Charitable lead trusts offer philanthropic and family benefits

Affluent families who wish to give to charity while minimizing gift and estate taxes should consider a charitable lead trust (CLT). These trusts are most effective in a low-interest-rate environment, so conditions for taking advantage of a CLT currently are favorable. Although interest rates have crept up a bit in recent years, they remain quite low.

CLTs come in two flavors

A CLT provides a regular income stream to one or more charities during the trust term, after which the remaining assets pass to your children or other noncharitable beneficiaries.

There are two types of CLTs: 1) a charitable lead annuity trust (CLAT), which makes annual payments to charity equal to a fixed dollar amount or a fixed percentage of the trust assets’ initial value, and 2) a charitable lead unitrust (CLUT), which pays out a set percentage of the trust assets’ value, recalculated annually. Most people prefer CLATs because they provide a better opportunity to maximize the amount received by the noncharitable beneficiaries.

Typically, people establish CLATs during their lives because it allows them to lock in a favorable interest rate. Another option is a testamentary CLAT, or “T-CLAT,” which is established at death by your will or living trust.

Interest matters

Why are CLATs so effective when interest rates are low? When you fund a CLAT, you make a taxable gift equal to the initial value of the assets you contribute to the trust, less the value of all charitable interests. A charity’s interest is equal to the total payments it will receive over the trust term, discounted to present value using the Section 7520 rate, a conservative interest rate set monthly by the IRS. As of this writing, the Sec. 7520 rate has fluctuated between 2.8% and 3.4% this year.

If trust assets outperform the applicable Sec. 7520 rate (that is, the rate published in the month the trust is established), the trust will produce wealth transfer benefits. For example, if the applicable Sec. 7520 rate is 2.5% and the trust assets actually grow at a 7% rate, your noncharitable beneficiaries will receive assets well in excess of the taxable gift you report when the trust is established.

Act now

If a CLAT appeals to you, the sooner you act, the better. In a low-interest-rate environment, outperforming the Sec. 7520 rate is relatively easy, so the prospects of transferring a significant amount of wealth tax-free are good. Contact us with questions.

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Leave your mark with a dynasty trust

If a prime objective of your estate plan is to leave a lasting legacy, a dynasty trust may be the right estate planning vehicle for you. And, thanks to the substantially increased generation-skipping transfer (GST) tax exemption amount established by the Tax Cuts and Jobs Act, a dynasty trust is more appealing than ever.

GST tax and dynasty trusts

A dynasty trust allows substantial amounts of wealth to grow and compound free of federal gift, estate and GST taxes, providing tax-free benefits for your grandchildren and future generations. The longevity of a dynasty trust varies from state to state, but it’s becoming more common for states to allow these trusts to last for hundreds of years or even in perpetuity.

Avoiding GST tax liability is critical to a dynasty trust’s success. An additional 40% tax on transfers to grandchildren or others that skip a generation, the GST tax can quickly consume substantial amounts of wealth. The key to avoiding the tax is to leverage your $11.40 million GST tax exemption.

For example, let’s say you haven’t used any of your $11.40 million combined gift and estate tax exemption. In 2019, you transfer $10 million to a properly structured dynasty trust. There’s no gift tax on the transaction because it’s within your unused exemption amount. And the funds, together with all future appreciation, are removed from your taxable estate.

Most important, by allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes. This is true even if the value of the assets grows well beyond the exemption amount or the exemption is reduced in the future.

Setting up a dynasty trust

A dynasty trust can be established during your lifetime, as an inter vivos trust or part of your will as a testamentary trust. An inter vivos transfer to a dynasty trust may have additional benefits associated with transferring assets that have greater appreciation potential out of your taxable estate.

After creating the trust, you must determine which assets to transfer to it. Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests.

Finally, you must appoint a trustee. Your choices may include a succession of family members or estate planning professionals. For most people, however, a safer approach is to use a reputable trust company with a proven track record, as opposed to assigning this duty to family members who might not be born yet.

If you think a dynasty trust might be right for your family, talk with us before taking action. A currently effective dynasty trust is irrevocable — meaning that, once you create it, you may be unable to modify the arrangement if your family dynamic changes.

