Do you have an estate tax issue? Here are some fancy estate planning concepts broken down in plain English. But first, let’s start with the basics.
What’s the current exemption?
The estate tax exemption will be HALVED in 2026 due to the expiration of the 2017 Tax Cut and Jobs Act (barring any other additional Congressional legislation). The current exemption is $12.9M per person or $25.8M for couples. Those are considerable dollar amounts!
But when cut in half ($6M for individuals, $12M for couples), some may wonder if they might breach this threshold at some point during their lifetime. Some may unexpectedly cross this threshold overnight if they hang onto equity stock compensation or experience a liquidity event.
So what’s the goal here?
- Move assets out of your taxable estate.
- Retain access to those assets without jeopardizing #1.
Here are five estate planning concepts that may be worth your consideration.
ILIT – Irrevocable Life Insurance Trust
This is basically life insurance held in a trust. So why would you do this? Really for two reasons:
- It’s excluded from the taxable estate.
- It allows you to “protect” the life insurance proceeds. It dictates how the proceeds are managed and distributed upon the insured’s death. This is particularly important in the following scenarios: the surviving spouse remarries, the beneficiaries lack prudent money management skills, the fruition of an impending lawsuit, or minor beneficiaries.
SLAT – Spousal Lifetime Access Trust
This design allows one spouse to create a trust for the other spouse and/or kids and vice versa. It’s considered more flexible and robust than an ILIT but still irrevocable. It also:
- Removes assets from your taxable estate.
- Permits a degree of control during your lifetime (via your spouse).
Things to keep in mind with this type of trust:
- Divorce (you lose your claim to the assets).
- If both spouses set one up, they should not be identical. If they are, you will violate the “reciprocal trust doctrine,” which could invalidate the trust.
What about a Backdoor SLAT? With this strategy, a new trust is created upon the first spouse’s death returning the funds to the surviving spouse (the spouse who initially set up the trust). Again, you’ll have to check your state laws for rules allowing the appointment back to the surviving spouse.
DAPT – Domestic Asset Protection Trust (aka Self-Settled Trust)
This is similar to a SLAT, but you can also be named as a beneficiary if you reside in one of the 19 states that permit this structure.
You may also hear the term “hybrid-DAPT.” This may be desirable if you don’t live in a state that permits a self-settled trust (yet). It allows a third party to add beneficiaries (which could still be you) after it’s created.
SPAT – Special power of appointment trust
Again, this is if you live in a state that doesn’t permit a DAPT. So, what’s the difference between this and a hybrid-DAPT? A third party (not a trustee) with limited or special power can direct the trustee to make a distribution to you.
QPRT – Qualified Personal Residence Trust
Last one! This is also an irrevocable trust and allows you to remove your primary residence from your estate. Why would you do this? To reduce the gift tax when transferring assets to a beneficiary. It allows the owner to remain in the home for a certain period of time with “retained interest.” Once that period is over, the interest remaining is transferred to the beneficiaries as “remainder interest.”
Utilizing appliable federal rates from the IRS to calculate the retained interest, the resulting gift value of the home is lower than the market value.
Here’s the kicker: you must outlive the trust term. If you die during the trust term, then the full value of the home is included in your estate.
Let’s Wrap It Up
It’s helpful to have a trusted attorney draft these documents for you and consider an independent institutional trustee (i.e., a trust company) to properly administer your trust. Why? The IRS or court may try to “pierce” the transaction arguing you had a “side deal” with the parties involved to access the funds that were supposed to be excluded from your taxable estate and out of creditors’ reach. Interested in reading more? Check out this article.
Unsure if these fancy estate planning concepts apply to your situation? Contact us today.
All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services.