The COVID-19 virus, or Coronavirus, has thrown the world in to a tailspin. Businesses have closed their doors, once crowded streets are deserted and people are self-isolating in their homes. During this crisis, there are certain estate planning documents that everyone should have in place. There are also more sophisticated transfer tax planning techniques that clients can take advantage of in the current economic environment.
Basic Estate Planning Documents
In addition to a Will, every adult should have Powers of Attorney and a HIPAA release form. There are two types of Powers of Attorney: (i) a Durable General Power of Attorney; and (ii) and Health Care Power of Attorney. The Durable General Power of Attorney lets an individual (the “principal”) name an agent to handle the principal’s financial affairs. Generally, the agent’s authority is effective immediately, but a Durable General Power of Attorney can be structured so that the agent’s authority does not come in to effect until a triggering event, e.g. the principal is determined to be incompetent. The agent’s authority under a Durable General Power of Attorney is generally broad, including the authority to make gifts, pay bills, manage accounts, and even change beneficiary designations on retirement accounts or life insurance. Of course, these powers can be tailored as the principal wishes.
The second type of power of attorney (and perhaps the more important of the two in these times) is a Health Care Power of Attorney. In this document, the principal can name an agent to make health care decisions, including end-of-life decisions. The agent’s authority does not come in to effect unless the principal is unable to make his or her own decisions. Having a Health Care Power of Attorney, especially one with the principal’s end-of-life decisions laid out, will lessen the burden on loved ones who may be called to make those difficult decisions. The principal should give a copy of his Health Care Power of Attorney to his agent(s) and to his primary care physician.
The HIPAA form will allow a principal’s health care agent, and any other person designated by the principal, to access the principal’s protected health information.
This is also a good time to review one’s beneficiary designations on retirement assets and life insurance. Remember, those designations will trump the provisions in a Will, so it is important to make sure they are properly filled out and in keeping with an individual’s estate plan.
Transfer Tax Planning
- Intra-family Gifts
In 2020, each American can pass $11.58 million, either by way of lifetime gifts or testamentary transfers, without the imposition of a gift or estate tax. We call that $11.58 million the “Exemption Amount” because it is the amount that is exempted from transfer tax. On January 1, 2026, the Exemption Amount will automatically be cut in half with clients able to transfer only about $6 million free of transfer tax. Clients with taxable estates are in a “use it or lose” it situation and should take advantage of the increased Exemption Amount while we have it.
With market conditions so volatile, now may be the time to transfer assets to children, taking advantage of lower valuations. If a client transfers an asset to a family member at a depressed value, when the market rebounds, that appreciation will be out of the client’s estate for transfer tax purposes. In other words, if a client transfers and asset valued at $1 million today, he will use $1 million of his Exemption Amount. If at the client’s death, and after economic conditions improve, that asset is valued at $2 million, the client has effectively removed $1 million of appreciation from his taxable estate.
- Spousal Lifetime Access Trust
For couples that may want to make gifts but not actually part with that much wealth, a spousal lifetime access trust (“SLAT”) may be the solution. In this trust, the grantor would make a large gift to a trust for spouse and children. The spouse could be Trustee of the SLAT, make distributions to herself or himself for health, maintenance and support and make discretionary distributions to children. As long as the couple is together, the grantor will still indirectly have the benefit of the funds. Again, depressed values make this an appealing technique and as with an outright gift, post-gift appreciate is removed from the grantor’s taxable estate.
- Sale to Intentionally Defective Grantor Trust
The applicable federal rate in April for loans with terms of 9 years or more is 1.44%. that rate is less than 1% for loan terms of 8 years or less. In this low interest rate environment, sales of assets to junior family members, or trusts for their benefit, may be very appealing. These transactions serve to “freeze” the value of the asset in the transferor’s estate by replacing the asset, which itself may have a depressed value, with a promissory note of equal value. If rate of appreciation of the assets after the transfer is greater than the nominal interest rate charged, the transfer has been successful and the transferor has removed the appreciation of that asset from his taxable estate. We commonly use these sale techniques along with grantor trusts. With a grantor trust the transferor is treated as the owner of the trust assets for income tax purposes, but not estate tax purposes. That means that if the client sells the assets to a grantor trust in return for a promissory note, the trust’s interest payments to the client are not taxable income to the client.
- Grantor Retained Annuity Trusts
Another technique that may prove successful in this low interest rate environment is the use of a Grantor Retained Annuity Trust (a "GRAT"). This allows a client to transfer assets into a GRAT while retaining a right to receive, over a term of years, an annuity stream from the trust. When the term expires, the balance of the assets held in the GRAT pass to the client’s intended beneficiaries (or trusts for their benefit). It is possible to structure the transaction so that the client uses none of his available Exemption Amount. This is done by making sure that the annuity back to the client is as close as possible in value to the assets transferred. To calculate the annuity stream back to the client, the IRS uses an assumed rate of return (commonly known as the 7520 rate). The current 7520 rate is 1.2%. Therefore, if a client retains the right to receive an annuity stream from the GRAT equal to the value of the assets transferred plus a 1.2% rate of return, any assets remaining in the Trust at the end of the term, will pass to the client’s intended beneficiaries transfer tax free. If the transferred assets appreciate over the 1.2% hurdle rate the GRAT has been successful and the appreciation is excluded from the client’s taxable estate.
- Charitable Lead Annuity Trusts
If clients have charitable inclinations, they may want to consider a Charitable Lead Annuity Trust (a "CLAT"). This technique is similar to a GRAT in that the client/grantor transfers assets to a trust and designates a charity to receive an annuity for a term of years. At the end of the CLAT term, the remaining assets pass to beneficiaries of the client’s choosing. The grantor makes a gift of the remaining assets to the beneficiaries and the value of that gift is determined by subtracting the value of the annuity the charity receives from the value of the assets at the time the CLAT is funded.
In these unprecedented times, everyone should review their estate plan, make sure they have the necessary Powers of Attorney in place and ensure that their beneficiary designations are complete and in keeping with their wishes. Additionally, clients with taxable estates may use this time of market volatility and depressed rates to engage in more advanced estate planning techniques which may mitigate or even eliminate a future estate tax liability.