Thoughtful Intergenerational Conversations May Yield Fruit for Your Family

Intergenerational estate planning conversations yield good fruit for families. So why don’t more of them take place? It may be because folks dislike discussing private matters with heirs. Or it could be that the potential benefits are beyond the imagination of the layperson, and the estate planning team has not stepped to the plate with creative ideas. At Bragg Financial, we value the team approach to estate planning, preferring to engage with the lawyer and/or the accountant when appropriate to consider all angles, be they tax or personal. Here are some examples:

Thoughtful Giving

Robin and Jim are in their 90s and have a $6,000,000 estate and therefore are not subject to estate taxes at death. However, their assets are highly appreciated. Their only heir, Sara, with her spouse, has an ample estate—well over the combined estate tax exemption of $26,000,000 that is available to a married couple. All of Sara’s assets are highly appreciated and subject to capital gains taxes if sold. She has very little after-tax cash and she earns $1,000,000 per year. Sara will soon sell an office building for $3,000,000 and will incur significant capital gains tax. Philanthropy is an important family value and Jim and Robin are planning to leave half of their estate to charity.

In a family meeting coordinated by their financial advisor, they mention the importance of “giving back” in their legacy plan. Sara is excited to learn of her parents’ charitable goals. The family’s advisor suggests an alternative plan that might increase everyone’s share but the government’s. Sara gives the office building that she owns to a donor-advised fund (DAF) for which her parents are the named advisors, and Robin and Jim remove the charitable bequest from their estate plan.

Here are the results of this plan:

1. Sara will avoid paying about $700,000 in capital gains taxes on the sale of the building because the DAF (charity) holds the building at the date of sale.
2. Benefiting from a sizeable charitable deduction, Sara will save about $720,000 in income taxes over five years. (She is only able to use part of the $3,000,000 deduction due to annual limits.) Had Sara’s parents made a charitable bequest through their estate plan, there would be no income tax deduction afforded and the estate tax charitable deduction would be of no benefit since they do not have a taxable estate.
3. Robin and Jim enjoy giving away the $3,000,000 from the DAF during their lifetime. This is much more fun than the previous plan that required them to die before the charities received anything!
4. Sara inherits the full $6,000,000 from her parents instead of half that amount, all of which receives a “step-up” in basis at their death. This leaves her with plenty of after-tax high-basis assets on which she can live without tapping her tax-locked assets to the same degree.

Timely conversations and thoughtful planning across generations yield fruit for both households and for charity.

IRA to Charity or Not

Susan has a large taxable estate, including an IRA worth $3,000,000. Currently, her two children are the primary beneficiaries. One of the children, Jon, declares that he doesn’t need the IRA and would rather not have the heavily taxed income added to his return annually. Instead, he would rather see his share pass to certain charities of his choosing.

This conversation results in some excellent planning coordinated by Susan’s financial advisor and estate lawyer. Susan splits her IRA into two IRAs, and the one payable to Jon lists his donor-advised fund as his contingent beneficiary. Now, Jon has the option to disclaim some or all of his half of the IRA, thereby avoiding the income and accompanying tax liability. In addition to avoiding high taxes on $1,500,000 of income, Jon’s disclaimer reduces the estate tax Susan’s estate owes by $600,000 (40% of $1,500,000). Susan’s lawyer is careful to add specific tax apportionment language to her estate documents, allowing Jon to inherit that much more of Susan’s other assets; after all, it was his disclaimer, not his sibling’s, that created the savings. This does not cost Jon’s sibling anything; it simply rewards Jon accordingly. Susan’s conversation, with help from her advisors, yields real fruit for the family and for charity.

GST or Not

Elsie has a large estate and one child, Jack, who has children of his own. Elsie has learned about Generation Skipping Trusts, and her estate plan creates a separate trust for Jack that is designed to provide for him while bypassing his estates for tax purposes. Elsie’s advisor is also an advisor for Jack and knows that Jack and his wife are not likely ever to have a taxable estate. The advisor knows that the GST provision is not valuable to Jack’s children because of this. In fact, it would be better if the assets were included in Jack’s estate, as this would mean Jack’s children will inherit stepped-up assets that are as good as cash instead of inheriting highly appreciated assets from a trust that carry embedded capital gains taxes. Elsie’s advisor gets permission from Jack to share this with Elsie and Elsie’s estate lawyer, who inserts language that will provide a means of inclusion of trust assets instead of exclusion from Jack’s estate. Jack’s access to the trust as a beneficiary does not change materially. However, his children may now inherit the remainder interest with significantly less potential tax burden. Generation Skipping Planning is not for everyone—something that the right kind of conversations can uncover.

Give the Beach House or Not

There are two individuals—unrelated—with identical balance sheets and similar family structures. One individual should give their highly appreciated beach home to their children to get the future appreciation of that asset out of his estate. The other individual should not. Intergenerational conversations uncover the “why” for each. Here are the details.

Bob has a taxable estate. Going forward, a tax of 40% will be assessed against any assets he transfers to heirs during his lifetime and at his death. Bob’s beach house is worth $1,000,000 and his cost basis is $500,000. Bob anticipates the home’s value will double in the next ten years. His children have the means and the desire to keep the beach house for a long, long time.

Mike’s situation is nearly identical, except that his children do not have the means or desire to keep the beach home.

With the help of legal counsel, Bob establishes a Qualified Personal Residence Trust (QPRT), transferring the beach home to the children while reporting a gift of only $400,000, incurring gift taxes of $160,000. In ten years, the children will own this home, then worth $2,000,000, and Bob will have removed the $1,000,000 of appreciation from his estate, saving $400,000 (40%) in estate taxes. The children’s basis will be the same as his—$500,000—thus, they have embedded capital gains of about $1,500,000 and tax liability of about 30% or $450,000. However, they do not have plans to sell the home, so the embedded gain is not of concern.

Mike listens to counsel and keeps the beach home in his name. Instead of a QPRT, he employs a ten-year Grantor Retained Annuity Trust (GRAT) funded with stocks that similarly results in a gift tax of $160,000 and removes $1,000,000 of appreciation from his estate, saving $400,000 in estate taxes. The beach home, however, passes to Mike’s children from his estate with a new cost basis due to the step-up received at his death. Thus, the children can sell the beach home with no capital gains taxes. Granted, they inherited appreciated stocks from the GRAT, but they may choose to hold these positions and enjoy the dividends—much easier than holding a beach home burdened with a steady stream of bills.

Thus, both Bob and Mike take advantage of estate freeze techniques, but they choose the appropriate structure for them based on their particular family’s needs.

In summary, a perfect estate plan should consider the personal objectives and tax situation of the heirs. Important information may be obtained and taken into consideration without requiring the client to share their balance sheet and plans; full disclosure is not required as long as the conversations are thoughtfully planned and conducted. Finally, an estate plan should be reviewed often enough that the impact of changes to heirs’ circumstances, to tax laws, or to the client’s balance sheet will be regularly considered.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.