The sweeping federal tax legislation enacted in 2001 was a boon for many, but it also created a thorny issue for estate tax planning. The law provided that tax advantages phased in over the subsequent 10 years would be eliminated at the end of that period if further legislation didn't extend them. In December 2010 — at the proverbial 11th hour — Congress did enact new gifting and estate tax legislation, with far better terms than even the most optimistic pundits could have predicted. But the legislation is temporary, providing only a two-year extension. This means that investors may face another last-minute scramble by Congress at the year-end 2012 deadline.

What are the implications of the new tax law, and, most importantly, how do we quantify the benefits of taking action now during the year-and-a-half window that's left? For many families, the planning they do during the remaining year-and-a-half window could address many of their estate planning needs for the rest of their lives. Let's explore the implications of both the temporary income tax law and the temporary estate tax law and then discuss the current low interest rates, which may well be at an inflection point.

New Income Tax Law

Let's start by putting income taxes in context. Under the 2010 tax law, the capital gains rate will rise from 15 percent today to 23.8 percent in 2013. (See “Top Marginal Federal Income Tax Rates,” this page.) The highest ordinary income tax rate will go from 35 percent to 43.4 percent (the 3.8 percent healthcare surcharge is included in both rates). Obviously, there's tremendous uncertainty about future legislation, but in looking at this long-term horizon, we can clearly see that today's rates are very low. Given the level of deficits and debt, we think it's far more likely that rates will go up rather than down.

The principles of effective tax management are pretty simple: Avoid avoidable taxes; defer deferrable taxes. But do you want to defer your taxes into a higher rate? This creates a very interesting conundrum. The bias at our firm, AllianceBernstein, is to defer. We'd consider accelerating taxes only if we think the probability of a meaningful benefit is very high. We've identified two reasons that meet this criterion and that we think are worth considering in this window. (See “Should You Harvest Gains?” this page.)

The first reason applies if you're also getting risk reduction as part of accelerating capital gains. Harvesting the gains of a well-diversified long-term portfolio adds up to just $5,000 per million dollars of a portfolio (in today's dollars) — a benefit that's not compelling enough to inspire action.

But say you have a concentrated single-stock exposure that you want to diversify in the next five years. The benefit of doing it today and locking in this low capital gains tax rate is about $137,000 per $1 million — an immediate 14 percent benefit. In some cases, investors plan on holding their single-stock position for the long term, potentially until death, at which time they will avoid capital gains altogether and their heirs will get a step-up in basis. However, stock option grants are time-bound and must be exercised at some point. If you're an executive with stock options and you accelerate them today to take advantage of a lower ordinary income tax rate, the benefit is about $169,000 per $1 million. Obviously, this can also apply to illiquid holdings such as a business or real estate that an owner is contemplating selling in the not-too-distant future.

The second reason for accelerating taxes arises with a Roth individual retirement account conversion. The key to determining whether to make a Roth IRA conversion can be summarized in one word: spending. A Roth IRA is compelling because it frees you from having to take required minimum distributions at age 70½. And while we hate accelerating taxes, we love investing in tax-advantaged vehicles. By converting to a Roth and paying the taxes from non-IRA assets and then spending down the remaining assets first, you can keep more of your wealth longer in a tax-deferred environment. That can be a big win.

You might be wondering how we know what a client's spending will be and whether she has enough taxable assets to live on. The starting point is an analysis of a client's “core” and “excess” capital. (See “To Roth or Not to Roth?” p. 32.) We define core capital as the amount of money needed to endow spending for the rest of a client's life, grown with inflation, in poor markets. We stress-test this number in multiple ways.1 Provided the Roth IRA money is in the excess capital portion of a portfolio, we're confident that a client won't need to spend that money.

For a 65-year-old investor who converts to a Roth IRA and won't touch the assets for 20 years, the value is $400,000 per $1 million — an immediate 40 percent increase in wealth. (See “Converting to a Roth,” p. 32.) But if the investor plans to leave the assets to his children, they will inherit a far larger IRA. And if the children can let the IRA grow for 30 years, that's where the exciting win is: The (present value) benefit is $4 million per $1 million! For anyone who expects to pass a legacy to children, there's no better vehicle in which to leave assets than in a Roth IRA. Converting should be a first step in most such clients' estate plans.2 (For more information, see “Taking Another Look at Roth IRAs,” by Lena Rizkallah in this issue, p. 51.)

