#estateplanning

When it comes to effective estate planning and wealth transfer strategies, Grantor Retained Annuity Trusts (GRATs) stand out as one of the best tools. They were popularized by the Walton family (best known for founding the retailers Walmart and Sam’s Club) as a way to get around owing the IRS millions in taxes. This strategy has been used by many other notable individuals like Phil Knight, the founder of Nike. You do not need to be a billionaire to get the same benefits!

A GRAT is an irrevocable trust into which an individual places an asset with the expectation that it will grow in value. In exchange for putting assets into the trust, the individual receives annuity payments for a specified number of years. At the end of that term, any assets left in the trust (typically the appreciated value) are transferred to the beneficiaries (like your children) tax-free.

Think of a GRAT like a special box where you put an asset (e.g., stocks, real estate, or other investments). This asset might be worth a certain amount today, but you believe it will be worth more in the future. The GRAT allows you to benefit from the asset’s growth while minimizing potential gift or estate taxes.

How does a GRAT work?

Imagine that a stock is like a Luke Skywalker action figure toy that’s worth $10 today, but you think it’ll be worth $100 in a few years.¹ You want to give this stock (toy) to your child in the future, but if you wait until it’s worth $100, you might have to pay a big gift tax. So, you use a GRAT:

1. You (the grantor) put the toy (stock) in a special box (the GRAT) and say that for the next few years, the toy will pay you back a little bit of its value each year. This “payback” is called an annuity. The annuity can be a stated dollar amount, fixed fraction, or a percentage of the initial fair market value of the property transferred to the GRAT.

2. If, at the end of those few years, the toy has grown in value more than you expected, everything extra (the remainder interest) goes to your child without any gift tax. *The value of the remainder interest is determined by subtracting the present value of the expected future annuity payments from the fair market value of the original transfer to the GRAT.

3. If the toy doesn’t grow in value, or if it’s worth less, that’s okay! You just got your annuity payments, and the toy goes back to you, so you’re still able to play with the toy after it spent its time in the GRAT.

Example:

Why Use a GRAT?

1. Tax Efficiency – When setting up a GRAT, the value of the gift is reduced by the annuity payments you’ll receive. If the assets grow more than expected, the excess growth passes to your beneficiaries free of gift tax.

2.  If the assets don’t appreciate as much as you hoped, no worries. The assets just revert to you with no adverse gift-tax consequences.

3.  Asset Protection – Assets in the GRAT are generally protected from creditors.

A Few Things to Remember:

• Timing is Essential – GRATs work best in low-interest-rate environments because the assets in the GRAT only need to outperform the IRS’s set interest rate (often referred to as the “Section 7520 rate”) to provide a benefit.
• Risk – If the grantor (the person who set up the GRAT) dies during the trust term, most or all of the trust assets may be included in their estate for tax purposes. Hence, it’s essential to select an appropriate trust term.
• Legal Counsel – Setting up a GRAT involves specific legal processes and paperwork. Always consult with an attorney or financial planner familiar with GRATs and your personal financial situation.

GRATs offer a unique avenue for individuals to pass on appreciating assets to beneficiaries in a tax-efficient manner. Like all financial strategies, it’s vital to understand the ins and outs and seek expert advice tailored to your needs. Remember, as with all financial decisions, it’s always wise to consult with a trusted financial advisor or attorney to ensure that a GRAT is right for your specific situation.

1. A 1978 Luke Skywalker figurine sold for $25,000 in 2015 as part of a $500,000 Star Wars collection at Sotheby’s.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

A trust is a fiduciary arrangement that allows a third party or trustee to execute fiduciary functions on behalf of the beneficiaries. Under the traditional trust model, a trust names one trustee (or co-trustees) to oversee the investment management, coordinate trust distributions and perform all administrative responsibilities of the trust. In this model, nearly all decisions surrounding the trust are made by a single trustee.

However, a single trustee may not always have the knowledge, expertise, time or resources to fully administer a trust and handle the workload, especially when the investment portfolio of the trust requires more specialized oversight.

In a directed trust, by contrast, the terms of the trust may separate certain responsibilities traditionally held by a single trustee, depending on the applicable state law. One individual may be named to oversee investments, another to direct beneficiary distributions, while a third party may be responsible for the trust administration.  Directed trusts have gained popularity over the past decade, largely driven by the desire to allow for better overall oversight and management of the trust, especially where there may be more complex assets which require specialized knowledge to properly administer.

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Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

This resource was produced by an affiliate of BFSG and has been distributed for informational purposes only and is not an offer of legal advice, investment advice, or financial planning advice.

