May 25, 2023
Here’s a look at how the ultra rich pass on their wealth tax free to their heirs — and what you can learn from them.
Erica Ellis, advanced planning attorney, was quoted in this article published on GoBankingRates.com.
We are currently in the midst of the “great wealth transfer”: A recent study found that $53 trillion in wealth will be transferred from boomers onto the next generation between now and 2045. If you’re part of the baby boomer generation, you may be in the process of making plans to pass on any assets you have to your children and other beneficiaries.
When making these plans, it’s important to consider how taxes can play a role. The ultra rich have long been using strategies to pass on their wealth with limited or no taxes owed, and many of these strategies can be useful for you as well.
Here’s a look at how the ultra rich pass on their wealth tax free to their heirs — and what you can learn from them.
Susan Hirshman, director of Schwab Wealth Advisory, said it can be beneficial to start transferring wealth during your lifetime rather than after your death. This is a method the ultra wealthy often use for the tax benefits.
“With the lifetime estate and gift exclusion amount at all-time highs and subject to being reduced to pre-2017 levels in 2026 due to the sunset of the 2017 Tax Cuts and Jobs Act,” she said, “now more than ever a focus on lifetime gifting should be considered.
“Currently, you can gift to any number of people up to $17,000 each in a single year ($34,000 for spouses ‘splitting’ gifts) without incurring a taxable gift and eating into your estate and gift tax exemption,” she continued. “People often use their annual exclusion for gifts of cash and deposits into 529 plans. These plans allow one to ‘frontload’ five years’ worth of gifts into one year — which can allow for longer and greater compounded growth.”
If you plan to use your wealth to help a loved one pay for healthcare needs or education costs, the best way to do this without having to worry about taxes is to pay the institution directly.
“You can make unlimited payments directly to medical providers or educational institutions on behalf of others for qualified expenses without incurring a taxable gift or affecting your $17,000 gift exclusion,” Hirshman said. “Generally speaking, qualified medical expenses are those that are considered deductible for income tax purposes. Educational expenses are tuition — meaning they don’t include living expenses, dorm fees, etc. However, it does not have to be for college only; it could be for primary, high school and, depending on the facts and circumstances, even some day care and activity institutions.”
Hirshman gives the example of wanting to pay a granddaughter’s $50,000 tuition for her medical degree.
“You could pay the university directly for her tuition and still give her an additional $17,000 tax free,” she said. “This strategy reduces your taxable estate and helps preserve your lifetime gift and estate exemption.”
Your gifting strategy does not have to be limited by the annual exclusion, Hirshman said.
“One of the best estate planning strategies is to gift assets that you think will have significant appreciation in the future,” she said. “For example, say you have a $100,000 investment in a tech start-up that you believe will appreciate 10 times over the next five years. By gifting the $100,000 of investment today, you eat slightly into your gift and estate tax exemption, but all that future appreciation is out of your estate, and in the hands of your heir’s estate and gift-tax free.”
A Roth conversion can help lighten the tax burden for inherited IRAs.
“With the Secure Act and the enactment of the 10-year rule, the idea of ‘stretch’ IRAs becomes, in certain circumstances, outdated,” Hirshman said. “A way then to help bear the income tax burden on your children on a potential inherited IRA is to convert those assets to a Roth IRA. By doing a Roth conversion, you remove the income tax due from conversion out of your estate, remove any future appreciation on the income tax payment out of your estate, continue to enjoy compounded growth since Roth IRAs are not subject to required minimum distributions, and your heirs will inherit an income-tax-free asset.”
This complex strategy may be useful for assets that you expect to appreciate.
“Freeze strategies are estate and gift strategies that are used to lock in the value of an asset in an estate at a certain point in time and remove the future appreciation to the heirs — and thus from future estate tax,” Hirshman said. “These strategies are often used when you have potentially high-appreciation assets on hand. Examples of freeze strategies are GRATs (Grantor Retained Annuity Trusts) and IDGTs (Intentionally Defective Grantor Trusts).”
This is another complex strategy that’s commonly used for transferring family businesses or real estate.
“Discount strategies have the effect of reducing the value of an interest prior to its transfer, so that its value for gift tax purposes is reduced,” Hirshman said. “Often, they are used coupled with a freeze technique. Typically, in these strategies you want to maintain some type of control or benefit from the asset after the transfer. Typical discounts are for lack of marketability and lack of control. Examples of discount strategies are FLPs (Family Limited Partnerships), Limited Liabilities Companies (LLC) and Qualified Personal Residence Trusts (QPRT).”
Irrevocable Life Insurance Trusts offer a tax-efficient way to pass on life insurance benefits.
“Irrevocable Life Insurance Trusts (ILITs) can be a powerful tool to pass on wealth tax free,” said Erica Ellis, advanced planning attorney with Hargrove Firm, a national estate, tax and business planning law firm. “By placing life insurance policies within an irrevocable trust, the policy proceeds can be distributed to beneficiaries without being subject to estate taxes. Properly structured ILITs can also provide liquidity to help cover estate taxes or other financial obligations.”