Four Estate and Tax Planning Opportunities in an Uncertain Environment
May 4, 2023
Reprinted with permission from the April 27, 2023 edition of The Legal Intelligencer © 2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
Since 2017, estate planning attorneys have seen a steadily increasing exemption amount and an environment where an increasing number of clients are engaging in long-term, generation-skipping planning. However, we are seemingly again headed for a planning “cliff” on Dec. 31, 2025. The scheduled changes to the current tax laws and the potential for tax law changes prior to the cliff, as was attempted last year by the Biden administration, create ambiguities for clients and challenges for practitioners. Despite this uncertainty, there are planning opportunities for clients in the right situations.
Leverage child IRAs to maximize CRUT investments. The Secure Act, passed in 2019, and the Secure Act 2.0, passed in 2022, made a variety of changes to the rules that apply to Individual Retirement Accounts (IRA). I think it is safe to say that neither the Secure Act nor the Secure Act 2.0 made planning with IRAs any less complicated. One of the most significant changes is that in most instances, children will need to withdraw an inherited IRA over a 10-year period instead of the child’s life expectancy. This accelerated pay-out rate makes planning with accumulation trusts more challenging due to the acceleration of the recognition of taxable income by a beneficiary who benefits from a conduit trust or who directly inherits the IRA.
Clients may want to consider funding a charitable remainder unitrust (CRUT) for a child with an IRA. One of the benefits of a rising interest rate environment is that CRUTs become more attractive, both in terms of the available tax deductions and the ability to stretch the CRUT for the lifetime of the beneficiary as opposed to a term of years. For example, a client may consider a 20-year CRUT or charitable remainder annuity trust (CRAT), which doubles the “stretch” of the IRA and spreads out the income tax recognition of the child for required minimum distributions (RMDs). For example, a $1 million inherited IRA would need to be paid out over 10 years. A 20-year CRUT with a 6% payout would provide a tax deduction of $300,562. If we assume an 8% rate of return on the CRUT’s investments, then the total payments to the beneficiary over 20 years would be $1,957,136.
Funding GRATs with marketable securities. Grantor retained annuity trusts (GRATs) have been a popular planning technique for many years. One of the primary benefits is that the roadmap and rules for establishing a GRAT are set forth in the Internal Revenue Code and the Treasury Regulations. Although GRATs have some drawbacks, such as being inefficient for allocating the generation skipping transfer (GST) exemption and the risk of estate tax inclusion, there is appeal with them in that they do not “push the envelope” like some other techniques and can be used in a repeating manner (rolling GRATs).
GRATs can be funded with marketable or nonmarketable securities. Nonmarketable can be discounted for lack of marketability and lack of control. Using nonmarketable securities, however, will entail the cost of a professional valuation and runs the risk of the IRS challenging that market value or the amount of discounts claimed.
It may be beneficial to consider funding GRATs with marketable securities. Using marketable securities eliminates the risk associated with valuation discounts and avoids the cost of paying for a valuation report. Most valuation reports for nonmarketable securities come in with a discount of between 30-35%. The S&P 500 index opened 2022 at 4,766.18. As of April 4, the index value was 4,097.37, which represents a 14.03% decrease in value. The Nasdaq opened 2022 at 15,732.50 and it closed at 12,115.27 on April 4, which represents a 22.99% decline in value. So, a natural correction in the stock market has produced, without the cost of a valuation report, a discount in value that is almost as significant as a typical valuation discount for a non-marketable security. There may not be as much potential upside as with non-marketable securities that will be sold for a premium during the GRAT term, but using a GRAT with marketable securities can be a low-risk way to “chip away” at estate tax exposure.
Use it or lose it. During the last part of 2021, many clients created spousal lifetime access trusts or other irrevocable trusts to ensure that estate and gift tax exemption was not lost. Estate planning practitioners are eyeing 2025 for another potential mad rush of client planning. However, depending on the results of the 2024 presidential and congressional elections, we could see the end of 2024 being as busy as the end of 2021.
Clients should be encouraged to create new irrevocable trusts well in advance of 2024 and certainly 2025. As we all know, it can be difficult to prepare a meaningful and thoughtful trust agreement in the short amount of time that exists at the end of the year (granted, 2022 was a surprise).
Clients may also consider adding gifts to existing irrevocable trusts. A client could “top off” a previously created spousal trust or could pre-fund life insurance premium payments for an irrevocable life insurance trust (ILIT) to avoid the ongoing need to issue withdrawal notices. If one spouse created a Spousal Trust, now could be the time to create a new spousal trust.
Another possible planning option is to have a GST exempt irrevocable trust purchase the assets of a non-GST exempt GRAT. The purchasing trust may need additional funding to carry out the purchase, although there normally is seller financing. The idea is to freeze the value of the non-exempt GRAT since it will eventually be treated as part of the estate of a beneficiary through a general power of appointment.
Plan for flexibility. Flexible estate planning documents are important for every client no matter the client’s net worth or individual situation. For clients who have trusts, when possible and appropriate, the granting of powers of appointment should be considered. This can include a broader limited power of appointment—for example, including persons other than descendants as permissible appointees. This would allow for the creation of a general power of appointment by an independent party to maximize GST exemption planning at each generational level.
Some clients who had estate tax exposure during 2001-2010 may no longer have that exposure. Those clients often have “disclaimer planning” and may have separately titled assets as a result to create a probate estate for each spouse. Depending on exactly what happens in 2024 and 2025, for these clients practitioners may be able to simplify their plans and jointly title assets. This will be a client-by-client analysis, but for many clients, this type of update could be beneficial.
In addition, some clients have older ILITs from a time when the estate tax exemption was lower. These clients should consider their options with respect to the life insurance policies held in trust. For example, a client may decide to reduce the death benefit to reduce the premiums required to keep the contract in force and to ensure that the life insurance policy stays above water. Other clients may elect to terminate the life insurance policy or exchange it for a new policy. Finally, in the right situations a sale of the policy may make sense. Generally speaking, the trustee of the ILIT should obtain an in-force illustration every one to two years to assess the policies performance and longevity. Any decisions with respect to whether a policy should be modified or terminated should be made in consultation with a client’s financial adviser.
An ever-changing landscape. The last 21 years of my estate planning practice have seemed like a roller coaster ride. When I began in 2002, the exemption was $1,000,000 and the top tax rate was 50%. The GST exemption and estate tax exemption were different amounts at that time. For the most part, the changes to the tax laws over the last 21 years have been favorable, but the seemingly constant uncertainty can make planning difficult. Each client’s situation is unique and should be treated as such. The best we can do is take advantage of the current law and incorporate as much flexibility as possible into plans to best equip our clients and their descendants for their futures.
Vance Antonacci leads the estate planning practice at McNees Wallace & Nurick and serves clients from Lancaster. He has 21 years of experience in estate planning, business succession planning and estate and trust administration. Vance can be reached at firstname.lastname@example.org or 717-581-3701.