Wealth Preservation Strategies
The Two Major Issues Facing High Net Worth Families – Saving Estate Taxes and Keeping Assets in the Bloodline
We are often surprised at how few families (1) actually save the maximum estate taxes allowed by law, (2) protect the inheritances they are leaving from their children’s divorces, and (3) arrange to keep their assets in the bloodline for their grandchildren. Taking these issues in order, below please find our article on the current state of estate taxes showing what you can save. Following that is an article we have written about the planning technique of using trusts to reduce, and often eliminate New York and Federal estate taxes.
Secondly, please also have a look at our article explaining Ettinger Law Firm’s trademarked “Inheritance Protection Trust”, in use for over twenty-four years now. These trusts protect the inheritances you leave from your children’s divorces, lawsuits and creditors and, upon their death, guarantee whatever’s left goes back to your blood relatives instead of in-laws and their families.
The State of Estate Taxes
The current exemption from New York estate taxes is 5.93 million, indexed for inflation. For example, last year it was 5.85 million. For the majority of our clients this presents no issue – their estates will never approach the exemption.
However, for the fortunate few who have assets, including life insurance, that may exceed roughly six million dollars, there is a significant tax liability. Changes in New York estate tax law in the last few years introduced a “fiscal cliff”. Whereas formerly New York only taxed the amount over the exemption, if you exceed the limit today they tax the whole estate. You’re over the cliff!
The tax is surprisingly large. On a roughly six million dollar estate, the taxes payable to New York exceed five hundred thousand dollars. An estate over ten million would owe over a million in estate tax.
These New York estate taxes are avoidable if you have a spouse and you create an estate plan using two trusts – one for each spouse. By setting up two trusts, over which you and your spouse both have complete control, you may double the exemption and would not have to pay estate taxes unless you exceeded the two exemptions. This planning must be done before the first spouse dies. The technique is explained in detail in the following article “Disclaimer Trusts for Couples with Taxable Estates”.
While the Federal estate tax exemption of 11.7 million is “portable”, i.e. if the first spouse doesn’t use their exemption or any part of it, it passes to the surviving spouse, New York does not allow for portability. It’s use it or lose it.
The Federal exemption is expected to be reduced from the 11.7 million exemption passed by the Trump administration to the 5.93 million that New York uses, under the Biden administration. Current thinking is that this will not occur in 2021 but more likely in 2022. For larger estates, there remains a planning opportunity by making gifts while the higher exemption is in place for one more year. You may use any of your estate tax exemptions to make gifts while you are living. These gifts are reported to the IRS and get subtracted from what you may give at death.
One added attraction to gifting is that New York does not tax gifts -- so that gifts also avoid onerous estate taxes at death. There is a minor exception that gifts made within three years of the death of the donor are brought back into the donor’s estate for estate tax purposes.
Disclaimer Trusts for Couples with Taxable Estates
For couples with taxable estates, disclaimer trusts are commonly used today to allow the surviving spouse greater flexibility in optimizing estate tax savings. These trusts are generally used in states that have a "state" estate tax that the client may be exposed to.
Here’s how they work. Each spouse sets up their revocable living trust. Husband and wife are co-trustees of his trust, using his social security number and, similarly, they are both co-trustees of her trust with her social security number. Let’s say husband dies first. His trust says “leave everything to my wife except that, whatever she disclaims, i.e. refuses to take, will remain in my trust”. The disclaimer is a legal document that lists the assets disclaimed and their value. Wife remains as trustee on husband’s trust after he dies nd may use the funds in his trust for her health, maintenance and support. She may also remove 5% of the trust every year for any reason, or $5,000, whichever is greater.
The reason wife is limited to health, maintenance and support is that if she had the right to take whatever she wanted at any time for any reason, the taxing authority would say that she had complete control of the funds and would then seek to tax those funds in her estate. The access for health, maintenance and support, however, is sufficiently broad so as not to cause a problem for her. She may also continue to buy, sell and trade assets in the husband’s trust. This trust continues for her lifetime and pays out to the heirs at her death along with her own trust.
