Estate Planning Strategies in the Pandemic

“Estate Planning Strategies in the Pandemic,” that is the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Susan Snyder, ACTEC Fellow from Chicago. The pandemic has brought estate planning to the top of our clients’ minds. To talk more about this topic, you will be hearing today from ACTEC Fellow Skip Fox of Charlottesville, Virginia. Welcome, Skip.

Thank you very much, Susan, and good day. We are delighted to talk with you today about some of the opportunities and obstacles that individuals may face in doing planning during the pandemic. I should say up front that this will be a very high-level discussion of some of the techniques that we think are important in planning in a time of stress and economic hardship but in which there are also opportunities because, quite honestly, there has been the economic downturn and that can present roads or paths that people can take to improve their planning. And there really are a lot of sophisticated and creative techniques that one can use at any time to transfer wealth down to younger generation family members or charities or others; but today we are going to be talking about some that are particularly appropriate when you have the conditions that are present during the pandemic. Now, what we would like to do is start with the simplest of techniques, and that is the annual exclusion.

Estate Planning – Annual Exclusion

I think we are all aware that the gift tax annual exclusion allows an individual to give 15,000 dollars to any one or more individuals that he or she would like to in a given year. The only basic requirement of the gift tax annual exclusion is that it be a gift of a present interest. Well, because of the economic hardships that may have occurred to many individuals because of the pandemic, you may see situations in which, for example, a parent would like to benefit a child who is facing some economic hardship. A child may want to benefit a parent who might be facing some economic hardship, such as the loss of income to live on because of the decline in the value of the assets on which the parents are living. Or grandparents may want to help grandchildren or vice versa, and the simplest way to do that is through the gift tax annual exclusion. That can be an extraordinarily powerful tool these days but just remember that the gift of the annual exclusion, if it is going to qualify, has to be a gift of a present interest.

Estate Planning – Estate and Medical Expenses

Now, another technique or another idea that comes up from time to time, especially when there are economic challenges, is how do you pay for education or medical expenses of a family member or other who is close to you? And there’s that special provision of the Internal Revenue Code Section 2503(e) that basically provides two ways in which people can make transfers of funds and escape any estate-tax or gift-tax consequences. These are exclusions from the estate tax and the gift tax, and one is a transfer for educational expenses, and one is a transfer for medical expenses.

The transfer for educational expenses, which is unlimited, is only really for tuition, and the catch to this exclusion is that the payments must be made directly to the provider. So, for example, if a grandparent is paying the tuition for a grandchild at an educational institution, the grandparent must make the check or send the funds directly to the institution. You cannot give it to the grandchild in our example and have it be counted, even if the grandchild then gives the money to the institution. Likewise, you have the exclusion for medical expenses. Those payments too must be made directly to the provider, but these are payments that can be very broad in nature in terms of the medical expenses they can cover. And this really may be important these days, especially for children who are supporting parents who may have medical needs, because the medical expense exclusion includes payments for things such as long-term care insurance, nursing home expenses, anything that might not be covered by the health insurance or other plans that a parent or other relative might have. In fact, the only exclusion from the medical expense exclusion, one you cannot pay for, is voluntary plastic surgery. At least that is the one that I am aware of.

Estate Planning – Low Interest Loan to Children

Now, one of the facts — people might call it interesting, people might say, “oh, no!” about the pandemic — has been the recession and the extraordinarily low interest rates that currently prevail. And it is possible to take advantage of these extraordinarily low interest rates in a variety of different ways. You may have a parent who would like to provide for his or her children, but they do not want to give the kids money right now because they think they might need it at some time in the future. What is an alternative? One alternative is simply to provide a low interest loan to the child. Let’s just look at an example. Right now (June 2020) the minimum interest rate that a parent would have to charge a child for a loan would be 18 basis points for a short-term loan, which is up to three years; 43 basis points for a mid-term loan, which is three to nine years; and 101 basis points for a long-term loan, which is nine years and greater. That is a pretty low interest rate, the lowest we have ever seen. And that can make the loan really attractive. For example, a parent could loan a child one million dollars for five years for the 43-basis point midterm, simple interest rate. The child invests the one million dollars and earns five percent a year on the funds over the next five years, which could happen. At the end of the five years, the million dollars has grown to 1,276,300 dollars. The child then owes 21,500 dollars in total interest and the net benefit to the child is 254,800 dollars. That is a pretty good deal simply because the parent loaned funds to a child that the child was able to invest successfully. Now, of course, that makes the assumption that the investments will pan out and that does not always happen, but in most instances, this can be a good thing.

Estate Planning – Refinancing a Loan to Family

Another possibility is simply refinancing existing loans where there is a higher interest rate that could be refinanced at a lower rate. And I think that is something many people should look into, be it for commercial loans; but also many times parents, grandparents have loaned children and grandchildren money when there was a higher minimum rate to have a valid loan and that rate is down now and the parent or grandparent may want to consider refinancing the loans at those lower rates.