New Estate Tax Law

The new estate tax law has three significant provisions:

  • It unifies the amount of the exemptions for the gift tax, estate tax and generation-skipping transfer (GST) tax at $5 million (grown with inflation);
  • It establishes a 35 percent tax rate for transfers above the $5 million exemption; and
  • It introduces portability of any unused estate tax exemption to a surviving spouse.

Two common reactions to the new tax law are: “I don't need to plan because my wife and I are likely to be below the $10 million gift and estate tax exemption,” and “There's so much uncertainty that I'm not going to bother taking action until 2013.” But doing nothing could be a big mistake. Planning during this period is crucial, especially for those whose estates are in the $5 million-$20 million range.

We analyzed the probability of having to write a $1 million estate tax check — an amount high enough to grab anyone's attention. At first glance, it's not an issue. As the “Federal only” column in “Who Needs Estate Planning Under the New Law?” (p. 33) shows, the chance that a couple with $5 million will get hit with a $1 million tax bill is very small. But for those at the $15 million level, the probability climbs to 41 percent.

There's another factor. An important consequence of the new law is that state-level estate taxes have now become a significant consideration. Many states put in place a state estate tax that was originally entirely creditable against the decedent's federal estate tax liability. When this credit was available, separate planning for the state-level estate tax was generally unnecessary. Over the last decade, however, these state estate taxes have become effectively decoupled from the federal rules, and so now the state estate tax often substantially increases the total estate tax burden. For example, a couple with $10 million residing in one of these states has a 50/50 chance of paying more than $1 million in estate taxes.

What About Portability?

Under the prior law, if a couple's estate plan didn't provide for a credit shelter trust (CST) and one spouse died, his exemption was likely lost. The most popular method for preserving the unused exemption of the first spouse to die was to fund a CST that could benefit the surviving spouse but that wouldn't be included in her estate for estate tax purposes. This left the surviving spouse with her full exemption to shield additional assets from gift and estate tax subsequently.

With the new legislation, Congress has effectively said, “Why make people go through these gyrations? Let's just create portability.” So when the first partner in a marriage dies now, his $5 million exemption, to the extent unused, becomes portable to the remaining spouse, allowing her to potentially maintain the full combined $10 million exemption that can be passed on to the next generation without having to set up a CST. Portability will probably make the most sense for couples who believe that their assets will remain at or below the value of their combined exclusion for the rest of their lives, since, in this case, portability represents a simple estate plan that shouldn't give rise to any federal estate tax and that will also provide heirs with a complete step-up in cost basis. Of course, couples must discuss with their advisors the possibility that Congress may change the estate tax rules in a way that would adversely affect estate plans that rely on portability.

Beyond legislative risk, however, there will likely continue to be significant benefits to the CST structure for many couples following the death of the first spouse. Why? The major benefit of placing the exemption of the first spouse to die in a CST is that all of the growth on the CST assets will be removed from the survivor's estate so that it isn't subject to estate taxes upon her death. The portable exclusion, by contrast, won't grow in the hands of the surviving spouse. Indeed, it isn't even adjusted for inflation under the new law.

“Benefits of a Credit Shelter Trust” (p. 34), quantifies this growth benefit. Here we see the probable range of growth generated by $5 million invested in a 60/40 globally diversified portfolio and thus the potential benefit of establishing a CST. The key factor is time — the greater the number of years intervening between the deaths of the spouses, the more valuable it is to place $5 million in a CST and keep its growth out of the estate. With a 10-year gap, in the median case (indicated by the circle in the middle), we project a $2.6 million growth component for the CST (adjusted for inflation), and with a 20-year gap, a $5.4 million growth component. Note that assets held in a CST are generally not entitled to a step-up in cost basis upon the surviving spouse's death. To account for this fact, “Benefits of a Credit Shelter Trust” assumes that the portfolio is liquidated just prior to termination so that each set of values displayed is net of all capital gains taxes.

Another benefit of the CST over the portable exclusion relates to GST tax considerations. Any unused GST tax exemption of the first spouse to die can be applied to a CST. By contrast, unused GST tax exemption isn't portable to the surviving spouse under the new law. This point is important if the couple hopes that some or all of their combined $10 million exclusion may benefit their grandchildren one day without it having to go through another layer of estate tax when their children pass away.3

The choice between CST planning and portability may not be clear one way or another in many cases, particularly in light of the ongoing legislative uncertainty and also because of state estate tax considerations in many jurisdictions. We expect that many practitioners will cope with this problem by writing as much flexibility into the estate planning documents as possible, thereby deferring the resolution of the question until the first spouse dies. At that point, the surviving spouse's advisors can determine which plan — CST or portability — makes the most sense.

