Estate planning is an ongoing process, simply because it touches upon some of life’s most emotional financial questions, such as what your children and grandchildren’s future will look like and what kind of legacy you want to leave behind.
It’s always a good idea to update your estate plan periodically, especially after significant changes in your life. But there are also outside forces, such as changes in the tax law, that can make an estate plan obsolete overnight. Estate taxes, which are often a key motivation behind estate planning, always seem to wind up on the negotiating table when legislatures are hammering out budgets, and they’ve been very unpredictable over the last 10 to 15 years. Even “permanent” legislation usually doesn’t last forever. It simply isn’t practical, or cost effective, to revise your documents every time there’s new tax law. The flexibility to adapt to changing circumstances has become increasingly important in designing estate plans.
The federal government, 18 states and the District of Columbia impose some kind of tax on the transfer of assets upon the owner’s death. The federal estate tax exemption has ranged from $2 million to $5.45 million since 2002. The tax was repealed in 2010 and then reinstated in 2011. The exemption was scheduled to drop to $1 million at the end of 2012, but Congress acted at the last minute to prevent that. New developments over the last few years include portability, meaning that a surviving spouse can take over the unused exemption of a deceased spouse, and inflation indexing on the amount of the exemption.
Kathleen Cassidy
While the current estate tax law is not scheduled to sunset, there’s always the chance that Congress will make changes. The 2016 political season underscored how widely positions can vary when it comes to the appropriate exemption and rate of taxation. Hillary Clinton proposed raising the top federal estate tax rate from 40 percent to 65 percent, while Donald Trump pledged to repeal the tax altogether. This article was written prior to the election, but regardless of the winner, there very likely will be debate among lawmakers about the future of the tax in 2017.
State estate taxes have been directly affected by the tumultuous path of the federal estate tax. Currently, the majority of states do not have an estate tax. For many of the states that do, it’s still a work in progress. For example, New York revamped its tax drastically in 2014. New Jersey’s legislature recently voted to repeal its estate tax, beginning on Jan. 1, 2018 (although New Jersey will still have an inheritance tax).
Adapting To Future Changes
While we can’t predict where, or even if, the estate tax law will settle, we can focus on building estate plans that are able to adapt to future legislative changes, as well as changes in the lives of the people involved. A flexible plan can eliminate the need to revise documents every time there’s a change in the law, but it can also make it more palatable for people to execute strategies that require them to give up some measure of access and control. For people who know they want to leave a legacy to their heirs, but who don’t know yet what that legacy should look like, it can also take some of the pressure off decision making.
Ron A. Pac
Clearly, estate planning can be a complex business. A few flexible strategies are outlined below, but please be aware that space does not permit a detailed description of these, or indeed of all the issues that can arise with an individual’s estate plan. Consulting a professional is highly advisable.
A Credit Shelter Trust (also known as a Bypass Trust) is a traditional estate tax strategy to preserve the estate tax exemptions of both spouses by moving assets outside the taxable estate when the first spouse passes away. Many estate plans making this funding happen automatically, but with portability now in effect on a federal level, a surviving spouse does not necessarily need a Credit Shelter Trust to keep the deceased spouse’s exemption. There are still valid reasons why funding the trust may be beneficial, not the least of which is that most states’ exemptions are not portable, but it may be a good idea give the surviving spouse a choice about whether to fund the trust or not, and in what amount.
By making gifts to an irrevocable trust during life, a donor can take advantage of the annual gift tax exclusion (in 2016, $14,000 per year, per beneficiary) and move appreciating assets outside the taxable estate. However, this requires the donor to give up access to, and control over, the gifted assets. The uncertain future of the estate tax presents another hurdle, since it’s hard to predict whether today’s planning will be beneficial under tomorrow’s law. But this type of trust can be drafted for maximum flexibility by some of the methods noted below:
The donor can make his or her spouse a beneficiary of the trust, creating something like a backdoor to the trust assets. The trustee has discretion to distribute assets to the beneficiary-spouse if necessary.
When an estate plan involves giving up access and control over assets, the choice of who should be trustee is a common road block. Many people are reluctant to look beyond the family circle, and rather than considering a professional trustee such as an accountant, attorney, or trust company, they end up doing nothing at all. When a trust agreement contains provisions making it simple to change trustees in the future, it can be much easier to make a decision and execute on a plan.
The donor can retain the right to substitute assets of equal value for the trust assets at any time.
The trust agreement can include provisions allowing the assets to be “decanted,” i.e., poured from the current trust to another with more favorable terms.
The trust agreement can contain provisions allowing parents to delay the ultimate decision about if and when children will have unrestricted ownership of the assets.
Life insurance, held outside the taxable estate in trust, is a common tool to fund estate tax liability. For individuals who may or may not have taxable estate in the future, a simple way to adapt is to establish an irrevocable trust and fund it with convertible term insurance. That allows them to lock in their insurability today for a relatively low cost, and if estate taxes remain a concern, the policy can be converted to permanent insurance in the future.
Kathleen Cassidy, J.D., is an advanced markets director who works in the Wealth Strategies Division of the Barnum Financial Group and can be reached at kcassidy@barnumfg.com; Ron Pac, RICP, is a financial planner with Barnum and can be reached at rpac@barnumfg.com.