By:  Henry VanBuskirk, CFP®, Wealth Manager

(This is part 4 of a four-part estate planning series)

In the previous posting, we discussed how Mark Zuckerberg of Meta Platforms, Inc. had the same strategies available, that you have available in order to reduce or possibly eliminate your estate tax bill.  In this final part of the estate planning series, we would like to review how gifting assets from your estate can be beneficial to your estate tax bill. If you have concerns regarding how these strategies could affect certain estate and gift planning transactions in which you intend to engage or have previously engaged, please contact your tax advisor and estate planning attorney to further discuss your estate and gift planning inquiries. Our firm is happy to work with you and your estate planning attorney on your unique situation and we can work together to help you achieve your estate planning goals.

During my CFP® studies, one of my professors quipped, “Some people are charitable by choice, but some people get to a certain level of net worth and are charitable by necessity.”  This means that even though some people aren’t charitably inclined, it may be best for their bottom line to be charitable for their own sake and/or their heir’s sake.

The Charitable Remainder Trust (CRT) and the Charitable Lead Trust (CLAT)

I’ve lumped these two strategies together because they generally both gift assets to charity and get assets out of the estate, but one pays the charity in a lump sum and the other pays an annual income stream to the charity over a stated number of years.  When a Charitable Remainder Trust (CRT) is funded, income gets paid to the beneficiary(ies) at least annually for a set number of years and the charity gets the remainder. The Charitable Lead Annuity Trust (CLAT) (sometimes referred to as just a Charitable Lead Trust) is structured where income gets paid to the charity over a stated number of years and afterward, the beneficiary(ies) gets the remainder. Both trusts are irrevocable and serve the purpose of lowering your taxable estate. The CRT allows for an immediate charitable deduction when you fund the trust, while the CLAT allows the estate to take a charitable deduction for the value of the interest paid to charity.

Here are some graphical examples of how a Charitable Remainder Trust and Charitable Lead Annuity Trust work:

Charitable Remainder Trust (CRT):

Charitable Lead Annuity Trust (CLAT)

Superfunding 529 Plans

The 529 plan is an investment account typically used for college planning that allows for tax-free growth and possible tax-free distributions if those distributions are made to pay for qualified educational expenses. One strategy that is available to you is using the annual gift tax exemption of $16,000 per person per beneficiary since (as we discussed in part 1 of this series) this is typically the maximum that you can gift without triggering the gift tax and having your gift tax exclusion reduced. However, we can do one better. You can “superfund” a 529 plan by making five years’ worth of gifts in one year.  Therefore, we can gift $80,000 per person per beneficiary (or if you are a married couple, you can use gift splitting and instead gift $160,000 per beneficiary) all without triggering gift tax and while getting that $160,000 out of the estate. Notice that the definition states: “per beneficiary”. The catch is that you need to live at least 5 years after the gift is made for it to have successfully left your estate. After the first five years are completed, you can do it again if you wish. If one of the 529 plan beneficiaries decides not to go to college, you can always change the beneficiary at any time, or even make a once per year rollover of 529 plan assets to another 529 plan beneficiary’s account.

529 Plan Superfunding Example:  Say you have six grandchildren, and you are benevolent Grandma and Grandpa. You want to superfund their 529 plans, so you then make a gift of $160,000 to each of the six grandchildren to their 529 plan accounts (for a total of $960,000). You wait 5 years and do it again, but unfortunately, passed away 2 years later. The first $960,000 that you gifted will be out of your estate. But the second time you tried to superfund their 529 plans for the second $960,000, it will be counted in your gross estate. In this example, there was still $1,920,000 contributed to the six grandchildren’s 529 plans and $960,000 left in your gross estate – all without triggering any gift tax.

In summary, there are many different estate planning strategies that can help reduce your overall income tax burden. If you would like to revisit any of our prior posts in this estate planning series here are the articles for easy reference:

• What is the Estate and Gift Tax
• Getting Assets out of the Estate
• Getting Future Growth out of the Estate

Furthermore, earlier this year we posted a white paper, “2022 Estate and Gift Tax Planning”, that discussed making gifts to children and grandchildren during 2022 while incurring little or no gift tax.