Accelerating Gifts?

As you can see, time creates additional value. Therefore, there's even greater benefit to making a gift during a couple's lifetime, when there will be many more years of growth outside the estate. The ability to make a $5 million gift now is the most noteworthy aspect of the new law — previously, lifetime gifting had a $1 million limit. However, for emotional reasons, most people don't want to accelerate gifts. If a married couple hesitated at giving away $2 million when they could, we can assume that very few will feel comfortable giving away $10 million. However, taking a hard look at the numbers may change some minds. First, a determination must be made regarding what one's “core capital” is, which, as we discussed earlier, is the amount of money one needs to support spending for the rest of one's life, grown with inflation, in poor markets. The remaining amount is what's called “excess capital,” which represents one's legacy. These funds are available for accelerated gifting — but without planning, much of that is likely to be taxed by the government.

Let's look at the value of accelerating gifts in “Accelerating Gifts” (this page). By gifting today, investors not only can apply the GST tax exemption and get the growth out of their estates for more years, but also they can get the benefits of a grantor trust (that is, the parents continue to pay income taxes on the income of the trust; these payments represent additional transfers to the trust that aren't subject to gift tax) and avoid the often-onerous state estate taxes. (Note that as of this writing, very few states impose a state gift tax.)

Leveraged Planning

Another key opportunity created by the new law is the ability to leverage a gift via an installment sale to a grantor trust. By selling assets to children via a trust, valuations can be frozen at today's levels. However, for parents to sell assets to their children, the children need to have capital — which can be satisfied by seeding their trust with a gift.

Practitioners generally agree that the maximum allowable value for loans is about nine times one's equity. So, under the prior law, a $2 million gift could be combined with an $18 million loan to sell $20 million in assets. For most families, that's a significant number — and can take care of most of their estate planning needs. But now, by giving a $10 million gift, a couple could conceivably sell $100 million in assets. And, if they're selling commercial real estate or a private business that's illiquid, it may be possible to take some discounts on those assets in some cases.

For example, suppose the parents get a 30 percent discount on those real estate assets. Now the amount of money they can move using a sale to their children (plus the allowable loan) is more than $140 million. With a $10 million gift, any family with $140 million or less can conceivably freeze the value of its entire estate at today's prices. And depending on the cash flow coming out of those assets, a family can potentially transfer all of its wealth by putting a sale into place during this window. This strategy is particularly effective today, given the low interest rates in effect for intra-family loans.

Let's take this example to the extreme and look at a family with about $130 million in real estate and a $30 million liquid portfolio. (See “Benefit of an Installment Sale,” this page.) The parents are 70 years old and would like to pass their real estate holdings intact to their children, without having to sell those holdings. Their accountant believes the tax law allows them a 30 percent discount on those illiquid assets. If they do no additional planning, the present value for their children will be $108 million. Under the old law, they could have made a $20 million sale and their children might have netted $118 million. With the new law, the children could get $179 million — about $60 million more wealth, a 50 percent increase. Of course, one of the reasons this strategy works so well is that current interest rates are so low. Let's take a closer look at why.

Impact of Interest Rates

Given all the market anxiety over the last three years, many investors adopted U.S. Treasury debt as their safe haven; that pushed down Treasury yields. An unintended consequence is that since wealth transfer rates are set based on Treasury yields, the hurdles on wealth transfer strategies have also been greatly reduced. Today, applicable federal rates for short-, mid- and long-term intra-family loans are among the lowest they've ever been. (See “Interest Rates,” p. 36.) And the Internal Revenue Code Section 7520 rate, which applies to wealth transfer trusts, is also near the lowest it's ever been. So now's an ideal time to put into place wealth transfer strategies that are dependent on the interest rate. For clients who would benefit from any type of grantor retained annuity trust, charitable lead annuity trust or intra-family loan, now's the time to build and execute a plan before interest rates return to normal. The cost of waiting three, five or 10 years or of doing something on a testamentary basis instead of doing it today could be very, very meaningful. (See “Get Moving,” p. 36.)


