Don't Wait

Pardon my cynicism,” says Curt Weil of Weil Capital Management in Palo Alto, California, “but I can’t believe the ‘death tax’ will really disappear.” His prime estate planning attorney, Jim Quillinan, concurs: “It’s really business as usual for the next five years and then we will see.”

While most advisors agree with Weil about the permanent disappearance of the inheritance tax, there are a few things you can do now to prepare for an unknowable scenario. Weil’s firm is doing “more education work than before, more 529 plans, and charitable gift trust work,” and he’s not alone.

Education is high on the list for many planners, since many clients have misconceptions about what the new tax law and its sunset clause mean. Laird Lile, a trusts and estates attorney with Lowry Hill, a Minneapolis-based money management firm, says that the biggest challenge is clients’ “awareness that the shelf life of estate plans has decreased dramatically.” Steve Long, a tax attorney with Ballon Stoll Bader & Nadler in Manhattan, agrees. “I spent much of last year trying to explain to people that we still have an estate tax. A lot of people think it is not there anymore.”

Lile, in the firm’s Naples, Florida office, says it is more likely that the tax will not go away. Long agrees. “The statute is such a disaster that as a planner I’ve got to figure that Congress will come back to it sooner rather than later,” says Long. “And with politics, they’ll come back to it sooner because of recession, or if Bush loses a re-election bid, or the deficit is such that revenue needs to come from somewhere. All these things are in play.”

One challenge for estate planning professionals is convincing clients that it makes sense to part with some money now in the form of gift tax, Lile says. “For the people we work with, that continues to be a concern, not because people don’t believe there will be an estate tax in 2010, but because they want to hold onto more of their money and are reluctant to incur a substantial gift tax.”

So What Can You Do?

There are a number of techniques you can use that you may not have considered.

529 plans Gail Cohen, senior VP and chief trust counsel at Fiduciary Trust Company International in New York, is big on 529 plans, which she says are underutilized. “While these are not new, the tax law passed last year changed some of their attributes and made them much more attractive.” Says Cohen, “Specifically, it’s similar to an IRA in that the funds put into it grow tax-free, and the income on the funds is also tax-free. It’s not like an IRA because what you contribute is not tax-deductible”–making it more like a Roth. But what made them more attractive, says Cohen, is that formerly the money coming out was taxable. Now, as long as it’s used for qualified college expenses, it’s not. And qualified college expenses cover a lot of ground–books, computers, vocational school.

If the beneficiary doesn’t want to go on to higher education, the beneficiary can be changed within the same family. The owner of the account, or donor, thereby retains more control over the money and even the investments within the account than is usual with trusts set up to remove assets from an estate. Since control of assets can be a big sticking point with donors, this appeals to many clients.

The 529 offers the added benefit for estate planning of gifting up to $11,000 per year into as many of these accounts as you have beneficiaries–and you can put in five years’ worth of funding in the first year. Assets are not removed from the donor’s estate until the donor has lived the full five years, but for a donor with 10 beneficiaries, or a couple who each use their $11,000 per year gift opportunity, this can amount to over a million dollars out of the estate at the end of the fifth year.

Zeroed-out short-term GRAT Says Jeff Erickson of Lowry Hill, “Volatility is your friend.” He and Lile fund a GRAT for a period of only two to three years with a higher-volatility, higher-return stock already in a client’s portfolio. If the stock does well during that short period of time, the increase in value goes to the beneficiary and the grantor retains the stock. If the stock does not do so well, the grantor has not been harmed. According to Erickson, “The rate we’re trying to beat is an IRS rate, actuarially based, of 6%. If you have a return greater than 6% by the end of the period of the trust, the excess amount goes to the beneficiary.”

Zero-cost collars For a client with a large concentration in a particular stock, you can use a zero-cost collar, says Erickson. This is selling an out-of-the-money call. “If a stock is a $50 stock, you can sell a call priced at $70–a three-year position–and with the money that you get for selling that call, you buy a put–an out-of-the-money put below the value of the stock, probably at $46. This allows you to have up to $70, but limits your downside to $46. During that period of time, you also get to keep any dividends the stock would generate,” Erickson points out. “Set those two prices based upon making the amount you received for the call and equal to or as close to the amount you have to spend for the put. That’s where zero cost comes from. You pay for downside protection by limiting your upside. The IRS is okay with it as long as the band is wide enough that they would not perceive it a deemed sale.” He points out that this works well for elderly clients who have a large position in a particular stock of low basis. It avoids the capital gains tax in selling for diversification, and at their death the stock is stepped up in value for the heirs.