Yes You Have to Update Your Planning
Estate planning is about as much fun as getting a root canal. Unless there is a strong driver, like a pending change in taxes (there is with the exemption dropping in 2026) or asset protection need (can you ever know when someone might sue?) people tend to put off planning. That can be a costly and difficult mistake. If you or a loved one experience a life changing health issue, it may be too late to plan as signing documents may be impossible. If a claim arises, and certainly after a lawsuit is filed, it is probably too late to do asset protection planning. If you have a family business interest that might balloon in value, after the buyout deal, you will have lost an opportunity to have moved the asset out of your estate at a lower value. So, the moral of this tale is simple, plan now.
The single most common excuse for not planning (other than finding it unpleasant and that your advisers bill for their time) is “nothing has changed.” Seriously? What in the world is the same as only a few years ago? The best planning done a decade ago is unlikely to reflect your current financial position, family relationships or the most modern estate and related planning techniques.
So, give up the excuses and make a plan to plan!
Update Your Will, etc.
If your will, health care documents and financial power of attorney are even five years old, are they current? Are the people you named still those you want to name? Are their new marriages, divorces, grandchildren? Should the documents be update for those developments? Is the planning what works for your current net worth and under current law? If the documents are more than ten years old, is it worth the discussion or perhaps you should just get them updated. Too many people assume “Oh I have a will,” yes, but if it is old and outdated the cost of getting current documents may prove far less of a cost and hassle then the problems outdated or inadequate documents might create.
The Elephant in the Tax Room
The gift, estate and generation skipping transfer (“GST”) tax exemptions will all be cut in half in 2026. While that might seem like a long time away it is not. There is often lots of preliminary steps to planning to use exemption and the sooner you start the better. There are tax doctrines that the IRS (and creditors!) can assert to unravel your planning. Time is your ally in trying to deflect those challenges. For example, assume most of the assets you want to plan with are in your wife’s name alone. She might need to retitle some assets you’re your name so you have assets to gift to an irrevocable trust to use your exemption. The sooner the gift is made so that the gifted assets can be in your name before you regift them, the better. The more time those assets are in your name, the more time you an exert control over them, reinvest them in different ways and so forth. That may (no assurance) help deflect a challenge that the ultimate transfers were really by your wife and not by you. So plan now. Gift (if that is appropriate) now. Don’t delay. A common estate planning tool for married couples are spousal lifetime access trusts (“SLATs”). Each spouse creates a trust (with materially different provisions) for the other spouse and family/loved ones. Each spouse is in some manner a beneficiary of the other spouse’s trust. The hope is that in this way assets are removed from both of your estates, and the reach of your creditors, yet you can still gain some access to them if needed. Waiting to do this at the end of 2025 is not optimal. Better for one spouse to create and fund a trust in early 2024 and the other spouse to wait until later in 2025. The more time between the trusts, some advisers might suggest, the better the likelihood of differentiating the two trusts from a challenge by the IRS or a creditor using the reciprocal trust doctrine. Under that doctrine if the two trusts are too similar, then they can be uncrossed and the plan pierced. So, plan now, don’t wait.
But you don’t have enough wealth to worry about all of this? That might be true but predicting tax law changes is less accurate then predicting the weather (and we all know how reliable whether forecasts are!). Everyone needs to worry about asset protection planning, lawsuits happen, and if the tax laws get harsher and the exemption lower, you might lose out on trying to meet that planning objective.
Estate Exclusion and Exemption Amount Inflation Adjustments for 2024 Require Action
Inflation has been a big item in the news. The tax impact of that is increases in many tax figures that are inflation adjusted. From an estate planning perspective that could present a significant opportunity for those that have estate tax reduction goals. Also, for those who have not revisited their estate planning in several years or long, the cumulative impact of years of inflation adjustments could present planning opportunities.
For example, the amount you can gift changes every year for inflation. Inflation over the past few years has been significant, so you may have bandwidth to now top off trusts and other planning steps. There are two components to what you can gift. The first is the annual gift exclusion (an amount per person per year) and the second is the lifetime exemption.
The annual exclusion for gifts is an amount you can gift to any person, every year, and not use up any of your lifetime exemption amount (see below). That amount is inflation adjusted and in 2024 will be $18,000/person/year. For some people annual gifts were at the core of their estate planning. But for most people it may be easier to make a larger one time gift and not bother with the paperwork annual gifts (e.g. to trusts) may require. For some people, making annual gifts might be considered easier because, unlike using exemption, you won’t have to file a gift tax return reporting the gifts. For a few people that have both large estates and large families, annual gifting might still provide a way to move significant wealth over years out of your estate especially if you have used up all your lifetime exemption (or will).
