Giving Your All, Then Giving Some More: Creative Ways to Enhance Your Wealth Plan

January 06, 2023
Senior Wealth Planner Ali Hutchinson breaks down several estate planning techniques for individuals who have maxed out their available gift tax exemptions, as well as techniques that can be used to enhance gifts that have already been made and trusts that are already in place.

Many clients, appreciating the transfer tax savings associated with making gifts during life, as opposed to utilizing their transfer tax exemption at death, have “maxed out” their available transfer tax exemption. For individuals who have made lifetime transfers in excess of current exemption amounts ($12,920,000 per person in 2023), all is not lost. There are a number of estate planning techniques still available as well as techniques that can be used to enhance gifts that have already been made and trusts that are already in place.

Zeroed-Out GRATs

GRAT stands for grantor retained annuity trust. To create a GRAT, someone (the grantor) makes a gift to a trust. The trust agreement says that the trust will last for a certain number of years – by way of example, let’s say two years. The trust also says that the trustee has to pay an annuity back to the grantor (this is the “grantor retained annuity” part of the trust) for as long as the trust lasts – in this case, for two years. After two years of annuity payments back to the grantor, anything remaining in the trust passes to the grantor’s descendants.

The grantor makes a gift to his descendants on the day he creates the GRAT, since the lucky descendants are entitled to get something after two years; however, that gift is not equal to the amount the grantor put in the trust initially, since for two years, some of that money is flowing back to the grantor through the annuity. In order to determine the gift’s total, the Internal Revenue Service (IRS) releases a monthly hurdle rate and uses it to calculate how much the grantor gave away when he funded the trust.

The reason to discuss GRATs again today, when many high-net-worth individuals may have little or no gift tax exemption amount remaining, is because it is possible to create a zeroed-out GRAT: a GRAT designed to result in a taxable gift that is valued at or close to zero. This result is possible because the value of the gift is measured on the day the GRAT is funded, and the amount of the gift depends on the hurdle rate. In a zeroed-out GRAT, the annuity payments are calculated so that if the assets in the GRAT appreciate in an amount exactly equal to the hurdle rate, after two years the trust will be empty, and there will be nothing transferred to the next generation. The gift is valued at zero (and reported as such on a gift tax return). Then again, if the assets happen to beat the hurdle rate, the gift was already valued and reported in the year the trust was created; any assets above the hurdle rate pass to the grantor’s descendants gift tax free. If the assets in the GRAT do not beat the hurdle rate, there are no negative tax consequences; the GRAT will just be fully depleted by making payments back to the grantor, and there will be nothing left to pass to the next generation at the end of the GRAT term.

Gifts and Loans

Other strategies take advantage of current interest rates and lock them in, in the face of a rising rate environment. To put today's rates in context, nearby is a chart showing some historical rates for loans between family members and how they stack up against current rates. We have included the hurdle rates for the same time periods, given the earlier GRAT discussion. Loan rates assume annual compounding.

Date Short-Term Loan
< 3 Years
Mid-Term Loan
3 - 9 Years
Long-Term Loan
> 9 Years
Hurdle Rate
January 2023
January 2022 0.44% 1.30% 1.82% 1.6%
January 2021
0.14% 0.52% 1.35% 0.6%
January 2020 1.60% 1.69% 2.07% 2.0%
January 2019 2.72% 2.89% 3.15% 3.4%
January 2017
0.96% 1.97% 2.75% 2.4%
January 2013
0.21% 0.87% 2.31% 1.0%
January 2008 3.18% 3.58% 4.46% 4.4%
January 2003
1.81% 3.43% 4.90% 4.2%
January 1998
5.70% 5.93% 6.13% 7.2%

These rates can be used to transfer money tax free. Following is an example of a client who took advantage of the low rates in 2013. A father loaned his daughter $2 million for eight years. The IRS determined this is a “mid-term” loan, so the child had to pay her parent 0.87% interest annually (see the highlighted portion of the previous chart). This was a loan, not a gift, so the daughter also had to pay back the full $2 million after eight years. If the child invested the $2 million at Brown Brothers Harriman (BBH), or bought an apartment with it, and it grew at a rate greater than 0.87% before she had to pay it back, she would have been able to keep that appreciation gift tax free. If, for example, the $2 million enjoyed a 7% rate of return, parent/client would have passed over $1 million to the child transfer tax free (see the chart below).

Assumed Rates of Return

  0.87% 3% 7%
Additional amount in child's account (and out of father's estate) after eight years, as a result of this strategy   $0 $378,814 $1,257,852
For illustrative purposes only.        

If the parent was feeling especially generous, he might decide to forgive some of the interest each year using his annual exclusion (currently $17,000 per year, described further in this article).

Similarly, if you or members of your family have high interest rate loans currently outstanding, and the borrower is in a lower generation, refinancing the note in a lower interest rate environment would be a relatively painless way of reducing your estate and passing some money to the borrower. The lower rate would mean less interest would be required to be paid back before the end of the note’s term. As long as there is some consideration for refinancing (i.e., it is not just a gift from the lender to the borrower, but there is some reason to refinance – a longer loan term, or perhaps a partial prepayment), this strategy should not result in gift tax or use of exemption. As rates rise, this strategy becomes less appealing; however, opportunities to refinance and/or restructure today’s intra-family loans if and when rates fall again should be considered on a regular basis.

