Time Is Ticking to Capitalize on Historic Wealth Transfer Opportunities

A major benefit of long-term financial planning is that you can remain opportunistic in any economic environment. And while 2020 has been besieged by uncertainty and economic tumult, tremendous opportunities have also emerged, particularly when it comes to estate planning for high-net-worth individuals. 

Several factors coming together right now have yielded an ideal environment to take advantage of sophisticated wealth transfer strategies that significantly minimize taxes. It’s not a stretch to call this a once-in-a-generation opportunity, but like all opportunities the window to seize it won’t be open for long.

Here’s why 2020 is the year to act on your estate plan, and why time is of the essence. 

COVID-19 HAS US THINKING

Like many Americans, the pandemic and its consequences likely caused you to pause, reassess your goals and objectives and consider what’s truly important to you and your family.  As you contemplate changes to your existing plan, your financial plan, estate planning documents, and any business succession planning must accordingly be updated.

If the pandemic has thoughts about your family’s financial future swirling, it’s time to speak with your financial advisor and revisit the course you’ve charted together.

Now, to the opportunity at hand.

INTEREST RATES ARE HISTORICALLY LOW

If you have a large estate, one of your primary goals is likely to transfer as much of it as possible to your family rather than the government — you want to be tax efficient. Intra-family loans, installment sales, third-party borrowing, Grantor Retained Annuity Trusts (GRATs) and Charitable Lead Annuity Trusts (CLATs) are beneficial strategies to transfer wealth, and their effectiveness is driven by interest rates. Those interest rates are currently at their lowest point in a generation which makes these strategies particularly tax efficient right now.

For example, an intra-family loan is one of the simplest ways to transfer wealth directly to a family member or a trust in exchange for a note. While the note can be any duration, it must be made at or above the Applicable Federal Rate (AFR), which is set monthly by the IRS. Over the last 20 years, the rate has ranged from a high of 6.62 percent to a low of 0.16 percent. As of August 2020, the short-term AFR, which applies to loans with a term of three years or less, is 0.17 percent (the long-term rate, a term applying to loans over 9 years, is 1.12 percent). Similarly, the § 7520 Rate and Bank Financed Rate, applied to other wealth transfer strategies, are also at historically low levels. The § 7520 Rate stands at 0.4 percent for August 2020, for example.

While the Federal Reserve has signaled it isn’t even thinking about raising rates any time soon, there’s no telling if or when economic circumstances will force the central bank’s hand. Therefore, it’s a good time to lock in these rates while they’re low.

ASSET VALUES HAVE FALLEN

Despite some stock market volatility early in the pandemic, markets are now at historical highs.  However, impacts are still reverberating through the broader economy. Depending on what you own, many businesses and other assets are worth less — and in some cases, much less — than they were entering 2020.  

That’s created another opportunity to utilize a wealth-transfer technique known as an installment sale. Using this strategy, you can sell highly appreciating, income-producing assets to an irrevocable trust, structured as a “grantor” trust by the IRS, in exchange for a note.

This strategy, conceptually, is like an intra-family loan: You’re transferring assets in exchange for a note that’s subject to the AFR. The main difference is that the assets sold in an installment sale may be eligible for valuation discounts depending on the lack of marketability and control.

“Discounts typically can range from 10 to 40 percent depending on the assets being transferred,” says Anh Bishop, JD, CFP®, senior director of concierge planning at Northwestern Mutual.

As an example, let’s say mom owns a closely held business valued at $10 million and wants to give her daughter 10 percent of her non-voting shares.  Assuming a 30 percent discount is applied, the gift to her daughter is not $1 million, but instead $700,000. Why a discount? The value of the business may have a lower assessed value depending upon how it fared during the pandemic. 

“While a family business might weather the storm, its sales may only be 75 percent of what they were in 2019, and net income projections in the future might be lower. This is a ripe time to transfer that asset while the value is low if the owner believes it will rebound long-term,” says Bishop.

Today, those assets could be sold at a lower price and lock in a historically low AFR. If those assets still have long-term appreciation potential, that can greatly enhance the benefit to the recipient over time.

TAX LAW IS BENEFICIAL … FOR NOW

The federal government imposes transfer taxes — specifically, a gift tax during life or an estate tax at death — of 40 percent when you transfer wealth. It also imposes an additional 40 percent generation-skipping transfer (GST) tax if you make these transfers to a grandchild or further descendant. Fortunately, the law allows a certain amount of assets to be exempt from all these taxes. Recent tax law changes lifted the amount exempt from $5 million to $10 million per person in 2018. The exemption increases with inflation, so it’s currently $11.58 million per person for 2020. If you’re married, you get twice this amount — a combined exemption of $23.16 million in 2020.

Under current law, the increased exemption is scheduled to “sunset” after 2025 and drop back to $5 million (plus inflation) in 2026. However, there’s an election coming up in November — and, in general, politics are hardly predictable.

“While we can’t predict what will happen in 2021, estate planners know what the law is through the end of 2020. Right now, clients have certainty. We are witnessing many clients taking advantage of the current favorable environment and moving to update their estate plan by year end,” indicated Bishop. 

There’s no guarantee these historically high exemptions will stick around for another five years. Just like interest rates, time may be ticking to capitalize on these generous exemptions.

SCHEDULES ARE FILLING

This last point is more logistics. Estate planners and tax attorney schedules are filling up, and demand for their services will only accelerate as we get closer to the year-end rush. Likewise, you may need to get a closely held business valued as part of your planning, which will require the services of a qualified appraiser.

Now is the time to take advantage of these historic estate planning opportunities. So, get your appointments set sooner rather than later to get the ball rolling. Need a little help building a game plan? Your Northwestern Mutual financial advisor can guide you in a discussion — from clarifying your current goals and objectives, ensuring that your financial plan is aligned and on track, and assisting you and your attorneys with any estate and business planning changes.