What is wealth transfer planning?
Wealth transfer planning incorporates estate tax planning into your estate planning.
The federal estate tax exemption is set at $5 million for each U.S. citizen or permanent U.S. resident. The amount gets adjusted for inflation and for 2016, the adjusted amount is $5,450,000. That means a married couple can protect a total of $10,900,000 from the federal estate tax.
If you are an individual and your assets exceed the federal estate tax exemption amount, you should consider wealth transfer planning. If you’re married and the assets you own with your spouse exceed your combined federal estate tax exemption amounts, you should consider wealth transfer planning. For estate tax purposes, “assets” means any property that you own or can control or can benefit from. It includes your real estate, bank accounts, investment accounts, retirement assets, business interests, vehicles, boats, club memberships, receivables, and (in many circumstances) life insurance.
With proper wealth transfer planning, you can greatly reduce the impact of the 40% federal estate tax. (California does not have a separate estate tax – though some other states have their own estate or inheritance tax.)
What tools are available for wealth transfer planning?
- Annual giving is one of the most effective and often overlooked wealth transfer planning techniques. Every calendar year, you can give $14,000 to as many people as you want tax-free. If you are married, your spouse can give the same amount to the same people, bringing the amount you can give to each child, child-in-law, grandchild and great-grandchild to $28,000. Simply through consistent annual giving, you can remove millions of dollars from your estate over the years. Some people use their annual gifts to purchase life insurance, increasing each dollar gifted.
- The marital deduction allows you to pass an unlimited amount of assets to or for your spouse, deferring the estate tax on those assets until the spouse’s death. A properly structured marital trust can allow your spouse to benefit from all of your assets during his or her lifetime while ensuring that the assets eventually pass to the people you identify as future beneficiaries. Since 2012, the rules have allowed you to “transfer” your own federal estate tax exemption to your spouse so it can be applied when he or she dies.
- You can transfer assets to an irrevocable trust to remove it from the estate tax calculation altogether. Unlike the trusts used in basic estate planning, transfers to an irrevocable trust cannot be undone, so this technique requires careful analysis. After the transfer, you would have limited control over or use of the assets. Typically, use of the assets transfers to your children (or grandchildren). Your estate tax exemption amount can be applied during your life to these kinds of transfers so they are not taxable.
- Gifts through irrevocable trusts are often not attractive because you lose use of the assets. Estate freeze techniques allow you to retain some use of the assets you want to transfer to your children (or grandchildren). These techniques are complicated. In essence, you retain an interest in some or all of the income the assets generate for your lifetime or for a period of years but the beneficial interest in the principal is transferred to your children (or grandchildren), although they cannot access it during the term of the trust. The value of the transfer is based on today’s value. Future appreciation accrues outside the estate tax calculation and ultimately benefits your children (or grandchildren).
- Gifts through irrevocable trusts and estate freeze techniques should be combined with generation-skipping transfer tax planning (“GST”). The GST tax is a separate 40% tax that applies when you make gifts for your grandchildren or their descendants. Just as you have an exemption against the estate tax, you have an exemption against the GST tax. Your GST tax exemption is also currently $5 million, adjusted for inflation. Proper GST tax planning maximizes the amount of assets you can pass on to your grandchildren or their descendants free of this additional GST tax.
- Charitable planning can be very effective in reducing your estate tax. The rules allow assets you leave to charity to pass outside the estate tax calculation. Straightforward gifts to charity are easy to understand. However, similar to gifts through irrevocable trusts, the usefulness of straightforward gifts to charity is limited because you lose the use of the transferred assets. Split-interest charitable remainder gifts allow you to retain the use of the assets for your lifetime or a period of years while avoiding tax on the principal that will eventually pass to charity. Split-interest charitable lead gifts provide an income stream for charity upfront for a period of years with the principal eventually passing to your children. Lead gifts can provide surprisingly effective wealth transfer outcomes.