Littlejohn: Limiting the tax hit when transferring assets to others

Brian Littlejohn
Special to The Aspen Times
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It may be difficult to see, but a large wealth transfer is underway.

No, I’m not talking about the 2023 tax season. I’m talking about the Cerulli Associates estimate that nearly 45 million U.S. households will transfer $68 trillion to the next generation over the next 25 years.

This transfer could be particularly interesting given that many provisions of the Tax Cut and Jobs Act of 2017 are due to expire in 2025. Some of the wealthiest Americans could end up owing much more in taxes as a result.

Indeed, tax laws are always in flux. However, it’s safe to assume that Uncle Sam will want his share no matter when you transfer your estate. If you expect to leave a significant amount of assets to your heirs, proper estate planning is key. Fortunately, there are strategies you can leverage to help minimize your family’s potential tax burden.  

To minimize taxes on transferred assets, consider the following estate planning strategies:

Life Insurance

Depending on the size of your estate, it may owe federal and possibly even state taxes when it passes to your heirs. Many families end up purchasing life-insurance policies to cover the potential tax liability and preserve the next generation’s inheritance.

Your beneficiaries can also use the payout to establish a cash reserve to pay the various expenses they incur when settling your estate. A cash reserve can be especially helpful if you own illiquid assets like property and other valuables.

Roth IRA Conversions

The SECURE Act of 2019 abolished the “stretch IRA” for most individual retirement account (IRA) beneficiaries. Previously, beneficiaries could stretch withdrawals over their lifetimes to minimize their tax burden. Now, many IRA beneficiaries must completely empty the IRA within 10 years of inheriting it.

This situation can be problematic for traditional IRA beneficiaries since withdrawals are taxed as ordinary income. If your heirs happen to be high earners, the negative tax consequences can be significant. The required withdrawals can force them into an even higher tax bracket.

If you anticipate transferring a sizable account balance, a Roth IRA conversion may be a worthwhile endeavor. Withdrawals made from a Roth IRA are tax-free if the account has been open for at least five years. Assuming that requirement has been met, your beneficiaries will be able to keep the entire account balance you’ve left them. 

Of course, there is a catch to be aware of when using this strategy. A Roth IRA conversion doesn’t allow you to avoid paying taxes altogether. Instead, the conversion is a currently taxable event. The amount converted is treated as income and taxed accordingly. Therefore, it’s important to work with a financial planner to determine if a Roth conversion makes sense.

Lifetime Gifting

In many cases, gifting is one of the simplest ways to reduce the size of an estate and thus the associated tax burden. Each year, the annual gift-tax exclusion allows you to give a certain amount (up to $17,000 in 2023) to as many people as you like without any federal gift tax consequences. Moreover, spouses can combine the annual exclusion to double the amount they can gift tax-free.  

Cash gifts are most common. However, you can also use the annual exclusion to transfer personal property or make contributions to a 529 education savings plan. Alternatively, the IRS allows you to pay educational and medical expenses on behalf of someone else without incurring any federal taxes. The only caveat there is that you must pay the institution or facility directly.

As an aside, spouses can transfer an unlimited amount of assets to each other without incurring any taxes. This provision in the tax code, called the unlimited marital deduction, can be a useful estate planning tool for many married couples.      


Properly-structured trusts can also be useful estate planning tools because they can reduce the taxes due on transferred wealth. For example, a grantor retained annuity trust (or GRAT) can shift asset appreciation to the trust beneficiaries in order to lessen the value of your taxable estate. A lifetime credit shelter trust can keep assets out of the estate of a surviving spouse, so that they can pass tax-free to the beneficiaries when the surviving spouse dies.

Trusts come in all kinds of different flavors, and they can be complex. As such, it’s important to consult with your financial planner or estate planning attorney to determine if they should be a part of your estate plan.

Review strategy with a pro

Your estate plan should be a living set of documents, meaning they should be updated to reflect certain changes in your life and certain changes in the tax laws. An update can provide the perfect opportunity to discuss the above strategies with your financial advisor or estate planning attorney to see if one or more of them may be right for you.

Brian Littlejohn, MBA, CFP®, CFA is the founder of Sherwood Wealth Management, an independently-registered investment advisor firm that specializes in inherited wealth. He lives in Woody Creek and works with clients in the Roaring Fork Valley and beyond.