How to Transfer Assets Out of Your Estate Yet Retain Access to the Money

You can take advantage of today’s big estate and gift tax opportunities and still retain some access to your wealth.Estate planning strategies are never going to be as effective as they are now because of the high exemption amounts, low estate and gift tax rate and low interest rates. See our July 2020 issue for details.

The estate planning environment is as good as it is ever going to be. But there’s a limited window to capture the opportunity, and many people are hesitant to act, though action will increase their family’s after-tax wealth.One factor deterring many people from capturing these advantages be-fore they disappear is that to reap the benefits you have to remove property from your estate. That usually means making gifts.

The gifts must be complete, which means no strings attached. Fortunately, you don’t have to give away everything to benefit from the current law. Any amount removed from your estate provides benefits. But many people aren’t sure how much money they can give without endangering their standards of living. They’re hesitant to transfer the wealth. Fortunately, there are ways to make gifts that still provide you with some access to or control over the property. For example, there is the spousal lifetime access trust (SLAT).

Let’s say Max Profits transfers assets to an irrevocable trust for the benefit of his wife Rosie, with their children as contingent beneficiaries. The trustee has discretion over making distributions. The assets in the trust are safe from Max’s creditors under most state laws.The assets in the trust also should be excluded from both Max’s and Rosie’s taxable estates as long as the trust is irrevocable and Rosie doesn’t have a general power of appointment of future beneficiaries of the trust.

Other technical details that an estate planner can take care of also must be met. So, the property is out of their estates. But Rosie benefits from distributions that are made to her at the trustee’s discretion, and Max effectively benefits because distributions to Rosie can be spent on anything, including the couple’s joint expenses.

Rosie also can create a SLAT of her own with Max as the primary beneficiary. But care must be taken that the trusts aren’t reciprocal. There should be significant differences between the trusts, which an estate planner can design.Another strategy is to sell assets to trusts, taking promissory notes in return.

For example, you can create a trust in which you are considered the owner of the trust, known as a grantor trust. You are taxed on all the income of the trust, so you don’t recognize any gain on the sale. Yet, when the trust is structured properly its assets aren’t included in your estate.You sell assets to the trust in return for promissory notes.

When the promissory notes are for the full market value of the assets, there is no gift.These trusts are very flexible. The details can vary based on your needs and goals. For example, the trust can use its income and gains from sales of the property to make payments on the promissory note to you. You can continue to receive payments for the term of the note.

Eventually, the note is paid, and the property remaining in the trust is transferred to the trust beneficiaries at no gift tax cost.Or you can decide at some point in the future to forgive some or all of the note. That will be a gift and use some of your lifetime exemption amount. That allows you to transfer the property to the trust now but decide later how much of a gift, if any, to make. Because interest rates are so low today, you can set a very low interest rate on the loan without any tax consequences.

The low interest rates let you maximize the amount transferred tax free to the beneficiaries. The promisso-ry note gives you cash flow and could result in most of the trust’s initial value being returned to you over time.The strategy effectively lets you change your mind about making a gift. You can decide never to forgive the note and receive full payment on it, so all the property you contributed to the trust is returned, plus some interest. A related popular strategy is the grantor retained annuity trust (GRAT).

In a GRAT, you transfer assets to an irrevocable trust, and the trust makes annuity payments to you over a period of years. After your annuity payments end, the assets remaining in the trust belong to the trust or its beneficiaries, free of gift and estate taxes.

A GRAT can be structured so that little or no gift tax is due on the creation of the trust.

Most GRATs these days make annuity payments for two to five years. The trust makes the annuity payments over that time, and whatever remains in the trust at the end of the period belongs to the trust or its beneficiaries. Because interest rates are close to zero today, the amount of the annuity payments required to make the gift tax close to zero is relatively low.

For the GRAT to transfer wealth to the next generation, the trust only needs to earn a return on its investments that exceeds the minimum required IRS interest rate. Generally, GRATs are best created with assets that are expected to appreciate in value in a short time, such as growth stocks.

If the creator of a GRAT passes away before the annuity term ends, the en-tire value of the trust is included in the creator’s estate as though the GRAT weren’t created.A related strategy is the grantor retained income trust (GRIT). In a GRIT, you transfer property to a trust and retain the right to use the property or receive its income for years or the rest of your life.

After your income period ends, the trust or its beneficiaries have full ownership of the property.You’ll be able to transfer full value of the property at a reduced gift tax cost, because the beneficiary has to wait to receive ownership. Plus, you benefit from the property or its income for a period of years.

But the GRIT can be used for only non-depreciable tangible personal property.

A special type of GRIT is the qualified personal residence trust. A GRIT also can be used for assets such as artwork, vacant land and collectibles. Another strategy is to make a legally enforceable promise to provide a gift in the future.

An enforceable promise to make a gift is treated as a gift for tax purposes on the date the promise is made, though no money or property has changed hands.

Your estate should be able to claim the gift tax exemption amount that was in effect on the date the gift was made, even if the exemption amount is lower at the time of your death.In the meantime, you haven’t had to give up any money or property. This is a tricky strategy that requires careful work with your estate planner.

There are a number of other strategies that permit you access to assets while making use of today’s estate and gift tax exempt amounts. Business owners can set up family limited partnerships or limited liability companies to reduce the taxable amount of gifts and transfer future growth of the business to other family members.

The strategies also can be used with real estate and substantial investment portfolios. You can make loans to family members at low interest rates and forgive them later if you want, as we discussed in past issues such as the August 2019 newsletter.

It is important to guard against the potential negative consequences of taking advantage of today’s opportunities.One risk is that you give away property that subsequently suffers a permanent decline in value. You’ll have used part of your lifetime gift tax exempt amount based on the value of the property on the date of the gift, but your loved ones will receive a gift of substantially less value.

You can avoid this consequence by giving a trustee or beneficiary the right to disclaim within nine months any gifts to the trust. This lets them reverse any gifts that decline in value soon after being contributed to the trust.

A more sophisticated action is to give someone, other than you or a beneficiary of the trust, the ability to allow you to appoint a different beneficiary of the trust principal in your will. If the person does confer that power on you, the property is included in your estate.

This effectively restores the exempt amount that was used on the property that declined in value. That’s another strategy an estate planner needs to craft.

If you’re interested in taking advantage of today’s estate and gift tax reduction opportunity while retaining some access to the property, the important step is to let your estate planner know and begin considering the strategies that would work best for you.