With so many asset values depressed, the time for planning has never been better. Fractional interests and other freeze techniques can be used to discount the value of your clients’ assets when making tax-advantaged gifts. Multigenerational pooled income funds (PIFs) can provide your clients (and their heirs) with lifetime income while shielding millions of dollars from estate taxes.
In the midst of this unimaginable health care and financial crisis, it’s hard to believe it was only a month ago when things seemed fine and relatively normal. Will it ever be the same? I’m pretty sure it will, but I can’t give you a timetable.
In the throes of a panicky market—which seems to have no bottom—it’s hard to know where to go or what to do, much less how to advise your clients. But suppose we allow ourselves a deep breath and take a step back. There are plenty of great opportunities looming in all types of asset classes and in all types of gifting and wealth transfer techniques.
I know this may sound premature when everyone is in panic mode, “sheltering in place,” glued to the headlines and scrambling for groceries, cleaning supplies and toilet paper. But, with so many depressed asset values, the time for planning has never been better. For high-net-worth (HNW) and ultra-HNW clients, the time for transferring huge amounts of assets at deep discounts is right now.
Let me share two good examples with you.
Opportunistic Discounting
Mel and Jill are a healthy 50-something couple. They were recently talking to their advisors about estate planning before the COVID-19 virus turned everyone’s world upside down. Several years ago, Mel had inherited a portfolio of stocks from his parents worth $150 million. The portfolio had grown steadily to approximately $200 million before the pandemic-driven market correction drove the value down significantly. Unfortunately, Mel’s parents didn’t do much planning before making the gift, so there were a lot of taxes paid on his parents’ estate when they died.
Mel and Jill want to avoid making the same mistake. They’ve been discussing several estate-planning options with their advisors, most of which involved making gifts to different trusts for their two daughters. They also talked about using fractional interests and other freeze techniques to discount the value of their assets. At the very least, Mel and Jill were going to use their personal estate tax exemptions of $11.58 million each (for 2020). Then, along came COVID-19, and their asset values suddenly plunged. The portfolio was down to $160 million, and, not surprisingly, they stopped their planning discussions.
Fortunately, Mel and Jill are rational, clear-headed people. They know the world will eventually normalize.
- They now have a 20% ($40,000) discount on the value of their portfolio ($200,000 - $160,000 = $40,000).
- With some good planning, they can complete gifts of up to $11.58 million each that would have been valued at $14.45 million just a few weeks ago ($11.58 million / 1 - 20%).
- That gives them an extra $5.74 million saved in exposure to estate taxes ($14.45 million - $11.5 million = $2.8 million x 2 = 5.7 million) for doing nothing more than making the gift they were going to make.
PIFs
In another case, Stan and Lacey were in the process of establishing a multigenerational PIF. The PIF would pay Stan and Lacey income for the rest of their lifetimes. After they passed, the PIF would pay their two sons an income for the rest of their lives. Since Stan and Lacey retained the right to revoke the gift anytime prior to their death, the gift is considered incomplete and doesn’t use any of their current estate exemption of $11.58 million each. Stan and Lacey were considering using $25 million worth of a single stock they owned as their contribution to the PIF so they could better diversify their concentrated portfolio. They’ve been discussing this strategy for more than a year but haven’t been able to pull the trigger yet.
Although the market has dropped precipitously, Stan and Lacey still have significant holdings.
- Their best strategy would be to continue moving forward and donating the same $25 million worth of stock to the PIF.
- Doing so at today’s depressed prices would allow them to gift about 30% more total shares than if they had made the gift a few months ago when markets were at all-time highs.
- When the stock market eventually recovers, Stan and Lacey will actually shelter more income from capital gains than if they had done the transfer a few months ago.
- And, they’ll ultimately transfer more wealth out of their estate.
I doubt many HNW people will want to act right now. Fear tends to paralyze all but a very few bold leaders. But as soon as things calm down and we understand our new normal, advisors can have a big impact on many families.
In the meantime, stay safe. Plant a few seeds. Remain confident in the face of challenge. It’s our job to lead the way through upheaval and to help guide our clients to good decisions, whether they’re counterintuitive or not.
Randy A. Fox, CFP, AEP is the founder of Two Hawks Consulting LLC.
