The Shifting Sands of Wealth Transfer Planning

Active Tax Management
April 5, 2022

After the challenging planning environment of 2021, wealth advisors might do well to regroup with clients to ensure that decisions made under the constraints that prevailed late in the year are best positioned for implementation. Across today’s dynamic tax, political, and economic landscapes, effective planning will require adapting to these shifting sands and monitoring, updating and maintaining wealth transfer objectives over time. In the year ahead, the confluence of the current tax code, low but rising interest rates, political uncertainty, and market volatility provides fertile ground for wealth transfer planning.

Gift and estate tax exemption planning

Shifting gift and estate tax exemptions and transfer tax rates can complicate planning, but viewing these metrics through a historical lens can provide important perspective.

In 2021, the gift and estate tax exemption was $11.70 million per individual. In 2022, the exemption increases to $12.06 million. Taxpayers who maxed out lifetime gifts in 2021 can now gift an additional $360,000 free of gift tax. Married couples can gift an additional $720,000. The gift and estate tax rate remains at 40% in 2022.

Compared to historical estate tax rates and exemption amounts, wealth transfer planning conditions in 2022 are relatively favorable. For example, the top federal estate tax rate has been as high as 77% (1941–1976), and we have to go back only about 20 years (2001) to find an estate tax exemption below $1M (with a top estate tax rate of 55%).1


Figure 1: Sourced from Internal Revenue Service.

 


Figure 2: Sourced from Internal Revenue Service.

 

Although tax proposals targeting wealth transfer planning strategies appear to have lost momentum in the current political environment, some project that the exemption may be reduced and the gift and estate tax rate increased at some point.

Even absent any future tax legislation, the exemption is already scheduled to be reduced to $5 million, adjusted for inflation, after 2025 when many of the individual provisions of the Tax Cuts and Jobs Act2 sunset. Donors with the means and intent to fully use up the $12.06 million exemption should consider doing so now.

 
Low but rising interest rates

Interest rates remain near historic lows but are expected to rise during 2022 and have already begun to do so. A low-interest-rate environment can be conducive to certain powerful wealth transfer planning strategies, such as grantor retained annuity trusts (GRATs) and installment sales to intentionally defective grantor trusts.

Such strategies offer estate-freeze techniques that can be especially beneficial to individuals who have exhausted their gift tax exemptions but wish to transfer additional wealth tax efficiently. In these structures, any income and appreciation in excess of the relevant Internal Revenue Service hurdle rate passes to the trust beneficiaries free of transfer taxes. Accordingly, these strategies are most effective when the relevant hurdle rates are low. These hurdle rates are based on the interest rates for Treasury obligations and so tend to increase as interest rates rise.

In March 2022, the GRAT hurdle rate (Section 7520 rate) is 2.0%, up from 1.6% in February 2022, 1.0% in September 2021, and 0.6% in February 2021. To put these shifting rates in historical context, we have to go back only to 2007 to find 7520 rates near 6.0% and to 2000 to find rates near 8.0%.3


Figure 3: Sourced from Internal Revenue Service. The Internal Revenue Code Section 7520 rate is updated monthly.


Given that higher hurdle rates could reduce the efficacy of these strategies, 2022 may be an opportune time to take advantage of them.

 
Political uncertainty

Rising interest rates are not the only threat to GRATs. Some of the recent tax legislation proposals,4 if enacted, would adversely impact, if not eliminate, the benefits of grantor trust structures like GRATs. However, grantor trusts created and trust contributions made before the date of enactment may be grandfathered under existing rules.5

Although these and many other proposals targeting wealth transfer planning strategies appear to have fallen out of favor, and efforts to pass major tax reform this year have stalled, tax proposals have historically had a long shelf life, and these proposals may be revisited in the future.

It’s also important to note that in some cases, planning in late 2021 was completed under significant time pressure as attorneys and tax advisors rushed to assist clients before proposed tax legislation could pass and become effective.

Given the stressful and uncertain 2021 planning environment, it may be prudent for wealth advisors to circle back with clients, estate planning attorneys, and tax advisors to make sure all the Is are dotted and Ts are crossed and everyone is on the same page regarding the planning that was put into effect.

It would be incredibly unfortunate to have planning executed in 2021 be unsuccessful or challenged in the future because of miscommunication or critical tasks slipping through the cracks. Accordingly, ensure that the client, financial advisor, tax advisor, and attorney are all in agreement about how recently enacted planning will be fully implemented and sufficiently administered.


Market volatility

Watching the news these days can be unsettling. Reports about the tragic Russia-Ukraine war, stock market volatility, and surging inflation can be discouraging and distressing. Unsurprisingly, wealth transfer planning is likely not top of mind for many people.

However, depressed asset values may provide opportunities6 to gift assets at temporarily reduced valuations and lower transfer tax costs—and may permit any future rebound to occur outside the donor’s gross estate.

In a year like 2022, we’ll take all the silver linings we can get.

 
Conclusion

The wealth transfer planning landscape remains fluid and is constantly evolving due to shifting tax, economic, and political sands. Although change is inevitable and uncertainty remains high, planning opportunities abound in 2022.

Clients may feel greater peace of mind and increase their odds of successfully reducing taxes and preserving wealth by regularly revisiting their wealth transfer planning.

 

Send questions or comments to aperio.blog@blackrock.com.

 

Important Notes: The strategies and/or investment options referenced may not be suitable for all investors, because the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. None of the examples or information herein should be considered advice tailored to the needs of any specific investor or a recommendation to buy or sell any securities.

1 Source: Internal Revenue Service.
2 US Congress, Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, December 22,2017.
3 The Internal Revenue Code Section 7520 rate is updated monthly: Section 7520 Interest Rates, Section 7520 Interest Rates for Prior Years.
4 US House Ways and Means Committee, proposed changes to budget reconciliation bill, September 12, 2021.
5 Future planning should also factor in any tax proposals that may arise after the time of this writing.
6 Other tax planning opportunities may include tax-loss harvesting and Roth IRA conversions.

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