A 'perfect storm' for estate planning

Low asset values and interest rates make this a good time to make some moves

Nov 6, 2011 @ 12:01 am

By Andrew Osterland

Politics, the weak economy and low interest rates have combined to create one of the best environments for estate planning in a generation, according to experts. “If individuals are trying to transition assets to the next generation, we currently have a perfect storm — in a good sense — to do it,” said David Scott, vice president of advanced sales for Penn Mutual Life Insurance Co.

The elements of that perfect storm begin with a $5 million exemption from estate taxes ($10 million for married couples), which was part of the Middle Class Tax Relief Act of 2010 enacted in December. The value of real estate assets and securities are at low levels, making it more attractive to give such assets to other individuals. And with interest rates near zero, wealthy clients also can make loans to their children and to trusts at a very low cost.

The Republicans, fresh off their midterm-election victories last year, agreed to reinstate the estate tax for 2011-12, after it had lapsed in 2010, but raised the exemption to $5 million per person and $10 million for married couples. The unused portion of the exemption is portable between spouses as long as an estate tax return is filed within nine months of a person's death. The tax rate on amounts over that threshold is 35%.

The large exemption applies for the next two years and represents a major window of opportunity for aging Americans to avoid taxes on their estates.

“The $5 million exemption is the 800-pound gorilla in the estate-planning room,” said Charles Aulino, director of financial planning at Glenmede Trust Co., a wealth management firm catering to wealthy individuals and institutions.

The opportunity comes from the fact that Congress also unified the gift and estate tax laws, the result being that individuals can make a gift of up to $5 million during their lifetime — or at death — tax-free.

Given that the estate tax rules have been changed 19 times since 1976, investors and their advisers should be taking advantage of the circumstances, Mr. Scott said. The current rules are slated to expire at the end of 2012, and the previous tax rates and exemption levels will apply if Congress does nothing to stop it. And judging by the record of this Congress, there's a good chance that nothing will be done before next year's election, or by a lame-duck Congress at the end of 2012.

“We're not likely to see a resolution of the estate tax until 2013, as part of broader tax reform,” Mr. Scott said.

If that is the case, the exemption will revert back to $1 million and estates would be taxed at a 55% rate over that amount.

The first step for an adviser involved in planning a client's estate is to determine what the client's objective is and how it can be accomplished most easily.


“It's amazing how often people explore the complicated stuff without looking at basic strategies that might be enough,” said Brian Conroy, an adviser with Savant Capital Management LLC, who specializes in estate planning. “Before looking at the trust strategies, people should consider the easy things.”

A first consideration would be whether a client was comfortable giving away large amounts of money. Many are not. One way to determine that is to suggest smaller gift amounts, Mr. Conroy said.

“Forget about the increased exemption,” he said. “People can give up to $13,000 annually to anyone, without it being reportable against the exemption. If they're unwilling to give that amount, it's unlikely they're willing to make bigger gifts.”

Parents who want to avoid potentially higher estate taxes down the road, but worry about giving large sums of money to their children now, can set up a variety of trust structures that take advantage of the current tax rules, but distribute money in a more measured way.


Grantor-retained annuity trusts remain a popular option, particularly given low interest rates and low real asset values. Individuals place assets in a trust and receive annuity payments back — usually for two to three years. Any appreciation on the assets above the prevailing GRAT rate published by the IRS — currently 1.4% — is distributed to the trust beneficiaries without estate or gift taxes being applied.

The low interest rates and asset values make the chances of the assets' appreciating more than the prescribed GRAT rate better. Individuals can set up multiple GRATs with different assets in each. Those that increase in value save on estate taxes; those that don't are simply rolled back in to the estate.

The current estate tax rules and low-interest-rate environment also are ideal for small-business owners who want to transfer ownership of their businesses to descendants in a tax-efficient manner, Mr. Scott said.

For example, a married couple with a combined exemption of $10 million can give over assets worth the full amount of the exemption tax-free. And if the business is worth more than $10 million, they can sell the remainder to the receiver using intra-family loans on very favorable terms.

The current interest rate published by the Internal Revenue Service for a loan of less than three years made to a family member is only 0.19%. As of the end of October, it was still a very low 2.67% for loans longer than nine years. The interest payments on a 10-year, $5 million loan would be just $133,500 annually.

“Business owners who want to transition their business to the next generation have to take advantage of this opportunity,” Mr. Scott said. “Advisers can save their clients potentially millions of dollars if they get them to do something before the end of next year.”


The variety of trust mechanisms that customize estate-planning and gift strategies while taking advantage of the current tax rules are extensive.

Generation-skipping trusts allow individuals to put aside funds for grandchildren. Charitable remainder annuity trusts are GRATs in which charities are the beneficiary.

Qualified personal resident trusts can be another source of potential tax savings, Mr. Aulino said. QPERTs enable individuals to make a gift of their homes to descendants on a 10-year term. With housing prices down, any rise in the value of the house during the loan term is free of estate tax.

With all the twists and variations in trust strategies, it's easy for taxpayers and their advisers to take their eye off the ball, said Mr. Scott. The objective is to ensure that people achieve what they want with their estates — not merely that they minimize their taxes.

“Taxes are the tail,” said Mr. Scott. “They are not the dog.”

However, with the most favorable estate tax rules in a generation and a high likelihood that they might change in the near future, wealthy taxpayers and their advisers should be discussing options.

“Anything you don't give away now is subject to estate taxes when you die,” said Laura Twomey, a partner specializing in estate planning at law firm Simpson Thacher & Bartlett LLP. “People may end up looking back and thinking, "could've, would've, should've.'”

Email Andrew Osterland at aosterland@investmentnews.com


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