Estate planners need to assess their clients' trust strategies as the expiration date on key Tax Cuts and Jobs Act provisions draws nearer, advisors say.
Tax breaks for estates that were part of the Tax Cuts and Jobs Act of seven years ago will end at the close of next year unless Congress says otherwise, meaning the estate tax exemption could be halved from its current $13.61 million for an individual in December 2025, with amounts exceeding that incurring the 40% estate tax.
One way to protect assets against such a change is through trusts, advisors said.
“Clients can spend it during their lifetime, gift to family, gift to charity or pay gift and estate taxes. Our goal is to disinherit Uncle Sam, and our clients tend to agree,” said Aaron White, chief growth officer and wealth advisor with Adero Partners in California's Bay Area.
Getting clients to consider trusts sometimes requires some prodding by advisors.
“Wealthy clients might know about trusts in the abstract but don’t know the details. Many clients are suspicious of trusts because they don’t understand how they work and are scared of losing control,” said Azriel J. Baer, trusts and estates partner at Farrell Fritz in New York.
Properly drawn up trusts can provide both control (particularly in terms of picking the right trustee) and tax savings, as well as creditor protection for beneficiaries, advisors say.
For example, “a revocable living trust is not of public record, which could limit potential lawsuits that typically arise after someone’s last will and testament is made public during the probate process,” said Pamela Dennett, a partner in private client services at Eisner Advisory Group in Dallas.
One way to avoid probate is to create such a trust and transfer assets to the trust during the client's lifetime, Dennett said. “The person creating the revocable trust continues to have full access and control over the assets and the trust is disregarded for income tax purposes. When the creator of the trust [dies], assets are transferred to the trust beneficiaries without having to deal with the probate court system,” she said.
A qualified terminable interest property trust (QTIP) can hold different assets, including cash, stocks, bonds, real estate or business interests, said Megan Slatter, wealth advisor at Crewe Advisors in Salt Lake City. “Your spouse gets all the income from the trust for life [and] the leftover assets go to the people you picked. It also helps delay estate taxes until your spouse is gone, using the marital deduction,” she said.
Irrevocable life insurance trusts remove policy proceeds from an insured’s estate, said Andrew J. Mescon, CEO of Ballast Rock Private Wealth in San Diego. “Affluent couples sometimes use life insurance to minimize income tax later in life. When structured correctly, these types of policies can provide streams of tax-free income, in perpetuity, for the surviving spouse,” he said.
“Permanent life insurance policies accumulate cash value over time. This cash value grows tax-deferred and can eventually be borrowed against by the insured,” Mescon said. “These loans are typically tax-free because they aren’t considered distributions. Depending on the type of policy you use—indexed universal life, for example—it’s possible for these income streams to last throughout the insured’s life.”
With an “ILIT,” an irrevocable trust primarily designed to own life insurance, “an individual can either transfer an existing policy to an ILIT or sufficient cash for the trustee to purchase a new or existing insurance policy,” Baer said. “An ILIT is a good tool to leverage the death benefit of life insurance so that the policy proceeds are available to the beneficiaries without incurring estate tax.”
For younger clients, White’s firm likes grantor retained annuity trusts (GRATs), which return some or all the contributed value plus interest to the grantor and transfers appreciation outside the estate. To be successful, a GRAT does need significant growth in the first few years.
At the end of the term, the GRAT distributes the remaining assets to an irrevocable trust for beneficiaries, or outright free of any trust. “If growth doesn’t materialize, returned assets can be contributed to a series of new GRATs,” White said.
“For gift tax purposes, only the value of the remainder interest in a GRAT is considered a taxable gift,” Baer said. “One popular technique is to structure the GRAT so that it’s ‘zeroed out’ [so] no gift tax exemption is used.”