Transferring Wealth After the Tax Reform Act

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The new tax reform that was signed into law in December, 2017, made important changes that will affect estate planning and wealth transfer strategies for many individuals and families. Here are some of these changes and how they might impact you and your family.

Estate and Gift Tax Exclusion Doubled

The main provision of the tax reform that affects wealth transfer strategies is the doubling of the estate and gift tax exclusion from $5 million to $10 million, indexed for inflation. This applies to the estates of those who die, generation-skipping transfers, and gifts made between the start of 2018 and the end of 2025.

In 2018, due to the inflation indexing, the exclusion amount will be $11.18 million per person, or $22. million for a married couple. While the estate tax wasn’t repealed outright, only the wealthiest individuals and families will be subject to the estate tax between now and 2026. According to one estimate, just 1,800 estates will have to pay the estate tax this year, which is down from about 5,000 estates last year.

Also note that in addition to the doubling of the estate and gift tax exclusion, the annual exclusion amount for gifts has been increased from $14,000 to $15,000 per donor. This change is due to inflation adjustments, not the tax reform act.

Strategies for the Rest of Us

If you’re not one of these 1,800 wealthy families, then what should you be doing now from an estate planning and wealth transfer perspective? Here are a few suggestions based on the size of your estate:

  • If you and your spouse’s combined assets are less than $5 million, you may want to address whether your assets will be left outright to the surviving spouse or left in a trust. Also, when the second spouse passes, will the assets of your estate receive a second step-up in basis when the combined estate transfers to the next generation?
  • If you and your spouse’s combined assets are valued at between $5 million and $11 million dollars, you could use outright gifts to a surviving spouse with disclaimer planning to make use of the first spouse’s increased annual exclusion amount (as noted above). This will give you flexibility in case the doubled gift and estate tax exclusion sunsets back to $5 million (indexed for inflation) after 2025.
  • If you and your spouse’s combined assets are valued at between $11 million and $22 million, think about following the suggestions in the previous paragraph. Also consider making use of the doubled gift tax exclusion that’s available through 2025.

Flexibility is Key

Given the uncertainty about whether the increased exclusion amount will sunset after 2025, it’s critical to build flexibility into your wealth transfer strategies and trust arrangements. This is especially true if the value of your estate falls in the $5 million to $22 million range — because estates of this size fall in the “gray area” that could be most impacted if the exclusion amounts do sunset.

Some ways to do this are to use nontaxable powers of appointment, provide broad distribution standards by independent trustees, grant substitution powers to the estate settlor, and provide special modification powers to trust protectors.

Estate transfer and “freeze” planning also remains important even if the size of your estate is well below the new exclusion amounts. This will provide creditor protection while also helping you move some of your assets downstream during your life — a strategy that’s becoming more common due to longer life expectancies and delayed inheritances. It can also transfer wealth to family members in lower tax brackets.

Impact of Rising Interest Rates

In light of the current rising interest rate environment, it’s also important to consider how higher interest rates could affect your estate planning and wealth transfer strategies — specifically, a higher discount or “hurdle” rate.

The hurdle rate — or in IRS lingo, the IRC Section 7520 rate — applies to several different kinds of trusts that are commonly used in estate planning. Set on a monthly basis at 120% of the mid-term applicable federal rate (AFR), it is used by the IRS to discount present values, annuities or future interests in the following types of trusts:

  • Qualified Personal Residence Trust (QPRT) — A high 7520 rate is generally preferable for QPRTs because this will result in a higher retained value of the grantor’s use of the property for the trust term and a lower gift amount.
  • Grantor Retained Annuity Trust (GRAT) — A low 7520 rate is generally preferable for GRATs because asset appreciation in excess of this rate is shifted to remainder beneficiaries without transfer tax costs.
  • Charitable Giving (including partial interest charitable gifts) — A low 7520 rate could be preferable for a Charitable Lead Annuity Trust (CLAT) or Unitrust (CLUT), relinquishment of an income interest in a Charitable Remainder Trust (CRT), or even a charitable gift annuity.

Complex Details Require Expert Assistance

The details of estate planning and wealth transfer can be complex, but seeking trust and estate planning expertise before devising your own strategies can go a long way in ensuring that your transfer of wealth goes the way you want.

To learn more about taxes and how they fit into your overall financial strategy, download our free Personal Capital Tax Guide for Holistic Planning.

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The information and content provided herein is general in nature and is for informational purposes only. It is not intended and should not be construed as a specific recommendation, or legal, tax or investment advice, or a legal opinion. Individuals should contact their own professional tax advisors or other professional to help answer questions about specific situations or needs prior to taking action based on this information. Tax laws and authorities are subject to change, either prospectively or retroactively, and any subsequent change could have a material impact on your situation. To comply with U.S. Treasury Regulations, in particular IRS Circular 230, we also inform you that, unless expressly stated otherwise, the information contained in this communication is not intended to and cannot be used to avoid IRS penalties, and is provided to support the marketing of our services.

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Jason Largey

Jason Largey

As Personal Capital’s senior estate planning strategist, Jason applies his estate planning experience that he gained from his legal career as an Air Force JAG Attorney, through civilian law practice helping families and business owners with their estate plans, and as a wealth and estate strategist in the financial services industry. Jason collaborates with Personal Capital clients to identify their current intentions and long-term goals, empowering them to make informed decisions when meeting with an estate attorney to create or revise their estate plans.

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