You may need to transfer assets for all sorts of reasons. A working knowledge of various transfer techniques can help you determine when it’s appropriate to move money around, and how to minimize the tax and legal implications of the process.

Asset transfers are an important part of financial planning. As you move through life, you are constantly acquiring and disposing of assets until that final transfer takes place—the one you’re not around to see.

Some asset transfers are initiated as a result of a life event or other major decision. Others are suggested by attorneys or financial advisors as a way to better arrange your affairs. Some asset transfers are as easy as handing a tangible item over to another individual. Others are fraught with legalities and should not be attempted without counsel.

Here is an overview of asset transfers—the tip of the iceberg, if you will. Many of the regulations governing asset transfers are state laws, so your best bet is to check with your financial advisor and a good attorney— several of them, actually, in different specialties—who can guide you through the transfer process.

Why assets move

There are lots of reasons why people transfer assets. Here are some of them.

• Marriage or cohabitation. You want to put a new spouse or partner’s name on the title.

• Divorce. A couple wants to divide joint property between the two spouses and retitle it in separate names.

• Buyout (or sale to) co-owner. One of two co- owners wants to own full rights to the asset.

• Anticipation of incapacity or death. An elderly person wants to put a son or daughter on the title for ease of transfer.

• Establishment of a trust. There are many reasons for forming a trust; assets must be retitled in order to be transferred into the trust.

• Establishment of a private annuity. You need income and want to keep assets in the family; assets are sold to family members in exchange for regular payments.

• Reduction of estate taxes. You may want to remove assets from your estate in order to reduce the amount subject to estate tax.

• Reduction of income taxes. You may want to transfer assets to a low-bracket family member so investment earnings will be taxed at a lower rate.

• Medicaid eligibility. You may want to reduce the amount of “countable assets” so that Medicaid will pay for nursing home care.

• Bankruptcy. You may need to meet the state’s asset requirement laws in order to discharge debts or other obligations.

• Anticipation of lawsuits. You might need to protect assets from judgments (applicable to people in high-risk occupations, such as surgeons).

• Gifting. You may want to gift securities or other property to an individual or to charity.

• Cash or asset exchange. You may want to sell an asset for cash and/or buy a different asset.

Tax and legal considerations

It would seem that if an individual wants to get rid of an asset or if two individuals want to enter into a private transaction, they ought to be able to do it without tripping over a bunch of laws. For smaller transactions, they can. For instance, gift giving at birthdays and holidays would normally be exempt from asset-transfer laws.

In some transfer situations, however, there’s opportunity for tax evasion, taking advantage of people, or exploiting laws that are designed to help the needy. In those cases, certain procedures must be followed. And to make sure they are, the transfer process itself— the physical transfer of title to another person—may be extremely complex and not possible to complete without the help of an attorney, escrow officer, transfer agent, or other intermediary.

Even so, the intermediary arranging for the transfer may not be obligated to warn clients of the various tax and legal ramifications—in some cases he or she may simply be following instructions to transfer title—so it is up to you to know the law—or obtain legal counsel. Here are a few of the common considerations involved in asset transfers:

Gift tax

If you are thinking about transferring assets to family members to save income or estate taxes or to facilitate transfer later on, then you should be aware of gift tax rules. In 2020, any gift to an individual that exceeds $15,000 for the year ($30,000 for joint gifts by married couples) applies against the lifetime gift tax exclusion and requires the filing of Form 709 for the year in which the gift was made. The gift tax does not need to be paid at the time Form 709 is filed, unless the client has exceeded the lifetime gift tax exclusion of $11.6 million in 2020 (adjusted annually for inflation until 2025). Transfers to spouses who are U.S. citizens and to charitable organizations are exempt from gift tax. Payments made directly to an educational or health care institution are also exempt from gift tax. Property exchanged for equivalent value (as in a sale to another party) is not subject to gift tax. However, low-interest loans to family members may be subject to gift tax. Complicated transactions like these require the advice of an attorney or tax advisor.

Kiddie tax

The practice of transferring assets to children to avoid income tax on investment earnings is less popular since taxation grew more stringent, but it is still valid. Starting in 2018, investment income earned by qualified children is taxed at the same rate as trusts and estates. This will continue until 2025. It’s certainly possible to get around the kiddie tax by investing in assets that don’t pay current income—but then what’s the point of transferring assets to children, especially when parents must think about funding college.

