Estate planning is really “transfer planning.” It is an ongoing exercise of planning how you accumulate, conserve, and distribute your assets during life, at death, and beyond. There are both financial and non-financial reasons to plan. These range from minimizing income and estate taxes, preserving business value, maximizing benefits for a surviving spouse, protecting against the spendthrift tendencies of a child or grandchild, meeting needs of dependents, controlling assets premortem and postmortem, and protecting assets from creditors.
Tax laws are not written in stone and may well change over time. Currently there are three types of transfer taxes: tax on gifts made during lifetime; tax on estate assets transferred at death; and the GSTT (Generation Skipping Transfer Tax), which is an additional tax on lifetime gifts and transfers at death to persons two or more generations younger than the transferor (ie., a donor’s or decedent’s grandchildren).
Estate and gift taxes are unified, which means that the tax is identical whether the transfer occurs as a gift during life or a transfer at death. Gifting removes assets from the donor’s estate. Gift tax is only assessed on the amount gifted to a donee over and above the annual exclusion amount (currently $14,000/ year for singles or $28,000/year for married couples for each donee). Estate taxes are assessed on the entire taxable estate, which includes the assets which will be used to pay the taxes (thus transfers at death are tax-inclusive whereas lifetime gifts are tax-exclusive).
As of now, estates may exclude a lifetime total of $5.45 million (for singles) or $10.9 million (for married couples) from gift and/or estate tax. Put another way, an individual will only have to pay gift or estate tax when the total amount of assets he/she gave away or transferred at death exceeds $5.45 million. If the first-to-die spouse did not use up all his/her lifetime exclusion amount, the unused exclusion (called DSUE, or Deceased Spouse Unused Exclusion) can be ported to the surviving spouse, allowing the surviving spouse to take advantage of the full amount remaining of the $10.9 million. Similar exclusion limits apply to the GSTT.
The Trump Administration’s current tax proposal seeks to eliminate estate taxes altogether. Let’s wait and see how that goes!
Meanwhile, there are considerable factors to consider in “transfer planning.” Do you want to give away a substantial portion of your assets during lifetime, give them away at your death, or leave them in trust to be managed across one or more generations?
Reasons for giving away assets during your lifetime (Intervivos Transfers) include providing for the particular needs of beneficiaries currently, enjoying watching those to whom you gift enjoy the benefits of the transferred property during your life, no longer wanting to maintain property, removing highly appreciating property from your estate, taking advantage of the annual gift exclusion amount, and receiving charitable deductions. Keep in mind that you are allowed to give to each donee up to $14,000 (or $28,000 as a married couple) each year without invoking gift tax. Also, tuition payments made directly to an educational organization on behalf of a person, and payments for a person’s medical care made directly to the provider, are not treated as taxable gifts. This means they do not count toward either gift tax or GSTT (a great planning technique to gift to grandchildren tax-free).
The marital deduction allows spouses to gift assets to each other on an unlimited tax-free basis throughout their lifetimes as well as at death. (This only is available to U.S. citizen spouses.) Transfers to a spouse at death only delays (does not eliminate) the payment of taxes. Estate taxes will be owed on the taxable estate of the surviving spouse exceeding the available total lifetime exclusion (the surviving spouse’s remaining lifetime exclusion plus any ported DSUE).
There may be reasons why it is more beneficial for the estate of the first-to-die spouse to utilize his/her full available lifetime tax credit. In this case, a Bypass Trust might be useful to hold assets that the estate does not want to qualify for the marital deduction. This allows the estate to use the decedent’s tax credit and gives the surviving spouse a terminable interest in the property which bypasses the surviving spouse’s estate at death. A QTIP (Qualified Terminable Interest Property) Trust allows the use of the marital deduction for some but not all the assets.
Tax reduction techniques often employ charitable gifts and/or charitable bequests. Gift and estate tax deductions for charitable gifts are unlimited. Outright qualified charitable gifts remove assets from the taxable estate and provide some income tax deductions. Multiple varieties of “partial interest” trusts can generate tax deductions and remove assets from estates while allowing the donor or his/her beneficiaries to enjoy either present or future benefits of the property. Charitable Lead Annuity Trusts (CLATS) and Charitable Lead Unitrust Trusts (CLUTs) allow charities to enjoy the lead interest—annual income from the property—for a period of time while allowing the property to transfer back to the grantor or other beneficiaries at the end of the term. Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrust Trusts (CRUTs) allow a grantor to retain income or give income to beneficiaries generated from donated property for a period of time, while receiving a tax deduction for (and removal from the estate of) the remainder interest which is donated to the charity.
A variety of planning techniques can help to remove assets from an estate while allowing the grantor to benefit from the property and/or minimize GSTT for multigenerational planning. Two popular types of trusts are Intentionally Defective Grantor Trusts (IDGTs) and Dynasty Trusts. IDGTs allow the grantor trust rules (whereby the grantor pays the income tax on income generated by the trust) to apply but not the transfer rules of grantor trusts. IDGTs are irrevocable, and assets placed in those trusts are no longer part of the grantor’s estate. Other variations on the IDGTs can effectively remove additional assets from the estate through the installment sale of assets to the trust. Dynasty trusts remove assets from the grantor’s estate and reduce taxes on transfers to future generations by taking advantage of the full GSTT exemption. Earnings and appreciation are not subject to further transfer taxes (income tax is, however, paid on income).
Estate planning—effective intervivos and testamentary transfer planning—requires a team approach and collaboration among the client and the client’s estate attorney, CPA, and financial planner. Estate planning is not just for the old and wealthy. Planning needs to start early in life because transfer strategies can be deployed throughout life. Young parents need to provide for the care of their children (both guardianship for personal care and conservatorship for financial matters). Life insurance needs are also a part of the comprehensive planning process. A CERTIFIED FINANCIAL PLANNERTM professional can be a valuable partner to quarterback the estate planning team for life!