One goal of estate planning is to bring some certainty to a multitude of variables. Recent increases in inflation, interest rates, and market volatility, however, are causing some experts to reassess their options.
“These past several years, estate planners have been working in a low-interest-rate environment that negated many estate planning opportunities,” says Lawrence Richman, a partner at Neal, Gerber & Eisenberg in Chicago and chair of its private wealth services practice group. But in “today’s inflationary environment,” he says, certain planning techniques “can be actively considered.”
Here’s a partial list.
Inflation
To some, the impact of rising inflation can’t be overstated.
“Inflation is a huge estate planning factor,” says Steven J. Schacter, an attorney at Forest Hills Financial Group in Chappaqua, N.Y. It affects projections of the future value of assets, he says, as well as the length of time it may take for assets to reach a particular value.
What’s more, if inflation changes the real value of an estate, it can also change the taxes due on distributions. “In order to properly execute an estate plan, it is crucial to know the value of an individual’s assets and how the value may change over time,” says James P. Daniels, a managing director at UHY Advisors in Albany, N.Y.
It may also become necessary, he says, “to determine an estate’s liquidity to more accurately measure the ability to pay estate taxes.”
Gifting And Estate Taxes
But inflation can also affect how much you can give away in life or bequeath after death without paying federal taxes on those asset transfers. The exemption levels rise with inflation every January 1.
“Inflation will be causing the federal estate- and gift-tax exemptions to increase significantly this upcoming January, which will give our wealthy clients who have used their annual gift-tax exemption another opportunity to make a large gift next year,” says Steven J. Oshins, a partner at the Law Offices of Oshins & Associates in Las Vegas. “Knowing that our clients will have so much more in exemptions next year, I have been able to plan for this by suggesting [they] make additional gifts in January.”
For 2022, the annual exclusion for gifts—other than for medical or educational purposes—is $16,000 per donor; you may give that amount to as many recipients as you wish. But any gifts over that amount count toward your lifetime exemption, which is currently $12.06 million. The lifetime exemption works jointly with the estate tax exemption amount; it covers transfers given through your estate as well.
Real Inflation Vs. Government Estimates
Yet the amount by which these limits are adjusted every January is determined by federal inflation estimates, which aren’t always accurate.
“If ‘real’ inflation exceeds the government numbers, it is possible that an estate could become taxable due to inflation alone,” cautions Steven Podnos, a physician and certified financial planner at Wealth Care, a fee-only RIA in Cocoa Beach, Fla.
Another caveat: After the 2017 Tax Cuts and Jobs Act, the exemption amounts doubled, a provision that’s set to expire in 2025 unless Congress acts before then.
“In 2026, the lifetime exemption amount will revert [to its old level], or perhaps even lower,” says Tyler Sterk, a wealth advisor at Kayne Anderson Rudnick in Los Angeles. “Luckily, if you make a gift today that exceeds [the future exemption level], you will still secure your current lifetime exemption.”
Landon Rogers, a wealth advisor at Gratus Capital in Atlanta, concurs. “It’s a great time to lock in historically high exemptions before the 2025 sunset,” he says.
Interest Rates
Others argue that inflation should be kept in perspective. “Inflation has little impact on estate planning, which by its very nature is a long-term endeavor not subject to trade-like activity,” says Jeffrey R. Lauterbach, an attorney and wealth advisor in Chadds Ford, Pa.
Lauterbach concedes, however, that inflation is often tied to interest rates, and interest rates do matter. When interest rates rise, he says, “some strategies become more advantageous and others fall out of favor.”
Charitable Remainder Trusts
For example, he says that charitable remainder trusts are “a better deal today” because of rising interest rates. With these instruments, your initial donation to the trust is partially tax-deductible and any income generated by the trust is tax exempt. The trust, which is irrevocable, then distributes income to the grantor or other beneficiary for a specified amount of time—after which, the remainder is donated to charity.
A primary reason for using charitable remainder trusts is to reduce taxes; the deduction you receive for putting in funds is partly based on prevailing interest rates.
“As interest rates increase, the value of the charity’s interest increases, which means that a larger income-tax deduction will be available,” says Jennifer Junker, chief fiduciary office at Arden Trust Company in Atlanta.
GRATs And QPRTs
At the same time, planning techniques that rely on declining interest rates become less advantageous. For instance, grantor-retained annuity trusts (GRATs) and qualified personal residence trusts (QPRTs).
GRATs allow clients to lock assets in an irrevocable trust for a set period of time, during which they can draw an annual income from them at an interest-rate-dependent amount set by the IRS. When the term expires, any appreciation of the original assets, minus the payout rate, passes to heirs with little or no gift taxes.
Similarly, qualified personal residence trusts allow users to lock away the value of a personal home in an irrevocable trust for a period of time. The grantor can remain in the home during that time and keep partial interest in its value. Afterward, the rest of the value, as determined by the IRS, is transferred to heirs. The goal is to remove a family mansion from the estate, and thus decrease the gift tax that would be incurred by otherwise transferring the asset. But if the grantor happens to die before the trust expires, the plan fails. The value is included in the estate and taxed with it.
Both options “use a monthly declared IRS interest rate to calculate the tax consequences,” says Steve Parrish, an attorney and co-director of the Retirement Income Center at the American College of Financial Services in King of Prussia, Pa. “The particular month’s interest rate will continue to apply to the transaction for years to come.”
So the recent hike in interest rates “can significantly erode the tax savings advantage” of these strategies, says Parrish.
SLATs
For those who are uncomfortable locking up or giving away assets they may need later, another option is a spousal lifetime access trust (SLAT).
“A SLAT is an irrevocable trust that has the grantor’s spouse and descendants as discretionary beneficiaries,” explains Jere Doyle, senior vice president and senior wealth strategist at BNY Mellon Wealth Management in Boston.
The transfer of assets into this trust counts toward gift- and estate-tax exclusions. The difference is, if you later need the assets, the trustee of the SLAT can make a “discretionary distribution” to the donor’s spouse, as long as the couple is still married and the spouse is still alive. (These non-donor spouses can actually be the trustees themselves and thus distribute to themselves.) In this way, says Doyle, “the grantor has indirect access to the assets.”
Moreover, if the grantor dies, the assets in the SLAT don’t count as part of the estate and are not subject to federal estate tax. If the non-donor spouse dies first, though, the trust is automatically terminated and the assets pass to the children or other contingent beneficiaries.
Market Volatility
Recent huge swings in equity markets can add further confusion to estate planning.
“Market volatility is a double-edged sword,” says Michael Kazakewich, a partner and chief planning officer at Coastal Bridge Advisors in Westport, Conn.
Declining portfolio values make clients nervous; they may become reluctant to make gifts or fund trusts that would otherwise be advantageous, says Kazakewich.
On the other hand, any transfers of stock that they do make will use up less of the gift- and estate-tax exemptions. “When the asset values subsequently increase, the appreciation will be out of the donor’s estate and will have been successfully transferred to the lower generation,” says Doyle.