What Will an Election Mean for My Estate Planning?

Every four years during the presidential election cycle, it is very common for clients to begin asking how an election outcome will affect their financial and estate planning.  My colleague Brad Swinsburg, our Chief Investment Officer, has previously written about how elections can affect investments, and our tax department fields questions about how candidates’ tax proposals will affect their income taxes in the coming year.

As Certified Financial Planners, we often find ourselves at the intersection of taxes and estate law.  Part of the Certified Financial Planner’s responsibilities is to help clients understand their options when working with an estate planning attorney.  With any election cycle, no advisor knows for sure the outcome of the race, nor can they tell you which tax proposals (if any) will pass through Congress and make it to the President’s desk to be signed. But, as Financial Planners, we can help you evaluate options to lessen estate taxes on your heirs if the laws change.

Gifting

Currently, the lifetime exemption amount for estates is $11.58 million per individual, more than double the $5.49 million exemption in 2017, and 10 times the $1 million exemption in 2008.  What this means is that a couple with an estate valued at $23 million at their death can pass that estate to their heirs without an estate tax.  And don’t forget that amount is going up approximately $360,000 / year for a married couple under the current law.

Taxpayers can also make annual gifts of up to $15,000 to as many people as they wish without having to use their lifetime exemption.  As a married couple, that power of gifting doubles to $30,000 per year per recipient.  If it doesn’t affect spending plans for retirement, individuals can gift more than the annual gifting limit and use some of their lifetime exemption.

Those couples with estates over $23 million may consider trying to use all their available lifetime exemptions before the exemption sunsets in 2025, or sooner if they believe a new President and Congress may lower the lifetime exemption amount.  The IRS has already ruled that lifetime exemption amounts used prior to 2025 will not be taxed if changes are made in the future to lower lifetime exemption limits.  If lifetime exemption amounts are lowered, previous gifts would be counted towards any new exemption amount.

The question remains, “What are households to do that might find their estates falling somewhere between the current lifetime exemption amounts and an amount that might be lower in the future?”  There are a couple of options and concepts households can employ, that have worked before and will return in popularity if lifetime exemptions are reduced.  Below are some of the options.

1. Removing Asset Appreciation from the Estate

There are a couple of options to pass on appreciation of estate assets to another generation instead of allowing the value to grow in an estate.

Assets can be transferred to an irrevocable Grantor Retained Annuity Trust (GRAT).  Over the term of the trust, the grantor retains the right to receive the original value of the assets plus the current minimum rate of return required by the IRS.  When the term expires any remaining assets in the trust are paid out to the trust’s beneficiaries.   However, if the grantor passes away before the end of the trust term, the assets become part of the estate.

Individuals with large estates can also loan family members money at low rates that they can reinvest with the potential of higher return.  The last time that interest rates were this low and the yield curve was this flat was in the mid 1950’s.  A flat yield curve means there is very little increase in interest rates for longer terms for borrowers.  For October 2020, the minimum rate the IRS requires for loans to family members is only 0.38% for mid-term 3-9-year loan. Loan terms can be set with more flexibility than a grantor retained annuity trust and any growth that is earned above the interest rate is kept by the borrower, free from estate tax.  For example, the individual loans $1,000,000 to their child for one year at 0.38% and the child reinvests the money with an average annual return of 8.0%.  In a year, the child earns $80,000 on their investment and pays $3,800 in interest.  At the end of the loan, the original $1,000,000 is returned to the individual but avoids $76,200 in appreciation in their estate.

If the asset that makes up a large portion of the estate is a business or real estate, the owner can opt to sell the asset, or a portion of it, to a family member.  Selling the asset allows the new owner to realize future appreciation.  If the asset is a privately held business, there is the opportunity to discount the sales price due to lack of marketability, or if the portion purchased lacks control over the business, because it is a minority shareholder and lacks managerial control.

2. Charitable Deductions

Any money from an estate left for a charity, private foundation, or donor advised fund will pass without an estate tax.  This option is best for families that are charitably inclined and don’t mind splitting their estate between family and charities.  Another option within this category is to designate an amount to a Charitable Remainder Trust that pays an income to your heirs over 20 years and leaves the remainder to a named charity.

3. Using Life Insurance with Annual Gifting to Provide Liquidity to Pay Estate Tax

Clients can consider setting up an irrevocable trust to own a “Second-to-Die” guaranteed life insurance policy that is outside the estate.  The policy is paid for with funds that fall under the current annual gifting limits of $15,000/year to avoid using lifetime exemptions.   Having the policy owned by the trust, outside the estate, means the estate value is not increased by the policy.  In addition to paying estate taxes, the second-to-die policy can provide a floor for other trust investment assets and allow for riskier allocations.  The right type of Permanent Life Insurance can act as a non-correlated asset to other investment.

The most important point to take from this article is to know that regardless of election results and any future tax law changes, the Certified Financial Planners and the rest of the team at Smith and Howard Wealth Management are always here to help you evaluate your options.  If you have questions about your situation, please reach out to Jeff Brandon or Michael Mueller so we can schedule a conversation.

Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.