Welcome back for part 3 of my estate planning series. If you have not, make sure to check out:
Those will help get you up to speed for this blog post.
Moving on now to part 3. This blog post is about some of the advanced estate/tax planning strategies that high net worth individuals (HNWI’s) are using. There are too many to go through them all, but we will highlight some of the most popular one’s we are seeing used today.
But before we get into the tools, you have to understand that estate taxes exist. Right now you have a gift exemption and estate tax exemption (both count the same) of $12.92 million per person, so $25.84 million per couple when done correctly. But… this will get cut in half in 2026 which is why learning and planning around this now is so crucial.
Most of these estate planning tools are used to get money out of HNW individuals’ taxable estate while the individuals are still alive so they can avoid the 40% estate tax on wealth above $25.84 million. Note: some states have lower limits for when the tax kicks in.
Now that you understand that, we can get into the most popular tools we see HNWI’s using.
Note: You won’t see any charitable strategies as that is the topic for next week.
Many wealthy individuals like to give to their family on a regular basis to make use of the gift amount that does not need to be reported and does not eat into the tax exemption. In 2023, the number is $17,000 per spouse. As long as you stay under that, the gift does not need to be reported and it does not count towards your gift exemption.
However, when gifting to young children where control by a trusted adult is important, or to accumulate the regular gifts into a more meaningful sum over time, many high net worth individuals consider using a Gifting or “Crummey” Trust (named after a famous tax case). They offer creditor protection and the age of control by the beneficiary can be set beyond the age of majority (if control is ever given), unlike a UTMA account.
ILIT stands for Irrevocable Life Insurance Trust. I am sure you have heard “life insurance is paid out tax free” before in your life. But there is a huge misconception here. The proceeds go into your taxable estate and if passed to anyone other than your spouse or charity, they will be subject to the death tax. ILITs move the proceeds out of your estate so you can avoid this tax hit. This is so powerful that some estate planners believe that all permanent insurance policies on your own life should be held in an ILIT.
With an ILIT, you set it up so the trust holds the insurance policy, not the individual who’s life is being insured. Then, once the individual passes away, the beneficiaries receive the benefit tax free.
Note: if the premiums are more than the gift amount per year, then the payment of premiums by the policy owner starts to count towards the gift exemption amount.
GRAT stands for Grantor Retained Annuity Trusts. They are a great tool that high net worth folks use when they expect an asset to appreciate a lot. GRATs allow you to transfer assets to your beneficiaries and minimize gift and estate taxes.
When you establish a GRAT, the grantor retains an annuity for a period of time while transferring the remaining assets to the beneficiary.
Here’s how it would work: let’s say I put $10mil of my company’s stock in a GRAT. I would then receive part of that back per year in an annuity. Maybe that is $1mil per year for 10 years. Then all the growth goes to my beneficiaries and does not count towards the estate tax exemption. (This is a simplified version and need to know hurdle rate, look at growth of the asset, etc). They can be a really powerful tool when used correctly!
Right now, because the tax exemption is so high and the doubled exemption will be lost if not used before 2026, most estate planners recommend a strategy other than the GRAT until you’ve used up all your exemption. GRATs can be “zeroed” out so that no exemption is used at all when transferring assets out of the estate. For those reasons, GRATs can continue to be used when the individual has run out of the exemption.
SLAT stands for Spousal Lifetime Access Trust. One spouse establishes it for the benefit of the other spouse thus enabling the transferring spouse to reduce their taxable estate while still providing some access to these assets through the other spouse, the beneficiary. Note: This removes the assets from both spouses’ taxable estates which is why SLATs are so powerful.
People love SLATs as they allow spouses to leverage their gift and estate tax exemptions very effectively. But be careful here, you oftentimes cannot do a SLAT for each spouse that is identical and you must consider the possibility of separation and divorce. You can run into IRS audit issues as these are highly scrutinized.
