The IRS Has Ruled - What Are You Waiting For?

On November 22nd, 2019 final regulations were released by the Internal Revenue Service putting to bed the concerns about claw backs of any grantor gifts made due to the sunset of the current lifetime exemption limits expanded by the 2017 Tax Cut and Jobs Act of the Trump Administration. A WealthManagement.com article published on the 26th goes into great detail on the regulations.

So, with this concern out of the way for good, what is the plan now? Why wait to take advantage of this massive gift to move assets into a trust, forever escaping the gift and estate tax system, which is constantly changing. We may never see gift tax exemption levels like the ones enacted in 2017 in our lifetime.

To refresh quickly, the 2017 Tax Cut and Jobs Act increased the lifetime exemption gift and the estate exemption limit to $10,000,000 per individual or $20,000,000 per married couple adjusted for inflation through indexing. This essentially doubled the limits previously available. Today, as we start 2020, the limits have increased to $11,580,000 per individual and $23,160,000 per married couple. 

The Trump Tax Act, as it is also known, also created a sunset date of the limits on January 1st, 2026 to return to the previous limits, also indexed for inflation. So regardless of what may happen politically, we know that this limit will change, unless it is made permanent, which is highly unlikely in our current environment. Furthermore, there are already proposals (U.S Senate S.B 309, the “For the 99.8% Act”) to reduce the exemption to $3,500,000 per individual. The estate and gift tax regimes have been hotly debated for years and will likely continue to be as political parties change control OR our national debt becomes so onerous that we will all be taxed to death regardless of net worth … no pun intended.

For those taxpayers that are fortunate enough to have a meaningful net worth and are desirous of leaving legacy assets to their children, grandchildren, great grandchildren or others along the way, making a gift today is an important tax strategy to consider.

Assume that the taxpayers are a 65-year-old married couple with meaningful income and assets. The chart to the right shows the legacy value of a $10,000,000 portfolio at the client’s age 90 assuming no estate or gift planning. It is assumed that the assets grow at a sequential 6% before taxes with an income tax assumption of 30% (combined income and capital gains) and an estate tax assumption of 40%.

Let’s explore the benefits of making a $10,000,000 gift to a trust, as an example, and forever getting that asset plus all its appreciation FOREVER out of the taxpayer’s taxable estate. (By the way, take a zero off and make the example $1,000,000 and the economics are the same. The key consideration is whether the assets will be subject to estate taxes or not). 

The chart to the left shows the 25-year result (again, at the client’s age 90) of making the gift to a trust in 2020. At the end of 25 years, over $11,000,000 would be lost to taxes to the detriment of the legacy of the taxpayer. I don’t know about you, but I don’t know too many wealthy people that would be happy with this result.

Many estate and financial planners use the gifted assets to leverage them by purchasing second-to-die life insurance. While making a single premium of $10,000,000 to the life insurance policy would maximize the insurance asset in the trust, it would also deplete the entire investment account from an investment management standpoint. We will consider an annual premium, lower than the annual net return on the account, of $250,000 annually, to retain a growing portfolio of invested assets under the care of the investment manager. Without getting into a long discussion about product, we ran one of the more competitive guaranteed for life products available in the market. For a 65-year-old couple (male and female) in good health, the amount of insurance protection, or said a different way, the value of the assets left in the trust assuming the second to die is age 90 is equal to $17,796,523. This is a return of 7.33% tax free on the $250,000 annual premium investment (10.47% pre-tax assuming a 30% tax rate) – GUARANTEED. This is in addition to the $16,824,334 of investment assets also in the trust (see table below).

But wait, as they say, there’s more. The insurance proceeds are paid to the trust regardless of how equities, debt, real estate or other asset classes are performing in that particular year or what they have done in the past. Insurance is available, ALWAYS, at face value and uncorrelated to any other asset class on the planet. For those of you who remember 2008-2009, imagine having a $10,000,000 asset at the beginning of 2008 and think of what it would have been worth at the beginning of 2009 ……. $6,000,000? $6,500,000? The point is that clients cannot predict what the markets will be doing on the day they pass away, so locking in an asset that is guaranteed to be worth exactly what it was projected to be is powerful from a legacy planning perspective.

See the comparison graph below of the three scenarios illustrated. In addition to providing a guaranteed foundation for the legacy assets, the advantage of adding insurance to the legacy portfolio is obvious.

So, back to the IRS claw back announcement. Why would anyone wait? The reality is that most wealthy people are generally at an age where health can be fragile. Furthermore, as each year goes by, insurance is just a bit more expensive, but at age 65 and older it gets expensive quickly. If this 65-year-old couple waited until 2025 to make the gift and purchase the insurance, assuming no change of health, the amount of insurance they could buy would decrease by $5,557,596 for the same investment (premium), a 31.2% reduction in legacy value.

But what if their health deteriorated just a little bit and they are both a Standard risk class as opposed to a Preferred risk class? The amount they could buy for the same investment would go down to just under $10,200,000. If the male in the couple became uninsurable, the coverage amount would drop further to just under $8,000,000. The risk of not acting today is real and the value of the desired legacy assets for generations to come could be meaningfully impacted.

AgencyONE has developed analytics as seen in this article to assist clients in this decision-making process. Contact us at 301.803.7500 or contact the AgencyONE 100 insurance advisor in your area to assist you in providing guidance for your clients on this subject. Our goal is to assist wealth management advisors and other fiduciaries guide their clients to make decisions that are in the best interest of themselves, their beneficiaries, their favorite charities and ultimately, their family legacies. www.agencyone.net