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Does your estate plan include a formula funding clause?

The gift and estate tax exemption is higher than it’s ever been, thanks to the Tax Cuts and Jobs Act (TCJA), which temporarily doubled the exemption to an inflation-adjusted $10 million ($20 million for married couples who design their estate plans properly). This year, the exemption amount is $11.4 million ($22.8 million for married couples).

If you’re married and you executed your estate planning documents years ago, when the exemption was substantially lower, review your plan to ensure that the increased exemption doesn’t trigger unintended results. It’s not unusual for older estate planning documents to include a “formula funding clause,” which splits assets between a credit shelter trust and the surviving spouse — either outright or in a marital trust.

Formula funding clause in action

Although the precise language may vary, a typical clause funds the credit shelter trust with “the greatest amount of property that may pass to others free of federal estate tax,” with the balance going to the surviving spouse or marital trust. It is not uncommon to see credit shelter trusts in older wills that are designed to preserve wealth for one’s children (from an existing or previous marriage), with limited benefits, if any, for the surviving spouse.

A formula clause works well when an estate is substantially larger than the exemption amount — but, if that’s no longer the case, it can lead to undesirable results, including inadvertent disinheritance of one’s spouse.

For example, Ciara and Mike, a married couple, each own $10 million in assets, and their estate plan contains a formula funding clause. If Ciara died in 2017, when the estate tax exemption was $5.49 million, that amount would have gone into a credit shelter trust and the remaining $4.51 million would have gone to a marital trust for Mike’s benefit. But if Ciara dies in 2019, when the exemption has increased to $11.4 million, her entire estate will pass to the credit shelter trust, leaving nothing for the marital trust.  If Ciara had a credit shelter trust that named her children from her prior marriage as the only beneficiaries, Mike would get nothing through her will.

Exemption amount heading up and then down

With the TCJA temporarily doubling the gift and estate tax exemption amount, unexpected results may occur if you don’t review and revise your plan accordingly. This is especially true if your plan includes a formula funding clause.

Also, be aware that, even though the exemption amount will continue to be adjusted annually for inflation, it expires after 2025. Without further legislation, the exemption will return to an inflation-adjusted $5 million in 2026. We’d be pleased to help review your plan and determine if changes are needed.

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Managing Partner Cleve Hill Interviewed on Estate Planning Basics

Estate planning sounds like it is something very grandiose that the average person tends not to identify with. They look at needing a “simple” will. However, taking a simplistic approach to a will or estate planning can have some unintended consequences.

It is recommended at a minimum, that you have three foundational documents: a financial power of attorney, a last Will and Testament, and an Advance Directive for Health Care.

Recently, Hill & Watchko managing partner, Cleve Hill, sat down for an interview with Meredith Moore of Moore & Associates Wealth Management to explore the purpose of the three foundational documents in your estate plan and what the risks can be without them.

[Click link here to watch video.]

Planning for the time when you will longer be here is never easy. Many people put off the preparation needed to make things easier on their loved ones or they come at it with an overly simplistic approach.  In the interview, you’ll hear a discussion of the following:

  • Why people put off estate planning (:17)
  • Why “simple solutions” can have unintended consequences (2:47)
  • What happens when Georgia residents die without a will or estate planning documents (3:20)
  • What happens if a minor child is listed on a life insurance policy (5:33)
  • Why trusts are not just for the rich, who needs one and how they work (7:24)
  • Who should prepare your estate planning documents (14:40)
  • Why you should talk to someone who specializes in estate planning (16:52)
  • What to ask when interviewing an estate attorney (19:30)
  • How much it will cost for an estate plan if you live in the Atlanta area (21:02)

 

 

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Estate planning for single parents requires special considerations

Here’s a fast fact: The percentage of U.S. children who live with an unmarried parent has jumped from 13% in 1968 to 32% in 2017, according to Pew Research Center’s most recent poll.

While estate planning for single parents is similar to estate planning for families with two parents, when only one parent is involved, certain aspects demand your special attention.

