It is estimated that $16 Trillion (yes, you read that correctly, Trillion with a “T”) will pass from the Baby Boomer generation and their parents to younger generations that include millennials.
Accenture postulates that “At the peak, between 2031 and 2045, 10% of total wealth in the United States will be changing hands every five years. This is a massive amount of wealth being transferred to a younger generation. The percentage of this generation that has retirement accounts is historically low and of those in the generation that do have retirement accounts, it is estimated by UBS Investor Watch that 25% of them have already had to dip into them. This makes planning for the transfer of wealth to this generation even more important to ensure that the maximum value of all assets is retained by the recipients.
There are many different types of trusts that can be used to reach estate planning goals and objectives, but when transferring larger sums of money and assets into trusts all at one time, you can run into gift liability. This can be resolved through things like a Crummey Power or a 5 by 5 power, but every estate is different and other trusts and strategies may need to be put into place.
A simple strategy that is often put into place is to establish a special type of trust knows as an Intentionally Defective Grantor Trust or IDGT. The IDG is an irrevocable trust that has been designed so that any assets or funds put into the trust are not taxable to the grantor for gift, estate, generation skipping transfer tax or trust purposes. It is important to note that the grantor of the trust must pay income tax on any revenue generated by the trust, but, since the income tax is paid annually, the assets in the trust are allowed to grow tax free and avoid gift taxation to the grantor’s beneficiaries. One just needs to be sure the assets are sold at fair market value.
The type of assets that are placed into the trust is obviously important as well. When trying to reduce or eliminate gift tax, it is important to use limited or master limited partnership assets since they are not assessed at their fair market values. Limited partners have little control over how the limited partnership is run, so a discount valuation is given. These are substantial and can be 35-45% of the value of the limited partnership.
Here is an example of the Intentionally Defective Grantor Trust from Investopedia:
“Example – Reducing Taxable Estate
Frank Newman, a wealthy widower, is 75 years old and has a gross estate valued at more than $20 million. About half of that is tied up in an illiquid limited partnership, while the rest is composed of stocks, bonds, cash and real estate. Obviously, Frank will have a rather large estate tax bill unless appropriate measures are taken. He would like to leave the bulk of his estate to his four children. Therefore, Frank plans to take out a $5 million universal life insurancepolicy on himself to cover the cost of estate taxes. The annual premiums for this policy will cost approximately $250,000 per year, but less than 20% ($48,000) of this cost ($12,000 annual gift tax exclusion for each child) will be covered by the gift tax exclusion. This means that $202,000 of the cost of the premium will be subject to gift tax each year.
Of course, Frank could use a portion of his unified credit exemption each year, but he has already established a credit shelter trust arrangement that would be compromised by such a strategy. However, by establishing an IDGT trust, Frank can gift 10% of his partnership assets into the trust at a valuation far below their actual worth. The total value of the partnership is $9.5 million, and so $950,000 is gifted into the trust to begin with. But this gift will be valued at $570,000 after the 40% valuation discount is applied. Then, the remaining 90% of the partnership will make annual distributions to the trust. These distributions will also receive the same discount, effectively lowering Frank’s taxable estate by $3.8 million. The trust will take the distribution and use it to make an interest payment to Frank and also cover the cost of the insurance premiums. If there is not enough income to do this, then additional trust assets can be sold to make up for the shortfall.
Frank is now in a winning position regardless of whether he lives or dies. If the latter occurs, then the trust will own both the policy and the partnership, thus shielding them from taxation. But if Frank lives, then he has achieved additional income of at least $202,000 to pay his insurance premiums.”
Get all of that?! It’s fairly complex, even for professionals. That is why it is important to schedule your free consultation today!