Financial aid

The formula that determines need-based aid factors is a much higher percentage of assets when they belong to children (20%) as opposed to parents (5.64%). So the classic financial aid strategy is to keep assets away from children and stash parents’ assets in retirement plans, home equity, and other exempt assets. What if a child already has significant assets—say, in an UGMA or UTMA account? Is there any way to get them out of the child’s name? Probably not (check with an attorney to be sure), at least not until the child turns 18 or 21 and has the legal authority to transfer property. But by then it may be too late for financial aid, since schools look at the family’s financial picture as early as the student’s junior year of high school. Any parent who wants to maintain maximum financial aid flexibility (and this includes need-based scholarships, not just loans) should think twice before transferring assets to children.

Medicaid

Medicaid is designed for people with few assets who can’t afford to pay for custodial care. In the past, people had to “spend down” to such small amounts that often the healthy spouse was left nearly destitute. This led to rampant asset transfers and big business in “Medicaid planning.” However, the laws have been liberalized to better protect the healthy spouse, so asset-transfer gimmicks have waned somewhat. In any case, clients contemplating asset transfers in anticipation of applying for Medicaid need to be aware of “look back” laws—60 months for transfers to individuals (with some exceptions if the transfer is to a child under 21 or a child of any age who is blind or disabled) and trusts.

Bankruptcy

Each state has its own laws relating to how much property a client can keep and still discharge debts in bankruptcy. These laws also address property transfers in which it appears that the debtor is trying to pull a fast one.

Popular asset-transfer strategies

The main point to understand is that asset transfers may not be as straightforward as you think, and some transfers may have unintended consequences. At the same time, strategies you may not have considered could provide the perfect financial planning tools. Popular alternatives include:

• Annual gifting. Every year, give cash or property equal to that year’s gift tax exclusion to each child, grandchild, or any prospective heir to remove assets from the estate.

• Transferring assets to parents. If you are supporting elderly parents you may want to transfer assets to low-bracket parents who would pay taxes on the income being used for their support.

• Writing checks directly to educational institutions. Grandparents who are paying for their grandchildren’s education should pay the school directly; during the accumulation phase they should contribute to a 529 plan rather than an UGMA.

• Trusts and other advanced strategies. There’s no substitute for consulting with an estate planning attorney and tax advisor for individual advice regarding asset transfers that can accomplish specific objectives.

It’s a big transition when you leave the workforce to live off your savings, requiring an attitude adjustment in both you and your financial professional. Here are the issues to consider when time, compounding, and conventional investment principles no longer work in your favor.

Retirement planning is easy during the accumulation phase. Just stash as much savings as possible into retirement and investment accounts, and maximize total returns. All that really matters is what the client ends up with at retirement. If investment returns vary from year to year, or if returns are made up of interest, dividends, or capital gains, none of it much matters. It’s all a race to grow the nest egg as large as possible. Success is measured by account values, pure and simple.

Then comes the day when you can finally crack the nest egg and start withdrawing funds. Now the goal is no longer simply to grow the account balance, but rather to provide enough current income to meet your spending needs and to allow the nest egg to diminish, as it naturally must, without letting it disappear. Success is measured by your happiness and the careful monitoring of withdrawal rates and account values to ensure that your money is not in danger of running out.

Attitude adjustment

Dollar-cost averaging works in reverse. As you probably know, investing a fixed dollar amount during volatile markets allows you to buy more shares when prices are down. This is a good thing. But when you are withdrawing fixed dollar amounts from a volatile portfolio, temporary dips can do serious damage because more shares must be liquidated to provide the same amount of cash.

Compounding also works in reverse. In the classic “Why save now?” pitch, you learned that the early build-up of an investment account provides a larger base for future compounding. The rule comes into play a little differently when determining withdrawal rates: taking out too much too soon will diminish the impact of compounding on the remaining assets.

The sequence of investment returns matters. Under an accumulation strategy, dips in asset values can be made up by a bull market or increased savings. What matters is the average annual total return. During the distribution phase, poor returns in the early years can cripple a portfolio and cause money to run out early.

