Estate Planning Opportunities Abound When The Stock Market and/or The Economy Go Bad
Introduction To Estate Planning In Bad Economies/Markets
A bear market in stocks and a sub optimal economy battered by multiple negative factors may be painful, but it can create the right circumstances for an estate planning opportunity to pass gains and wealth to the next generation.
And, if done right you can also give your heirs and beneficiaries creditor and divorce protection.
If passing on wealth and protecting it for your heirs from death taxes, lawsuits and possible divorce claims sounds like something that interests you, read on…
U.S. stocks recently reached “bear market” territory, which is defined as a drop of 20% in value from recent record highs. Then Silicon Valley Bank’s bank failure threatened even more trouble ahead.
While generally no one likes lower stock prices.
But these conditions do enable shareholders to transfer the future growth and appreciation of stocks (or real estate and other investments) into the hands of heirs and out of an estate where they might be subject to death taxes.
How? Well, when stock prices are lower, any transfer to your heirs uses up less of the federal estate tax exemption, or annual gift tax exclusions which recently increased substantially due to inflation adjustments. Currently, the Internal Revenue Code allows individuals to transfer $17k per year to any individual and up to $12.92 million tax-free over their lifetime or as part of their estate planning process.
Transferring assets with depressed values to heirs(or to an asset protective trusts for heirs) is one simple way to capitalize on a bear market (or even a significant recession), but there are also more sophisticated ways, to use these economic conditions to your advantage.
More Advanced Strategies and Ideas To Consider
Estate planning, by its nature, goes beyond personal wealth to the overall building and protection of family wealth. In addition, the risks of lawsuits, liability exposures and the threat of loss of assets in a divorce are also at historical highs.
These facts are important to consider when there are shifts in the direction of markets and when you are considering gifts or transfers of wealth to your children, heirs and beneficiaries.
Such transfers of assets, with depressed valuation, can be made either outright to the beneficiary of the gift, OR they can be made into special trusts that offer the beneficiary high levels of protection of those assets if the beneficiary gets sued, declares bankruptcy (from a business problem), or gets divorced and faces such claims.
While outright gifts will be available to their creditors, and can be taken from the beneficiary, a well-constructed trust can offer significant “creditor protection” from such risks.
A more complex strategy that wealthy clients can use is a grantor retained annuity trust or GRAT. Another is an outright sale of assets to the beneficiary or a trust (where the client also often takes back financing). This technique (in all of its variations can allow clients to transfer future growth in the business in a highly tax advantaged manner.
While you’ll need specific legal, estate planning and income tax advice to do these techniques, let’s look at both in a bit more detail.
With a GRAT the initial “gift” value of the assets gets returned to the grantor but, when the trust expires, the appreciation of those assets are out of the grantor’s estate and in the hands of beneficiaries (or in trusts for them).
During the term of the GRAT, the client receives an annuity payment equal to the amount put in the trust plus interest (a rate set by the IRS). Any appreciation over that rate goes to heirs when the trust expires.
The GRAT strategy is complex (and beyond the scope of this short review – call your legal and tax advisors about it) but historically has been used to transfer Walmart and Meta stock as well as many smaller privately held businesses, and it works well when stock prices are artificially low.
In the case of a sale, many families will obtain a formal valuation of a business (including businesses that own real estate) and will, in addition, get a minority discount appraisal.
The result is that they can then organize a sale to beneficiaries or their trusts, take back financing on that sale and effectively move the growth asset out of the estate leaving only the notes to be repaid.
These sales can be structured in many many ways but should be considered by families owning closely held businesses that have current low valuations but that are poised for growth when the economy improves.
Proceed with caution, however, as these types of transactions can have unintended consequences if they aren’t thought out in advance.
According to David Frees of Unruh, Turner, Burke and Frees, “Clients often have very different views of the same type of transactions. Some of our clients make sales of stock to their children (or to asset protective trusts for their children) when stock prices are depressed and they lock in those values.”
But, Frees also observed, that such sales “must be carefully considered and analyzed from the stand point of the client’s views on control or loss of control. And they have other income tax consequences so be sure that your entire team is consulted if you want to act while stock prices are low.”
Aside from capitalizing on bear-market or recession level conditions, wealthy clients also have to think about how they will be affected when provisions of the tax reform act enacted in late 2017 expire on December 31, 2025. While the exemption for an individual is US is currently $12.92 million, it is set by law to fall to half that by 2026, if the current provision in the law is allowed to sunset.
While the future of the law may be unknown, we believe that, it’s important for clients to become educated about the potential changes, to consider advanced estate planning techniques while values are low, and to build flexibility into their planning knowing that the laws are subject to change.
While no one likes a bear market or a recession, both conditions offer wealthy families several opportunities to pass wealth to their heirs and to let the growth in these assets accrue to the next generation.
In addition, the coming changes in the tax law may be significantly less generous so planning should be done now to consider using the low valuation of not only publicly traded stocks but also privately held businesses and even real estate.
Finally, you can take this opportunity to make outright gifts/transfers OR you can consider the use of various trust vehicles that can offer substantial protection of heirs and beneficiaries from law suits, bankruptcy, and even divorce claims against them.
These techniques often have both estate/gift tax as well as income tax consequences so get a team of estate, trust, wealth and tax advisors to optimize the use of any planning strategies.
Click here to read our follow up article with six more tips for transferring and protecting wealth in bad economic times.
David M. Frees III and the team of business, trust and estate lawyers at Unruh, Turner, Burke and Frees are available to work with you and your advisors on such planning. Please contact the firm at 610-933-8069.