identify legacy goals. If a top priority is retaining wealth during transfer to the next generation, consider these tax-efficient techniques.

Consider 6 tax strategies for wealth distribution

1. Annual gifting

The annual gift tax exclusion for 2024 is $18,000 per donee (or $36,000 for spouses splitting gifts). Up to this amount can be gifted to any number of people, per year, without having to pay gift tax.

Anything above this limit reduces your federal lifetime exemption — and you must file a gift tax return. Giving away the maximum amount every year can be a meaningful way to shift wealth to the next generation.

2. Direct payments

Making direct payments for qualified medical care or educational expenses on behalf of a loved one is a simple and straightforward gifting strategy.

For example, if a grandparent wants to give more than the annual gifting limit to a college-aged grandchild, many schools will allow the grandparent to pay tuition directly and avoid any gift tax consequences. There are no limits on the amount of these gifts, but they must be paid directly to the institution (rather than the recipient), otherwise it could be subject to gift taxes.

3. Roth IRA conversions

Depending on your income tax bracket and overall financial situation, it could make sense to convert some or all traditional IRA assets to Roth IRAs.

In the year the conversion takes place, the account owner pays income taxes on the amount converted. As a result, the assets in the Roth IRA can grow tax-free and eventually be distributed tax-free to the beneficiaries, which can be a spouse, children, grandchildren, and others.

4. Intra-family lending

The IRS established special interest rates, called applicable federal rates (AFR), for intra-family loans, and these rates are typically lower than commercial lending rates.

This can be an effective family wealth planning strategy if you want to give for a specific use (home purchase, business startup, and similar purposes). Just be sure to properly document the loan with a promissory note that includes the loan amount, interest rate, repayment terms, and consequences of default.

5. Irrevocable grantor trusts

Selling appreciating assets to an irrevocable grantor trust (IGT) held for the benefit of heirs is another potentially attractive planning strategy. Doing so removes the transferred assets (plus any future appreciation) out of the grantor’s estate while retaining access to a certain level of cash flow. Common types of IGTs include the grantor retained annuity trust (GRAT) and intentionally defective grantor trust (IDGT).

6. Plan and educate heirs

Transferring wealth is only half the battle. Before implementing any plan, verify those on the receiving end are prepared for it.

Many times, family assets are lost from one generation to the next. Often it’s because heirs aren’t financially literate on money matters, in part because parents and grandparents are uncomfortable discussing it. Some people simply don’t believe their children or grandchildren are responsible enough to handle an inheritance.

Learn how bringing tax and wealth advisory together can set your heirs up to be financially confident. Get the guide.

It’s up to you to change that by having open and honest conversations with those who will be the recipients. Talk about the desired long-term objectives for the wealth and help them to understand the role they play.

How we can help

Thoughtful decisions throughout your life can help you achieve goals including wealth transfer, reducing taxation, and charitable giving. Determining which wealth transfer strategies to employ depends upon your goals and personal financial situation. And the sooner you begin, the more likely it is your plan is implemented the way you wish.

CLA private client services brings tax and wealth advisory together. Because decisions you make with one can impact the other. Collaborate with a team of tax and wealth planning professionals to help guide decisions for you, your family, and your legacy.

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