A changing economy can have a significant effect on your estate planning. Estate plans created during a historically-low interest rate environment under a booming economy with low inflation and a rising stock market may need to be re-examined and new strategies considered, according to a recent article titled “Estate Planning For A New Day” from Financial Advisor.
Inflation alters the future value of assets and therefore the value of real estate and taxes due on distributions. For an estate plan to succeed, it is critical to know the value of the assets and how the value of those assets change over time. Accurately determining the value of an estate is necessary to measure any potential estate tax liabilities and plan for their payment.
Inflation may also impact how much is gifted during life or after death without paying federal estate taxes. These exemption levels are reevaluated every January 1 and are increased as necessary due to inflation. Starting January 2023, the federal estate and gift tax exemptions will increase significantly, which will give wealthier clients the ability to make larger gifts in 2023.
For 2022, the exclusion for gifts other than those for medical or educational purposes is $16,000 per donor. However, gifts over that amount count towards the lifetime exemption, currently at $12.06 million per person. The lifetime exemption works jointly with the estate tax exemption and also covers transfers gifted through the estate.
How much these amounts are adjusted is determined by federal inflation estimates, which are not necessarily 100% accurate. If real inflation exceeds the government’s projections, an estate could become taxable due to inflation alone. Once the 2017 Tax Cuts and Jobs Act expires in 2025, the exemption amounts are expected to take a nosedive. Unless Congress acts, on Jan. 1, 2026, the lifetime exemption amount will revert to its old level, or even lower. So, now is the time to look into using those exemptions.
Some professionals believe inflation has little impact on estate planning, which is by its nature a long-term matter and not subject to daily ups and downs of markets or news cycles. However, inflation is tied to interest rates, and rising interest rates need to be considered since they impact estate planning strategies.
Charitable remainder trusts (CRTs) are more attractive now because of higher interest rates. The initial donation to the trust is partially tax-deductible and any income generated by the trust is tax exempt. The trust, which is irrevocable, then distributes income to the grantor or beneficiary for a specified period of time. At the conclusion of the time period, the remainder is donated to charity.
Grantor retained annuity trusts (GRATs) and qualified personal residence trusts (QPRTs) are less advantageous, since they rely on declining interest rates. GRATS allow assets to be locked into irrevocable trusts for a set period of time, during which the beneficiaries can draw an annual income at interest rate set by the IRS. When the term expires, any appreciation of the original assets, minus the payout rate, passes to heirs with little or no gift taxes.
QPRTs allow users to lock away the value of a residence in an irrevocable trust for a period of time. The grantor can remain in the home and keep partial interest in its value. Afterwards, the rest of the value, determined by the IRS, is transferred to heirs. The goal is to remove the family home from the estate and decrease the gift tax incurred by otherwise transferring the asset. However, if the grantor dies before the trust expires, the value of the residence is included in the estate and taxed with it.
Estate planning must also plan for a changing economy. Your estate planning attorney in Davie, Florida will be able to review your current estate plan with an eye to rising interest rates and inflation and deem which strategies still work, which don’t, and how best to move forward.
Reference: Financial Advisor (Oct. 1, 2022) “Estate Planning For A New Day”