The bottom line is we are happy and willing to work with you and your estate planning attorney on your unique estate planning goals.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Henry VanBuskirk, CFP®, Wealth Manager

(This is part 3 of a four-part estate planning series)

In part 2 of this series, we discussed strategic ways that you can get assets out of your estate. In this post, we would like to go over how you can capitalize on minimizing your estate tax, while your heirs enjoy the appreciated value of your asset, and how you are able to have some benefits of your own during your lifetime. This is sometimes referred to as an “estate freeze”.  Two estate freezing techniques that may be appropriate for your unique estate planning goals are utilizing an Intentionally Defective Grantor Trust (IDGT) and a Grantor Retained Annuity Trust (GRAT).  If you have concerns regarding how these strategies could affect certain estate and gift planning transactions in which you intend to engage or have previously engaged, please contact your tax advisor and estate planning attorney to further discuss your estate and gift planning inquiries. Our firm is happy to work with you and your estate planning attorney on your unique situation and we can work together to help you achieve your estate planning goals.

Intentionally Defective Grantor Trust (IDGT)

This irrevocable trust allows the grantor to continue paying income taxes on certain trust assets. Even though this sounds like a negative feature, this is what makes it “intentionally defective” and it has several benefits. This is because since the grantor must pay all taxes on all trust income annually, the assets in the trust can grow tax-free, and more importantly, avoid gift taxation for the beneficiaries of the trust.  Generally, it is best to sell assets to the IDGT because gifting assets to the IDGT could trigger gift taxes. Further, when assets are sold to an IDGT, there are no taxes owed because there is no capital gain recognized. Therefore, it is recommended that you take a highly appreciated asset (like a stock with a low-cost basis or shares of a family business) and sell it to the IDGT over a stated time (usually 10 years) in the form of an installment sale.  The goal of the IDGT is to have your heirs inherit the funds in the IDGT and gift those assets at the original value that the IDGT was funded at and lower your taxable estate.

Basics of an IDGT

IDGT example:  Mommy and Daddy Warbucks have an estate worth $100 million and are concerned about the size of their estate when it comes to what their heirs will inherit and what the estate tax bill will look like upon the Warbucks’ death. Part of their estate includes ABC stock that they bought for $100,000 that is now worth $10 million. Assume that the Warbucks’ sell the ABC stock to their newly formed IDGT over 10 years. After the end of the 10 years, the IDGT is fully funded with ABC stock. Now assume that for the next 10 years, the Warbucks’ IDGT appreciates to $20 million, their estate is now $110 million and then they pass away. During those 10 years that all shares of the ABC stock were in the IDGT, the Warbucks’ paid income tax on the dividends received, but did not pay any capital gains on any of the appreciation throughout the life of owning ABC stock. Further, they were able to gift their heirs $20 million of stock and receive a step up in cost basis. Additionally, they reduced the size of their estate when it comes to calculating tax liability to $90 million (instead of $110 million if they had not done an IDGT). As there are a lot of moving parts and due to an IDGT’s complexity, it is highly recommended that we work with you and an experienced attorney if an IDGT is recommended for your estate plan.

Grantor Retained Annuity Trust (GRAT)

A GRAT is an irrevocable trust that allows the grantor to fund the trust but retain the right to receive the original value of the assets contributed, while earning a rate of return specified by the IRS (referred to as the 7520 rate).  After a predetermined period, the beneficiary will be gifted the assets tax-free in the trust and the grantor will have to pay a gift tax on the original value of the GRAT. The grantor will still be on the hook for income taxes for income received during the term of the GRAT. If the grantor passes away before the term of the GRAT is up, then the value of the remainder interest is also included in the grantor’s estate.

Basics of a GRAT

Fun Fact – Mark Zuckerberg transferred $3,023,128 to his GRAT as Facebook went public in 2012.  He did this to help future generations in his estate receive the value of the stock when the GRAT term was up. When the GRAT term was up, the stock was valued at $37,315,513 and Mark was able to transfer that to his beneficiaries tax-free, while also being able to receive the original $3,023,128 after the term of the GRAT is up. Mark did have to pay income taxes on income received during the term of the GRAT and had a gift tax liability based on the original $3,023,128 at the end of the GRAT term, but as we learned from previous installments of this series, he would just utilize some of his married lifetime federal estate tax exemption of $24,120,000 to take care of the gift tax liability. Think what you will about Meta Platforms, Inc. (formerly known as Facebook), but Mark was able to legally lower his future tax bill with some careful planning that everyone has access to, not just the major CEOs of the world.

For the 4^th and final part of this estate planning series, we will cover the last planning pillar that we use when discussing estate planning – Gifting Assets from the Estate.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Henry VanBuskirk, CFP®, Wealth Manager

(This is part 2 of a four-part estate planning series)

In our previous installment in this series, we discussed what Estate and Gift Taxes are and why they exist.  In this installment, we will discuss strategies that can help reduce your overall income tax burden from the estate tax. 

