Estate Planning Strategies for 2023 - Reduce Taxes and Preserve Wealth
With a Democratic majority in Congress, the Senate, and control of the presidential seat, significant changes to the country’s current tax structure are likely.
In particular, the estate tax laws passed in 2017 during President Trump's time in office.
In 2023, the exemption is $12,920,000 per individual and $25,840,000 for a married couple. Those tax exemptions are currently set to be reduced about $6,000,000, by 2026. However, with the Democrats in control, we could see a reduction as early as next year. So, how does this impact you?
Quick Article Guide
Here’s what we'll cover in this post:
- High-Net-Worth Individuals Should Take Advantage of the Current Exemption
- Estate Planning Solutions for Shifting Wealth
- What's a Spousal Lifetime Access Trust or SLAT?
- What's a Self-Settled Domestic Asset Protection Trust or DAPT?
- What's a Hybrid Domestic Asset Protection Trust or Hybrid DAPT?
- What's a Special Power of Appointment Trust or SPAT?
- What's a Grantor Retained Annuity Trust or GRAT?
- The Takeaway
High-Net-Worth Individuals Should Take Advantage of the Current Exemption
Because of these potential changes, it may make sense to take advantage of the current estate tax exemption. For example, suppose an affluent single parent wants to leave their child an inheritance of $8,000,000.
If they pass after January 1, 2026, when the estate tax exemption will likely decrease to $6,000,000, their child will owe taxes on $2,000,000, or the amount of the inheritance that exceeds that year’s exemption. However, they can avoid this dilemma if they gift their child $8,000,000 now, while the exemption is set at $12,920,000.
Even if they pass away after 2026, when the estate tax exemption has decreased, the IRS would not “clawback” the $2,000,000 in excess of the current exemption.
To benefit from this strategy, affluent individuals must use the entire exemption now before it decreases. Otherwise, the result is the same as if they had never made the gift since there is no increase in the amount left for the child.
If the parent were to gift their child $4,000,000 now, and leave an additional $4,000,000 to them in 2026, their child will still owe estate taxes on the amount of the inheritance that exceeds that year’s exemption, defeating the purpose of gifting them the money earlier.
What if you need money later, though?
Estate Planning Solutions for Shifting Wealth
Estate planning attorneys have developed several tools to deal with this issue. There are types of trusts that allow one to shift wealth to children or grandchildren while still maintaining access to the funds if needed.
Such trusts include:
- Spousal lifetime access trust (SLATs)–permit each spouse to be a beneficiary of the trust created by the reciprocal spouse.
- Self-settled domestic asset protection trust (DAPTs)–permit access by naming the grantor as a beneficiary.
- Non-self-settled trust (Hybrid DAPTs) –permit access by giving someone a non-fiduciary power to add beneficiaries from a class that includes the grantor.
- Special power of appointment trusts (SPATs) –permit access but avoid self-settled trust status.
- Grantor retained annuity trust (GRATs) –valuable in a low-interest environment.
What's a Spousal Lifetime Access Trust or SLAT?
A Spousal Lifetime Access Trust (SLAT) can provide asset protection from creditors, allow reasonable access to assets, and make use of the estate tax and generation-skipping tax exemptions.
In a SLAT, each spouse creates a trust for the other. As a result, the beneficiary would have access to the trust’s distributions and thus give the grantor spouse access as well.
However, there are two risks with this. One is that if the trusts are not made sufficiently different, the IRS can call it a shame transaction under the Reciprocal Trust Doctrine. The second is that if the SLAT’s beneficiary spouse dies, the grantor spouse loses their indirect access.
To mitigate that risk, the SLAT could be used to purchase life insurance. The SLAT’s grantor becomes a beneficiary of that insurance, thus ensuring access to wealth that would have otherwise been cut off when their spouse passed.
The trust in which the surviving spouse is a beneficiary will collect the death benefit that the surviving spouse and descendants can access. The eventual death benefit will be exempt from income or transfer taxes.
