You can never go wrong with regular reviews and updates of your wealth transfer plans. But the current economic conditions give you a special incentive to review and to act. This economic climate is really an unbelievable opportunity. It's the perfect time to effectively implement a number of wealth transfer techniques. How's that?
Take the long view. Your assets are likely sitting below their recent values. However, it may be likely they will appreciate as the economy recovers and moves into the next cycle of economic expansion. Meanwhile, depressed values minimize the current tax consequences of certain wealth transfer techniques, as do the current low IRS interest rates used to calculate gift taxes on some trusts. The perfect storm of temporarily depressed asset prices and low interest rates presents affluent families with an opportunity for their wealth transfer strategies.
Maximize your generosity
One of the best tax breaks to take full advantage of this year is the annual and lifetime gift tax exclusions. The IRS lets you give $13,000 worth of assets annually to as many people as you choose - and in addition, $1 million throughout your lifetime - without incurring a gift tax. In both cases, look for an asset that is valued low now - such as a piece of rental property or a family business - that may be worth a lot more later. This year, a husband and wife could give to their two married children and four grandchildren gifts valued in total at $208,000. That not only avoids the gift tax, it also removes the value from the giftee's taxable estate.
It is a good time to look at setting up a grantor-retained annuity trust. A GRAT is an irrevocable trust set up for a predesignated period of time - two to three years is typical, though it can cover a longer time period. Assets inside the trust - anything from stocks and bonds to business partnerships and real estate - yield an annuity income to the grantor. At the end of the time period, whatever assets remain in the trust pass on to its beneficiary. When set up correctly, the trust lets the grantor pass on wealth with little or no gift tax, while also, of course, removing the assets from his or her estate and reducing its eventual estate tax burden.
GRATs are made more appealing by IRS assumptions of how assets grow within them. This "7520 rate," or the "hurdle rate," as it's commonly called, is at 2.0% for February 2009 - unusually low compared with historical rates (in November 2007, for instance, the rate was 5%). By calculating the length of the trust, the amount contributed, the 7520 rate, and the value of the annuity payments, the IRS can determine what, if any, gift tax is to be paid on the GRAT's assets.
When structured properly, of course, a GRAT may be able to avoid gift taxes entirely. The current benefit here is that you're presuming the assets inside the trust will grow faster than the IRS's 2% assumption. Coming out of a depressed economic environment, that may be likely. If that happens, the assets left in the GRAT pass to your beneficiaries free of gift taxes and outside of your estate.
A similar technique, which takes advantage of both depressed asset values and low interest rates, is possible through an intentionally defective grantor trust (IDGT). Here, you put money in the trust, which the trust uses to buy assets from your estate. The purchase is typically funded with 10% down payment; the rest is done via a promissory note. The note's interest rate works off an applicable federal rate (AFR), which the IRS provides monthly. For instance, an IDGT with a term of nine years or less uses the midterm rate, 1.65% as of February 2009. If the trust purchases an asset from the grantor's estate that grows more than the amount of money the trust pays out, that growth is not taxable.
Again, it's likely that assets - especially those coming out of a depressed economic climate - are positioned to appreciate at a higher rate than the AFR. For example, if you seed an IDGT with $1 million to buy a $9 million asset, at the current AFR of 1.65% it will pay out $148,500. If the asset is growing at 7.0%, or $630,000 a year, the $481,500 difference between the growth and the AFR-based payout stays in the trust and is returned or passed on - tax-free - when the trust expires.
Think long term
For those able to look past the immediate shock of economic and market volatility, the current situation favors tax-saving estate planning techniques. But it's vital you work closely with your financial planner to find which strategies work best in your current situation and to ensure their proper implementation. At the end of the day, the market turmoil may take an immediate toll on your investments. But with smart planning, a long-term view, and some immediate action, you can turn the situation to your advantage and comfort yourself with the knowledge that you're able to provide for your heirs in the way you have always envisioned.
Talk to your financial planner about:
• Taking full advantage of the annual gift tax exclusion, and how to gift noncash assets like stock portfolios or private business shares
• Reducing your exposure to the estate tax via a grantor-retained annuity trust
• Putting highly appreciating assets into an intentionally defective income trust to help maximize the tax-efficient returns when the economy recovers.
The content of this material was created by Lincoln Financial Advisors for its representatives and their clients CRN 200901-2025711. Any discussion pertaining to taxes in this communication (including attachments) may be part of a promotion or marketing effort. As provided for in government regulations, advice (if any) related to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.