Reduce Your Estate: Wealth Transfer Planning

Any change to the administration in the White House almost always brings change to tax law. The Biden administration is no different. We’ve heard a wide range of ideas from the President as well as Democrats in Congress. While we can’t predict which of these proposals will become a reality, we can be certain change is coming.

Tax law changes take time and often require many iterations before getting passed. This means that we can see change coming and often have time to adjust our plans. We prefer to be proactive when possible. If you’re contemplating a change to your plans, act now. Any midyear legislative changes are unlikely to be made retroactive, so anything you do now has a good chance of being preserved.

Why you should plan now

Temporarily high exemptions

•  By now you are probably aware of the increased exemption amount provided in the 2017 Tax Cuts and Jobs Act (TCJA). The amount you can irrevocably transfer to another individual or irrevocable trust is at an all-time high of $11.7 million. This is scheduled to sunset back to the 2017 value of $5 million (adjusted for inflation) at the end of 2025.
• President Biden has proposed many changes to the TCJA, including the immediate repeal of this increased exemption amount and even reducing it below $5 million.
• With these factors in mind, you may want to use your exemption before it is reduced. To make effective use of the current “extra” exemption, the assets you give away must exceed any future exemption amount. See our earlier article on this concept: Estate Planning: Keep Your Eye on the Sunset.

Historically low interest-rates

• In December 2020, the Fed “reiterated…that it expects to keep its benchmark short-term interest rate near zero through at least 2023.” (APNews.com, Dec. 15, 2020). But rates can’t get much lower than they are today, and the rates used for wealth transfer planning have already risen since November 2020.
• The low interest rates make certain wealth transfer strategies very attractive by enhancing their effectiveness.
• For more on the low interest rates and planning opportunities, keep reading. Also see Planning in a Low Interest Rate Environment.

Depressed asset values

Although the equity markets have done extremely well since the low in March 2020, certain types of assets have not recovered as well. Specifically, real estate and some operating businesses remain depressed. It may be beneficial to transfer wealth now using these depressed assets that are expected to recover value over time.

Ordinary income tax rates may be changing

• One proposal would increase the top tax rate from 37% to 39.6% for individuals earning $400,000 or more, with other top brackets seeing a rate increase, as well.
• Changes to itemized deductions could affect the treatment of charitable contributions, resulting in a higher effective tax rate.
• Given that ordinary income tax rates may increase under the current administration, you might consider shifting income to lower-income tax brackets (i.e. your children) or delaying the recognition of income into future years when your income or tax bracket is lower. Like the general topic of wealth transfer, shifting or delaying income recognition is a complex topic. Be sure to consult your advisor for more information if you think this could apply to your situation.

Strategies to Reduce Your Estate

Consumption (spending) and charitable gifts (now or at death)

• Simply put, the more you spend now, the less you’ll have in your estate. But balancing your rate of asset spend down with your life expectancy isn’t easy.
• You can also reduce your net worth by making substantial charitable gifts. You can receive a charitable deduction for gifts made during your lifetime if you itemize your tax returns. If you include charities in your estate plan, your estate will receive the charitable deduction.

Annual exclusion gifts

Each year, you can give up to $15,000 (in 2021) to as many individuals as you’d like. And if you’re married, your spouse can do the same. This means if you have three children and six grandchildren, you and your spouse can both give annual exclusion gifts of $15,000 to each, for a total giving amount of $270,000 per year. And this doesn’t even include children’s spouses! You can also pay for children’s and grandchildren’s tuition and medical expenses directly in addition to the annual exclusion gifts. As a reminder, annual exclusion gifts are separate from your cumulative lifetime and estate exemption amount. They don’t count against that “temporarily high exemption” we referenced above.

Estate freeze techniques

These wealth transfer strategies don’t use any of your wealth transfer exclusion amount, but they do remove the growth of those assets from your estate. Examples include:

• Intra-family loans. For example, if you have children or heirs who have a near-term cash need and you can afford to part with the cash you might consider serving as their lender rather than sending them to a bank.
• Installment sales to dynasty trusts. The current low-rate environment is ideal for selling assets to dynasty trusts to freeze the value of those assets in your taxable estate at their current, possibly depressed rate. This sale is often preceded by an initial “seed gift” of 10% of the value of the asset. The remainder is then sold to the trust in exchange for a promissory note using the current applicable federal rate (AFR) as the minimum interest rate.
• Annuity trusts. Consider taking advantage of the low interest rate environment without using any exemption by transferring assets to a grantor retained annuity trust (GRAT) or a charitable lead annuity trust (CLAT). In a GRAT, you retain the right to receive an annuity for a term of years. The payments are structured to equal the value of the assets at funding plus required interest. Any value (or growth) above the annuity amount remaining at the end of the trust term is passed to heirs without using any exemption. A CLAT is similar but instead of the grantor retaining the annuity stream, the annuity is paid to charity.

Use applicable exclusion

Give some—or all—of that $11.7 million we talked about at the beginning of this article to trusts for children, grandchildren, or even your spouse.

• Gifts to grantor trusts. If a trust is structured as a grantor trust, the grantor—the person who creates the trust—is the one who must pay all the income tax on behalf of the trust. (As opposed to a non-grantor trust where the trust itself must pay all income tax at the higher trust income tax levels.) This strategy allows the assets to grow inside the trust without the trust incurring the burden of income tax. As an added benefit, the size of the grantor’s estate is further reduced by paying the income tax for the trust, .
• Gift to a grantor spousal lifetime access trust. Worthy of an entire article on its own, a spousal lifetime access trust (or SLAT) is a special kind of irrevocable grantor trust created by one spouse, using his or her applicable exclusion amount, for the benefit of the other spouse. Like any other gift to an irrevocable trust, the spouse creating the trust gives up his or her right to the property transferred to the trust. The beneficiary spouse maintains access to that same property. The grantor spouse may continue to benefit from the trust property through the beneficiary spouse without concerns of creditor claims or estate-tax inclusion. A word of caution here: once the beneficiary spouse dies, the trust assets remain for the benefit of the remainder beneficiaries named in the trust (who cannot include the surviving spouse). To use this strategy, you must be sure that the grantor spouse is left with sufficient assets outside the trust to support them for the rest of their own life.

The strategies mentioned in this article are not intended for everyone and this is not intended to be a comprehensive list. If you would like to learn more about how any of these strategies may be applied to your specific situation, please give us a call. As always, please seek advice from your accountant or estate planning attorney before taking any action on these ideas.