5 questions to ask

Of course, parents want to provide for their children’s care and financial needs after they’re gone. If you’re a single parent, here are five questions you should ask:

  1. Have I selected an appropriate guardian? If the other parent is unavailable to take custody of your children should you become incapacitated or unexpectedly die, your estate plan must designate a suitable, willing guardian to care for them.
  2. What happens if I remarry? Will you need to provide for your new spouse as well as your children? Where will you get the resources to provide for your new spouse? What if you placed your life insurance policy in an irrevocable trust for your kids to avoid estate taxes on the proceeds or for other planning reasons? Further complications can arise if you and your new spouse have children together or if your spouse has children from a previous marriage.
  3. What if I become incapacitated? As a single parent, it’s particularly important to include in your estate plan a living will, advance directive or health care power of attorney to specify your health care preferences in the event you become incapacitated and to designate someone to make medical decisions on your behalf. You should also have a revocable living trust or durable power of attorney that provides for the management of your finances in the event you’re unable to do so.
  4. Should I establish a trust for my children? Trust planning is one of the most effective ways to provide for your children. Trust assets are managed by one or more qualified, trusted individuals or corporate trustees. You specify when and under what circumstances funds should be distributed to your kids. A trust is particularly important if you have minor children. Without one, your assets may come under the control of your former spouse or a court-appointed administrator.
  5. Am I adequately insured? With only one income to depend on, plan carefully to ensure that you can provide for your retirement as well as your children’s financial security. Life insurance can be an effective way to augment your estate. You should also consider disability insurance. Unlike many married couples, single parents don’t have a “backup” income in the event they can no longer work.

Review your estate plan

If you’ve recently become a single parent, it’s critical to review your estate plan. We’d be pleased to help you make any necessary revisions.

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College financing may be an integral part of your estate plan

The staggering cost of college makes it critical for families to plan carefully for this major expense, and in many cases grandparents want to play a role. As you examine the many financing options for your grandchildren, be sure to consider their impact on your estate plan.

Make direct payments

A simple, but effective, technique is to make tuition payments on behalf of your grandchild. So long as you make the payments directly to the college, they avoid gift and generation-skipping transfer (GST) tax without using up any of your $11.4 million gift or GST tax exemptions or your $15,000 annual gift tax exclusion.

A disadvantage of direct payments is that, if your grandchild is young, you have to wait until the student has tuition bills to pay. So there’s a risk that you’ll die before the funds are removed from your estate.

Draft a grantor trust

Trusts offer several important benefits. For example, a trust can be established for one grandchild or for multiple beneficiaries, and assets contributed to one, together with future appreciation, are removed from your taxable estate. In addition, the funds can be used for college expenses or for other purposes. Also, if the trust is structured as a “grantor trust” for income tax purposes, its income will be taxable to you, allowing the assets to grow tax-free for the benefit of the beneficiaries.

On the downside, for financial aid purposes a trust is considered the child’s asset, potentially reducing or eliminating the amount of aid available to him or her. So keep this in mind if your grandchild is hoping to qualify for financial aid.

Explore all of your options

Other college financing options include Sec. 529 college savings and prepaid tuition plans, savings bonds, retirement plan loans, Coverdell Education Savings Accounts, and various other tax-advantaged accounts. If you’d like to learn more about your options to help fund your grandchild’s education expenses, please contact us.

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Need to protect a beneficiary?  Add spendthrift language to a trust to safeguard assets

Protecting assets from creditors is a critical aspect of estate planning, but you need to think about more than just your own creditors: You also need to consider your beneficiaries’ creditors and potential impact of the undue influence from third parties (bad spouses, divorces, predators, etc.). Adding spendthrift language to a trust benefiting your beneficiaries can help safeguard assets.

Spendthrift language explained

Despite its name, the purpose of a spendthrift trust isn’t just to protect profligate beneficiaries from themselves. Although that’s one use for this trust type, even the most financially responsible beneficiaries can be exposed to frivolous lawsuits, dishonest business partners, the undue influence of bad spouses, predators, or unscrupulous creditors.  A properly designed spendthrift trust can protect assets against such attacks.