Non-citizen spouses don’t qualify for the unlimited estate tax marital deduction but you can gift $185,000 without a tax cost. While that may not be enough to accomplish estate planning goals, a regular plan of annual gifts to a non-citizen spouse over many years (and other planning too) can move the needle.
The exemption amount increases $700,000 from 2023 to 2024. Thus, the lifetime exemption amount for estate, gift and GST taxes in 2024 is $13,610,000. If you are concerned about estate tax minimization and/or asset protection, consider making gifts of all of your exemption (if affordable) early in 2024. If you made gifts to irrevocable trusts in 2023 or earlier years, you might now be able to make large additional gifts to those trusts (or heirs directly but at these amounts not using a trust to protect the gifts may be a mistake). Also, review those trusts first before making gifts to see if they need a facelift. You might be able to improve and modify old irrevocable trusts by decanting (merging) them into newer and better trusts.
Trust Income Tax Planning
If you have non-grantor or complex trusts there may be a number of trust income tax planning steps that might be beneficial. These are the types of trusts that pay their own income tax rather than the income flowing to your return. Too often trust income tax planning gets overlooked and whatever was done last year just gets repeated in the current year. One planning consideration is whether the trust is paying income taxes in a high tax state. If that is the case, consult with your advisers about the possibility of moving the trust to a low or no tax state. That might be done by changing trustees to a trustee in the low tax state. The savings can add up over the years.
Another consideration is to monitor the high federal income tax rates that apply to trusts. A non-grantor trust hits the maximum bracket at $15,201. In contrast, the top income tax bracket of 37% for married people filing joint is $731,200. That is a wide gap so getting income to an individual taxpayer, and out of the trust, may provide a valuable income tax savings each year. The mechanism to accomplish this is through a fundamental trust income tax concept of distributable net income (“DNI”). If a non-grantor trust distributes cash to a beneficiary that cash will generally push income out of the trust to that beneficiary/taxpayer equal to the amount of the cash distributed. Distributions may also avoid the 3.8% net investment income tax (NIIT). So monitor trusts (and plan new trusts) to be able to shift income to human beneficiaries who may pay lower tax.
But isn’t 2023 trust income tax planning now in the rearview mirror? Not necessarily. There is a special rule for taxation of trusts called the “65 Day Rule.” A non-grantor trust can distribute income to a beneficiary within 65-days of year end, the first few days of March 2024, and treat the distribution as if made in the prior year 2023. That might facilitate shifting income to beneficiaries at a lower tax rates then what the trust might pay. If your trust has marketable securities, for example, have your broker and CPA brainstorm whether there will be a savings and if so, the election might be made by the trustee. Before you jump to making a distribution, consider the non-tax goals of the trust and beneficiaries. If the beneficiary is a spendthrift, in the midst of a divorce or lawsuit, a distribution may not be worth the tax savings as the entire amount distributed might be jeopardized. Don’t assume that the trustee knows the issues, have an open discussion when evaluating whether the tax savings is feasible and if so what should be done.
Another trust income tax planning opportunity might be to have your non-grantor trust make charitable donations instead of you making them personally. A non-grantor trust might get a better tax deduction for charity than if you made the donation personally because trusts don’t have to exceed the standard deduction before they get a tax benefit for donations. Also, trusts, unlike people, don’t have limitations as to what percentage of adjusted gross income can be donated. If you personally face that limitation, a trust may provide a valuable work-around. Trusts, however, must pass several hurdles to get this potentially more valuable donation deduction. The charitable gift must be paid from trust gross income. This is quite different than how individual taxpayers calculate the deduction. You as an individual taxpayer can wire appreciated stock to a charity and, subject to other limitations, get a contribution deduction of the full value of the securities. A trust cannot do that. Instead, the trust must realize the gain by selling the appreciated securities. The trust cannot merely ACAT appreciated stock. Also, a trust must have authority under the trust agreement to make charitable donations. A trust cannot pay donations if it is not expressly permitted.
Plan for Retirement Realistically
Are you really on track for retirement? And what might that have to do with your estate plan? If you don’t have a realistic retirement plan, there may be little or nothing left to bequeath your heirs thereby undermining your estate plan. This is why retirement and estate planning really should be looked at together. Some folks just don’t want to face the harsh realities of a real plan. Have you forecasted your financial position out to at least age 95 or 100? Unless you have a health issue, longevity might be one of the greatest risks to your plan. Consider that there is a correlation with wealth and longevity so using standard tables may significantly understate how long you live. Some people don’t use realistic assumptions. Yes, you might read an article or study showing what percentage of pre-retirement income is typically paid after retirement. But those are general numbers. Will they work for you? Many people face lower expenses post-retirement. Some actually have expenses that are comparable, or even higher, than pre-retirement expenses. If your travel and entertainment activities were constrained by work obligations, you might well spend more on travel, cruises, and fancy dinners post-retirement. For some, it’s actually a hybrid. After retirement expenses may bump up for a period of time then decline as age makes travel more difficult. The point is you want to have a realistic budget and financial forecasts and then periodically update them.
