The end of the “stretch” strategy, possible sunset of the Tax Cuts and Jobs Act and opportunities for qualified small business stock offer investors potential savings through trust strategies.
A charitable remainder unitrust or annuity trust could help inherited individual retirement account heirs push back the additional income and accompanying taxes; a non-grantor trust can tap into the tax-free capital gains of up to $10 million for qualifying small business stock; and a grantor retained annuity trust may assist in freezing the value of their estate, according to Aaron White, chief growth officer of Pleasanton, California-based Adero Partners. Earlier this year, he wrote a guide to the many kinds of trusts that could assist high net worth estates.
Two of the strategies for the consideration of financial advisors, tax professionals and their clients come with especially timely components. Implementation of the new rules from the Secure Act obligates most IRA beneficiaries to take required minimum distributions next year and empty the accounts within a decade of inheriting them — a giant shift from being able to stretch the new income out in small portions over their lifetime. And the expiration of many provisions of the 2017 tax law at the end of next year means that more estates could soon face payments to Uncle Sam.
“Every client is going to have different preferences and priorities. When I talk to clients about their financial planning, we want to make sure that they have enough assets to support their lifestyles and potential changes to their lifestyles over time,” White said in an interview. “When they pass, they’ll have to make some choices there as to how their estate is structured.”
White’s guide on Adero’s website includes 16 different wealth transfer strategies, a list of frequently asked questions and states that have specific taxes on estates or gifts, as well as three case studies explaining the applications of the planning methods. “Family governance and communication,” which is an often-tense area of estate planning that’s also euphemistically referred to as “family dynamics,” carries at least as much importance as tax strategies and knowledge of all of the different acronyms.
“Establishing frameworks for managing family assets and making financial decisions is essential in generational estate planning,” White wrote. “This may involve creating family constitutions, establishing family offices and appointing trustees or advisors to oversee the management of assets. Communication and education are also critical components. It can be beneficial to involve family members in discussions about wealth management, financial responsibilities, and the values that guide the family’s legacy.”
For some wealthier clients, the influx of their deceased parent’s IRA may loom large in their overall taxes. Assigning an IRA to a charitable remainder unitrust or a charitable remainder annuity trust with the heir as the beneficiary would remove the applicability of the new 10-year rule and delay that income for as much as 25 or 35 years, according to White. Clients with heavy holdings of highly appreciated stock could use these trusts as a means of spreading out their capital gains over a longer time span, too.
The clients can decide how much of the trust will transfer to the charity of their choice and the amount that will go to their heir. The annuity version provides fixed distributions, while the unitrust enables additional contributions after setting up the trust and payments based on an annual revaluation of the assets. IRS rules state that the trusts have to remove between 5% and 50% of the assets each year.
Savings “from a tax-planning standpoint” stem from “being able to spread that out over multiple decades versus 10 years,” which is especially handy for clients in the top brackets during prime earning years, White said. “They don’t want to take the IRA distribution over the last 10 years of their working careers. They would rather delay it.”
Clients receiving qualified small business stock could use a non-grantor trust that, unlike a grantor entity, gets its own exclusion from capital gains taxes, White noted.
The trusts bring protection from lawsuits and creditors, with a “simple version” that is “required to distribute all annual income to beneficiaries, must retain trust principal and cannot make gifts to charitable organizations” or a “complex” type that “may accumulate income, distribute trust principal and make charitable gifts,” he wrote in the guide. The client who set up the trust gives up control of the assets to an independent trustee, but the entity represents an irrevocable, finished transfer outside of their estate that becomes a separate taxpayer.
For younger holders of startup company stock as founders or early employees or other clients “who are concerned around the future growth in their estate,” a grantor retained annuity trust can remove the appreciation from the equation, White noted.
The short-term entities of two to four years return the contributed assets plus interest to most grantors who can then forward them into a new grantor retained annuity trust. The appreciation flows to the trust’s beneficiary, who can keep those assets in another trust. In the process, the grantor avoids using any portion of their lifetime exemption for gift and estate taxes.
In thinking through the many available strategies, advisors and their clients must decide how much their households will need for the day-to-day and foreseeable future, the extent they expect beneficiaries to find their own sources of income when they grow into adulthood and the level of charitable giving they would like to set aside to chosen causes, according to White.
Each topic and strategy evokes specific questions about their goals and the particular requirements for the underlying trust entity. For example, the grantor retained annuity trust entails legal expenses and repeated valuations that add up — except when compared to the price of a 40% tax haircut on the largest estates, White said.
“There are some costs, certainly, to each time you set up these GRATs,” he said. “The math pencils out pretty well when you consider the long-term benefits for clients and their families.”
Tobias Salinger Chief Correspondent, Financial Planning