While we may or may not agree with President Donald Trump’s policies, the recent tax reform does allow for an increase of wealth transfer to the next generation for the next 8 years. The estate tax exemption limit has increased from around $5 million to about $11.2 million (the IRS website notes that the adjustment for inflation has not yet been finalized for 2018), set to revert in 2026. The result; we can give now more than we ever could before (except 2010 when there was technically no estate tax!).
With estate taxes having a history of fluctuation (see our estate tax blog), it’s a good idea to give now, while you will not be taxed for anything up to $22.4 million. Here are some ways you or your affluent clients can become part of the free giving movement:
Love and (Irrevocable) Trust
Creating an irrevocable trust permanently removes assets from your estate into the trust.
- Benefits: Using an irrevocable trust means that the estate and gift tax laws in place at the time of the gift will prevail; when you die, it will not be subject to estate tax because it is not part of your estate. Moreover, an irrevocable trust protects you and your beneficiaries from creditors; they can’t touch assets that you do not own.
- Disadvantages: While you get to name the beneficiary(ies) and conditions regarding when/how they will receive the assets, you are no longer the owner of the assets, and you have no further access to the funds.
As a comparison, let’s define a revocable trust. The main difference is that once you place assets into the trust, you still retain control over the assets, so they are not considered separate from your estate. Because of this, anything that you gift to the trust may still be subject to the estate tax laws in effect at the time of your death.
But what if you could have all the pleasure and none of the pain? That is, what if you could gain the benefits of an irrevocable trust (taking advantage of the short-lived estate tax exemption limit increase), while eliminating the disadvantages (loss of liquidity and control over your assets)? There may be a way if you are married. Read on.
How about gifting your spouse half of your combined estate through an irrevocable trust? At the same time, your spouse creates another irrevocable trust and gifts you half of your combined estate. You don’t technically have control over all the assets, but do have control over half. And as long as you and your spouse are in agreement, you can still benefit indirectly from their use of the assets. If the total is under $22.4 million, and it it set up properly, neither trust will be subject to estate taxes.
Give your Gift and Keep It, Too
Well, partially. Let us explain: you can retain some liquidity while still taking advantage of the increased gifting limit by creating an irrevocable trust, having the trust purchase a good-sized life insurance policy on your life, and financing the premiums.
- Benefits: You will have to gift the premium payments to the trust, but even very high premiums will not trigger the lifetime gift tax (which is applied to your estate). Moreover, by financing the premium payments, you will wind up paying the bank a fraction of the premiums, but your beneficiaries get the death benefit tax free.
- Disadvantages: A portion of the death benefit will have to be used to pay back the loan.
There are a few more giving options (via trusts) that allow you to give while retaining some control over the assets during your lifetime. But these options also carry the risk that if you die before the trust expires, the trust assets are returned to your taxable estate.
- Qualified Personal Residence Trust – a type of irrevocable trust in which you gift your home to the QPRT, removing it from your taxable estate. There are several pros and cons.
- Benefits: You take advantage of the current estate tax exemption limit, and you can remain as the resident in the home.
- Disadvantages: It is harder for your beneficiaries to sell a home held within the trust, so it may be best to gift properties that your children do not plan on selling. Also, if the term for this trust expires, and you are still alive, you will have to pay rent to the trust for use of the home. The real risk, however, is that if you die before the trust term expires, it will become part of your taxable estate again.
- Grantor Retained Annuity Trust – An irrevocable trust in which an annuity is paid every year to the person who created the trust, and the beneficiaries receive the remaining assets when the trust expires.
- Benefits: Your gifts to the trust are removed from your taxable estate now while the gift tax exemption is high. You also have some liquidity because you receive a set amount of cash each year.
- Disadvantages: If you die before the term expires, the assets revert back to your taxable estate.
We hope these ideas get you thinking. If you would like our team here at Axia Global to help you determine whether any of these strategies will work for you or you affluent clients, please let us know. It is our goal to make a measurable difference in your financial life.
Note: the statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with your trusted financial advisors and lawyers. For current tax or legal advice, please consult with an accountant or an attorney.