It can also protect your loved ones in the event of relationship changes. If one of your children divorces, your child’s spouse generally can’t claim a share of the trust property in the divorce settlement.  Georgia has some exceptions, however, for child support and alimony.  However, the spendthrift trust can protect inherited assets from being co-mingled with assets held with the beneficiary’s spouse.  If the assets are co-mingled with joint assets held with a spouse, it could be subject to division in a divorce action.

Also, if your child predeceases his or her spouse, the spouse might be named as primary or sole beneficiary of your child’s estate planning document; but if there is no Will or Living Trust, the child’s spouse generally is entitled by law to a significant portion of your child’s estate, including property you left the child outright. In some cases, that may be a desirable outcome. But in others, such as second marriages when there are children from a prior marriage, a spendthrift trust can prevent your child’s inheritance from ending up in the hands of his or her spouse rather than in those of your grandchildren.

A variety of trusts can be spendthrift trusts. It’s just a matter of including a spendthrift clause, which restricts a beneficiary’s ability to assign or transfer his or her interest in the trust and restricts the rights of creditors to reach the trust assets.

Additional considerations

It’s important to recognize that the protection offered by a spendthrift trust isn’t absolute. Depending on applicable law, it may be possible for government agencies to reach the trust assets — to satisfy a tax obligation, for example.  As noted above, there are other exceptions under Georgia law including alimony, child support, intentional tort judgments, and criminal restitution.

Generally, the more discretion you give the trustee over distributions from the trust, the greater the protection against creditors’ claims. For increased protection, it’s preferable to give the trustee full discretion over whether and when to make distributions.

Protect wealth after transfer

Protecting your wealth after you’ve transferred it to your family is just as important as other estate planning strategies such as reducing tax liability on the transfer. One way to do this is to include spendthrift language in a trust. Contact us to learn whether a spendthrift trust is right for your estate plan.

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If art donations are part of your estate plan, consider these four tips

Charitable giving is a key part of estate planning for many people. If you have a collection of valuable art and are charitably minded, consider donating one or more pieces to receive tax deductions. Generally, it’s advantageous to donate appreciated property to avoid capital gains taxes. Because the top federal capital gains rate for art and other “collectibles” is 28%, donating art is particularly effective.

Considerations before donating

If you’re considering a donation of art, here are four tips to keep in mind:

  1. Get an appraisal. Given the subjective nature of art valuation and the potential for abuse, the IRS scrutinizes charitable donations and other transactions involving valuable artwork. Most art donations require a “qualified appraisal” by a “qualified appraiser.” IRS rules contain detailed requirements about the qualifications an appraiser must possess and the contents of an appraisal.

IRS auditors are required to refer all gifts of art valued at $20,000 or more to the IRS Art Advisory Panel. The panel’s findings are the IRS’s official position on the art’s value, so it’s critical to provide a solid appraisal to support your valuation.

  1. Donate to a public charity. To maximize your charitable deduction, donate artwork to a public charity, such as a museum or university with public charity status. These donations generally entitle you to deduct the artwork’s full fair market value. Be aware that your charitable deduction may be reduced if it exceeds certain limits based on your adjusted gross income, the type of donation and the type of charity receiving the donation.
  2. Beware the related-use rule. To qualify for a full fair-market-value deduction, the charity’s use of the artwork must be related to its tax-exempt purpose. So, for example, if you donate a painting to a museum for display or to a university for use in art classes, you’ll satisfy the related-use rule.

Even if the related-use rule is satisfied initially, you may lose some or all of your deductions if the artwork is worth more than $5,000 and the charity sells or otherwise disposes of it within three years after receiving it.

  1. Transfer the copyright. If you own both the work of art and the copyright to the work, you must assign the copyright to the charity to qualify for a charitable deduction.

Fractional donations

At one time, it was possible to give art away gradually using a series of fractional gifts, and claim increasing deductions if the art continued to appreciate. Under current rules, however, the deduction for future fractional gifts is limited to the value of the initial fractional gift (or, if lower, the fair market value of the later fractional gift).

The rules surrounding donations of art can be complex. We can help you achieve your charitable giving goals while maximizing your tax benefits.

