The process of transferring wealth from one generation to another is a delicate and impactful decision, and there are several strategies that you can pick from to do so. Research shows that 70% of family wealth is lost by the second generation, which increases to 90% by the third generation. Each wealth transfer strategy has advantages and disadvantages, so it’s essential to investigate them before deciding where to place your assets. Below are four different wealth transfer strategies that could assist with estate planning.
Irrevocable Life Insurance Trusts
Life insurance stands out as a valuable asset for wealth transfer due to its tax-free inheritance of both estate and income. It serves various goals like covering estate taxes or directly passing wealth to beneficiaries. Irrevocable Life Insurance Trusts (ILITs) play a crucial role in this process by removing the death benefit’s value from the owner’s taxable estate. The advantages include a potential reduction in estate taxes since the death benefit is excluded from the taxable estate, maximizing the wealth transferred to the next generation.
ILITs provide flexibility in distributing death benefit procedures, allowing for adherence to trust terms rather than a lump-sum payout. However, it’s important to note the irrevocable nature of ILITs, meaning once the policy is in the trust, it cannot be easily removed. Additionally, if an existing life insurance policy is transferred to an ILIT and the policyholder passes away within three years of the transfer, the policy may revert to the taxable estate. Despite these considerations, implementing ILITs remains relatively straightforward, especially if an existing life insurance policy is already in place.
Spousal Lifetime Access Trust
Spousal Lifetime Access Trusts (SLATs) are effective tools for wealth transfer, as they empower individuals to gift assets to an irrevocable trust benefiting their spouse. This unique setup allows the spouse to receive income or distributions from the trust throughout their lifetime, ensuring a reliable source of financial support. The strength of SLATs lies in their capacity to preserve spousal benefits while actively facilitating the transfer of wealth.
Furthermore, using SLATs enables individuals to capitalize on their gift tax exemption, effectively mitigating potential tax implications associated with the transfer. In summary, SLATs present a strategic and holistic approach to wealth transfer by seamlessly combining financial security for the spouse with the tax-efficient distribution of assets.
Grantor Retained Annuity Trust
Grantor Retained Annuity Trusts (GRATs) are effective tools for wealth transfer due to their unique structure. With GRATs, individuals can transfer assets to an irrevocable trust while retaining the right to receive fixed annual payments for a specified period. The key advantage lies in the potential for the transferred assets to appreciate at a rate higher than the IRS’s assumed rate, allowing the excess value to pass to beneficiaries without having additional gift taxes.
This makes GRATs particularly beneficial for transferring appreciating assets and maximizing the wealth passed on to heirs. If the grantor survives the annuity period, the remaining assets in the trust are excluded from the taxable estate, further reducing potential estate tax liabilities. In essence, GRATs offer a strategic and tax-efficient way to transfer wealth while providing the grantor with a predictable income stream during their lifetime.
Intentionally Defective Grantor Trust
An Intentionally Defective Grantor Trust (IDGT) stands as an irrevocable trust purposely deemed “defective” for income tax purposes, allowing the grantor to continue paying income taxes on trust assets while simultaneously excluding the asset value from the taxable estate. The advantages of IDGTs lie in their ability to effectively diminish the future growth’s impact on the taxable estate. This is facilitated by the grantor’s ability to cover income taxes generated within the trust, preserving trust assets and lowering the overall taxable estate value.
Depending on the situation, selling assets into an IDGT might also be a viable option. However, it’s essential to recognize the irrevocable nature of IDGTs and the absence of a step-up in basis for transferred assets, necessitating consultation with a CPA to avoid unintended income tax consequences related to the tax basis of assets considered for inclusion in the trust.
Conclusion
Choosing how to transfer your wealth can be challenging, with many factors to think about. The strategies mentioned aim to lower or eliminate future estate taxes, but it’s crucial not to focus solely on taxes. While taxes are important, they shouldn’t be the sole consideration. It’s essential to find a plan that aligns with your overall goals. If you have any questions, please schedule a 20-minute “Ask me anything” session by contacting Josie Whiteside at jwhiteside@cffinancialgroup.com or contact CF Financial here.