Time is the enemy. Under an accumulation strategy, the longer the money stays invested, the more it will grow. When funds are withdrawn, the opposite is true.

Mistakes can be fatal. During the accumulation phase, mistakes in planning, saving, or investing can always be fixed by adding more money, revising the portfolio, working longer, and so on. In retirement, when money is coming out and no new money is going in, there is far less room for error.

Part of transitioning into retirement is learning some fundamental concepts relating to the management of your nest egg.In particular, pay attention to the dangers of volatility, excessive withdrawals in the early years, and a longer-than-expected withdrawal period. These potential dangers can undo a lifetime of diligent saving. The worst part is these mistakes may not show up until it is too late to reverse the impact.

Income planning

Planning for income requires careful number crunching and a strategy for actually getting your hands on cash Here are some popular retirement-income strategies:

Live off the interest (or dividends). The classic retirement-income strategy is to shift from a growth oriented portfolio at retirement to investments that generate income. These might include bonds and dividend-paying stocks. Your income consists of the actual payments thrown off by the investments. Any assets not needed for current income generation may be invested in equities for inflation protection and long-term growth.

Set up a withdrawal plan. Another approach is to invest for total return and set up a withdrawal plan starting at, say, 4% of the account balance. Each subsequent withdrawal would be increased by the annual inflation rate. Under the so-called “4% rule,” the assets are invested in a diversified portfolio of stocks and bonds.

Draw from a cash bucket. Another strategy is to keep enough cash in a money-market fund to fund two years worth of expenses and invest the bulk of the portfolio for total return. As the cash bucket empties, enough long-term assets are liquidated to fill it back up.

Where are the assets?

The retirement-income strategies you use for taxable accounts won’t necessarily be appropriate for nontaxable accounts. For example, if you want tax-free income from a taxable account, you can buy municipal bonds. If you want tax-free income from an IRA, you’ll have to convert it to a Roth, which means paying taxes on the account at the time of the conversion.

By the time you reach retirement you may have lots of different accounts. When arranging for distributions you’ll need to look at them as a whole for overall investment planning, and also individually to determine which accounts will generate which distributions.

When should you sell?

The liquidation of assets is often an important part of the transition to the distribution phase. If you will be doing a major portfolio overhaul, you’ll need to consider the tax and investment implications of asset sales. For taxable accounts you should know the tax basis of each and every holding. You’ll also need to know the your overall tax situation in any year you propose a sale of assets, including previous loss carry-forwards, AMT status, the receipt of taxable retirement distributions, and so on.

If you think a major reorganization of the your investment portfolio is in order to meet your new objectives of income, liquidity, and capital preservation, meet with your tax advisor and map out a plan for the orderly liquidation of assets. This could take years. Periodic asset sales will also be necessary during your retirement years, especially if you are using the cash bucket strategy. Each time a liquidation becomes necessary you’ll need to balance tax and investment considerations and time these asset sales for optimal benefit.

What will be the impact of IRA withdrawals?

If part of your income will come from regular IRA withdrawals, you’ll need to consider the current—and future—tax impact of these withdrawals. It may not make sense to defer distributions from traditional IRAs until the last possible moment if doing so might create such large required minimum distributions that you end up in a higher tax bracket.

Also, consider the income and estate tax consequences of a large IRA that is allowed to grow out of control. Long-term income projections need to be part of your transition planning so you can set up accounts and plan distributions from the outset.

What future transitions are in store?

You may decide you don’t want to retire all at once. You may plan to ease into retirement by working part time for a while and then seeing how you feel. Distribution planning for this type of retirement involves a series of transitions. You may set up the accounts and the portfolio to generate a relatively small income now with the idea of increasing the income later. This may require another transition or two, with all the same attention given to asset positioning, the timing of liquidations, and the tax impact of IRA withdrawals–not to mention seeking the advice of a financial professional.

Perhaps one of the biggest differences between accumulation planning and distribution planning is that once you begin drawing income from your investment portfolio, your accounts require much closer attention. Not only must you invest the assets in a prudent manner, you also must watch the amount and timing of distributions to ensure that the nest egg lasts. Investors who are used to investing only for growth may need to go through an important transition themselves to fully understand the nuances of retirement-income planning.