  • The Bernstein Wealth Forecasting System (WFS) is designed to assist investors in making a range of key decisions, including setting their long-term allocation of financial assets. The WFS consists of a four-step process: (1) Client Profile Input: the client's asset allocation, income, expenses, cash withdrawals, tax rate, risk-tolerance goals and other factors; (2) Client Scenarios: in effect, questions the client would like our guidance on, which may touch on issues such as which vehicles are best for intergenerational and philanthropic giving, what a client's cash-flow stream is likely to be, whether his portfolio can beat inflation long-term, when to retire and how different asset allocations might impact his long-term security; (3) The Capital Markets Engine: our proprietary model that uses our research and historical data to create a vast range of market returns, taking into account the linkages within and among the capital markets (not Bernstein portfolios), as well as their unpredictability; and (4) A Probability Distribution of Outcomes: based on the assets invested pursuant to the stated asset allocation, 90 percent of the estimated returns and asset values the client could expect to experience, represented within a range established by the 5th and 95th percentiles of probability. However, outcomes outside this range are expected to occur 10 percent of the time; thus, the range doesn't establish the boundaries for all outcomes. Further, we often focus on the 10th, 50th and 90th percentiles to represent the upside, median and downside cases. Asset-class projections used in this article are derived from the following: U.S. value stocks are represented by the S&P/Barra Value Index, with an assumed 20-year compounding rate of 8.8 percent, based on simulations with initial market conditions as of Sept. 30, 2010; U.S. growth stocks by the S&P/Barra Growth Index (compounding rate of 8.3 percent); developed international stocks by the Morgan Stanley Capital International (MSCI) EAFE Index of major markets in Europe, Australasia and the Far East, with countries weighted by market capitalization and currency positions unhedged (compounding rate of 9.3 percent); emerging markets stocks by the MSCI Emerging Markets Index (compounding rate of 7.4 percent); municipal bonds by diversified AA-rated securities with seven-year maturities (compounding rate of 2.9 percent); taxable bonds by diversified securities with seven-year maturities (compounding rate of 3.8 percent ); and inflation by the Consumer Price Index (compounding rate of 2.6 percent). Expected market returns on bonds are derived taking into account yield and other criteria. An important assumption is that stocks will, over time, outperform long-term bonds by a reasonable amount, although this is by no means a certainty. Moreover, actual future results may not be consonant with Bernstein's estimates of the range of market returns, as these returns are subject to a variety of economic, market and other variables. Accordingly, this analysis shouldn't be construed as a promise of actual future results, the actual range of future results or the actual probability that these results will be realized.
  • For Bernstein research on determining when a Roth conversion makes sense, visit and type “Roth” in the Search function.
  • A third potential benefit of using credit shelter trusts (CSTs) over the portable exclusion relates to the possibility that the surviving spouse will remarry. Such a remarriage could, in some circumstances, adversely affect the value of the surviving spouse's portable exclusion, but shouldn't affect the value of a CST.

Gregory D. Singer, far left, is the director of research for Bernstein's Wealth Management Group, based in New York. Andrew Auchincloss is a director in Bernstein's Wealth Management Group, based in New York

Converting to a Roth

It should be the first step in estate plans for clients with excess capital


Per $1 million IRA ($ millions, inflation-adjusted)

Traditional Roth: Tax from
outside IRA
Initial IRA assets $1.0 $1.0
Initial taxable assets 0.4 0.0
Liquidate after 20 years 2.0 2.4 $0.4
(federal tax rate increases to 39.6%)

Initial account values for investor age 65; tax on converting a $1 million traditional IRA to a Roth IRA would total $392,250; assumes any potential death taxes are paid for from other assets. Assumes any traditional IRA assets remaining after 20 years are liquidated, resulting in an income tax liability at the stated rate. All assets are invested in 60 percent global equities and 40 percent intermediate fixed income; wealth values are inflation-adjusted.

Based on Bernstein's estimates of the range of returns for the applicable capital markets over the next 20 years. Data do not represent past performance and are not a promise of actual future results or a range of future results.

Who Needs Estate Planning Under the New Law?

For those with assets over $5 million, doing nothing can be a huge mistake

Case study

  • Retired 65-year-old couple

  • Spends 3.5% of 60/40 portfolio

…And don't forget illiquid assets

Probability of > $1 million estate tax bill: Year 30*


Liquid assets Federal Federal and only state tax

$5 million 6% 17%
$10 million 25 45
$15 million 41 60
$20 million 52 68

*Assets assumed to be invested in 60 percent globally diversified equities and 40 percent municipal income. Spending has been modeled as 3.5 percent of the initial portfolio, grown with inflation. Assumes both parties die at the end of Year 30. Federal estate tax assumed to be 35 percent with a combined exemption of $10 million, grown with inflation. State estate taxation based on New York estate tax brackets as of 2011.

Based on Bernstein's estimates of the range of returns for the applicable capital markets. Data do not represent past performance and are not a promise of actual future results or a range of future results.