Leaving a legacy is important to most Americans. That legacy is usually expressed in terms of passing wealth to children, grandchildren or other family members, but it can also include gifts to charity or passing on family values. The desire to leave a legacy is not confined to the wealthy — a fact that’s often overlooked by planners working with families with modest estates.
For wealthy Americans, trusts and estate planning provide a variety of techniques to transfer wealth with a focus on maximizing the transfer and minimizing taxes and expenses. For those of more modest estates, the same goals apply, although concern about estate taxes has now vanished for nearly all Americans after the enactment of the American Taxpayer Relief Act of 2012 (ATRA).
ATRA was enacted to resolve many of the tax issues that were part of the fiscal cliff crisis at the end of 2012. The biggest tax issue was the sunset of various tax rate cuts and other provisions that had been enacted since 2001. For the most part, the income tax provisions have been extended permanently except for certain high-income taxpayers. For estate tax purposes, the exemption was made permanent at $5 million, adjusted for inflation from 2011, which results in an exemption of $5.25 million in 2013. The top estate tax rate was increased to 40 percent.
The gift tax has been reunified with the estate tax, so the exemption is available during life or at death. In addition, the concept of portability is now permanent. This effectively gives a married couple a double estate and gift tax exemption ($10.5 million in 2013) without the need for special planning at the death of the first spouse to die. As a result of these changes, few Americans will be subject to federal estate taxes in the future.
The good news is that Americans can now focus on passing their wealth at the times and in the ways they want, rather than having a plan driven by tax considerations. Minimizing costs and expenses will continue to be important, as will avoiding other taxes — usually income taxes associated with the transfer of assets. In some states, inheritance or estate taxes will still apply, and additional planning may be necessary.
Some assets, particularly retirement accounts, have income tax consequences that do not go away because the account holder dies. Unlike capital assets — such as stocks and bonds or real estate, where there is a basis step-up at death and any unrecognized capital gain liability is eliminated — the beneficiaries of retirement accounts have to pay the income tax liability associated with the account in the same way as if the account holder were alive. This income tax burden is often effectively increased because the beneficiaries are typically in a higher tax bracket than the account holder. Beneficiaries are often in their 50s or early 60s, still working and in their peak earning years, unlike the parent, who had likely been retired for many years and lived on a modest income.
The capital transfer solution
For clients with modest estates, capital transfer can offer an opportunity to enhance the value of the legacy while minimizing costs and expenses. By repositioning assets into properly structured life insurance, clients can know how much will be transferred, eliminate potential income taxes associated with the transfer of assets and know the beneficiaries will receive the death benefit without the expenses of probate.
Capital transfer can also address concerns about how much will be passed to the beneficiaries. With low interest rates and continued volatility in the stock markets, future values become difficult to predict and the amount that will be passed on can vary significantly from month to month.
See also: 5 ways to help middle-class clients with estate planning
While capital transfer is only suitable for assets not needed for living expenses or emergency funds, most clients express the “what if?” concern about surplus assets. If circumstances change dramatically, can they access the asset? This concern usually leads to unwillingness to do any planning. A properly selected capital transfer product can address these concerns by allowing a return of premium, access to the cash value or use of the accelerated death benefit, depending on the client’s situation.