Investors are eager to put the chaos of 2022 behind themIn a seminal and in-depth analysis of investor mood and trends, Northern Trust Institute has published its 2023 Wealth Planning Outlook. Excerpts are provided below. Access the full report here.
Planning For A Rising Inflation And Interest Rate Environment
In late 2022, the Internal Revenue Service (IRS) announced some of the biggest inflation adjustments made in history, which will increase income tax brackets and more than 60 tax provisions. One benefit of these changes is the increase in federal estate and gift tax exclusion amounts you can give away tax-free both on an annual and lifetime basis.
Planning for these increased amounts is especially important given that the historically high exemption is due to expire as of January 1, 2026, when it will return to its previous amount of $5 million (adjusted for inflation as of 2017). Making use of this high exemption in depressed market environments creates an even more valuable opportunity to pass wealth on to future generations. The most successful wealth transfer occurs when the assets transferred go on to increase in value, and the future appreciation occurs outside the transferor’s estate, avoiding future estate taxes.
Beyond direct gifting, some of the methods used to freeze asset values in an estate are also going through a paradigm shift. From 2010 to 2022, we were planning in a low interest rate environment, which greatly benefited certain gift and estate tax freeze strategies. These strategies depend on transferring wealth in return for a payment stream that is indirectly dependent on the prevailing federal funds rate; future appreciation above that rate is transferred to family members tax-free. As a result, common strategies such as intrafamily loans, sales or transfers to grantor retained annuity trusts (GRATs) have been highly effective.
Planning For Continued Tax Uncertainty
The midterm elections in 2022 brought clarity to what we can expect near-term: a newly divided Congress signals gridlock, with the Tax Cuts and Jobs Act (TCJA) and its expiring provisions likely to remain in effect for at least the next two years. Beyond that, whether those provisions continue to be extended or left to expire is hard to predict. The most recent Budget and Economic Outlook from the Congressional Budget Office (CBO), published May 25, 2022, estimated that over the next decade interest payments on the national debt will nearly triple from $399 billion to $1.2 trillion. Interest expense on that debt could exceed $8.1 trillion. If these projections are accurate, interest costs over the next decade would exceed what the government has historically spent on infrastructure, education, research and development combined.
While these projections did not take into account plans to reduce the deficit via the Inflation Reduction Act, they also preceded efforts by the Federal Reserve to curb inflation by raising interest rates. Rising interest rates raise the federal government’s borrowing costs and future interest payments on the national debt, which may force difficult decisions around taxing and spending and could result in higher tax rates in the future. Rather than trying to predict future policy changes, consider opportunities to diversify your balance sheet from a tax perspective by holding a mixture of both taxable and nontaxable accounts (e.g., Roth IRAs, municipals). Your advisors should consider your unique goals and use them as a guide to determine the optimal asset allocation to ensure you are able to maintain your lifestyle spending needs while taking into account taxes, inflation and expenses. This will give you the confidence to take full advantage of planning strategies.
Resilient Families: Living A Shared Legacy
Different generations experience market downturns in distinct ways. Older generations have experienced multiple market cycles, giving them confidence that markets will recover over time. Younger investors are likely to find themselves in the early stages of wealth building, with lower incomes but a longer investment time horizon and less experience staying invested through market cycles.
According to Investopedia’s Affluent Millennial Investing Survey, the majority of affluent millennials do not feel knowledgeable about investing. The study also found that affluent millennials tend to be a financially cautious generation, shaped by the Great Recession, the gig economy and the burden of student debt. Despite having a longer window to invest and recoup losses, they are significantly less likely than Gen X to own stocks (37% vs. 47%), but just as likely as Gen X to own bonds (19% vs. 18%), and more likely to allocate their income to a low-yield savings account (21% vs. 16%).
While millennials witnessed much harsher economic realities in 2008, Gen Z has not. Despite a brief, but steep, setback in 2020, they have experienced the longest bull market on record. This led some Zers to overly invest in speculative meme stocks or risky, unregulated investments, such as in the FTX cryptocurrency exchange. Although about one-quarter of Gen Zers hold cryptocurrencies, 40% say they don’t really understand the asset class. According to the same study, only one in three (31%) feel confident they can explain how the stock market works. And while they feel most confident about consuming and saving, nearly one-third feel they have only a beginner’s knowledge of financial basics, such as paying taxes and managing debt.
