When the Tax Cuts and Jobs Act of 2017 (the “Act”) became law, it ushered in an unprecedented era in terms of what could be achieved in the realm of estate planning.
Specifically, the Act set a new federal estate and gift tax exemption amount that was nearly double what it had been prior and allowed for annual adjustments for inflation (the 2023 level is $12.92 which increases to $13.61 million in 2024). This new level is far higher than we have seen in modern times.
As we learned from the television show “Once Upon a Time,” magic always has a price. In terms of the Act, that price is the sunsetting of the exemption levels after eight years. This means that at the end of 2025, unless Congress acts, the exemption will sunset back to the 2017 rate adjusted for inflation, somewhere between $6 million and $7 million.
This looming deadline, and the potential tax consequences of a greater portion of an estate being exposed to a 40% estate tax, means planning needs to happen now. This can be done in three steps:
Find a lawyer
Create and fund a trust
Buy life insurance
Step One: Get Professional Help
Given the stakes involved, it is important to work with advisors who have familiarity with estate planning for HNW and uHNW individuals and families. In terms of legal advice, this means retaining a qualified trust and estates attorney who focuses solely on this type of planning.
However, given the upcoming sunset, these types of attorneys are increasingly in high demand. Not identifying and retaining one soon may mean you are stuck with a legal advisor with less familiarity with these matters….or none at all.
When looking for a trusts and estates attorney, you want to find a lawyer who has a deep understanding of estate planning, trusts, probate, and other related issues, including life insurance. Look for an attorney who has been practicing in this area for several years and who has a track record of success in helping clients achieve their goals.
Experience alone is not enough. Get a sense of the attorney’s approach to planning, ensuring that they have a holistic view of how planning works and that their values and goals align with yours. Communication in planning is key, so check to see if their communication style is a match for you personally. Finally, availability and fees should be discussed up front. You don’t want to find your lawyer isn’t returning your calls because they are too busy or a bill in the mail for more than you expected.
Step Two: Trust Exercises
The most common way to get assets out of an estate, and therefore not subject to an estate tax, is the use of an irrevocable trust. With an irrevocable trust, a grantor establishes a trust for the benefit of named beneficiaries and gifts assets to the trust. After such a grant, the grantor no longer has access to those assets and cannot revoke or change the terms of the trust. This is what allows the assets in the trust to be considered out of the grantor’s estate.
Assets held in a trust can include a number of different types of assets including, but not limited to, a business, investment assets, cash and life insurance policies. Ideally, assets that are likely to appreciate or are eligible for valuation discounts, like business interests or minority stakes in partnerships, should be transferred to the trust.
Let’s use a rough example to demonstrate how this works. A couple has a current net worth of $50 million in 2024. They create an irrevocable trust for the benefit of their children and then use their 2024 combined exemption to transfer $27.22 million into the trust. This reduces their taxable estate to $22.78 million.
The result - from this point forward, rather than $50 million growing in their estate, they have $27.22 million growing outside of their estate and $22.78 growing within their estate and subject to eventual federal estate taxation (which we will address in our next post).
For those concerned about losing access to the assets transferred to an irrevocable trust, there is a strategy that may be used to achieve the same outcome as above while addressing the lack of access issue. It is commonly referred to as a SLAT, or spousal lifetime access trust.
In a SLAT, each spouse gifts up to their 2024 maximum exemption amount of up to $13,610,000 to a trust for the benefit of the other spouse and their children/grandchildren. Assets in each trust would not be included in either spouse’s estate at death. Now, during his/her lifetime, Spouse 1 has access to the SLAT Spouse 2 established for him/her and when s/he passes, the SLAT will be divided up into separate trusts for the benefit of their children.
While generally used with spouses, a SLAT strategy can be used by any two individuals who have an insurable interest on each other, such as a brother and sister (meaning SLAT could stand for sibling lifetime access trust).
When using a SLAT, it is important that the two trusts not be perfect mirrors of each other. Also, a problem arises when one spouse dies and the surviving spouse effectively loses access to half of their assets. There is a solution….
Step 3: Life Insurance to the Rescue
The planning laid out above is very effective at helping to reduce potential estate tax liabilities, but there are still certain potential pitfalls that must be addressed. Luckily, life insurance can potentially offer solutions.
First, let’s go back to the SLAT situation and loss of access at the death of a spouse. Each SLAT should purchase a life insurance policy on the life of the other spouse. Then, if one spouse passes, the other will continue to benefit from their SLAT and that SLAT will collect life insurance death benefit proceeds to replace the access to the values of their spouse’s SLAT which has gone to the trust’s beneficiaries. This graphic demonstrates how this works:
And what about a non-SLAT situation? In the first example we discussed above, the couple still had a taxable estate of $22.78 million after creating their trust and using their entire exemption to gift assets. That entire amount will be subject to estate taxes at a 40% rate.
Again, life insurance offers a solution. The trust they established purchases a second-to-die life insurance policy with an appropriate death benefit amount. When the second spouse dies, the policy will pay the death benefit to the trust and those processed can be distributed to permit the beneficiaries to pay those taxes without having to liquidate other assets.
No Time To Wait
When it comes to taking advantage of the current golden opportunity in planning, there is no time to procrastinate. Absent a near miracle from Congress, at the end of 2025 the gift and estate tax exemption amounts will be nearly halved, making considerably more of an estate subject to estate taxation.
As explained above, this issue can be addressed in three steps: Find a good lawyer, create and fund a trust, and then purchase life insurance to maximize the benefit of the planning.
At Robin Glen, we use our expertise in income and estate tax, private capital, and insurance analysis and design to create unique solutions that deliver impactful results for our clients and advisor partners.
If you or your client have questions about the looming exemption sunset and how life insurance can play a role in planning, reach out. We can help.