By Patrick McDonald
Oct. 3, 2023
The clock is ticking for advisors seeking to shelter the estates of wealthy clients before components of the 2017 Tax Cuts and Jobs Act expire at the end of 2025.
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The TCJA, also known familiarly as the Trump tax cuts, brought significant changes to estate and gift taxes, including the doubling of the lifetime exemption limits. Previously set at $5.6 million for individuals and $11.18 million for couples, the act raised these limits to $11.18 million for individuals and $22.36 million for couples. The exemption has increased annually to keep pace with inflation—this year, the exemption stands at $12.92 million per person and $25.84 million for a married couple.
It is imperative for advisors of wealthy families to set in motion proactive estate planning now to ensure wealth remains safe from tax consequences should these exemptions be lowered or removed—as they will starting Jan. 1, 2026 unless Congress takes action.
Here are some strategies to consider.
Gift a life insurance policy. One option involves gifting a life insurance policy via an irrevocable trust in order to transfer the death benefit to the next generation without incurring estate and income taxes. When the policyholder passes away, the policy proceeds are safeguarded, relieving the beneficiaries from the responsibility of bearing those tax obligations.
Estate taxes can significantly erode the value of an estate. Furthermore, when an individual owns a policy it may be deemed as part of their estate, resulting in the death benefit being subject to income taxes. An irrevocable trust circumvents these issues, allowing the designated beneficiaries to receive the full amount.
Irrevocable trusts also enable greater control and flexibility over how the policy proceeds are distributed to beneficiaries. They can be structured to accommodate specific wishes and to protect the assets from potential risks, including creditor claims. Additionally, they provide the means to oversee the management of proceeds for minor beneficiaries or individuals who may lack the capacity to handle a substantial sum independently.
Fund a SLAT. Spousal lifetime access trusts have gained popularity in the run-up to the expiration of TCJA provisions and are a valuable estate planning strategy for high-net-worth couples. SLATs, categorized as irrevocable trusts, enable one spouse to transfer assets for the benefit of the other spouse and other designated beneficiaries.
As the grantor, the transferring spouse can take advantage of their lifetime gift tax exemption, while the trust can still provide the beneficiary with access to the assets. SLATs are especially advantageous for individuals who wish to leverage a portion of their lifetime exemption at the current favorable level.
When assets are transferred into a SLAT, they are effectively removed from the grantor’s estate, eliminating their exposure to estate taxes. Moreover, the assets held in the trust gain protection from creditors, maintain confidentiality, and can potentially enjoy tax advantages. For instance, SLATs can be customized so that the beneficiary has access to the assets via a distribution of income or capital gains, thus minimizing tax liability.
Prioritize philanthropic planning. Maximizing philanthropic planning strategies over the course of a donor’s life, versus waiting until end-of-life scenarios, provides numerous benefits. By integrating charitable gifts into an estate plan early on, wealthy clients can create a meaningful and enduring philanthropic legacy while optimizing their overall financial and estate planning goals. This approach allows for the prioritization of essential family causes and values, all while taking advantage of tax benefits for the benefit of future heirs.
An effective way to address the limitation on state and local tax deductions—SALT—imposed by the TCJA involves the utilization of donor-advised funds in combination with gifting appreciated securities. Financial planners can help clients to identify securities that have appreciated in value and contribute these securities to a DAF, subsequently securing a tax deduction corresponding to the fair market value of said securities. Within a DAF, contributed funds can grow tax-free until clients recommend grants to specific charitable organizations. With the strategic combination of DAFs and the gifting of appreciated securities, financial advisors empower their clients to optimize their philanthropic contributions, ensuring maximum benefits for society, all while effectively navigating the limitations on state and local tax deductions.
Establish a charitable remainder trust. Advanced planning vehicles such as charitable remainder trusts can help to eliminate or defer income tax on distributions after death via a “pay on death beneficiary” or contingent beneficiary of a client’s IRA or pension. By selecting a CRT as the designated beneficiary, individuals can ensure that their assets pass to the trust upon their death instead of directly to an individual. This allows the CRT to receive the distribution without incurring immediate income tax consequences. Once the assets are held within the trust, they are managed by a trustee who can strategically invest the funds.
CRTs are structured to provide income payments to designated beneficiaries, typically for a specified duration or their entire lifetime. While the income distributions made to beneficiaries from the trust are subject to income tax, this taxation is deferred over time. Since CRTs are tax-exempt entities, the trust itself does not pay income tax on the distributions it receives, potentially increasing the total value of the trust over time.
With the anticipated reduction in the lifetime estate and gift tax exemption looming, this often-overlooked component of financial planning becomes even more crucial. A proactive approach will not only protect family legacies, but solidify the advisor’s role as a trusted partner in navigating the complexities of the changing tax landscape.
This Barron's article was legally licensed by AdvisorStream.
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