Resilient Philanthropy: A New Commitment
In a year when markets were seriously challenged by uncertainty, volatility and persistently high inflation, donors are looking for new opportunities to achieve their philanthropic goals and help charitable organizations that provide essential services in their communities to become more sustainable. Philanthropy continues to evolve as donors evaluate their giving options to ensure their donations have the impact they intend.
Some donors are looking at new ways to give beyond traditional methods in favor of increased flexibility, simplicity and entrepreneurship. For example, the use of a for-profit limited-liability company (LLC) as a vehicle for charitable giving is gaining popularity among wealthier donors for the flexibility and privacy it offers compared with private foundations. Certain restrictions on private foundations don’t apply to for-profit companies, which are generally free to grant money broadly to nonprofit and for-profit organizations and participate in political advocacy and contributions.
Donations to charitable LLCs are not tax-deductible, but they do receive tax deductions when the LLC distributes funds to eligible charities. While private foundations have strict disclosure requirements, a charitable LLC offers donors more privacy surrounding how they spend their dollars. Noteworthy charitable LLCs have been established by Meta founder Mark Zuckerberg and his wife Dr. Priscilla Chan; Laurene Powell Jobs, widow of former Apple CEO Steve Jobs; and eBay co-founder Pierre Omidyar.
Another non-traditional approach was embraced by Patagonia founder Yvon Chouinard, who announced his family would donate its $3 billion company to a 501(c)(4) nonprofit to fight climate change. As with the LLC, the structure of the donation means the family will not receive any charitable deduction, but using a 501(c)(4) nonprofit structure will give them greater latitude than traditional charities to participate in lobbying efforts to address root causes.
Resilient Women: Owning Your Future
Whether it is climbing the ladder of corporate America or founding businesses at a historic pace, over the last several decades women have indelibly changed the face of leadership. There are 114% more women entrepreneurs than there were 20 years ago, and U.S. women-owned businesses generate $1.8 trillion a year. In 2021, the proportion of women in senior management roles globally grew to 31%, the highest number ever recorded. Women are boldly charting a new path for success — all while facing the increasingly complicated pressures of managing the day-to-day needs of their personal lives. Although women remain more likely than men to perform the majority of the duties at home, for dual-income families, the distribution of household tasks has become more equitable since 1996. Women have become less likely to be the primary partners handling things like grocery shopping (down 14%), cooking (down 12%) and cleaning (down 9%). As women look to expand their leadership success, it will be imperative for these trends to continue.
Women are also inheriting wealth at unprecedented rates. By 2030, approximately $30 trillion in wealth will be passed down from the baby boomer generation, and women — who tend to live longer than their male spouses — are poised to be some of the largest beneficiaries. Another implication of women living longer is the increased cost of health care during their lifetime. Historically, the price of medical care has outpaced inflation in the rest of the economy. While medical costs increased by 5% in 2022 (compared to a 7.7% increase in overall prices), it is possible that this high inflation eventually translates to higher prices for medical care in the coming years — an important consideration for women in the context of their wealth plan.
Resilient Business Owners
The saying “this has been a challenging year for business owners” is becoming a cliché. From enduring a global pandemic and remote work to navigating potential tax law changes, the past several years have put business owners and entrepreneurs to the test in ways that no one could have imagined. As we head into 2023, a new set of challenges awaits — inflation and rising interest rates, cybersecurity threats, labor and supply chain issues, and economic uncertainty, to name a few.
2021 saw a record number of private business sales, as multiple factors aligned to create an environment uniquely favorable for M&A. Although deal activity has not dried up entirely, many buyers are taking a pause heading into next year and are reluctant to acquire businesses without a clearer picture of the global economic outlook. In light of this macroeconomic uncertainty, buyers are increasingly placing more value on business resiliency.
Although the dismantling of large public companies has made headlines this year — Twitter’s takeover and FTX’s downfall, for example — private businesses have been quietly surviving and often thriving amid the tumult, challenging the old “shirtsleeves to shirtsleeves in three generations” notion that wealth tends to evaporate over time in the hands of those who inherit it. As baby boomers look to the next phase of their life, they must impart to their children the knowledge and skills to become responsible stewards of their parents’ business holdings. 2023 and the years that follow will be a critical test for both generations: As the older generation of founders passes down the principles that have sustained their businesses, they must do so in a way that empowers their children and allows them to learn from their own mistakes. In turn, the younger generation must apply this knowledge to a world that looks very different from the one that their parents grew up in.
Access the full report: Northern Trust Institute 2023 Wealth Planning Outlook – The Power Of Resilience here.