6 Tips to Kickstart Succession Planning with Your Business Owner Clients
Here are 6 tips you can share with your business owner clients to help kickstart their succession planning.
According to the Government Accountability Office, the US national debt has been hovering around 100% of US annual GDP, but it’s soon expected to rise sharply along with costs to service that debt due to rapidly rising interest rates meant to combat inflation. To put those concerns into perspective, the national debt peaked at 106% of GDP following World War II. According to current GAO projections, the debt will hit a record of 107% of GDP in 20281. With this as a backdrop, it is not surprising that President Biden’s 2023 federal budget included proposals to raise income taxes for high earners. In the current political environment, however, it is unlikely that Congress will pass new tax legislation through 2024.
But even without new legislation, the prospect of higher taxes in the future is still looming. The Tax Cuts and Jobs Act (TCJA), which passed at the end of 2017 and established current income tax rates, is scheduled to “sunset” at the end of 2025. This means if Congress does nothing, we will revert to 2017 tax rules for the 2026 tax year. If this were to occur, the impact on retirees would be substantial. This is because the TCJA made many changes to the tax code that benefit retirees.
For example, the Tax Cuts and Jobs Act introduced a much larger standard deduction available to most taxpayers ($13,850 for single filers in 2022, or $20,800 for head of household). At age 65, the standard deduction becomes even more generous ($15,700 for single filers, $30,700 for married filers (both age 65+), and $22,650 for head of household). Prior to the TCJA, the standard deduction was $6,350 for a single filer, $12,700 for a married couple, and $9,350 for a head of household. There was also a personal exemption of $4,050 per dependent that was phased out for high income earners2.
The standard deduction is particularly important to retirees who typically would not have a similar total of itemized deductions. In fact, it’s estimated that about 90% of taxpayers are taking the standard deduction when filing their taxes3. The importance of the standard deduction for retirees is that it completely offsets a corresponding amount of withdrawals from tax deferred retirement accounts. As a practical matter, for a 65-year-old couple, their first $28,700 withdrawn from a tax deferred retirement account is basically tax free. If the standard deduction is reduced, more retirement income would be subject to taxes.
The TCJA also expanded the 10% income tax bracket, replaced the 15% bracket with an expanded 12% bracket, and changed how the brackets would be indexed for inflation going forward. Under the old rules, brackets were adjusted more slowly. By indexing the brackets more aggressively to account for inflation, the TCJA keeps average tax rates lower.
The combination of a higher standard deduction and lower tax rates is a fantastic opportunity for retirees, especially those who are married. Based on 2023 brackets, a married couple with no other income, both age 65 and filing as a married couple, could pull $120,150 from a traditional IRA (taking them to the top of the 12% bracket) and have a federal income tax liability of just $10,294. That’s an effective tax rate of just over 8.6%. Given our current fiscal situation, it’s hard to envision that tax rate dropping. If the TCJA were to simply sunset at the end of 2025 and revert to the 2017 standard deduction, personal exemptions and tax rates, however, the resulting tax liability on the same distribution would be over $4,900 higher at $15,290 (with an effective tax rate of 12%)4. Keep in mind that this is a rough estimate. If the TCJA sunsets, the 2017 tax brackets will have to be indexed from 2017 numbers. This would result in a smaller tax increase and a lower effective tax rate.
As we look at the tax landscape for the foreseeable future, the one thing we can say with the most confidence is that tax rates are unlikely to go down. Given the intense, persistent pressure of the national debt, the reality is that the next few years could end up being a low point for federal income tax rates. This can make after tax savings opportunities, such as Roth accounts, permanent life insurance, and non-qualified annuities very attractive options for those with a long-term approach to retirement savings. Each of these vehicles provides retirees with flexibility to manage their retirement tax bill if (or more likely when) taxes increase in the future.
Tax diversification also remains an important strategy as we save for retirement. Having a mix of non-qualified taxable assets, tax-deferred retirement accounts, and potentially tax-free accounts can allow retirees the flexibility they need to actively manage their tax liability in retirement, and possibly avoid higher tax rates should they come to pass.
“The Nation’s Fiscal Health: Federal Action Critical to Pivot toward Fiscal Sustainability” U.S. Government Accountability Office, 2022, gao.gov
“Details and Analysis of President Joe Biden’s Campaign Tax Plan” Tax Foundation, 2020
“Key Elements of the U.S. Tax System” Tax Policy Center, 2018. taxpolicycenter.org
Federal income tax laws are complex and subject to change. The information is based on current interpretations of the law and is not guaranteed. Nationwide and its representatives do not give legal or tax advice. Please consult an attorney or tax advisor for answers to specific questions.