As noted, wills and trusts are the most common estate planning tools, but are far from the only tools. Depending on family dynamics, estate size and composition, a client may also want to engage the following.
FAMILY LIMITED PARTNERSHIPS AND LLC’S
For families that own significant assets such as rental property or operate small businesses can benefit from the use of entities such as family limited partnerships (FLPs) or family limited liability corporations (LLCs). These entities provide several benefits for parents and subsequent generations.
Family business entities provide asset protection for the family’s other assets by shielding those assets from liabilities relating to those held in the FLP or LLC. These entities are also useful for moving wealth from generation to generation. As a bonus, estate and gift taxes can be minimized through the application of valuation discounts. They also allow parents a means of passing on assets in a controlled manner (often times the parents will be the controlling partners or members), while teaching the younger generations management and financial responsibility. FLPs are also effective in protecting the underlying assets from, for instance, divorcing spouses of the younger generations.
FLPs and LLCs that are incorrectly created and/or not properly managed will be disregarded by the government and creditors, so it is important to work with professionals in setting up and running these entities.
Irrevocable trusts (IRTs) are set up by the trustmaker for the benefit of another (usually children), and are often funded with annual exclusion gifts (currently capped out at $14,000 per donor-donee). These assets are removed from the trustmaker’s estate for estate tax purposes, so it may be advantageous to fund these with assets that will appreciate. Properly drafted, these trusts will provide protection from the beneficiary’s creditors. Moreover, these trusts allow the trustmaker to ensure financial stability for the beneficiaries, whose financial management capabilities may be undeveloped or unknown at the time of creation. While an effective tool for avoiding estate taxes, this benefit must be balanced against the lack of a step-up in basis these assets would otherwise receive at the trustmaker’s death.
Grantor trusts (sometimes called intentionally defective grantor trusts or IDGTs) are similar to IRTs, but are drafted in such a way that the trustmaker/grantor is considered the owner for income tax purposes. The trustmaker therefore pays any income due to the trust assets during life, which may be beneficial if the trustmaker is not in the top tax bracket, and the trust is not distributing that income, due to the tax brackets applicable to trusts. At the trustmaker’s death however, the trust assets are not considered to be part of the trustmaker’s estate, and are therefore not subject to estate taxes. As with IRTs, the benefit of estate-tax avoidance must be balanced against the lack of basis step-up.
CRATS and CRUTS
Charitable remainder annuity and unitrusts are valuable as income tax planning tools. They are created by the trustmaker transferring highly appreciated property to the CRAT or CRUT, which names both an individual (usually the trustmaker or a relative) and a charitable beneficiary. The CRAT/CRUT, as a tax exempt entity, can sell the asset without paying capital gains. The trustmaker receives either a set annuity (in the case of a CRAT) or from the trust, or a set percentage from the trust (CRUT) for a fixed period of time. At the end of a set period, the charitable beneficiary receives at least 10% of the initial value of the asset; that amount is deductible to the trustmaker. These can also be set up so that the charity receives the annuity amount first (CLTs), and the private beneficiary (the trustmaker or other person) receives the property at the end of the set period.
Grantor retained annuity trusts (GRATs) are trusts used to make gifts to younger family members without paying gift or estate taxes. The trustmaker (aka grantor) transfers assets to the GRAT and, for a specific amount of time, receives an annuity from the GRAT. At the end of the specified term, if the trustmaker survives the period, the remainder goes to named beneficiaries gift and estate tax free.
Life insurance is not only valuable as an income-replacement tool in the event of the death of the primary income earner, but can also be a powerful wealth transfer tool by providing tax deferred gains. When combined with other tools, such as irrevocable life insurance trusts (ILITs), which remove the policy from the trustmaker’s estate for estate tax purposes, life insurance is a particularly valuable tool to high net worth families.
Retirement benefits can be used to provide a managed stream of income to later beneficiaries by using stretching out required minimum distributions (RMDs). They are also beneficial when rolled over to the surviving spouse (particularly if that spouse is younger), who then can take advantage of their own begin date for RMDs, as well as life expectancy tables which result in lower RMDs.
Qualified personal residence trusts are effective at transferring real property to younger generations without paying estate or gift taxes. Given the relatively high exemption amount for estate taxes, and the increase in income taxes, these trusts are used less frequently but may still be a valuable planning tool depending on your specific circumstances.