Seven Wealth Planning Techniques for the Current Market Environment

We urge those who are well positioned in terms of lifestyle liquidity to consider whether one of the following techniques may help to further optimize their family's wealth.

Market volatility, combined with low interest rates, presents powerful opportunities for planning that could produce greater wealth and tax savings over the long run. The COVID-19 pandemic has produced low market valuations and even lower interest rates. In addition, the corresponding reduction in federal income tax revenue, combined with fiscal stimulus, creates the very real potential for higher income taxes and lower gift and estate tax exemptions in the future. We urge those who are well positioned in terms of lifestyle liquidity to take an active approach to the current market environment and consider whether one of the following techniques may help to further optimize their family's wealth.

Promissory Notes. With interest rates for intrafamily loans currently under 1%, this is an ideal opportunity to make loans to children and grandchildren – either for immediate liquidity needs, such as upcoming tax payments, or for larger acquisitions such as the purchase of a home – with minimal cost to the borrower. Low-interest loans can allow for the transfer wealth to the borrower without using the lending family member's gift and estate tax exemption. Similarly, families that have outstanding promissory notes (whether standalone or as a part of sale transaction) should consider refinancing those to take advantage of the lower rates without gift tax implications.

Funding GRATs. A grantor-retained annuity trust (GRAT) is a statutory strategy designed to shift an asset's future appreciation to the grantor's family while using minimal or no gift tax exemption. The success of a GRAT hinges on assets appreciating at a rate greater than the published IRS rate during the term of the GRAT. The April 2020 rate is 1.2%. The key to funding a GRAT would be to select both the right duration of the trust and the right assets that have the likelihood of appreciating within the chosen timeframe. In the current market environment, those assets can be either significantly discounted publicly traded stock or shares in a privately held entity that stands to be sold or appreciate within a few years.

Sales to IDGTs. Selling an asset to an intentionally defective grantor trust (IDGT) is another effective way to shift the future appreciation of an asset outside of the taxable estate. The strategy is also more successful when the published IRS interest rate is low. The sale to an IDGT is similar to a GRAT in that the grantor retains the value of the assets initially transferred to the trust. However, the IDGT is more tax effective for those who want to pass appreciation to a generation younger than their children (i.e., grandchildren and beyond).

Gifting of Discounted Assets. For those who have taxable estates (i.e., estates larger than $11.58 per individual or $23.16 per married couple in 2020), the currently depressed valuations of assets are a great opportunity for gifting assets to family members with little or no gift tax consequences. Careful consideration has to be afforded to whether to gift assets outright or to trusts, as trusts provide greater protection from creditors and tend to preserve wealth within the family.

Roth Conversions. Converting a traditional IRA to a Roth IRA is a taxable event that generates ordinary income for the owner. Lower IRA values due to the current market dislocation make a Roth conversion attractive, particularly for those who expect to be in the same or a higher income tax bracket upon retirement. Lower asset values in the IRA should produce a more modest tax liability upon conversion. In addition, Roth IRAs do not have required minimum distributions (RMDs), which allows the owner to continue to accumulate assets inside the Roth. In a traditional IRA, RMDs are taxable to the owner and begin when he or she reaches age 72. Finally, the elimination of the “stretch" IRA for non-spouse beneficiaries under the recently enacted SECURE Act make traditional IRAs less attractive as a wealth transfer vehicle to children and grandchildren.1

Exercising Stock Options. When an employee exercises stock options, he or she pays ordinary income tax on the difference between the grant price and the fair market value of the stock upon exercise. If the company's stock price is temporarily low, it may make sense to exercise now and realize ordinary income based on the lower price.

Swapping Grantor Trust Assets. Many irrevocable trusts give the grantor “the power of substitution," i.e., the power to take assets out of the trust and replace them with assets equal in value. This power is designed to make the trust disregarded for income tax purposes, but it can also be used strategically to transfer assets that are expected to appreciate further into the trust and remove those assets from the taxable estate. By way of an example, a grantor could swap equities into an irrevocable trust in exchange for fixed income securities, with the expectation that that equities would appreciate more in the future.

In addition to considering of the above strategies, we recommend revisiting estate planning documents, including power of attorney designations and health care directives, to ensure that they conform to their current wishes and expectations.

  • 1 The elimination of “stretch" IRAs is not applicable to the following eligible designated beneficiaries: a surviving spouse, a minor child of the account owner, a disabled or chronically ill beneficiary, or an individual who is fewer than 10 years younger than the account owner at the time of their death; each of whom may receive distributions according to different limitations.

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