"When a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully."
— Samuel Johnson
Asset values and interest rates are very low. Add to the current market environment the uncertainty about future changes in the estate, income and capital gains taxes, and the wisdom of doing estate planning now becomes obvious.
One of the goals of estate planning is to transfer assets to intended beneficiaries at the lowest possible tax cost. How do you do this? By making transfers and using techniques to leverage those transfers to minimize estate and gift taxes.
When you're feeling vulnerable because your assets values have plummeted and you worry about the future of the economy, it's hard to focus on giving away your assets. Nevertheless, this is the absolute best time to do it. The prospect of a severe recession (I'll not use the D-word here) should, as Dr. Samuel Johnson said of the prospect of hanging, focus the mind wonderfully.
If your estate is likely to be subject to federal estate taxes, don't stop making annual exclusion gifts. You have until Wednesday to make $12,000 gifts per person for 2008. Beginning Jan. 1, you can make another round of $13,000 gifts per person. Give securities that are depressed in value. When they recover, they will already be through the transfer tax system and in the hands of your beneficiaries. (Gifts under $12,000 for 2008 and $13,000 for 2009 do not have to be reported and are not counted against the annual $1 million exclusion limit. Some folks say you "can't" give more than that. Not so. You can give more so long as you file a gift tax return reporting the amount by which the gifts exceed the exclusion amount. No gift tax is due until taxable lifetime transfers exceed $1 million.)
It's also a good time to make low-interest loans to family members. The applicable federal rate is very low. For example, the midterm rate for January 2009 is only 2.06 percent. It's a great time to make loans to the kids to help them buy homes, pay for education, start businesses. Loans are not gifts, and you can provide a substantial benefit to your loved ones at a low interest rate and preserve your gift and estate tax exemption.
Review your estate planning documents with your lawyer to make sure you have prioritized your beneficiaries appropriately.
Consider whether or not your spouse is adequately provided for before funds are available to other beneficiaries. Check for formulas that self-adjust when the law changes. If you made your plan some time ago, you may have intended to fund a trust with $600,000 — which was the amount that could then pass free of federal estate tax. If unchanged, that same formula provision could now pass $3.5 million (or your whole estate if it is valued at less than that) to a trust and perhaps give your spouse nothing.
Have you given specific assets to named beneficiaries? Have the values of these assets changed in proportion to the rest of your estate so that they should be re-examined?
Now is a perfect time to consider a Roth IRA conversion. With assets valued very low, paying the tax to convert can be a bargain. Even if income-tax rates increase in the future you will have tax-free income from your Roth IRA.
A Grantor Retained Annuity Trust, or GRAT, is one of the best ways to transfer wealth to your beneficiaries. A GRAT is an irrevocable trust in which the grantor retains the right to receive an annuity and the remainder interest passes to beneficiaries.
With a proper design, the remainder interest is valued at zero and yet passes very significant wealth to the beneficiaries.
The leverage provided by a GRAT is much greater when interest rates are low and when assets have a significant appreciation potential — that's exactly what we have right now.
Make reviewing your estate plan a priority in the new year.
E-mail: Patti@spencerlawfirm.com