4 Commonly Used Wealth Transfer Strategies
Whether you consider yourself “wealthy” or not, the truth is that everyone can benefit from a plan to distribute their money and other assets when they’re gone.
What Is a Wealth Transfer Vehicle, and Which One is Best for You?
Baby boomers are set to pass along more than $68 trillion to their children in what’s being referred to as the “Great Wealth Transfer.” It will be the greatest generational wealth transfer in history, from a generation that has accumulated a greater percentage of wealth than any other generation ever has[i].
Sadly, family assets are lost from one generation to the next approximately 70 percent of the time, according to some estimates[ii]. “A lot of people don’t know to distinguish between general estate planning and wealth transfer planning,” said Jeanne Krigbaum, Chief Wealth Planning Officer, SVP with 1834, a division of Old National Bank. “For example, wills and living trusts are core estate planning documents, but when it comes to wealth transfer tax planning, you may need to look at some additional strategies.” Here’s what you need to know about wealth transfer strategies to ensure you pick the right one for your needs.
What do we mean when we say wealth transfer?
"Wealth transfer” is the process of transferring wealth from one generation to another, and there are several strategies that you can pick from to do so. Each comes with its own unique set of advantages and disadvantages, so it’s essential to investigate all of them before deciding where to place your own assets.
What are common wealth transfer strategies to consider?
Listed below are some of the most common wealth transfer strategies. Be sure to consult with your financial advisor to discuss which would be best for you based on your own goals and circumstances.
Irrevocable Life Insurance Trusts
Life insurance is a great wealth transfer asset because the proceeds are inherited estate and income tax free, and can be used for goals like providing liquidity to pay for estate taxes, or transferring wealth directly to your beneficiary(ies). Irrevocable Life Insurance Trusts (ILITs) help to remove the value of the death benefit from the owner’s taxable estate.
Pros: Because the value of the death benefit is removed from your taxable estate, total estate taxes owed will likely be lower, helping to maximize the amount passing to the next generation. Additionally, death benefit proceeds pass pursuant to your trust terms, as opposed to outright in a lump sum. This may also be one of the easier options to implement if you already have a life insurance policy in place.
Cons: This option is irrevocable (as are all the options on this list), which means that once the policy is in the trust, it cannot be easily removed. Additionally, if you transfer an existing life insurance policy into an ILIT and you pass away within three years of the transfer, the policy may be pulled back into the estate.
Grantor Retained Annuity Trust
If you have an asset that you anticipate will appreciate over time, but either don’t have any federal exemption left or you aren’t comfortable transitioning a large asset, a Grantor Retained Annuity Trust (GRAT) may be a nice option for you. The goal with a GRAT is to remove the appreciation of an asset from your estate, while receiving annuity payments back to you over a period of years.
Pros: Any growth that occurs within the GRAT between the day it’s funded and when it's terminated is passed onto the beneficiaries estate tax-free. This removes growth from your estate, while at the same time providing an annuity payment to you on an annual basis. It’s a lower-risk strategy that can be effective with fast-growing assets.
Cons: If you pass away during the trust term, it’s as though the trust doesn’t exist, for estate tax purposes, so the value of the trust assets are includible in your taxable estate. It can also be expensive, depending on the type of asset, because of the ongoing asset valuations that can be required.
Intentionally Defective Grantor Trust
An Intentionally Defective Grantor Trust (IDGT) is an irrevocable trust that is considered “defective” for income tax purposes. In other words, you are allowed to continue paying the income tax owed on the trust assets, while at the same time having the value of those assets removed from your taxable estate.
Pros: IDGTs provide another great way to remove future growth from your taxable estate. Because the IRS allows you to continue paying income taxes on the funds generated within the trust, this helps preserve the assets in the trust and reduces the overall value of your taxable estate. Selling assets into an IDGT may be another option, depending on your situation.
Cons: IDGTs are irrevocable and assets transferring in do not receive a step up in basis. Consult with a CPA as it relates to the tax basis of assets you may consider putting into a trust so there are no unintended income tax consequences.
Spousal Lifetime Access Trust
A Spousal Lifetime Access Trust (SLAT) is a defective trust very similar to an IDGT. The primary difference between a SLAT and an IDGT is that, with a SLAT, the primary beneficiary is the spouse. This tends to make the most sense if you are concerned that you may need access to the trust assets down the road.
Pros: The SLAT has the same benefits as the IDGT, with the addition of providing your spouse with the ability to withdraw assets from the trust should you need them.
Cons: In addition to being irrevocable, if the spouse who is the beneficiary passes away first, or if the couple goes through a divorce, the grantor loses access to the trust. Additionally, the IRS prohibits spouses from creating identical SLATs for one another, so it is important to work with an attorney who has experience with this type of strategy.
What wealth transfer mistakes should I avoid?
Having a plan to distribute your wealth is only the first step. There are other things to be aware of when it comes to transferring your wealth to ensure that you — and your loved ones — don’t lose out, and that emotions are handled delicately. Mistakes to avoid include:
1. Keeping it to yourself: Communication is the key to a successful plan, and there are two key considerations to make. First, your loved ones need to understand that you have a plan in place, and generally how it’s structured, said Krigbaum. “I don’t recommend sharing all the details, like dollar amounts, but talking about the structure — whether an inheritance will be received outright or held in trust — ahead of time gives you a chance to explain your decisions, and beneficiaries a chance to ask questions.” Second, if you’ve named loved ones to a specific role — like as a trustee or agent for power of attorney — they should also know about that designation and what it involves.
2. Forgetting to include non-financial assets: While dollars are often the focus, it’s also important to be clear about any non-monetary items that you’ll be passing along, and how you’d like them to be handled. For example, Krigbaum suggests considering collections and personal property with sentimental value.
3. Not revisiting your plan: Trigger events — like a birth, death, marriage, divorce, retirement, or the sale of a business or other large asset — always warrant a plan check. If none of these occur, then Krigbaum recommends reviewing your plan at a minimum of every five years. “You should look at things like whether or not you’re passing assets along to the right people at the right time, and who you’re asking to execute the wishes in your documents,” she said. For example, as your fiduciaries age, it may be worth revisiting the roles you’ve assigned to them.
Deciding on the best way to transfer your wealth can be tricky, and there are a lot of moving parts to consider. The above strategies are intended to reduce or eliminate estate taxes down the road, but that should never be the only reason to implement them. Taxes should be one factor, but not the only factor, says Krigbaum. Instead, look for a plan that fits with your overall goals. Give us a call for any additional advice. We’re always here to help.