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Those who are well positioned with core capital reserves and lifestyle liquidity should consider the following strategies to help optimize their family's wealth.

Down markets present powerful planning opportunities that can produce greater wealth and tax savings over the long run. As a result, those who are well positioned with core capital reserves and lifestyle liquidity may want to take an active approach in optimizing their family's wealth. The following strategies can help when assets have temporarily low valuations. 


Gifting of Discounted Assets: For those who have taxable estates (i.e., estates that exceed the current Federal Estate Tax Exemption), depressed asset values could present optimal opportunities for gifting.  Lower valuations may allow for more assets, as the price recovers, to be passed to family members. However, careful consideration should be afforded to whether assets are gifted outright or to trusts. Trusts generally provide greater protection from creditors and tend to preserve wealth within the family. Additionally, other factors like income tax should be considered. For example, the donee keeps the donor’s basis in assets transferred in-kind.  


Roth Conversions: If market volatility has impacted your retirement account balance, it may be an opportune time to convert a traditional IRA or 401(k) to a Roth IRA. This conversion would be a taxable event that generates ordinary income for the owner in the year of conversion. When markets are down, lower retirement account values make Roth conversions an appealing option for those who expect to be in the same, or a higher, income tax bracket upon retirement.


If income tax is a concern upon conversion, there are other ways to manage that burden.  For example, a charitable deduction in the same year can help offset the rise in taxable income triggered by the conversion.  In a traditional IRA the account owner has a required minimum distribution (“RMD”) based on life expectancy that begins at age 73, which is taxable to the owner in each year.  Since Roth IRAs do not have RMDs, invested assets continue to grow inside the Roth making them a more attractive retirement vehicle.


Promissory Notes: With interest rates for intrafamily loans that are still historically low, there is an opportunity to make loans to family members – either for immediate liquidity needs, such as upcoming tax payments, or for larger acquisitions, such as the purchase of a home. Low-interest loans, using the stated Applicable Federal Rate (“AFR”) to avoid gift tax, allows wealth to be transferred to the borrower without using the lending family member's gift and estate tax exemption. Additionally, the lender can decide to forgive interest payments and/or principal which may qualify for the annual gift tax exclusion.  


Sales to IDGTs: Selling an asset to an intentionally defective grantor trust (IDGT) is another effective way to shift its future appreciation outside of the taxable estate. When drafted properly, the grantor pays income tax on the trust’s income, allowing trust assets to grow unencumbered by taxes.  An IDGT can be even more successful when high-growth assets are sold to the trust by use of an installment loan. 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 (usually structured with a balloon payment at the end of the term). Use of such notes can effectively pass appreciation to grandchildren and beyond, preserving wealth for multiple generations.


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 to strategically 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 equities will appreciate more in the future.


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. With this strategy, a grantor transfers property to an irrevocable trust and receives an annuity, fixed percentage or income payment for a specified term.  At the end of the GRAT term the assets pass to the chosen beneficiaries. The success of a GRAT hinges on property in the trust growing faster than the published IRS Section 7520 rate during the selected term. In the current market environment, those assets can either be significantly discounted publicly traded stock or shares in a privately held entity that are expected to greatly appreciate.  


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.


With careful planning, the above strategies can help take advantage of depressed values to further a family’s legacy. We also recommend revisiting estate planning documents, including powers of attorney for property and health care, to ensure that they achieve current wishes and expectations.


This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation.


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