Dynasty Trusts, also known as Generation-Skipping Trusts, allows you to move assets to your children, then to grandchildren and so on and so forth until your last living descendant, using what is known as the Generation Skipping Transfer (GST) tax exemption. The benefit of this type of trust is that it allows you to continue growing a pool of assets beyond the original exemption amount used to seed the trust and to pass all that wealth from one generation to another without any taxes needing to be paid when any beneficiaries pass away.
When done correctly, once you put the assets in a dynasty trust (and use your GST tax exemption to shield those assets) the assets and their appreciation should never be subject to federal estate taxes again. This tax planning can become combined with locating your dynasty trust in a state where trusts can last forever (until the last eligible beneficiary passes away).
It’s also important to discuss who pays the income taxes on these because the payment of income taxes can act as an additional gift. An Irrevocable trust can either be a grantor trust (as long as you, the grantor, is still alive) or as a non-grantor trust. “Grantor” means it’s your duty, as the grantor, to pay the income taxes of any assets in the trust. Non-grantor means it’s the duty of the trust (through the trustee) to pay its’ own income taxes. For ultra high net worth individuals, there are two advantages to keeping their gifting vehicles as grantor trusts. First, it’s a way to make an additional gift to your beneficiaries by paying the taxes owed by their trust. Second, paying the income taxes on behalf of the trust is not treated as a taxable gift. So this additional gifting does not further reduce any available tax exemption.
For example, you would like to make a gift of $1,000 in stock, which will generate a $5 income tax liability because the stocks pay dividends. If you gifted the stock directly to your child, your child would have to pay $5 in taxes. If you also wanted to cover the taxes, you would need to use $1,005 of your tax exemption to cover the whole gift. You could also put the same stock into a non-grantor trust for your child, but the trust would have to pay $5 of income taxes out of the $1000 (and potentially have to sell stock to cover the tax liability). So your gift to your child would be reduced. Now, instead, if you put the stock into a grantor trust for the benefit of your child, the trust would not pay any taxes because you would pay them instead. And that payment of $5 is not treated as a taxable gift that continues to eat into your remaining tax exemption.
IDGT stands for Intentionally Defective Grantor Trusts. They are irrevocable trusts designed to help move assets from the grantors taxable estate. The cool thing about them is the grantor is still allowed to pay the income taxes vs throw them onto the trust to pay its’ own taxes.
There are two disadvantages to letting a trust pay its own taxes. First, income taxes are reduced by a little bit each year as the assets that are growing inside the trust, are free of future estate taxes. It is much better to make a gift of assets, net of income taxes. Second, all things being equal, it is usually better for an individual to pay income taxes, rather than a trust, because the effective tax rate of trusts tends to be higher. To reach the highest marginal tax bracket, an individual must recognize a much higher income threshold than a trust. For example, a trust taxpayer reaches the 37% max rate if it recognizes just $14,451 of ordinary income, compared with $693,750 for married taxpayers filing jointly. The trust is likely to pay more taxes on the same amount of income as would the grantor.
When you see the word ‘defective’ here it is simply referring to triggering the features that make a trust a “grantor trust” for income tax purposes. This allows the grantor to minimize the overall tax burden of the trust assets that grow outside of their taxable estate. Usually, IDGTs are also structured to be Dynasty Trusts.
FLP stands for family limited partnership. HWNI’s use them to gift assets into the entity and then shares are transferred to family members as a way to make gifts to them of the underlying assets while the individual retains control over those assets (e.g., as a manager of the entity). So how does this help for estate taxes? By doing this, the value of the gift itself can be reduced by two discounts: one for the shares being “unmarketable” because there is no easy way to sell shares in a family entity like this and the other for the lack of control. This reduces the value of the transferred assets so that less of the individual’s tax exemption is used in making the gift.
FLPs are often paired with an irrevocable trust so that the FLP’s value continues to grow in an estate tax and GST tax-protected vehicle. Understand that FLP’s can get super complex fast. This is the most high level explanation I could give.
I know this post was long, but wanted to give you the inside scoop of what to think about as a high net worth individual. I hope this was helpful!
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Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax , and financial team before making any changes to your financial plan.
Financial Advisor