Estate Planning Alphabet Soup For High Net Worth Families

Investing

It looks like Joe Biden has won the White House and the Democrats have retained control of the House.  The Senate is still up for grabs and will not be known until the Georgia runoff election in January, though if current predictions hold true, the Republicans will keep control.  This is important to be aware of because if Democrats take both branches of Congress, there is a real possibility that we see a reduction in the estate application exclusion amount.  I’ve seen reports that the exclusion amount could fall from $11,580,000 to $3,500,000, which would be a huge impact to wealthy families.  If there is a blue wave, this change could happen as soon as mid-2021 but be retroactive for the entire year.

For families with significant wealth, this could result in millions of dollars of gift taxes at the end of their lives.  This is a tax the estate would have to pay the IRS meaning less money for your heirs.  I haven’t met anyone that likes to pay the government more than they need to pay in taxes and I assume you are the same way.

 

The following items are all things we have discussed with clients in estate tax territory and something you should consider if you find yourself there.  We have 1.5 months until the end of the year, so you still have time to get a plan in place.

 

1. Grantor Retained Annuity Trust (GRAT)

A GRAT is an estate freezing technique to transfer appreciating assets to the next generation with little to no gift tax consequences.  It works like this: an individual (grantor) establishes a GRAT and transfers investments into an irrevocable trust for a fixed length of time.  The grantor retains the right to receive an annual stream of cash from the trust for the given term, essentially paying yourself back the money you put in.  Any amount left over at the end of the term goes to the trust’s beneficiaries.

 

The big thing to note here is that the payments back to yourself include some interest, which is set by the IRS.  This rate is called the Section 7520 rate and is 0.4% (as of September) which is a HISTORIC low.  What this means is that if the trust’s assets appreciate by more than 0.4%, the beneficiaries receive all that extra growth/income and the grantor doesn’t owe any gift or estate tax.

 

We often prefer a “zeroed-out GRAT” that does not use any of your applicable exclusion amount at the start.  We have successfully implemented GRATs for clients and they continue to be an effective estate planning tool.  Here is an easy to read article from the Journal of Accountancy that was published last year on GRATs and provides numerous examples of its creative power: https://www.journalofaccountancy.com/issues/2019/oct/wealth-transfer-grantor-retained-annuity-trusts.html.  Note the multi-million dollar gifts to beneficiaries during your lifetime.

 

2. Intentionally Defective Grantor Trust (IDGT)

An IDGT is another estate planning favorite.  A grantor establishes a trust that is “defective” for income tax purposes but “effective” for estate tax purposes.  The concept is the same as a GRAT but with a couple of different nuances:  (1) you are unable to “zero-out” the sale of your asset to the IDGT – you must make a ~10% minimum gift, (2) an IDGT allows for much more cash flow flexibility, which can be especially important for sales of businesses to IDGTs, and (3) the grantor does not need to survive the term of the IDGT for a tax-free gift to the beneficiaries to be recorded.

 

We have seen IDGTs used primarily for the transfer the business interests and property to beneficiaries while GRATs leverage easily marketable securities like stocks.

 

3. Family Trust / Spousal Lifetime Access Trust (SLAT)

If you are especially concerned about the Democrats taking the White House and both branches of Congress, you may want to consider establishing a SLAT before year-end (or gifting outright to your heirs).  The idea here is that you can gift money to an irrevocable trust that your spouse can access at any time for any reason for the rest of his/her life.  Any amount that is used before the exclusion is set to sunset in 2025 cannot be clawed back (or in 2021 if the rules are changed).  The IRS confirmed this in notice IR-2019-189.  This strategy makes sense if you believe you have more than enough assets to live on yet want to take advantage of the current, high applicable exclusion amount.  We have helped clients establish these trusts and can help you think through the pros/cons of setting one up and funding it.

 

4. Family Limited Liability Company (LLC)

A family-owned LLC is a powerful tool for managing your assets and passing them along to your children.  Once established, you can contribute investments and property into it.  You can maintain control over your estate by assigning yourself as the manager of the LLC and then slowly gift shares of the LLC to your children and grandchildren.  Since you are the manager of the LLC, and your children are non-managing members, the value of the units you transfer to them can be discounted steeply for estate tax purposes due to lack of marketability, transferability, and control of the LLC (as you own all of the voting shares).  I’ve seen discounts north of 30%.  This is another way to keep assets intact if there is a spendthrift in the family.

 

5. Donor Advised Fund (DAF)

If you are charitably inclined, establishing a DAF before year-end is a favorite.  You are able to bunch multiple years of charitable gifts into one year to take advantage of an elevated tax write off, yet gift to charities over the years ahead.  Most clients utilize a DAF until they reach the age of 70.5, then start giving to charity directly from their IRA via a Qualified Charitable Distribution (QCD).  Here is an article I wrote on the topic back in 2018 that provides a bit more detail: https://wealthpointadv.com/a-good-time-to-consider-a-donor-advised-fund/.

 

Two other things that may be helpful:

  1. We recently helped a client think through the decision of setting up a private foundation vs. a donor advised fund. The donor-advised fund won out simply due to its ease of use and lack of administration.
  2. For business owners that are charitably inclined, don’t forget that you can gift a portion of your business to charity before the sale. This allows you to recognize the full value of the gift and not pay any tax on that portion, which can save you hundreds of thousands of dollars in taxes.

 

 

These are just a few ways we help families with net worth’s in the high seven figures and above plan for their assets now and in the future.  Estate laws change and you should ensure your plan accommodates these changes.  Work with a fee-only, fiduciary wealth advisor that can help.

 

About the Author: Alex Perkins

Alex is a Wealth Advisor for WealthPoint Advisors, LLC. After a successful career in management consulting where he helped business executives solve their corporate challenges, he decided to pursue a passion in helping families and individuals on the personal side. Alex now enjoys helping his clients answer their most pressing financial and life questions, through a comprehensive, evidence-based wealth management approach.