Husband’s social security number died with him so his trust took out a trust tax identification number when he died and reported as a separate taxpayer during her lifetime. It is not includable in her estate. Indeed, what has happened is that husband’s trust was settled on his death and left to his heirs, but subject to wife’s lifetime use and enjoyment of the trust assets.
The benefit of the disclaimer is that it allows the wife to decide (or the husband if wife dies first) how much to leave in the deceased spouse’s trust based on her age, health and the tax laws at that future time. Formerly, attorneys would simply do their best to split the assets between the two trusts and simply say whatever was in the deceased spouse’s trust remained there for the surviving spouse’s lifetime. This yielded some unfortunate results.
Let’s say husband’s trust exceeds the tax exempt amount. Formerly, wife would be required to pay tens of thousands of dollars in state estate tax based on the amount over the exemption. With the disclaimer trust, wife may take the excess over the exemption out of his trust for herself and claim the unlimited marital deduction which avoids estate tax on assets left to a spouse. Perhaps her estate will be under the exemption and no taxes will ever have to be paid on that money, she may spend or gift it down, or the exemption may be raised during her lifetime. In any event, worst case scenario is that taxes on those monies are deferred until after she dies and, in the meantime, she has the use and enjoyment of monies that would have formerly gone to the government.
A word about the Federal estate tax exemption which today exceeds eleven million dollars. For couples over eleven million, the Federal tax regime offers “portability” which means the surviving spouse is permitted to claim any unused portion of the deceased spouse’s exemption. Nevertheless, the disclaimer trust may still be used to “freeze” the growth of the deceased spouse’s share.
For example, let’s say husband’s trust has eleven million dollars. If it goes to wife, she can claim his eleven million plus exemption (adjusted for inflation) on her death. However, the eleven million may have grown to twenty million by the time of her death which, together with her own assets, may put her estate over the combined twenty-two million plus exemption.
By leaving the eleven million in husband’s trust at his death, all of the growth remains tax-free to the children at the wife’s death. The husband’s trust has passed the tax collector and is not looked at again upon the wife’s death.
At an estate tax rate of forty percent, millions of dollars may be saved at the Federal estate tax level by using disclaimer trusts.
Inheritance Protection Trusts TM to Keep Assets in the Family
With the size of estates having grown today to where middle class families are leaving substantial bequests to their children (depending, of course, on how many children they have), the trend is toward establishing trusts for the children to keep the inheritance in the bloodline. In the case of your children, there are a number of benefits to leaving assets to them in a trust. These are: (1) the assets will be protected from their spouse in the event of divorce (2) the assets may be protected from their creditors in the event of a lawsuit or other financial hardship, and (3) on your child's death, the unused assets will go to your blood relatives (usually grandchildren) instead of to in-laws or others.
We call this “multi-generational planning”. Whereas with a will your estate plan usually dies when you do, with an Inheritance Protection Trust (IPT) your wishes will go on for thirty, forty or even fifty or more years after you are gone, i.e., for two generations instead of just one.
These trusts provide that, during your children's lifetimes, they have complete access to the income and the principal of their Inheritance Protection Trusts – so that you're not giving them a “gift which strings attached” or “ruling from the grave”. But when your child dies, you would like the trust assets, which may have grown considerably, to go to your grandchildren. If the grandchildren are under age thirty, we recommend that the funds be held in trust for them until such age, with the trustee (usually one of your other children) using so much of the assets as may be needed for their health, education, maintenance and support. If one of your children dies without leaving children of their own, then the trust funds go to their surviving brothers and sisters.
Keep in mind that, without an Inheritance Protection Trust, if your son or daughter dies, the entire inheritance you have left may go to a son-in-law or daughter-in-law who may later get remarried and share your hard earned assets with a complete stranger. Nevertheless, some clients would not want to disinherit their son-in-law or daughter-in-law. In such cases, the Inheritance Protection Trust, or a portion of it, may be set up to continue for your in-law's lifetime, providing them with the “income only” so that if they get remarried or end up in a nursing home, the assets are still protected and will still go to your grandchildren, after the son-in-law or daughter-in-law dies.