When did you last update your plan? What are the assumptions in your plan and do they work for you? Have you insisted that your financial adviser discuss all this with your estate planner so that your estate plan realistically factors in your likely future finances? Many have not and that could adversely impact your estate planning and even your financial security. In haste to use exemption before it is cut in half in 2026 many people will make gifts that if they had a realistic financial plan, they might make. Be careful.
Plan for Loss of Capacity
This might be one of the more difficult and unpleasant planning topics but vitally important. Realistically many of us will ultimately deal with some cognitive impairment. There are simple steps you can take that collectively may make a material impact on keeping you safe as you age or deal with health issues that may bring cognitive issues. Consolidate and simplify financial accounts. The less you have the easier to keep track of for you, and the easier for an agent or successor trustee to step up and help. Communicate key information to those you will rely on. Be sure you have current estate planning documents that name appropriate people to step in to help. These should include a durable power of attorney for financial matters, and perhaps a revocable trust. For health care documents this should include a health proxy (appointing an agent to make medical decisions) and a living will (stating your health care wishes). Taking appropriate actions might protect you and may avoid a court having to appoint a guardian.
Talk to Those Involved or Affected by your Plan
Have a talk with your fiduciaries. Are the people you have named aware of their roles? Do they have copies of the documents appointing them? Have you ever spoken to your designated heirs? You don’t have to discuss dollar specifics but it might be helpful to speak to heirs so they have some general idea what might be happening. Sometimes these conversations can eliminate worries and reduce or eliminate the risks of fights.
Does Your Plan Consider the Risk of Divorce?
Most people that engage in estate planning tend to be older. That is the exact cohort of people for which divorce rates continue to grow. Divorce is a real issue that is rarely addressed when couples engage in estate planning. After all the assumption is that the couple will remain married. But is that a realistic assumption? Should you at least consider with your advisers what divorce might mean in light of your planning? Sometimes, adding insurance coverage or taking other simple steps might make that risk less dangerous for one or even both of you. The divorce rate for first marriages is often suggested to be 50%. The divorce rate for those 50+ is double the rate of 20 years ago. Some predict gray divorces will triple by 2030. With these state those with or contemplating estate plans to use exemption before 2026 when it will be halved should consider the implication of divorce. Many do not. Revisit those plans now and address this tough topic when planning. The differences in trusts and the implication of retitling assets can have a substantial impact if there is a later divorce.
Residency: Where Do You Pay Tax?
Where you are deemed a resident might affect which state you pay income taxes to. Where you are deemed domiciled (the place that you intend to ultimately return) may determine whether a state estate or inheritance tax might apply to you. Also, the state you reside in might govern which state law applies to your planning. That could be important in the event of a lawsuit, divorce, etc. If you have homes in more than one state which state may tax you may not be clear. Keep in mind states don’t have agreements to resolve residency issues and you could actually end up being taxed by two (or more!) states as if you were resident in each. So, where are you a resident for tax purposes can have an important impact. So, you got a new driver’s license in the new state with no income tax, but you still own your family home in your old high tax state. That doesn’t mean you’ll succeed on a state tax audit. Have you tracked days in each state using the rules each state has? Many states require you to prove you terminated your tax residency by clear and convincing evidence. Getting a new library card in the low tax state and spending more time there may not suffice to change your residency.
Entity and Trust Administration
Its is far more exciting to create an estate plan then to keep it up, and many people just don’t bother. But if you don’t adhere to the formalities of trusts and limited liability companies (“LLCs”), corporations and other entities (e.g., signing documents in the correct name and title, having properly transferred assets to the entity and/or trust, filing the right tax returns, etc.), or if you commingled funds (e.g. paying personal expenses from a business entity), you might taint the planning. For example, paying personal expense from an entity may void the asset protection that was fundamental to why you created the entity in the first place. Have your advisers to review trust and entity operations and what can be done to shore up the formalities.
Family Business Succession
Do you have a plan in place concerning who will take over a family or closely held business when you can no longer run it? What if you are disabled, die or simply want to retire. Do you have documentation controlling what happens? Do you have the financial arrangements in place to provide for that succession? When were the numbers last reviewed? Does the approach to financing the succession work?