Seven Unconventional Estate Planning Strategies

Today, most people prefer to place a bankcard in an automatic teller machine instead of speaking with a bank teller to get cash. Few people buy snow tires anymore because nearly all cars are sold with all-season radials. And laser discs are quickly squeezing out videos on the shelves of movie rental stores.

ATMs, radial tires and laser discs were once thought of as unconventional but are now widely accepted as a “best practice” or sound way of doing something. Unconventional does not always mean unworkable.

The same can be said for many “unconventional” wealth transfer strategies that can ultimately help your clients transfer multimillion-dollar estates to their loved ones. In some cases, these unconventional strategies–including estate freezing, discounting and leveraging–can accomplish your clients financial goals more efficiently than “conventional” estate planning tactics.

When it comes to estate planning, conventional wisdom holds that it is better to follow the strategies listed in Figure 1 (see page 12).

All of these “defer now and pay later” strategies can sometimes have flaws when it comes to transferring multimillion-dollar estate assets to lineal descendants. Conventional strategists attempt to justify their methods by relating investment time-value of money theories with estate distribution planning. When it comes to estate planning, any potential time-value of money advantages are often more than offset by increasing marginal federal gift and estate tax brackets. Marginal bracket creep currently can confiscate as much as 50% of assets not protected by annual gift exclusions ($11,000 per donee) or the applicable cumulative lifetime exemption of $1 million in 2002.

In addition to federal taxation, 19 states have death taxes ranging between 2% and 16%, and 29 other states rely on a “sponge” inheritance tax, according to state tax codes. The “sponge” states have an inheritance tax that matches the federal credit allowed. This federal credit for state death taxes ranged from 1% to 16% prior to the Economic Growth Tax Reform & Reconciliation Act of 2001 (EGTRRA) but is now scheduled to phase out over the next four years.

Some states, however, have already indicated that they will continue to use the pre-EGTRRA credit after 2004. Other states have indicated that they may not adopt the federal timetable to increase the lifetime credit exemptions from $1 million this year to $1.5 million in 2004, $2 million in 2006 and $3.5 million in 2009 for transfers of property domiciled within the state that are subject to state inheritance taxes.

Multimillion-dollar estate owners should be concerned about their assets not only appreciating over their lives, but the lives of their surviving spouses as well. The potential shrinkage of assets from a “defer now-pay later” plan could be exponentially magnified. Assets double in value every 10 years if they grow by just 7%–so could the taxes due on those assets through conventional asset transfer plans.

Consider the following “unconventional” strategies to create a more tax-efficient transfer of estate assets under current law:

1. Dont always defer taxes. Deliberately plan to incur the payment of some transfer taxes when the first spouse dies. Using the unlimited marital deduction for all of a spouses assets more often than not results in the ultimate payment of substantially higher taxes by the estate of the second spouse to die. Think “optimum” not “maximum” when it comes to the spousal marital deduction.

2. Divide spousal property. Insure that neither spouse forfeits the IRC Section 2505 lifetime exemption and corresponding tax credit by not owning sufficient assets. Joint ownership of marital property precludes the tax savings that can be realized with credit shelter trust planning. Dont forfeit a $345,800 tax credit on the $1 million exemption. Remember, unlimited tax-free gifts can be made to a spouse. Divide spousal property to conquer estate-tax liabilities when it comes to estate tax savings.

3. Incur gift taxes on lifetime property transfers. Inter-vivos gifts are more tax-efficient not only because they are “tax-exclusive” in nature but because they also remove all future asset growth from the taxpayers estate. Such gifts may even make sense for low cost-basis assets should the EGTRRA adjusted carry-over cost basis rules become the norm in 2010. Except for generation-skipping transfers, the dollars used to pay a gift tax are not subject to a tax. This is not the case with testamentary transfers.

4. Fund credit shelter family trusts with discounted gifts using Grantor Retained Annuity Trusts (GRAT) remainder interests, Family Limited Partnership (FLP) interests, Charitable Lead Trust (CLT) remainder interests, and the home of a Qualified Personal Residence Trust (QPRT). All of these gift tax leveraging and valuation discounting strategies can be used to minimize or completely avoid any gift taxation.

5. Utilize gift splitting. Double the value of one spouses annual exclusion and lifetime exemption through the use of spousal gift splitting privileges. One spouses exclusion/exemption can be applied to the other spouses property transfers.

6. Triple discounts are available. Triple discount an asset for gift-valuation purposes by converting a growth asset to a limited partnership interest that is then gifted to a Grantor Retained Annuity Trust (GRAT). Limited marketability, minority interest, and retained income discounts can be realized.

7. Use CLATs and FLPs. Combine a Charitable Lead Annuity Trust (CLAT) and Family Limited Partnership to magnify valuation discounts. Exchange estate assets for limited partnership interests and transfer these interests to a CLAT. The present value of the qualified charitys income interest plus the partnership limited marketability and minority interest characteristics again create a triple discount for valuing gifts of property to heirs.

The harsh consequences facing multimillion-dollar estates can be countered with estate freezing, discounting and leveraging strategies. The art of estate planning through discounting is a matter of timing. Its a matter of life or death, that is, using “unconventional” lifetime transfer techniques and instead more “conventional” death or testamentary transfers.

John S. Budihas, CLU, ChFC, CFP, is a business, estate and trust planning consultant for the individual life division of Hartford Life, a subsidiary of The Hartford Financial Services Group Inc. He can be reached at john.budihas

@hartfordlife.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, December 2, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.