Some well-known estate planning techniques are particularly effective in leveraging these new higher exemption amounts into even larger wealth transfers. Last year, there was substantial speculation that the government would curtail the use of the grantor retained annuity trust (GRAT), long a popular vehicle for minimizing gift and estate taxes. This vehicle-which transfers assets to a trust in exchange for an annuity for a set number of years, thus reducing or even eliminating the gift tax-survived unscathed. It remains a very attractive planning tool because of today's historically low interest rates and the upward trending valuations in the financial markets.
Various kinds of sales can also be used effectively, including sales to intentionally defective grantor trusts and private annuities. Similar to GRATs, these strategies allow for continued economic participation in the transferred asset for a period of time while allowing excess appreciation to accrue downstream, free of estate taxes. Like the GRAT, these approaches provide a cash flow hedge to the transferor, which may be called for as a result of the upfront financial planning review.
There are some caveats. Families need to pay close attention to the wording of their estate documents to make sure that these new, higher limits won't have unexpected consequences. For example, many older estate plans divided assets based on set formulas. A person might leave the full exemption amount to the children in order to allow those funds to escape estate tax. But given today's higher exemption limits, someone with a $5 million estate might effectively disinherit his or her spouse by following such a formula.
Any planning must also take into account state taxes, which were not explicitly affected by the new federal law. Many states have some type of gift or estate tax. Exemption rates at the state level are typically lower than those imposed by Uncle Sam. In Massachusetts, for example, there is no gift tax, but the exemption from the state's estate tax is $1 million. This may make it far more advantageous to transfer wealth as a gift rather than after death.
Crafting a good gifting strategy clearly takes time, which is why advisors need to make sure that their clients start considering the possibilities now. No one knows what Congress will do in two years when the current law expires. No one should assume that the $5 million exemption levels will be extended. While clients may yearn for certainty over the direction of future tax laws, those who wish to make significant wealth transfers would be wise to take advantage of today's tax opportunities before they disappear.
Jeffrey R. Arsenault is a partner and senior wealth advisor at New Wealth Advisors, a Boston-area wealth manager. He can be reached at [email protected].