Flexible Strategies for an Uncertain Estate Tax Environment

Regulatory uncertainty combined with long-lasting episodes of high inflation and a fluctuating economic landscape pose a challenge to every American. In the federal estate and gift tax arena, one important change was the 2017 Tax Cuts and Jobs Act (the “Act”). The Act doubled the federal estate and gift tax exemption (“transfer tax exemption”) from $5 million to $10 million, indexed for inflation. However, this exemption amount is scheduled to sunset in 2026, and based on current inflation, is estimated to be between $6 and 7 million per individual.

How could the sunset impact your clients? By way of an example, if your client’s estate is $9 million today, with the transfer tax exemption of $13.61 million, their estate will not be subject to federal estate taxes if their death occurs in 2024 or 2025. However, if your client were to die in 2026 with the same $9 million estate, and the transfer tax exemption is $6.5 million, their estate will be subject to federal estate tax. This may result in approximately $1 million in federal estate tax.

How could your client plan for the sunset and take advantage of today’s higher transfer tax exemption?  By way of an example, your client can make a large gift today and use their higher exemption amount to mitigate their exposure to future federal estate tax. Your client should take advantage of the “Coupon,” which expires on December 31, 2025. “Use it before you lose it.”

How could your client leverage this large gift?  In order to take advantage of the current transfer tax exemption, a flexible estate plan is more critical than ever. Incorporating life insurance and trusts into an estate plan can be an effective strategy for this uncertain estate tax environment.

What are the types of trusts for clients to consider?

Survivorship Standby Trust

A survivorship standby trust (“SST”) is a strategy that offers flexibility to married clients using a survivorship policy. An SST could achieve two main goals: (1) preserving the policy owner’s direct access to the survivorship policy on the life of a married couple, and (2) minimizing estate tax exposure for this couple. Generally, the spouse with the shorter life expectancy (“grantor spouse”) will establish a revocable SST. This grantor spouse will purchase a survivorship policy insuring both spouses’ lives and name the SST as the contingent owner of the policy. During the grantor spouse’s lifetime, the grantor spouse as the policyholder has full control and access to the policy. Upon the death of the grantor spouse, only the fair market value (in most cases much less than the death benefit) will be included in the grantor spouse’s estate, and the policy ownership will be transferred to the SST for continuing management. Moreover, the death benefit paid upon the non-grantor surviving spouse’s death will generally not be included in the surviving spouse’s estate.

Irrevocable Life Insurance Trust

An irrevocable life insurance trust (“ILIT”) is often used as a way of providing liquid assets and transferring wealth at the death of the insured. Typically, an individual will set up an ILIT and then the ILIT will purchase a life insurance policy on the grantor’s life. Because the grantor is neither the trustee nor the beneficiary, the grantor does not have access to the policy. Upon the grantor’s death, if everything is done correctly, the death benefit will not be included in the grantor’s estate.

Spousal Limited Access Trust

A spousal limited access trust, also referred to as a spousal lifetime access trust (“SLAT”), can provide a couple with some comfort if they are reluctant to part with significant assets fearing that they might need access to the assets in the future. Generally, one spouse (“grantor spouse”) will create a SLAT and have the SLAT own a life insurance policy on their life. The other spouse (“non-grantor spouse”) will be named as the trustee and beneficiary of the SLAT with certain limits. Because the non-grantor spouse has some access to the trust assets, the grantor spouse can indirectly benefit from the SLAT they created. Upon the grantor spouse’s death, if everything is done correctly, the death benefit will not be included in the grantor spouse’s estate. Moreover, if done correctly, the SLAT assets will not be included in the non-grantor trustee spouse’s estate upon their death.

Resources

To learn more about SSTs, see Survivorship Standby Trusts: A Flexible Alternative for Estate Planning.

To learn more about ILITs and SLATs, see Irrevocable Trusts and Life Insurance.

Conclusion

Each strategy has its own advantages and drawbacks. With the uncertainty and challenges in front of us due to the sunset, it is important for clients to act early rather than waiting until December 2025. To achieve their estate planning goals and objectives, clients should always consult their personal estate planning attorney to decide the best tools and techniques for their particular situation.