With December approaching, it’s a good time to think about end-of-the-year financial planning. What steps might you take?
One common strategy is to make charitable gifts—to support good causes, of course, as well as to reap a tax benefit. But before doing that, I suggest a related exercise, which is to fully understand your tax picture. Because of the complexity of tax forms, however, that is often easier said than done. Fortunately, you don’t need to decipher every number. Instead, I recommend focusing on what I call “the big three” questions on your tax return:
- Are you itemizing deductions? If not, how close are you to that threshold?
- What is your marginal tax bracket for ordinary income?
- What is your marginal tax bracket for long-term capital gains and qualified dividends?
If you know these three pieces of information, they will provide, in my view, most of what you’d want to know. More to the point, they’ll provide most of what’s important in making tax-related decisions. The good news: Most tax software programs provide answers to these three questions on a simple summary page. If you work with an accountant, he or she can provide this information.
With answers in hand, you can turn back to the question of charitable giving. What’s the most tax-advantaged way to give? Here, you’ll want to consult the first of the above questions—are you itemizing deductions? This is important because if you aren’t itemizing, then an incremental charitable gift, while certainly helpful to the charity, won’t provide a tax benefit to you. For that reason, if you’re in the neighborhood of the threshold for itemizing but not quite there, a strategy to consider is “bunching” deductions using a donor-advised fund. The idea is to double up on donations every other year, allowing your deductions to exceed the standard deduction in those years. I mapped out this strategy a while back, when the current rules were put in place.
This is also a good time of year to think about gifts to family members. If this is a priority for you, there are a few aspects to consider. First are the tax considerations, though these are fairly straightforward. As you may know, there is an annual exclusion for making gifts. In 2023, this would allow you to give any individual up to $17,000 without any gift or estate tax impact. In addition, there’s a lifetime exclusion, which is close to $13 million per person, though that figure is scheduled to drop by half in 2026.
Those are the quantitative considerations, and they’re certainly important. But a far more difficult question, in my view, isn’t quantitative at all. That question is how to structure gifts to family members in ways that don’t carry unintended consequences. If you’re thinking about a program of gifting to children or to other family members, I would consider the following:
Scale: Warren Buffett has noted that his strategy in making gifts to his children was based on a simple principle: He wanted his children “to have enough that they could do anything, but not so much that they could do nothing.” This makes sense and highlights a key challenge in making gifts. You don’t want the recipient to lose the motivation to get out of bed in the morning. And because everyone’s situation is different, there is no universal rule here. If you’re not sure how much is too much, what I suggest is to start with modest gifts and to increase them only when you can see that the funds are being used productively. Alternatively, you could make gifts that are restricted in one way or another. You could, for example, make a gift into a 529 account, to a custodial account or directly into a family member’s IRA account. In each case, the funds could be withdrawn and used in ways that run counter to your expectations, but it would be more difficult. For greater control—especially if you have a larger estate—you could consider establishing a trust and making gifts only through that vehicle.
Sustainability: It likely goes without saying, but it’s important to be sure the gifts you make don’t jeopardize your own financial plan. That’s another reason you might make gifts that increase only incrementally over time.
Transparency: If you’re making gifts to children or to other relatives, chances are they won’t ask too many questions. But that doesn’t mean they won’t have questions. They might wonder, for example, if they can expect further gifts, and what those might look like. That’s why I recommend being transparent with recipients. Let them know your intentions so there are fewer unknowns in making their own financial plans. If you’re not sure yet whether you intend to make further gifts, that’s okay. Letting recipients know that there’s uncertainty is helpful information in and of itself.
Consistency: More than once, I’ve worked with the recipients of gifts who were left feeling puzzled and a little uneasy. That’s because the gifts they received varied in size from year to year. This was a problem because the recipients were left to wonder whether the differences from year to year—especially when the gifts decreased in size—were meant to send a message. In most cases, differences from year to year had only benign explanations. In years when the market declined, for example, I’ve seen parents make smaller gifts. The problem, though, is that recipients didn’t always know that. That’s why, if you decide to make ongoing gifts, I suggest starting at a level you know you can maintain through any economic environment.
Equity: I have yet to meet two siblings whose financial situations were identical. But if you’re making gifts to children or grandchildren, I suggest not treating them any differently. Suppose at the extreme, you have two children, one of whom is a schoolteacher and the other a brain surgeon. Even in that case, I still think the best path is to not treat them any differently. Why? As I often say, brain surgeons have feelings too. In addition, it’s important to not make assumptions about others’ financial needs. In addition to facing higher tax brackets, those with high incomes also receive less financial aid and may have other obligations which make their actual disposable income less than what it might seem.