If the current economic and investment climate aren't enough to stimulate conversation with your high-net-worth clients, you may want to add “estate” to the list of ongoing discussion topics. Chances are those who could be affected will be unaware of the latest changes to the laws, the eventual cost their families may incur, and what can be done today to mitigate and eliminate any financial damage.
Here's what you need to know about the present and future of estate tax laws, and what you can do to protect your clients' assets in almost any scenario.
A Brief Update
Thanks to legislation passed several years ago, in 2009 estates worth less than $3.5 million avoided any “death” taxation at the federal level. But amounts over that figure were subject to a maximum tax of 45 percent.
The previously-written laws also dictated that as of January 1, 2010, the estate tax was effectively repealed, freeing the heirs of those who die this year from any federal inheritance tax liability. But if no new legislation is passed, in 2011 the exempt amount goes back down to $1 million, and inheritances could be subject to a maximum tax rate of 55 percent on amounts over that level.
To make matters even more difficult, currenthas done away with the ability to “step up” the cost basis of an asset passed on after the decedent's death. Instead, the capital gains tax liability lives on long after the original owner dies (albeit with complex exemptions that could shelter several hundred thousand in gains from taxation).
The absurdity of the current situation can be demonstrated by the example of the client who has, say, $3 million in assets. If she dies on December 31st of this year, her heirs will owe nothing in federal estate taxes.
But if she hangs on for just a few hours into 2011, in theory, her beneficiaries could then owe almost a million dollars in estate taxes. Congress recognizes the unfortunate situation this may create for families, and may eventually get around to solidifying a more sensible solution. Yet with 2010 being a hotly-contested election year, anything (or nothing) could happen.
It might be tempting to match the political inertia with your own version of “wait and see.” But that approach could cost your clients money, and cost you clients.
The Simplest Strategy
Even though you are probably not an estate planning expert, there are still a few shrewd moves you can suggest to clients who are concerned about incurring estate taxes. One relatively uncomplicated method is for clients to give some of their money to family members while everyone's still alive, and before Uncle Sam has any shot at garnishing the transaction.
Right now individuals can “gift” up to $13,000 to any other individual annually, and to as many individuals as they wish, without incurring gift taxes. So in theory, a husband and wife with three married adult children and six grandchildren could remove up to $312,000 tax-free from their estate right now, by each giving $13,000 to the six members in each of the next two generations.
Besides the annual gifting ceiling, individuals can also give away a total of up to $1 million over their respective lifetimes, again with no gift taxes incurred. In addition to the annual and lifetime limits, generous souls can pay for certain medical and higher education expenses of other family members without incurring the gift tax — as long as the check goes directly to the institution in question.
Slightly More Complex
Now an attentive advisor such as yourself will no doubt notice a potential drawback to the aforementioned “gifting” strategy: yes, the gifted money has been removed from the clients' taxable estates. But so has it been removed from the clients' net worth, and control.
One way your clients may be able to have their money and shelter it from estate taxes, too, is through the use of 529savings accounts. Qualified deposits for most immediate family members are removed from the client's taxable estate. But the clients can maintain control of the money by naming themselves as owners of the account.
Another method to consider is for the older generation to purchase permanent life insurance that will ostensibly pay some or all of any estate taxes due when the insured clients die. Finally, converting IRAs to Roth IRAs not only reduces future income taxes paid on distributions by clients and beneficiaries alike, but also reduces the taxable estate by the amount of the taxes paid on the conversion.
Better For Everybody
Although it's possible to accomplish the above tasks on your own, it's better to do them at the end of the estate planning process, instead of at the beginning. Thankfully, the first and most important step in navigating estate tax laws on behalf of your clients not only determines which moves to make, but also entails the least amount of work (at least, for you): getting some qualified legal advice.
You can help move the process along by offering to coordinate and host an introductory meeting with the clients' estate planning attorney. When the clients say, “We don't have one,” you have the opportunity to suggest a favorite few to interview. If your response to that idea is “I don't have any,” you better first find a couple by going to www.lawyers.com to search for ones licensed to practice in your clients' home state.
Contact those who specialize in estate planning, tell them you're going to have several potential clients who need to establish and update their estate plans, and suggest a get-to-know-you lunch date with the attorney. In the process of finding out if the lawyer can and will help your clients, you should also see if all of the attorney's clients are cared for by advisors as conscientious and proactive as you.
CFP© is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid a Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. Find out more at www.advisortipsheet.com.