The window for you and your family to transfer wealth to heirs and charities is wide open right now. For 2022, the federal estate and gift tax exemption stands at just over $12 million per individual and $24.1 million for married couples.1 You can give up to those amounts over your lifetime without paying federal income tax. Any amount above is taxed at a hefty 40%.
Maximize Wealth Transfer Strategies
The current estate and gift tax exemption is scheduled to end on the last day of 2025. After that, the exemption amount will drop back down to the prior law’s $5 million cap, which, when adjusted for inflation, is expected to be about $6.2 million.2 In addition, the 40% maximum gift and estate tax rate is set to increase to 45% in 2026.
If you haven’t reviewed your estate plan lately, consider meeting with your wealth advisor to ensure you are maximizing the current estate and gift tax exemption to leave more to your beneficiaries.
Here are some strategies and tools to consider.
Spousal Lifetime Access Trust (SLAT)
Using a SLAT, spouses can take advantage of the current gift tax exemption and receive income distributions. In this strategy, assets are transferred into an irrevocable trust, meaning they are permanently removed from the grantor’s estate and won’t be subject to estate tax. The grantor maintains an indirect interest in the trust assets through their access to income distributions.
In a SLAT, one spouse typically names the other spouse (and sometimes the couple’s children), as beneficiary. As long as the couple remains married and the beneficiary spouse is alive, the couple has access to distributions that the trustee is empowered to make to the non-grantor spouse. In some cases, each spouse sets up a SLAT, with the other named as beneficiary. IRS rules must be followed carefully in such cases for the arrangement to be considered valid.
It’s wise to fund SLATs with assets that are expected to appreciate the most. Having those assets appreciate within the trust rather than within your estate will spare you the associated tax consequences.
Grantor Retained Annuity Trust (GRAT)
GRATs are another type of irrevocable trust that can be used to move assets out of your estate while ensuring an income stream. In this case, the grantor, after transferring assets into the trust, is entitled to annuity payments for a specified number of years. After that period, the trust terminates, and the assets still within it are distributed to the remainder beneficiary—typically the grantor’s children or grandchildren.
While the transfer of assets into the trust is considered a taxable gift, properly structuring the annuity payments can help to ensure that tax liabilities on the distribution to the remainder beneficiary are minimized or eliminated. One of the biggest advantages of GRATs is that the full value of assets at the time they’re transferred into the trust can be repaid to the grantor in the form of the annuity. Assets’ growth above the original value is transferred to beneficiaries free of gift or estate tax.
Loans from one family member to another can be an effective tool for transferring wealth between generations free of gift and estate tax. Large intrafamily loans may be made to a family trust, which invests the money and repays the loan. Once the loan is repaid, the assets that remain are protected from estate tax by the trust, and they can be distributed to beneficiaries as specified in the trust document.
One benefit of an intrafamily loan is that they carry relatively low interest rates. That maximizes the probability that net returns earned by investing the loan proceeds will exceed interest payments on the loan.
Superfunding 529 Plan Accounts
Five-year gift-tax averaging, or superfunding, allows families to frontload contributions to a child or grandchild’s 529 plan. Lump-sum contributions allow for greater tax-free appreciation within the 529 account, while moving assets out of the givers’ taxable estate. As of 2022, individuals can contribute up to $80,000 per beneficiary ($160,000 for married couples),3 as long as the contribution is treated for tax purposes as though it were spread over five years.
Step-Up to Remain in Effect
One wealth transfer advantage that will remain after current estate tax exemptions sunset is the step-up in cost basis. The step-up allows heirs to avoid taxes on gains in the value of assets that occurred prior to the death of the estate holder.
Maximize Your Wealth Transfer Opportunities
With the estate and gift tax sunset just three years away, we recommend you meet with your wealth advisor to discuss how to minimize taxes on your estate. Your estate will pass to your heirs one way or another. Making changes to your estate plan and trusts while exemption limits are generous can help to ensure that those you care about receive as much wealth as possible.
Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing.
The availability of tax or other benefits may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors as applicable.
This commentary is limited to the dissemination of general information pertaining to estate planning and tax information and should not be construed as legal or tax advice. MWA does not provide legal advice. Please consult an attorney in your state to determine any legal requirements specific to your situation. Certain state laws that may be applicable to your situation may have an impact on the applicability, accuracy, or completeness of the information in this presentation. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on tax illustrations used in this presentation.