Estate Planning in a Down Economy: Take Advantage of the Financial Crisis

Contributed by Melissa Borrelli, Esq. of Hanson Bridgett LLP.

Most people know that they should have an estate plan in place; however, making estate planning a priority is difficult even in the best of times, let alone during times of financial crisis. While the benefits of estate planning are well known – including providing for your family and friends, avoiding probate, reducing estate taxes, helping a favorite cause, and planning for incapacity – the advantages of estate planning in a down economy are less familiar.

By making strategic estate planning decisions now, while asset values continue to drop and interest rates are at all time lows, individuals are able to pass more to future generations and reduce or eliminate estate taxes. Estate planners have a number of tools that take full advantage of a bad economy, including:

Outright Gifts
Individuals may give an annual gift amount, adjusted for inflation, which is excluded from gift taxes. In 2009, this amount is $13,000, and can be given to any number of beneficiaries. A married couple can transfer double the annual exclusion amount per year per beneficiary. Additionally, payment of another person’s medical or tuition expenses are exempt from gift tax liability and not counted toward the annual exclusion amount.

Why is this important? Annual exclusion gifting allows you to transfer funds, gift tax-free, to anyone you wish to assist immediately, rather than after your death. Annual gifting may also reduce your estate tax liability by removing assets from your estate during your lifetime. This is an especially useful tool with depressed assets such as stock. Leveraging the annual exclusion may allow you to transfer stock that has a low value today, but which you anticipate will rebound in the future while completely avoiding transfer taxes.

Family Loans
Loans to family members are a well-established estate planning tool and are an especially useful means of transferring wealth to a younger family member who may not yet qualify for traditional loans. You can loan the money at rock-bottom interest rates for use in investing, business start-up, education, home purchase, and other purposes.

The IRS sets minimum interest rates for these types of loans, well below bank rates, depending on the maturity date. Lower rates assist the debtor by requiring smaller payments and do not greatly increase the amount coming back into your estate.

The annual gift exclusion is often used in conjunction with family loans so that gifts of the loan’s principal are made yearly by forgiving that amount due, maximizing the transfer of wealth from one generation to the next and lowering your estate tax burden.

If you are considering making a family loan, be warned that these loans must be properly documented to ensure you receive the intended benefits. This is not a transaction to enter into using free loan forms found on the Internet.

Grantor-Retained Annuity Trusts (“GRATs”)
GRATs are especially powerful tools in a down economy because, if planned correctly, they allow the transfer of an appreciating asset nearly transfer tax-free. Assets that are currently low in value, but which are expected to increase in value in the future can be placed into a GRAT which is set to expire within a term of years (often in as little as two years). During the term of the GRAT, an annuity amount is paid to the grantor, or creator, of the trust. When the trust expires, the assets pass to the beneficiaries transfer tax-free.

As with family loans, the IRS sets rates for GRATs, and if the trust is well planned, the asset will appreciate at a rate higher than the GRAT rate allowing the excess amount to pass to your beneficiaries tax-free.

Charitable Lead Annuity Trust (“CLAT”)
CLATs benefit both charities and private, non-charitable beneficiaries because the trust pays an annuity to the designated charity for a specified term with the remainder going to the private beneficiaries. A CLAT effectively keeps an asset in your name for the term of the trust, provides a funding stream to your favorite charity, and allows the beneficiary of your choice to keep the asset.

The lower interest rates utilized in a CLAT result in a larger gift or estate tax deduction for the annuity interest going to the charity and a smaller value for any gift of the remainder interest going to a non-charitable beneficiary.

The Time to Act Is Now
While the estate tax is set to be repealed in 2010, Congress and the Obama administration have begun negotiations to ensure the estate tax remains in some form. The permanence of the estate tax will necessitate estate planning at some point in your life. Taking advantage of the above described methods and other estate planning tools when the economy is weak will provide tax and other benefits for years to come.

Everyone’s situation is unique and state laws differ, so it is best to consult your estate planning attorney and financial planning team to discuss whether and how these tools can be of benefit.