In Part 1 of this series, we explored the power of Donor-Advised Funds (DAFs) as a flexible tool for integrating philanthropy into your estate plan, offering tax benefits and opportunities for family involvement. However, DAFs are just one part of a comprehensive estate plan. In Part 2, we’ll shift our focus to lifetime gifting strategies—tools that not only help reduce your tax burden but also efficiently transfer wealth to your heirs.
For high-net-worth individuals, preserving wealth and minimizing taxes while transferring assets to future generations is a key part of estate planning. One of the most effective ways to achieve these goals is through lifetime gifting strategies. By transferring wealth during your lifetime, you can reduce your taxable estate, lower potential estate taxes, and create financial security for your heirs. This post will explore some of the most impactful lifetime gifting tools, including Spousal Lifetime Access Trusts (SLATs), Grantor Retained Annuity Trusts (GRATs), Qualified Personal Residence Trusts (QPRTs), and Irrevocable Life Insurance Trusts (ILITs). Each of these strategies offers unique tax benefits and flexibility, making them valuable options for high-net-worth families looking to pass down wealth efficiently.
1. Spousal Lifetime Access Trusts (SLATs)
A Spousal Lifetime Access Trust (SLAT) is a popular gifting strategy for married couples, allowing one spouse (the grantor) to make a significant gift to an irrevocable trust for the benefit of the other spouse (the beneficiary). By doing so, the assets in the SLAT are removed from the grantor’s estate, reducing estate taxes. While the beneficiary spouse can access the trust during their lifetime, the trust’s remaining assets will eventually pass to future generations free of additional estate taxes.
Key Benefits of SLATs:
Tax Efficiency: The transfer of assets to a SLAT is typically disregarded for income tax purposes, and the assets grow outside of the grantor’s taxable estate.
Flexibility: The beneficiary spouse can receive distributions from the trust, providing financial security for both spouses during their lifetimes.
Multi-Generational Wealth Transfer: After the death of the beneficiary spouse, the trust’s assets pass to children, grandchildren, or other heirs without incurring estate taxes.
In some cases, SLATs can be combined with limited liability companies (LLCs) or limited partnerships to maximize the tax efficiency of asset transfers. However, in community property states, special care must be taken to identify separate property before transferring assets into the SLAT.
2. Grantor Retained Annuity Trusts (GRATs)
A Grantor Retained Annuity Trust (GRAT) is a powerful tool for transferring appreciating assets, such as stocks or real estate, while minimizing gift and estate taxes. The grantor transfers assets into the GRAT and retains the right to receive an annuity payment over a specified term (usually between two and ten years). Once the term expires, any remaining assets in the trust pass to the beneficiaries—often children or grandchildren—without additional gift tax.
Key Benefits of GRATs:
Transfer of Appreciating Assets: GRATs are particularly effective when used to transfer assets that are expected to appreciate over the trust’s term. If the growth of the assets exceeds the IRS’s assumed rate of return, the excess passes to beneficiaries free of gift tax.
Tax Savings: By retaining an annuity payment, the grantor reduces the taxable value of the gift, minimizing gift taxes.
Rolling GRATs: If a GRAT underperforms, the grantor can establish a new GRAT (called a rolling GRAT), allowing for more opportunities to transfer future appreciation.
GRATs are best suited for individuals who have already used their estate and gift tax exemptions or who want to preserve their exemption for other purposes.
3. Qualified Personal Residence Trusts (QPRTs)
A Qualified Personal Residence Trust (QPRT) allows a homeowner to transfer their primary or secondary residence to a trust while continuing to live in the home for a specified period. By moving the residence into the trust, the value of the gift is frozen at the time of the transfer, and any future appreciation of the property passes to heirs free of estate taxes.
Key Benefits of QPRTs:
Tax Savings: The value of the home is removed from the grantor’s taxable estate, providing significant estate tax savings, especially if the property appreciates substantially over time.
Continued Use of the Home: The grantor can continue living in the home rent-free for the term of the trust. After the term ends, the grantor can continue living in the home by paying fair market rent to the beneficiaries.
Locking in Lower Values: In a rising real estate market, transferring a residence into a QPRT allows the grantor to lock in the current, lower value of the property for estate tax purposes.
QPRTs are particularly valuable for high-net-worth individuals who own valuable real estate that is expected to appreciate significantly in the future. The grantor’s age and life expectancy are critical factors in determining the length of the QPRT term.
4. Irrevocable Life Insurance Trusts (ILITs)
An Irrevocable Life Insurance Trust (ILIT) is a specialized trust designed to hold life insurance policies. By transferring the ownership of a life insurance policy to an ILIT, the death benefit is excluded from the grantor’s taxable estate. The proceeds from the policy can provide liquidity to pay estate taxes or other expenses, while the remaining assets can be held in trust for the benefit of the grantor’s heirs.
Key Benefits of ILITs:
Exclusion from Estate Taxes: The life insurance proceeds are not included in the grantor’s taxable estate, reducing overall estate tax liability.
Liquidity for Estate Expenses: Life insurance proceeds can provide immediate liquidity to cover estate taxes, debts, and other costs, preventing heirs from having to sell assets to cover these expenses.
Asset Protection: Since the life insurance policy is held in an irrevocable trust, the proceeds are protected from creditors and legal claims.
An ILIT requires careful planning to ensure the proper transfer of ownership and the funding of premium payments, but it can be an invaluable tool for individuals with large life insurance policies and significant estate tax exposure.
Looking Ahead: Advanced Trust Structures for Multi-Generational Wealth and Charitable Impact
In this post, we’ve explored key lifetime gifting strategies to reduce taxes and efficiently transfer wealth. But what if you’re looking to preserve wealth across multiple generations while also supporting charitable causes? In Part 3 of our series, we’ll dive into advanced trust structures, including dynasty trusts, Charitable Remainder Trusts (CRTs), and Charitable Lead Trusts (CLTs). These powerful tools not only protect family wealth for future generations but also allow you to create a lasting philanthropic legacy. Stay tuned to learn how these trusts can be key components in your long-term estate planning strategy.
Important Disclosures: This article is not intended to provide, and you should not rely upon it for accounting, legal, tax or investment advice or recommendations. We are not making any specific recommendations regarding any financial planning, investment or tax strategy, and you should not make any financial planning, investment or tax decisions based on the information in this article. This article is intended to be educational in nature and to discuss a few limited aspects of very complex legislation or other complex subject matters. This article is not a comprehensive or complete summary of considerations regarding its subject matter. We recognize that every individual has different needs and opinions expressed in this article may not be appropriate for everyone. Please consult with a Freestone client advisor, accountant, or lawyer regarding options specific to your needs. Please note that Freestone does not approve or endorse any third-party content hyperlinked to in this article.