The stock market, interest rates, and other economic and political circumstances have experienced considerable volatility of late. How should your planning be modified to address volatility?
It should not change. Whether the markets and environment are volatile or calm, you need to have the key legal documents and planning in place. More significantly, since estate planning is long term, your planning and documents will be impacted by volatility at many points in the future, even if you view the waters as calm at any particular time. Here’s the “volatility spin” on estate planning:
Grantor Retained Annuity Trusts (“GRATs”) are techniques that can shift value out of your estate for modest gift tax cost. Transfer assets to a GRAT, which pays you a high annuity for a short period, say two years. To the extent that your investment returns exceed the current federal interest rate, that gain is outside your estate tax free. If you catch the upside volatility in your GRAT you have the tax equivalent of a grand slam. If you catch the wrong side of the market swings, the GRAT busts, and you try again, with little down side. This repeated application of GRATs is referred to as rolling, or cascading GRATs. These short term GRATs thrive on volatility.
While investment theory advises against market timing, estate planners love their version of it... A QPRT (qualified personal residence trust) is a special trust designed to hold ownership of part or all your personal residence (home or second home). The trust is established for a number of years (term) by you (grantor). After the term ends your heirs, typically children (but not later generations) receive ownership of the house. In some cases, the QPRT on ending transfers title to a trust for your heirs, instead of directly to them. During the term of the QPRT, you can live in the house rent free. If interest rates are high QPRTs work better. If interest rates are low, GRATs and IDITs work better, and so on. From this perspective, volatility can enhance planning.
Not feeling financially secure? Instead of giving trusts or making annual gifts (you can gift $12,000/year/donee gift tax free) to the grandkids, you can gift the cash to 529 college savings plans for which you are the account owner. If the volatility hits you the wrong way, and you are in need of milk money, as the account owner you can withdraw funds from the 529 plans (yes, subject to a penalty, but at least you can access the assets). If your worries prove unfounded, the money can remain in the 529 plan so Junior can go to college instead of flipping pizza for a living.
Set up a self funded (you put the money in) trust, in which you remain a beneficiary. This type of trust is permitted in a number of states, including Delaware and Alaska. Arguably (but it’s not guaranteed or proven) you can gift assets to the trust and they will be removed from the reach of your creditors, and from your taxable estate. You will still be able to receive distributions from the trustee if you need them. If volatile times make you feel too financially insecure to give up assets completely, but you want to continue asset protection and estate tax minimization planning, these trusts could be the ticket.
These are the trusts used to safeguard the amount that can be passed estate tax free on the death of the first spouse. Many bypass trusts are drafted to permit distributions to the surviving spouse, children, and even others. If volatility has your stomach in knots, modify the trusts in your wills, so that the bypass (applicable exclusion or credit shelter) trust names only your spouse as beneficiary. If times get tight, it may be better not having the kids’ fingers in that pot. If you’re really worried, bequeath everything outright to your surviving spouse (and vice versa) and give your spouse the right to disclaim into a bypass trust. This gives the survivor the right to total control over the funds if times are tight.
Stop your gift program if you are worried that you will run out of money, and instead buy life insurance to pay estate tax or provide an inheritance for your heirs. Put a bumper sticker on your new Hummer, “I spent my kid’s inheritance on this car”.
Make all your planning and documents flexible. Do not mandate distributions from trusts in case someone else needs them. Reduce specific bequests to friends, charities and other secondary beneficiaries in your will so that key heirs inherit more. Use percentages instead of fixed dollar bequests or gifts.
Subscribe to our email list to receive information on consumer webcasts and blogs, for practical legal information in simple English, delivered to your inbox. For more professional driven information, please visit Shenkman Law to subscribe.