Estate Tax Exemption Sunset

Now let us move on to some more sophisticated types of planning. One of the things you hear about all the time these days is the possibility that the ten million dollar exemption from estate and gift taxes as well as the ten million dollar exemption for generation-skipping taxes will go away sooner than we think. Currently, the Federal Internal Revenue Code provides that the exemption will go away in 2026, but there is some concern that if there is a change in the composition and control of the Senate and the White House with the Democrats retaining control of the House of Representatives in 2021, that change may come sooner to the estate and gift tax exemption. Many people fear that the ten million dollar exemption will be gone some time in 2021 or 2022 and we do not know what is going to happen, but some people are saying, “let’s take advantage of that exemption now.” Or even if they think that the current law will stay in place, they say “let’s take advantage of the ten million dollar exemption now before it reverts to five million dollars in 2026.”

What are some techniques that can be used? One is to basically put assets into a long-term trust for the benefit of the children and grandchildren or more remote beneficiaries. These trusts can run for the period governed by the rule against perpetuities in a particular state. Some states still have the common law against perpetuities, which permits a trust to last for about 100 to 120 years.  Others have eliminated the rule against perpetuities and the trust can last forever, and others have set number of years for a trust to last.

Let’s say you put ten million dollars as a parent in a trust for the benefit of the children and grandchildren. You apply the generation-skipping tax exemption to that trust; therefore, the trust is exempt from estate taxation at each generation. The assets grow in that trust. If you look at various scenarios and things like that, the property in a trust that is long term, for the benefit of the children and grandchildren, may have grown tremendously in those years; may have grown absolutely tremendously over the years because tax did not have to be paid at each generation. But then parents come to you and say, “Well, hold it, we’re willing to give away money, we’d like to take advantage of the 10 million dollar exemption before it goes away, either in 2021 or 2022, or in 2026, but we might need access to those funds.” And one technique that many people talk about in this situation is basically to have one spouse set up a trust that is a long-term trust, such as the one we have just discussed, for the benefit of the other spouse and the kids and the grandkids. And, likewise, the other spouse will do the same thing for the first spouse. And you have to be careful when you do that, but that way, at least each spouse has access to some of the funds that were given away by the couple.

Now, one thing you have to watch out for, something called the reciprocal trust doctrine that basically means that the terms of each of the two trusts set up, one for spouse one, the second for spouse two, cannot be the same. So, you want to be very careful in how you structure one of these trusts; and these are sometimes referred to as spousal lifetime access trust or SLATs. Now, what do you do if the individual you are working with is single, does not have a spouse and cannot work out one of these spousal lifetime access trusts? One possibility is to take advantage of the domestic asset protection trust that currently 19 states permit — and they are basically designed as creditor protection devices but they permit the settlor to be a beneficiary of an irrevocable trust as long as certain requirements are met, including that the settlor can be a discretionary beneficiary of the income and principal. But there are also rulings and dicta and things out there that basically say that a gift — one of these domestic asset protection trusts — is a completed gift for gift-tax purposes. The grantor, provided certain requirements are met, can allocate his or her exemption to the trust as generation-skipping tax exemption to the trust, benefit from the trust while he or she is alive, and then when the grantor dies, the assets in the trust are out of the estate. Now there is some question about this. There has never been an official ruling that I am aware of that has said this technique absolutely works, but it should work, and people are taking advantage of that today.

Use of a Charitable Lead Trust in 2020

The last thing I would like to talk about very briefly is a technique that may be very useful during this pandemic time in an era of low interest rates, extraordinarily low interest rates, is the charitable lead trust. The charitable lead trust is essentially the orphan of estate planning. People talk about it a lot, not that many people actually implement them but the people who do have really benefited from them. And what is nice about a charitable lead trust, especially a charitable lead annuity trust in a low interest rate environment is, as you know, the government values the retained interest in a charitable lead trust and the remainder going to the kids based upon interest rate assumptions that change monthly. While it is possible to structure a charitable lead annuity trust so that the gift of the remainder to the children or other beneficiaries at the end of the term is equal to zero and the value of the annuity that passes to charity during the term is the entire amount of the property put into the trust.

So, just take this example. Individual transfers 100,000 dollars to a charitable lead annuity trust in June of this year, it pays one or more charities an annuity of 7,000 dollars each year for 15 years; the interest rate assumption under the tables right now is 60 basis points and the annuity interest under the valuation tables used by the Internal Revenue Service will be valued at 100,000 dollars for purposes of the gift tax. That means the value of the remainder going to the kids is zero — nothing. But if the trust can earn seven percent over the next 15 years and pay out the seven percent each year over the next 15 years, what is going to be left in the trust to go to the kids? It will be the entire amount in the trust. And if the trust performs better economically, there will be more to go to the kids, but if the trust does not perform as well as expected, there still will be something left to go to the kids. But this can be an extraordinarily effective way for people — for getting money down to the kids and also satisfying charitable intents; and with a 60 basis point interest rate assumption underlying the valuation tables, there has never been a better time to do this. Thank you very much.

Thank you, Skip, for reminding us of estate planning techniques our clients can use during these extraordinary times.

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