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Financial Planning > Trusts and Estates > Estate Planning

Down to the wire

By David Port

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Estate Planning Feel like the looming changes to federal estate tax have created more than their share of confusion? Keep an eye on the headlines, and, in the meantime, here are seven ideas to help your clients prepare for the potential last-minute legislative manipulations in store in 2010.

Some aspirin, antacids, access to C-SPAN and a little yoga could be just what the doctor orders for estate planners and tax specialists for the remainder of 2010 and into 2011, given all the issues they must grapple with as a result of the ongoing uncertainty surrounding federal estate tax policy.

Aside from needing remedies for the angst that accompanies trying to plan in a volatile tax environment, advisors must also have a means to keep abreast of what’s happening in Washington, D.C. Will lawmakers opt to keep the estate tax scheme currently set to take hold in 2011, or will they continue the scheme that’s in place this year, revert to the one that was in place in 2009 or find another alternative?

It’s all guesswork. Which means that — and here’s where yoga can help — estate planners must account for a range of possible policy outcomes.

“It’s really important to build as much flexibility into your [estate] plan as possible,” says Brian J. DesRosiers, Esq., LLM, a partner and estate planning attorney at Cody & Cody, LLC, Quincy, Mass.

“Right now, I’m advising clients to plan for the worst,” says David Schlossberg, CEP, president of Assured Concepts Group, an estate and financial planning practice, East Dundee, Ill.

The worst case, in his estimation, is lawmakers let the federal estate tax exclusion return to $1 million in 2011, as it is scheduled to do, after the unlimited exclusion in place in 2010 expires Dec. 31.

Exclusion intact
Few observers expected Congress to let the unlimited exclusion stand through 2010. Now, however, it appears destined to remain intact, leaving the public to wonder what happens next. Yet the show must go on. Accountants and attorneys still need to find ways of preserving and transferring wealth as tax-efficiently as possible.

Instead of doing nothing, estate planning experts recommend considering the following tactics to move forward amid the uncertainty. As always, it’s best to consult an accountant or attorney specializing in estate planning or wealth transfer for help determining which strategies are suitable for specific client circumstances.

1. Use ‘if … then’ planning tactics. The estate planning community is keeping close tabs on the estate tax policy debate on Capitol Hill. The consensus is lawmakers will likely try to tackle the issue early in 2011. Beyond that, “no one really has a clear idea how it’s going to shake out,” Schlossberg says.

The outcome will go a long way in determining the types of strategies estate planners put in place for
their clients. Will it involve a Qualified Terminable Interest Property trust, an AB marital trust or another alternative? An irrevocable trust, such as an ILIT, or a revocable trust?

That depends largely on the amount of the exclusion, whether it ends up at $1 million, as the law currently provides, $3.5 million, where it was in 2009, or some other threshold. The maximum estate tax rate is another X-factor. Will Congress leave it at 55 percent for 2011 or decide to lower it to the maximum 2009 level, 45 percent?

The upshot for estate planners, DesRosiers says, is a plan enacted today must have the flexibility to be revised if the outcome of the policy debate in Washington so dictates.

2. Buy convertible term life insurance. Estate tax policy may change, but the value of life insurance as a planning tool will not. Where the uncertainty comes into play is in the type of life insurance to buy.

Again, Schlossberg says, it’s all about flexibility. While in most circumstances purchasing a permanent life insurance policy to underpin a plan would be the right thing to do in a stable estate tax policy environment, the prudent move today in many cases is to buy a term life policy that can straightforwardly be converted to a permanent policy once it’s clear what tax parameters will be.

“Really it’s a short-term Band-Aid that can be replaced with a longer-term solution if necessary,” he explains. “By buying a guaranteed death benefit or guaranteed death benefit survivorship product, you could be throwing away a year’s premium, depending on what happens with the estate tax. So it’s worth spending a couple thousand dollars now on a term policy to protect a couple million dollars and also to guarantee insurability.

“You don’t need a 20-year product. Buy a five-year product if you can find it. And do it with a company with good conversion practices.”

Life insurance, Schlossberg adds, will only grow in importance — and value — as a wealth protection and transfer tool if the $1 million exemption does indeed return in 2011, thus exposing larger chunks of many estates to taxation.

3. Beware of changing basis and step-up rules
Confusing matters further are step-up rules, found in Section 1022 of the tax code, that apply only this year in computing the tax liability associated with assets transferred in an estate. While there’s no step-up to date-of-death value for assets owned by people dying in 2010, there is a $1.3 million exemption from gains, plus a $3 million exemption on assets inherited from a spouse.

But those parameters are currently due to give way in 2011 to more familiar step-up provisions. All this should weigh heavily in deciding on a type of trust and how to configure it, DesRosiers says.

“A client’s heirs could end up getting slammed if they inherit low-basis assets in 2010,” DesRosiers says.

4. Get more generous with gifting. For wealthy clients, it’s worth considering large gifts in 2010 while the gift tax rate is 35 percent. And because there’s no generation-skipping tax this year, also consider a generation-skipping gift.

“If the client has highly appreciated assets, it might be worth transferring those now,” Schlossberg says.

5. Use GRATs and IDGTs to exploit the current low-interest-rate environment. The Section 7520 interest-rate used by the IRS to value charitable interests inside trusts is as low as it’s been in recent memory, DesRosiers says, so it makes sense to consider putting assets that are expected to appreciate significantly, such as a business, inside an intentionally defective grantor trust or a grantor retained annuity trust.

“Those are ripe options right now,” he asserts. “A lot of clients, especially those with large estates, are using them to reduce the size of their taxable estates.”

In the case of GRATs, there’s an extra sense of urgency, DesRosiers says, because Congress could soon move to extend the minimum term of such a trust to 10 years. Existing law allows more favorable shorter-term GRATs, he notes.

6. Design an irrevocable trust so it can be decanted. Depending on state law, an irrevocable trust can be decanted, meaning all or some of the assets in one trust are shifted into a new trust. The ability to decant is vital when there’s flux in estate tax law, DesRosiers says.

7.Weigh whether to convert traditional IRAs to Roth IRAs. The one-year window is still open for direct, one-step conversion of a qualified plan to a Roth IRA without the limitation of a $100,000 adjusted-gross income cap. That’s a potentially huge opportunity for high-income, high-net-worth individuals with qualified IRAs.

Instead of leaving heirs on the hook to pay both estate and income taxes on those IRAs once ownership transfers, they can convert those accounts to Roth IRAs and pay income taxes on the transfer amount upfront in the 2010 tax year. Any subsequent growth in the converted Roth IRAs is income-tax-free, as are distributions from the accounts to those who inherited them.

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