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How Markets Affect Your Estate Planning

Last update on: Jun 17 2020
estate planning

*Publisher’s note: Please click here to view updated research on this topic.

The financial markets have changed Estate Planning strategies, and most people don’t even know it. Estate planning specialists don’t always realize what the markets have done to their clients’ plans. After the market upheavals of the last year, it is a good idea now to review your estate plan to see how its results might have been changed. Here are the estate planning issues you need to consider.

§ Most investment assets appreciated in 2003, many by 30% and more. A number of estates that would have avoided estate taxes 18 months ago now are above the exemption level. Others were pushed into higher estate tax rate brackets. An estate is tax free if its taxable value is $1.5 million or less, assuming none of the lifetime estate and gift tax credit has been used. You need to determine if higher asset values make the estate tax higher than anticipated a year ago. If it is, visit an estate planner to do discuss your options.

§ Reconsider specific bequests. I generally recommend that there be few or no specific bequests of property in a will because of the effects of market fluctuations. Suppose your will says a specific piece of real estate will go to charity. A few years ago when you first wrote the will, that real estate was a modest percentage of your estate. Now, after the strong real estate appreciation of the last five years, that property is a significantly higher proportion of your estate. The dollar value also is more than you want to give to the charity.

The same thing can happen with specific bequests to individuals. A division of certain assets or financial accounts between the heirs was reasonable at first. Now, after the assets appreciated at different rates, the values no longer are in line with each other.

In either case, the will has to be rewritten to make sure your wishes are reflected in the distributions.

An asset should be designated as a specific bequest only when it is unique and you want the beneficiary to get that asset regardless of its value. Examples are art, antiques, personal mementos, collections, heirlooms, and a family business. With charitable contributions, it is best to specify a dollar amount and a percentage of the estate. For example, “Charity A is to receive $100,000 or 10% of the estate, whichever is less.” For individuals, state a dollar amount or a percentage of the estate. For example, “Each of my children is to receive one third of the remainder of the estate.”

In either case, leave it up to the executor to decide whether to give cash or specific assets. The executor should be in a better position to decide which assets to sell and which to transfer to different beneficiaries instead of cash.

§ Market fluctuations also affect gift giving plans. In the past I’ve recommended that you consider giving loved ones more than the tax-free annual amount of $11,000. That’s because assets generally appreciate. More wealth avoids estate and gift taxes if the estate and gift tax credit is used with gifts now instead of through your estate. To the extent you can afford it and your heirs will responsibly manage the assets, it makes sense to give the assets now rather than later.

The past year shows how that estate plnning strategy works. Suppose instead of giving $11,000 in cash to an adult child a year ago, you gave $50,000 of shares in TCW Galileo Select Equity. By the end of the year, those shares would have been worth about $75,000. That extra $25,000 avoided estate and gift taxes.  Instead, those shares still are in your estate at the higher value. Unless they have a severe correction, getting them to the next generation will cost more in estate taxes down the road.

If you have assets that aren’t likely to be needed to maintain your standard of living and are likely to appreciate over the years, it is better to give them now instead of later.

§ Keep highly appreciated assets for life. If you make a gift of an asset that already has appreciated significantly, the donee takes the same tax basis in the asset that you had. When the donee eventually sells the property, he or she pays capital gains taxes on the appreciation that occurred while you owned the property plus the later appreciation.

If instead you hold the asset for life, the heir will get to increase the basis to its fair market value. No capital gains taxes would be due on the appreciation during your lifetime. If possible, assets with high embedded capital gains should be held for life.

§ Review marital deduction and credit shelter trust formulas. Many married couples have wills that create credit shelter trusts. The trust assets and income can be used to support the surviving spouse, and the remainder of the trust goes to the children of the couple. The purpose of the trust is to take advantage of the lifetime estate and gift tax exemption of the first spouse.

In the past many wills for married couples simply stated that the lifetime exemption amount should be put into the trust. This provision made sense when the lifetime exemption amount was fairly low. I’ve been saying that under the 2001 tax law this can be a bad provision. Suppose your estate is $2 million. Under this provision in 2004, $1.5 million of your estate goes into the trust. Only $500,000 goes to your spouse.

A better approach is to decide how much wealth your spouse should own outright to maintain his or her standard of living. Have the will put only the estate value greater than that amount into the credit shelter trust. It is better to give up some of the lifetime exemption than to leave your spouse without adequate assets.

§ Review estate planning strategies you decided against in the past. Some estate planning strategies become more attractive as interest rates decline. These include charitable lead annuity trusts, grantor retained annuity trusts, and private annuities. At recent lower interest rates, they could be worth implementing. This might be a good time to have your estate planner re-run the numbers so you can reconsider the decision.

Some estate planning strategies generate better results when interest rates are high. These are charitable remainder annuity trusts and qualified personal residence trusts. Keep these in mind as interest rates rise. Strategies that are not affected by interest rate fluctuations are charitable remainder unitrusts and grantor retained unitrusts.

Low interest and no interest loans to family members, also known as below market loans, can be good deals today. The tax law imputes a minimum interest rate on many loans if one is not agreed to by the parties. The minimum rate is based on market rates. At today’s low market interest rates the imputed rate would be quite low, making the tax consequences minimal.

Here’s how a no interest loan can work. You lend $50,000 for five years to an adult child. The child invests the money. After five years, the child has an investment return of $20,000. The original principal can be sold and returned to you. The child keeps the $20,000. You have the original capital back and have transferred $20,000 to your child at no estate or gift tax cost.

I wrote about low interest loans in the January 2002 issue. The article is available in the Grandkids’ Watch section of the Archive on the subscribers’ web site.

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