The most logical way to lower your taxable estate is to get assets out of your estate while you are alive so that they aren’t there when you pass for estate tax purposes. As mentioned in the previous blog, you can’t just gift assets away since you would be lowering your lifetime federal estate tax exemption by the amount you gifted over the annual exclusion of $16,000 per year (or $32,000 per year for married couples) and call it an effective strategy. Some strategies allow you to potentially get millions out of your estate and avoid future estate and gift tax liability, all while maintaining your lifetime federal estate tax exemption. If you have concerns regarding how these strategies could affect certain estate and gift planning transactions in which you intend to engage or have previously engaged, please contact your tax advisor and estate planning attorney to further discuss your estate and gift planning inquiries. Our firm is happy to work with you and your estate planning attorney on your unique situation and we can work together to help you achieve your estate planning goals.

Two strategies that I would like to discuss today are the ILIT (Irrevocable Life Insurance Trust) and the QPRT (Qualified Personal Residence Trust).

Irrevocable Life Insurance Trust

The Irrevocable Life Insurance Trust (ILIT) is where you set up a trust that will own and be the beneficiary of a life insurance policy on the grantor (the person or persons that created this trust). The trustee(s) (the person or persons that are given the legal authority to administer the trust as written) can be anyone except the grantor. An ILIT is irrevocable, meaning it cannot be changed after it has been executed. The ILIT allows the life insurance policy to be removed from the estate and the death benefit to be paid out to the beneficiaries directly, avoiding estate taxes. One important thing to note, is that the grantors that are insured by the life insurance policy must live at least 3 years past the funding of the ILIT, otherwise the life insurance policy will still be part of the estate. Therefore, many life insurance policies that are in a married couple’s ILIT are structured as a second-to-die policy, which means that the death benefit would only pay out upon the surviving spouse’s passing. Many life insurance companies that offer second-to-die policies also include a rider (an additional feature that is added to the policy, normally with an additional cost) to pay out an additional death benefit in the first three years of the policy. This is so that if the policy were to be included in the estate, the policy would also pay off the estate taxes due for having it be included in the estate if the grantor or grantors pass during the first three years of the ILIT.

ILIT example:  The Jones Family has an estate of $50,000,000 and they are concerned about their estate tax liability that their heirs would have to deal with at the time of their passing.  Therefore, Mr. and Mrs. Jones set up an ILIT and purchase a life insurance policy for $8 million and start paying annual premiums on the policy. Mr. Jones passes away 3 years later, while Mrs. Jones passes away 6 years later. The policy would pay out the death benefit of $8,000,000 after Mrs. Jones’ passing directly to Mr. and Mrs. Jones’ heirs tax-free. Their heirs would also inherit an estate of $42,000,000 that would be subject to the estate tax.  If an ILIT was not used, the heirs would instead inherit an estate of $50,000,000 subject to estate taxes.

Qualified Personal Residence Trust

A Qualified Personal Residence Trust (QPRT) is a type of irrevocable trust that allows you to move up to two personal residences (a primary residence and vacation home or secondary residence, or a fractional interest in each) out of your estate. The catch is that you would need to gift the assets into the QPRT to the named beneficiary(ies) at the end of the time frame established by the QPRT (usually 10 years). If the QPRT is properly structured and the time constraint is met, then all appreciation on the real estate from the date of the transfer to the QPRT is considered tax-free and the grantors of the QPRT will pay gift tax on the original value of the property at the start of the QPRT. 

Basics of a QPRT

QPRT example:  Mr. and Mrs. Smith have an estate worth $35 million and have a primary residence worth $3 million, a vacation home worth $2 million, and a secondary residence worth $1 million. The Smiths set up a QPRT for a term of 10 years and have their kids as the beneficiaries of the QPRT. This would allow the Smiths to continue to live in and use the properties for 10 years but would give up ownership of the property after the 10 years are up. They then gift their primary residence and vacation home to the QPRT. After 10 years the primary residence is worth $6 million, and the vacation home is worth $4 million. These assets are out of the estate and their estate is now worth $30,000,000.  The Smiths pay a gift tax on $5,000,000 (the gift tax is on the original value of the property at the start of the QPRT). The Smiths instead of getting their checkbook out and paying the gift tax, decide to instead utilize their lifetime federal estate tax exemption, combined with the $32,000 gift splitting election, which would lower their federal estate tax exemption from $24,120,000 to $19,152,000. 

For the next installment, I would like to discuss how you can minimize your estate tax to have your heirs enjoy the appreciated value of your asset, while being able to have some benefits of your own during your lifetime.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.