Now's the time for estate tax planning

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Two factors make this year an opportune time to consider succession and wealth planning.

Estate and wealth advisers suggest several strategies—three of which we discuss here—to take advantage of the currently large estate and gift tax exemption as well as the low interest rates.

According to Bankrate data, the average savings account paid just 0.09 percent interest as of September. However, you don’t have to settle for such a puny yield. There are high-yield accounts that pay more. Right now, the best ones pay around 0.9 percent, but that rate is still relatively low for money that you won’t need for a number of years.

Instead of keeping that money in a savings account, you could direct it into investments with greater growth and income potential, such as mutual funds, bonds, stocks, and exchange traded funds, or ETFs. These investments are riskier than a savings account, but offer higher potential rewards.

Financial educator Angel Radcliffe suggests that “your emergency fund should be at minimum three months of living expenses. I would recommend six.” That means someone with monthly bills totaling $3,000 should have between $9,000 and $18,000 in savings before they start investing their extra cash in higher-yielding investments.

“Once you have three months of expenses built up, ask yourself how much more you’d feel comfortable with,” Oelker says. “Is it six months? Nine months? Twelve months? A lot of this answer has to do with how comfortable you are with the risk of losing income, as well as how long you think you would need to stretch your (emergency) fund if needed.”

One of the first places to look for higher-yielding accounts should be online banks. They tend to offer some of the highest interest rates on savings accounts and rarely have minimum balances or charge monthly fees.

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The federal estate and gift tax exemption is at a historic high

All-time low IRS interest rates

The federal estate and gift tax exemption is at a historic high

First, the federal estate and gift tax exemption is at a historic high of $11,580,000 in 2020—$23,160,000 for couples if portability is elected on a federal estate tax return.

Portability allows a married decendant’s unused estate and gift tax exemption to pass to the surviving spouse. The tax rate is 40%.

This exemption amount expires at the end of 2025, but if the Democrats win big in November, odds are good the exemption will fall sooner, perhaps as early as 2021, because Joe Biden has called for lowering it. He hasn’t given an exact figure, but we think the exemption could revert to pre-2018 levels of about $5 million ($10 million for couples), with inflation adjustments.

All-time low IRS interest rates

All-time low IRS interest rates are another reason for succession planning, according to Pamela Lucina, chief fiduciary officer and head of the trust and advisory practice for Northern Trust Wealth Management. The low rates make intra-family loans and certain estate and gift freeze strategies valuable planning tools. She advises high-wealth individuals to start planning now by reviewing their goals and figuring out how much of their wealth they are ready to part with.

This quality of being non-correlated allows investors to build portfolios that zig when the market zags. By mixing and matching the qualities of the asset classes, an investor or financial adviser can make a portfolio less volatile and potentially achieve the same returns as or better than a riskier portfolio. Asset allocation takes advantage of the principle of diversification to reduce risk.

For instance, if you have 30 years until retirement, you can afford to take more risk in exchange for the higher potential returns available in the stock market. So a financial adviser or robo-adviser would usually recommend a higher allocation toward stocks and less in low-return bonds. However, as you near retirement an adviser might gradually shift you into safer assets, such as more CDs or bonds. CDs offer guaranteed returns, a valuable trait when you need low risk.

$11,580,000

for InDIVIDUALS

$23,160,000

for COUPLES

Tax rate

40%

Make Outright Gifts

...to each child, grandchild or any other person in 2020 without having to file a gift tax return, pay gift tax or tap your exemption.

You can give up to $15,000...

For example:

If you are married...

...with four children...

...and six grandkids...

...you and your spouse can each give up to $15,000 in 2020 to each of your 10 relatives without gift tax consequences.

That’s in tax-free gifts.

$300,000

Gifts made in 2020 that exceed the $15,000 per person limit will require the donor to file a gift tax return using IRS Form 709, but no gift tax will be due in 2020 unless your total lifetime gifts exceed $11,580,000. If you’ve been thinking of making a large gift to a family member, now may be the time to do it.

DOWNLOAD IRS Form 709

Consider a Grantor Retained Annuity Trust

A GRAT freezes the value of assets while transferring any appreciation to the next generation at little to no estate or gift tax.

At the end of the term, the assets are distributed to the trust’s beneficiaries, typically the grantors’ children.

An individual transfers investments or other assets into an irrevocable trust for a fixed term, while retaining the right to receive an annual stream of income plus interest based on the IRS’s applicable federal rate, which was 0.4% in September.

The actuarial value of the leftover assets in the GRAT is a taxable gift upfront, but the low interest rate trims the value of those assets, which tamps down the gift amount.

If the assets appreciate at a rate higher than the 0.4% federal rate, your heirs will receive the value of the extra growth tax-free when the trust expires.

Lucina advises that individuals who are thinking about a GRAT should begin working with an adviser now to set up the trust but can wait to fund it later.

Intra-family Loans Are Another Option

The interest rate on these loans must equal or exceed the IRS’s set interest rate for the month in which the loan is made, which is 1% for long-term loans in September.

The IRS pays close attention to loans made between family members and in an audit may seek to recharacterize certain loans as disguised gifts subject to gift tax.

Factors that can help prove the money was a loan include:

A written debt instrument with interest

A fixed repayment schedule and collateral

A reasonable expectation that the amount will be repaid.

U.S. News & World Report

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