A Tremendous Wealth Transfer Opportunity

In our December website update we told you about the changes in the estate tax laws that were passed last year.  There is one aspect of these changes that we thought needs some additional discussion. As we mentioned late last year, the estate tax changes mean many of our clients will need to review their estate planning.         In the tax bill that passed on December 17, 2010, the estate tax exemption was increased from $3.5 million to $5.0 million and the estate tax rate is now 35%. These changes are only effective for 2011 and 2012, so unless Congress acts before the end of 2012, the exemption will revert to $1 million.

For those of you unfamiliar with the estate tax exemption, it is the maximum level of assets that would not be subject to the estate tax.  So if you were to die this year and your total assets at death are under $5 million, you would not be subject to any federal estate tax unless you had already used up some of your exemption (however, you may be subject to state estate tax.)  You use up your exemption by gifting more than the annual gift tax exclusion (currently $13,000 per recipient) in any year.  Until this bill was passed, the gift tax exemption was only $1 million, so lifetime gifts over $1 million would have been subject to gift taxes.  The recent tax bill went back to the old policy of linking the estate tax exemption level to the gift tax exemption level.  This effectively means that you can now gift up to $5 million without paying any gift or generation skipping tax, as long as it is done in the next two years.  Of course, if you have previously used up some of your exemption, the actual amount you can gift will be less than $5 million.  Still, this is a huge increase from the $1 million gift tax exemption we were looking at just last year. 

What does this mean for a wealthy family? Having the opportunity to shift $5 million ($10 million for married couples) of wealth to the next generation can have a significant impact on a family’s financial situation. If you can transfer an asset that has significant appreciation potential, not only are you getting the initial asset value out of your estate, but also all future appreciation. In times of depressed asset values, such a strategy can transfer a lot of future value outside of the wealth transfer tax to future generations.

Trusts are often considered when you are thinking about shifting this kind of wealth to future generations. A trust arrangement can provide a degree of control and protection of these assets from future creditors, bad decisions, and failed marriages. Creating a trust that has future flexibility should be explored as circumstances can change down the road. It is also important to think about when and how future generations should have access to the funds. In the past, many estate planning attorneys would create trusts that distribute principal at certain ages in the future. The thinking behind this was to give beneficiaries access to the principal in the trust only when they were fiscally responsible.  The problem is that some beneficiaries might still be fiscally irresponsible even when they reach their later ages and are eligible to access the additional funds in the trust. You may also want to create the opportunity to keep the assets in trust for future generations, avoiding estate tax for many years.  A current trend is toward permanent trusts that give enough flexibility to access funds or change trustees in the future, if needed.

Of course, before any planning is done, you need to first be confident that your assets are sufficient enough to meet your own needs for the rest of your life. When faced with a choice of dying broke or dying with an estate that is subject to an estate tax, most people would choose the latter.   We often help clients work through a process of analyzing their cash flow needs, potential unexpected expenses (health care, etc.) and the ability of their asset base to meet these needs. For wealthy individuals, their families’ charitable intentions also typically come into play in these discussions. While the increase of the gifting exemption creates a great opportunity for those who have the ability to pass significant wealth on to future generations, your own personal situation is always going to be critical to deciding if this makes sense for you and your family. Let us know if we can help you think through this opportunity.

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