By incorporating insurance provisions, the SLAT can include life insurance trusts (ILIT). Since the SLAT includes other assets, the income earned from those assets can be used to pay the policy premium and avoid the annual gifts and the Crummey powers associated with them. There is no annual gift. Since the trust can cover premiums using its assets, there’s no need to notify the beneficiary.
The SLAT can also include Dynasty Trusts, which can serve as children’s trust and grandchildren’s trust. Because they are not self-settled trusts, SLATs can provide meaningful asset protection from potential claims of creditors. Asset protection alone may be one of the biggest reasons to do estate planning, even for smaller estates.
What's a Self-Settled Domestic Asset Protection Trust or DAPT?
With a self-settled domestic asset protection trust (DAPT), the grantor has been deemed a permissible beneficiary and has the right to access funds within the trust. In other words, the one who establishes the trust (the grantor or settlor) is also the trust beneficiary.
In this trust structure, the grantor must pay taxes on any income the trust generates from assets such as stocks or bonds. However, the assets within the trust are excluded from the grantor’s estate.
DAPTs also include spendthrift clauses limiting the voluntary and involuntary transfer of assets for the beneficiary’s interest. Once the trust structure is defined, an asset protection lawyer will assess the assets and recommend which ones should be included in the transfer of the trust assets.
Every state has a unique statute of limitations to define when the protections start. This timeframe is usually between two to four years after the transferring of the assets to the trust.
Wealthy individuals who have equity in property, stocks and bonds, or large bank accounts might be good candidates for this type of trust since it tends to be more affordable than a business entity or an offshore trust.
It’s important to note that this type of trust is currently not available in every state, only 17. Also, there have been known cases where creditors could poke holes through the protections of this trust, giving this trust some uncertainty.
What's a Hybrid Domestic Asset Protection Trust or Hybrid DAPT?
A hybrid domestic asset protection trust (Hybrid DAPT) is like a traditional DAPT, but the grantor isn’t a current discretionary beneficiary. Instead, the grantor can be added later at the trustee’s discretion.
In other words, the trust is established with the spouse or other dependents as the beneficiaries. Thus, making the Hybrid DAPT a third-party trust by definition and eliminating the possibility of potential creditors chipping away at some of the assets within.
An independent trusted party acting as trustee, but in a nonfiduciary capacity, can be given the power to add beneficiaries to the trust at some point in the future. For example, if the grantor has no spouse or child to share the distribution with, the grantor could be added as a beneficiary.
Alternatively, in 10 years, the trustee could name anyone who is a descendent of the grantor’s grandmother as beneficiary to the trust. Either method makes the grantor a beneficiary who would then have access to a distribution from the trust.
Like a SLAT, incorporating insurance provisions in a DAPT or Hybrid DAPT, such as life insurance trusts (ILIT), can help minimize risk and ensure the grantor is protected after their spouse passes away.
What's a Special Power of Appointment Trust or SPAT?The special power of appointment trust (SPAT) is a trust which can permit access to trust assets without the characterization as a self-settled trust. A self-settled trust comes with potential problems, such as creditor claims and estate tax inclusion.
However, these self-settles trusts are made in an attempt to protect the grantor’s assets. The grantor retains the right to benefits or can be given benefits at the trustee’s discretion. However, a SPAT puts the grantor in the position to expressly provide that he/she cannot be named as a beneficiary of the trust.
The grantor of the trust deems specific individual(s), not the trustee, to act as a non-fiduciary who has a special lifetime power of appointment. Using that position, they can direct the trust’s trustee to make distributions to a class of individuals, including the grantor.
For example, the class could be any descendent of the grantor’s grandmother. So, the grantor can name more than one individual with the power of appointment and then ask one of them to exercise power.
If they say no, the grantor goes to the next unique power holder. A provision could be included that would require that the grantor’s attorney also sign off on the request. The holder of the special powers might then be prevented from naming an antagonistic cousin from being named a beneficiary.
