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Three New Rules Of Estate Planning

Last update on: May 27 2020
Estate Planning

Many things changed in the last two years. Those changes should lead to revised estate plans and new approaches to Estate Planning.

The biggest change of course is the loss of $7 trillion to $8 trillion in stock market wealth. There also is uncertainty about the strength of the economy and the outlook for future stock market gains. Plus, interest rates are at their lowest levels in three or four decades. Low interest rates are great for borrowers but they slash investment income. Throw in longer life expectancies, a new tax law, and uncertainties created by the war on terror, and you have strong reasons for re-evaluating many traditional estate plans. We’re now looking at estate planning in extremely uncertain times.

The primary focus of most estate planning used to be tax reduction. People also were concerned with how they wanted to divide up their wealth and how soon to give. Now, people are more likely to be concerned with how to preserve their estates to maintain their standards of living. They also are re-evaluating ways of dividing the property among loved ones.

Here is a review of how estate planning goals and strategies have changed.

Control is more important.

A few years ago, many estate-planning Americans felt wealthy enough to give away substantial wealth during their lifetimes. They instituted lifetime giving programs and gave money and property in large lump sums. Now, many Americans look at the stock market and interest rates and conclude that they cannot give away as much wealth during their lifetimes as they thought. Giving programs are being suspended.

You don’t have to end your estate plan. Here are the strategies for reducing estate taxes while keeping control that are attracting today’s estate planners.

Family limited partnerships. The FLP is a classic strategy that gives estate owners continuing control of property, enabling them to manage it and distribute money as they desire. Yet, when properly set up the FLP reduces estate and gift taxes by 20% or more.

To use this strategy, parents create an FLP with themselves as general partners and limited partners. The general partners manage the property, decide when to buy and sell assets, and distribute money and property as they see fit.

Then the parents transfer investment and business property to the FLP. The limited partnership interests are transferred to their loved ones. There are several ways the limited partnership interests can be transferred, each having different tax consequences. Once the limited partnership interests are in the children’s hands, the value of the parents’ estates is reduced dramatically yet the parents continue to manage the property as general partners.

The result is that the parents retain control as a hedge against tougher times, but tax benefits are captured. More details about FLPs are in the Estate Watch and Grandkid’s Watch section of the Archive on the web site.

Parent investment accounts. Parents and grandparents used to line up for Section 529 plans, trusts, and other tax-advantaged ways to give and invest money for later generations. Now, the trend is for parents and grandparents to invest the money in their own names. This is partly to avoid triggering income taxes and financial aid problems for loved ones, as I’ve described in past issues. More importantly these days, parents and grandparents are retaining the accounts to protect their standards of living.

Some investment tax breaks are surrendered by using this strategy. All income and gains are taxed at the account owner’s tax rate. The property also remains in the parent’s estate where it might be taxed. Gift taxes can be avoided if the account owner pays for education expenses and the payments are made directly to the education institution.

Family loans. The family low-interest or no-interest loan can be ideal for someone who doesn’t need the money for expenses now but might need it in the future. The parent can lend money to a child. The child invests the money for, say, five years, then repays the principal to the parent. The child gets to keep the income and gains earned by investing the money. The parent gets the money back, owes no income or gift taxes on the transaction, and has helped the child.

The parent wants to take care to ensure that this is a real loan the IRS will recognize and also that the money will be repaid if it might be needed in the future.

I’ve covered the details of family loans in past issues. They can be found in the Archive section of the web site.

Dividing the estate takes more care.

A few years ago many estate owners were comfortable leaving specific investments and other assets to different family members. This approach was an easy way to give heirs inheritances of equal value without the heirs having to be co-owners or sell the assets and divide the proceeds. Unfortunately, different assets do not have the same rates of return over time.

Many people planned to leave a business or real estate to one heir and a stock portfolio to another heir, as a simple example. The business or real estate probably has had a fairly steady value the last two years. Meanwhile, the stock portfolio has lost value, perhaps substantial value if it was invested in a stock index or in growth stocks. The heirs would receive dramatically unequal inheritances today.

If you want to make bequests of equal value to heirs, leaving them different assets doesn’t have a good probability of achieving that result. Nevertheless, you also might not want to leave all the heirs as equal co-owners of assets. They might find it difficult to agree on how to manage the property or how to divide or dispose of it. Or one heir might be best-suited to manage a particular property, such as a business or real estate.

A better approach might be to leave heirs specific assets. Then go a step further and require that the heirs equalize the value of their inheritances. For example, the estate executor should establish values for each of the assets. Those who inherit the more valuable assets should have to compensate those with less valuable assets by either giving up other inherited assets or making installment payments.

New life for life insurance.

The primary use of life insurance in estate planning was to pay estate taxes. Now, estate owners are thinking that life insurance might perform better as a gift. Those whose estates shrank in the bear market might not need as much life insurance to pay estate taxes as they did a few years ago. Instead of canceling the insurance or reducing the benefits, some believe the excess insurance benefits should be given to heirs to help make up for stock market losses.

Other estate owners think life insurance might be a better way to establish a legacy. The values of stock portfolios and businesses are uncertain. Heirs could end up with substantially less than intended if they inherit after a market peak. The pay out from life insurance is certain as long as the insurer is financially healthy. Some people are considering using portions of the portfolios they aren’t likely to need to purchase life insurance for their heirs.

Life insurance as part of an estate plan should be owned through an irrevocable life insurance trust. This is a standard strategy that can be implemented with any experienced estate planning attorney.
Those are the key ways estate planning changed in the new century. In the next couple of months we’ll build on this by discussing the important estate planning decisions every one faces, regardless of the amount of wealth in the estate.

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