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April 14, 2020

Estate Planning in the Time of COVID-19

Please read important disclosures HERE.

The escalating COVID-19 pandemic has many of us thinking about the health and wellness of our families. While many individuals may have a basic estate plan in place, that estate plan may need updates or revisions. For others who do not have legal estate documents, now is a good time to focus on getting documents prepared. In addition, for those who are interested, challenging times create some unique opportunities in wealth transfer planning.

The following are some estate planning topics upon which to focus:

1. Review Basic Estate Planning Documents

Review current estate plans to ensure that the basic documents (wills, revocable trusts, durable powers of attorney, advanced healthcare directives, and beneficiary designations) are in order and reflect your current wishes.

Assess your choices for who will act on your behalf if you are unable to manage your healthcare or your financial affairs in the event you become incapacitated or pass away and who will care for minor children. If appropriate, reevaluate the individuals and charities you’ve chosen to inherit your assets and how those inheritances have been structured.

If the documents need revisions, focus on your current wishes and remember that documents can be changed in the future. Put your documents in a safe place and let someone know where the documents are located.

2. Track Personal, Financial, and Other Important Data

Track personal, financial, and other important data in one place. Having all of the information that a family member or other designated person will need readily available in the event of incapacity or death will be greatly appreciated. There are a variety of ways to assemble your personal and financial information: checklists, spreadsheets, or preprinted forms.

3. Explore Wealth Transfer Strategies

Lower estate and gift tax exemptions are currently scheduled to become effective in 2026. It is also possible that the November election may bring a change in administration and a change in the gift and estate tax laws.

Some of the most successful estate plans I have helped orchestrate came out of estate planning and wealth transfer strategies undertaken during the 2008 financial crisis. Currently, lower financial markets, depressed asset values, and low interest rates present significant opportunities to transfer wealth to intended beneficiaries.

The following are some wealth transfer techniques to consider:

a. Tax-Free and Taxable Gifting

Dips in the market trigger lifetime gifting opportunities. The annual tax-free gift exclusion of $15,000 per person per year does not count against one’s lifetime gift tax exclusion. Since the amount of the gift is measured at its current fair market value, gifting marketable securities now when valuations are down offers some extra mileage, because those gifts will offer greater value to recipients as valuations recover in the future.

The same philosophy holds true for larger taxable gifts. Gifts of assets with lower valuations will allow a greater amount of one’s lifetime exemption to remain available to offset estate taxes at death. Given the likelihood that the current high estate and gift exemptions will revert to lower amounts in 2026, and with a current estate tax rate of 40%, maximizing the estate tax exemption will be of utmost importance.

b. Grantor Retained Annuity Trusts (GRATs)

GRATs are financial vehicles used to leverage the gift tax exclusion amount. GRATs are often structured to use very little, if any, of the gift tax exclusion and are typically designed to transfer excess investment return without additional gift tax. GRATS are generally more powerful in a low interest rate environment.

In a GRAT, the grantor transfers assets to an irrevocable trust and retains an annuity payment for a certain term of years. The retained interest reduces the value of the remainder gift to the beneficiaries who are typically family members. To the extent that the assets inside the GRAT appreciate at a rate in excess of the interest rate used to calculate the value of the remainder at the time of the gift, the excess appreciation is transferred tax-free to the remainder beneficiaries. The applicable rate (known as the IRC section 7520 rate) in April 2020 is 1.2%, compared to 3.0% in April 2019, making GRATs particularly effective at this time.

For existing GRATs that may have declined significantly in value, there is generally an opportunity to swap out the assets in the GRAT and restart the GRAT from a lower funding value.

c. Intra-Family Transactions

i. New Intra-Family Loans or Refinancing Existing Loans

If family members are in need of funds, a loan may be a good way to help them. Intra-family loans can be made at below-market interest rates provided each month by the IRS. For April 2020, the rates are just 0.91% for loans of three years or less, 0.99% for loans of more than three years but less than nine years, and 1.44% for loans of more than nine years.

If done properly, existing loans at higher interest rates can also be refinanced at the lower rates. Loan documents must be properly drafted and the interest on the loan is taxable to the lender.

ii. Sales to Grantor Trusts

A grantor trust is a trust deemed to be owned by the grantor so that any sales of assets by the grantor to the trust are not subject to income tax. The transaction is deemed a sale by oneself to oneself. For example, parents can sell assets to a grantor trust for a child without triggering a recognition of gain. The sale can be for a promissory note, with interest payable at the minimum rates required by the below-market loan rules. To avoid an argument by the IRS that the trust is not a creditworthy borrower, it is generally recommended that a taxable gift of about 10% of the value of the asset to be purchased be contributed to the trust upon formation. The remainder of the sales price covered by the promissory note does not use additional gift tax exemption.

The sales price of the asset is determined by an appraisal and the grantor continues to pay the income taxes on the income generated in the trust. The payment of income taxes is also not deemed an additional gift. The value of the asset included in the grantor’s estate for estate tax purposes is the remaining balance owed on the promissory note and not the value of the asset held by the trust.

With current lower valuations and lower interest rates, this technique has the potential of unprecedented wealth transfer.

iii. Roth Conversions

Owners of traditional IRAs will likely be looking at higher income tax rates applied to both principal and growth when withdrawals from the IRAs are made in the future. On the other hand, distributions from a Roth IRA account are free of income tax.

Given that most IRA values are currently lower than they were a few months ago, making a Roth conversion and opting to pay the tax bill now, will allow the future recovery growth to go untaxed.

Roth IRAs are also not subject to required minimum distribution rules. Further, the recently passed Secure Act eliminated stretch IRAs for most beneficiaries. Instead, most IRAs inherited by non-spouses must be fully distributed within 10 years from the owner’s date of death. Converting a traditional IRA to a Roth IRA at this time will also help heirs avoid higher taxes down the road.

iv. Charitable Lead Annuity Trusts (CLATs)

In a CLAT, the grantor transfers specific assets to a trust in which a charity receives an annuity stream for a certain term of years, and at the termination of the trust, any remaining assets pass to the remainder beneficiaries.

The value of the annuity passing to the charity is affected by the IRC section 7520 rate. A lower 7520 rate means a higher present value of the annuity passing to the charity and a lower current value of the assets expected to pass to the remainder beneficiaries. For gift tax purposes, the taxable gift is the actuarial amount expected to pass to the remainder beneficiaries. Similar to the other strategies discussed herein, using this technique when asset values are depressed and interest rates are lower may result in more assets passing to beneficiaries.

Now Is the Time to Plan

With additional flexibility in current work and life schedules and perhaps the time to focus on other things, now is a good time to reach out to your current estate planning attorney or interview a new one and move estate planning up a few notches on your to-do list. Attorneys are working from home and most have the ability to “meet” with clients over the phone or the internet.

If you are interested in learning more about any of the techniques addressed above, please contact your B|O|S wealth management team to review your financial situation.

Filed under: Financial Planning

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