Finally, the simplest estate planning strategy around is still available and very effective. The annual gift tax exclusion has increased over the years in $1,000 increments from $10,000 to $17,000. This means that you can give away $17,000 each, to as many individuals (outright, or in a properly structured trust) as you choose, without incurring gift tax. If you plan to transfer wealth to grandchildren or more remote descendants, contact your estate planning attorney about GST tax implications.

Planning with Your Dynasty Trust

In 2012, 2020, and 2021, facing potential reductions in the lifetime exemption from transfer tax, many clients took advantage of their lifetime gift and GST tax exemptions by transferring assets to a dynasty or spousal access trust designed to benefit multiple generations without payment of transfer tax at each level. Those dynasty trusts, once “seasoned” with assets that have been in trust for some time, present excellent planning opportunities. Many of these trusts were structured as grantor trusts, meaning that the trust gets to pass along its income tax bill to the client who funded it. The grantor/client and the trust are treated as the same for income tax purposes. This is nice for the trust beneficiaries (frequently the client’s children and grandchildren), because money is not taken out of the trust account and mailed to the IRS each year – instead mom or dad writes a check to the IRS from a personal account, and the trust account continues to grow tax free. So, for each year that the trust has taxable income and mom or dad pays its income tax bill, children and grandchildren are enriched in a manner that is not currently subject to gift tax. In case mom and dad have second thoughts about this generous structure, some clients included a provision in the trust agreement allowing them to “turn off” the grantor trust status and decide when to shift the income tax burden to the next generation.

If you funded a trust in 2012 or over the past few years, this is not a “set it and forget it” wealth transfer strategy. First, because the exemptions doubled in 2018 and are indexed annually for inflation, the amount you can transfer tax free will continue to increase. Each year, to the extent aligned with your values and overall wealth plan, you should “max out” your trust – for example, in 2012, you could give $5.12 million transfer tax free. In 2023, the amount has increased to $12.92 million – transferring the balance of the exemption to the trust now moves those assets, as well as any appreciation between the date of transfer and your death, out of your estate.

Second, many of these trusts included a provision allowing the donor to reacquire trust property and substitute property of equal value. Assuming the trust was funded with property that was expected to appreciate, you should keep an eye on the growth of the trust assets and consider swapping out the assets and substituting cash to lock in gains. If your trust account is at BBH, your relationship manager and, if BBH is named as a trustee, trust officer are keeping close watch on the trust account for such opportunities.

Finally, even if you have maxed out your trust, you can enhance it in other ways. One great strategy is to lend assets to the trust for a few years. Why would you loan assets to a trust if the trust is just going to have to pay the assets right back to you, plus interest? Because as discussed earlier, to the extent the trust assets grow at a faster rate than the IRS interest rates for intra-family loans, the trust has increased in value in a manner not currently subject to gift or estate tax. Even better, there is no income tax on loans between the grantor and a grantor trust because, as noted, they are the same for income tax purposes. On the other hand, if the loan is not between a grantor and a grantor trust (for example, the eight-year loan between parent and child discussed earlier), the lender (parent) would pay income tax on the interest payments (even if interest is forgiven and not paid).

If you did not fund a grantor dynasty or spousal access trust in 2012 or the past couple of years and still have exemption remaining, it is not too late; however, we encourage you to consider acting soon. Under the current tax code, the transfer tax exemptions will continue to increase with inflation until January 1, 2026, when they are scheduled to revert to 2017 levels ($5.49 million, adjusted for inflation, vs. the current $12.92 million).

Shifting Gears: From Lifetime to Testamentary Planning

In the course of structuring new wealth transfer plans and enhancing existing plans, we heard many clients note that their wills and other testamentary documents had not been revised in years, and in some cases did not reflect their current wishes. However, in the rush to create and fund new trust agreements, clients put wills and other testamentary documents aside to be focused on at a later date, given the time-sensitive nature of using up the increased exemption amount. So, just as you are breathing a sigh of relief and feeling as though you have finally accomplished your wealth planning goals, remember to also look back at your existing testamentary documents and, if necessary, update them to reflect any recent gifts.

If, for example, you used some of your exemption to purchase a home for one child in 2012, but your will currently provides that your assets pass equally to all of your children at your death, you may want to insert an “equalization clause” providing that your other children be made whole in light of the gift made to the first child during life. Planning during life is so connected with testamentary planning that anyone who engaged in significant gifting in the past several years should take a look at her will and the interplay between that document and the planning accomplished so far.

If you are not sure whether your estate plan should be revised this year, your BBH wealth planner and relationship manager would be happy to take an initial look and provide some suggestions. Above all, it is important to assess your estate planning objectives and work closely with your BBH team, accountant, and estate planning attorney before moving forward with any of these strategies. Fortunately, especially for those of us who have made a career of the practice, it seems as though despite (or because of) the flood of transfer tax transactions implemented in 2012, 2020, and 2021, in addition to the 2018 increase in the transfer tax exemption amounts, estate planning will live to see another day!

Brown Brothers Harriman & Co. and its affiliates do not provide tax, legal or investment advice, and this communication cannot be used to avoid tax penalties. This material is intended for general information purposes only and does not take into account the particular investment objectives, financial situation or needs of individual clients. Clients should consult with their legal or tax advisor before taking any action relating to the subject matter of this material.

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