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Properly funding your revocable trust is the key to unlocking its benefits

If your estate plan includes a revocable trust — also known as a “living” trust — it’s critical to ensure that the trust is properly funded. Revocable trusts offer significant benefits, including asset management (in the event you become incapacitated) and probate avoidance. But these benefits aren’t available if you don’t fund the trust.

In our practice, it is not uncommon to have a family come in after there has been a death with a nicely organized three-ring estate planning binder that includes a living trust document; and inevitably one of the family member’s says, “Mom had a living trust, so I guess we avoid probate, right?”  My response is, “what did Mom have in the living trust?”  only to receive blank stares and the reply “nothing.”

Funding is, essentially, everything.

Funding the trust

Funding a living trust is a simple matter of transferring ownership of assets to the trust or, in some cases, designating the trust as beneficiary. Assets you should consider transferring include real estate, bank accounts, certificates of deposit, stocks and other investments, partnership and business interests, vehicles, and personal property (such as furniture and collectibles).

Be aware that moving an IRA or qualified retirement plan to a revocable trust can trigger unwanted tax consequences. Rather than transfer these assets to the trust, be sure that the trust is properly designed to allow you to designate the trust as beneficiary and enjoy the tax benefits of doing so.  In this instance, with qualified retirement plans, make sure that you are working with an estate planning attorney who knows the “ins and outs” of properly drafting trusts to be named as a beneficiary of a qualified plan.  Unfortunately, lawyers that just do the one-off Will may not be the best choice, and I have yet to see an internet-based self help document that addresses this properly.  Buyer beware!

For insurance policies and annuities, you can either transfer ownership or change the beneficiary designation. In some cases, it may be advisable to hold a life insurance policy in an irrevocable life insurance trust to shield the proceeds from estate taxes.

Avoiding a pitfall

It’s good to be diligent about funding a trust at the time you sign the trust documents. But trouble can arise when you acquire new assets after the trust is established. Unless you transfer new assets to your trust, or designate the trust as beneficiary, they won’t enjoy the trust’s benefits.  It will take some transition to get accustomed to owning your assets in the living trust, but the benefits are worth the effort.

So to make the most of a revocable trust, be sure that each time you acquire a significant asset, you take steps to transfer it to the trust or complete the appropriate beneficiary designation. A living trust is a key component of many people’s estate plan. Contact us to help ensure yours is properly funded.

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Life insurance can be a powerful estate planning tool for nontaxable estates

For years, life insurance has played a critical role in estate planning, providing a source of liquidity to pay estate taxes and other expenses. Today, the gift and estate tax exemption has climbed to $11.4 million, so estate taxes are no longer a concern for the vast majority of families. But even for nontaxable estates, life insurance continues to offer estate planning benefits.

Replacing income and wealth

Life insurance can protect your family by replacing your lost income. It can also be used to replace wealth in a variety of contexts. For example, suppose you own highly appreciated real estate or other assets and wish to dispose of them without generating current capital gains tax liability. One option is to contribute the assets to a charitable remainder trust (CRT).

As a tax-exempt entity, the CRT can sell the assets and reinvest the proceeds without triggering capital gains tax. In addition, you and your spouse will enjoy an income stream and charitable income tax deductions. Typically, distributions you receive from the CRT are treated as a combination of ordinary taxable income, capital gains, tax-exempt income and tax-free return of principal.

After you and your spouse die, the remaining trust assets pass to charity. This will reduce the amount of wealth available to your children or other heirs. But you can use life insurance (a cost-effective second-to-die policy, for example) to replace that lost wealth.

You can also use life insurance to replace wealth that’s lost to long term care (LTC) expenses, such as nursing home costs, for you or your spouse. Although LTC insurance is available, it can be expensive, especially if you’re already beyond retirement age. For many people, a better option is to use personal savings and investments to fund their LTC needs and to purchase life insurance to replace the money that’s spent on such care. One advantage of this approach is that, if neither you nor your spouse needs LTC, your heirs will enjoy a windfall.

Finding the right policy

These are just a few examples of the many benefits provided by life insurance. Build a good team of advisors to help you determine which type of life insurance policy is right for your situation.

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