Thinking about transferring wealth to the next generation? Now is the time!

Kegler Brown Estate Planning + Probate Newsletter

Each morning's newspaper seems to bring a new level of despair: real estate values are in a free fall, stock markets have plummeted, unemployment rates skyrocket, and credit markets continue to tighten. In light of the "doom and gloom" that surrounds us, it's hard to imagine that there is a silver lining, but for clients who are thinking about transferring some of their assets to the next generation, now is the perfect time to implement a strategy.

You might think of the current environment as a "perfect storm" for executing a new wealth transfer plan:

1. Valuations are Low. Although it's somewhat hard to grasp, low valuations are actually a good thing when dealing with wealth transfers. Because the fair market value of an asset as of the date of transfer is used in determining the existence and amount of a taxable gift, clients have more flexibility to transfer more investment assets at a lower cost.

  • An Example. For example, say you owned 10,000 shares of JP Morgan stock. When those shares were trading at $50/share, you could have done one of two things: (1) sold the stock to your children at the fair market value of $500,000 with no gift tax, or (2) gifted the stock outright and pay gift tax on the full $500,000 gift (with some reductions for annual exclusions, unified credit, etc.). Today, assuming a $25/share value, you can transfer those same 10,000 shares for $250,000, either by sale or gift. So, if you made an outright gift today, the gift tax savings would be approximately $125,000, or 50% of the $250,000 reduction in the valuation. Even if you have "unified credit" remaining so that your gift is not taxable, you would have preserved more of your unified credit for later use.
  • Complex Planning Strategies. Lower valuations also facilitate the use of more complex estate planning strategies that are designed to "freeze" the value of your taxable estate so that future appreciation goes to the next generation free from estate and gift taxes. Examples include Family Limited Partnerships (FLP), Qualified Personal Residence Trusts (QPRT), Grantor Retained Annuity Trusts (GRAT), and sales to grantor trusts (also known as sales to Intentionally Defective Irrevocable Trusts (IDIT)). Of course, a key assumption is that the real estate and stock markets are going to rebound, but if they do, the estate and gift tax savings can be substantial.

2. Income Tax Rates are Probably Going Up. In light of the upcoming change of power in Washington, it appears likely that the days of a 15% long-term capital gains rate may soon be gone. If you have investment assets with previously unrecognized gains and if you have to recognize gains now, it may make sense to do so while tax rates remain at their current levels. Although many strategies do not require recognition of tax gains, if implementation of your wealth transfer plan requires you to recognize gains, today's income tax rates will be significantly lower.

3. Interest Rates Continue to Fall. In order to spur growth while inflation remains in check, interest rates have fallen dramatically. Some complex estate planning strategies are maximized when the "Applicable Federal Rate" (AFR) is low. The AFR is the minimum interest rate that can be charged under the federal tax code without having "imputed income" on "below market" loans (i.e., the lender is taxed on interest he should have received even though the lender didn't actually charge interest). The February AFR used in many wealth transfer strategies is down to a ridiculously low 1.65%.

4. Annual Exclusion Gifting. As of January 1, the "annual exclusion amount" for tax-free gifts increased from $12,000 per recipient per year to $13,000 per recipient per year. The "annual exclusion amount" is the maximum gift that can be made to an individual recipient during any year without paying gift taxes or even reporting the gift, and there is no limit on the number of recipients of the gifts. If you are married, your spouse can join in making gifts, and the two of you may transfer up to $26,000 per recipient per year tax free. Combining this strategy with today's depressed valuations makes annual exclusion gifting of investment assets a potentially powerful strategy.

In addition, it's always a good idea to review your estate plan regularly just to make sure that everything is up-to-date and reflects your current needs and goals. A lot can happen over time, both in the nature of your investment portfolio and your personal situation, and these changes may warrant a modification to your plan. This year, there's even more reason for vigilance because the IRS's new deferred compensation laws under Section 409A take effect on January 1, 2009, and certain payment arrangements, including some nonqualified retirement plans, severance plans, and other deferred compensation programs, may be affected.

Now is a great time to sit down to review where you are and where you want to go. Taking advantage of the current economic climate could pay huge dividends to you and your family in the future.