A SPAT may be the most powerful way of protecting the grantor’s interests. It allows the grantor access to their trust assets without running the risk of the assets being subject to claims of creditors or being subject to estate taxes.
What's a Grantor Retained Annuity Trust or GRAT?
With grantor retained annuity trusts (GRATs), a grantor contributes assets to the trusts but maintains the right to receive distributions from the trust’s transferred assets. During this they earn a yield determined by the IRS, otherwise known as the 7520 rate.
When the terms of the trust expire after a few years, the remaining assets will be distributed to the trust beneficiaries. This amount is based on any appreciation and the assumed yield determined by the IRS.
Today, GRATs are typically structured as 2 year rolling GRATs. The grantor gifts an asset and then receives back 50% of the gift plus the imputed 7520 interest rate over the next two years. The grantor starts a new GRAT by gifting each annuity payment into the new GRAT.
By structuring the GRAT in this manner, the value of the gift is zero since the value of the annuity received is equal to the value of the original contribution to the GRAT. Any appreciation above the 7520 rate is left in the GRAT.
For those who own a share in startup companies, or any asset with huge upside potential, you might find GRATs more advantageous. This is because the rate of return for such companies may far exceed the rate of return assumed by the IRS.
In other words, more money will be passed to your heirs without impacting the lifetime estate exception. Under this trust structure, all annuity payments come from the interest the assets earn or as a percentage of the total asset value.
If the grantor dies before the terms of the trust expire, the assets filter back to the estate and are then taxable. With two-year rolling GRATs, the mortality risk is extremely low. The Democrats, however, have long talked about restricting or doing away with GRATs.
Therefore, the opportunity to roll the GRAT may not be there in the future. Today it might be better to do laddered GRATS of 6 years, 8 years, 10 years, and 12 years now, before the GRATs are restricted or outlawed.
With the longer GRATs, there is a greater mortality risk that the grantor dies before the end of the trust. A term life insurance plan would be worth investigating to mitigate the mortality risk.
As can be seen from the discussion, many flexible tools will allow a wealthy individual to have their cake and eat it too. You can retain access to your assets and still avoid onerous estate taxes.
While everything has risks, the biggest risk right now would be to do nothing. No one knows when the tax law changes will occur or what they will be, but changes will likely come.
Keep in mind that you also have conventional methods of reducing costs to your estate. Depending on your choices, you could pursue insurance to help in this as well as mitigate risk. For example, long-term care can be costly. If that might be something you need, you should have adequate long-term care coverage.
There is also life insurance that could help you preserve your estate’s value and provide for estate liquidity. Purchasing adequate insurance coverage, like these options, may give you the peace of mind to make the other steps in the planning process.
Because of each trust’s various features, it’s wise to consult with a professional estate attorney about the best estate planning solution for your needs.
Before choosing, it is also advisable to have a wealth adviser create a forecast to identify how much can be transferred so that one’s lifestyle can be supported even without access to the trust assets. While the trust may provide access to assets, the degree of control will not be the same, so it is vital to be comfortable with the plan.
Summarily, there are two core pillars to any good estate plan: insurance and professionally crafted solutions. Before any transfer is made, one should have adequate liability insurance, long term care coverage, and life insurance to ensure that one has adequate resources after the transfer.
Better planning will require the team effort of the attorney, wealth advisor, and insurance professional. A flexible, robust plan can be the result, no matter what an uncertain future brings.
Our life insurance agency specializes with policies that offer lifetime benefits and fixed rates. We'll compare options from dozens of highly-rated providers to match you with the best coverage for your needs. Call 855-247-9555 to learn more, or use the free calculator to get started.
Louis Lopes, CLU ChFC
Chartered Life Underwriter, Licensed Life and Health Agent
Louis has been in the insurance business for over 30 years. He specializes in “high risk” cases as well as more complex coverages for long term care, disability, and estate planning.