The changing tax landscape, along with the stress on financial markets due to the pandemic, creates both risks and opportunities from an estate planning perspective. Although it is still unclear what appetite there is for tax reform, and how extensive any proposed reform may be, there are some proactive moves individuals can take to get the most out of our current environment.
The fundamentals are still important.
Every estate plan should include a will, a financial power of attorney, and a health care directive. Those basic building blocks should be in place before any advanced planning takes place. It may also make sense to consider using revocable or irrevocable trusts in your estate plan, particularly if you may leave assets to minors, young adults, or individuals with special needs or unique financial situations. Trust planning can also help planning for the impact of state estate taxes, which in Minnesota are imposed on individuals with more than $3 million in assets at their death.
An important part of your basic estate plan should be gathering account numbers, contracts, and beneficiary designation information for any retirement accounts, investment accounts, and life insurance policies. The choices you make on the beneficiary designations for these assets will take precedence over anything in your will or trust, so it’s very important to review your beneficiaries regularly. If you do not have a beneficiary listed, or if your beneficiary dies before you do and you do not have a contingent beneficiary listed, the plan documents will control what happens to that asset. Often, it will go directly to your estate, resulting in a big tax bill that could have been avoided.
The federal lifetime estate and gift tax exemption has never been higher.
The Tax Cuts and Jobs Act of 2017 doubled the lifetime estate and gift tax exemption from just over $5 million, indexed for inflation, to an adjusted $11.7 million per person in 2021. This increase is already set to sunset as of January 1, 2026, if Congress takes no action, however proactive legislation could roll back the exemption earlier. For older, high asset individuals, this may be the perfect time to consider gifting assets, either directly to intended heirs and beneficiaries, or using irrevocable trusts. Gifting assets which are likely to appreciate in value or generate a significant income stream to an irrevocable trust, such as undeveloped real estate or interest in a closely held company, will remove the assets from the grantor’s estate, allow the asset to appreciate tax-free, and accomplish the grantor’s ultimate goals for passing the asset along to his or her intended beneficiaries.
Do not forget about the annual gift exclusion.
In addition to the lifetime unified estate and gift tax exemption, you can gift up to $15,000 to any individual per year before using any of your lifetime exemption. Married couples can elect to “gift-split” and gift any individual up to $30,000 per year. Gifts above the annual gift exclusion will require the grantor to file a gift tax return, but no tax would be due until the entire lifetime estate and gift tax exemption has been used. In addition, paying for medical and tuition expenses will not be treated as taxable gifts if they are made directly to the medical provider or educational institution. This may allow a grandparent, for example, to give the maximum annual gift to a grandchild in addition to paying tuition directly to a private school or college.
Interest rates are historically low.
The applicable federal rates, a rate set by the IRS monthly as the minimum interest rate required for a personal loan to avoid treatment as a taxable gift, have been hovering near zero, but slowly going up. An intra-family loan, with interest only payments, properly documented, can allow the borrower to keep earnings on the principal that exceed the minimal interest. The cash will grow, properly invested, outside of the grantor’s estate, and the borrower can then keep the appreciated value when the balance comes due. Similarly, assets can be sold to irrevocable trusts at incredibly favorable rates (0.6% for January and February 2021, for example).
It’s a good time to be generous.
A great way to lower a taxable estate is through charitable bequests. Many people are making use of donor advised funds to get the most out of their philanthropic dollars and benefit from a present tax deduction. A donor advised fund is a separate account, set up by the donor and maintained by a public charity. The donor (and perhaps other individuals determined by the donor), can then make recommendations to the supporting charity regarding what organizations or types of organizations the fund should support. Assets inside the donor advised fund can grow, outside of the donor’s estate and tax free. The supporting charity must undergo certain due diligence procedures to comply with the federal tax code.
Estate planning is not one size fits all. Depending on the size of a potential estate and the age of the individual, some tools may make more sense than others. It is important to speak with your financial advisors and legal counsel in determining the best course for you and your family.