As you may already know, we each can now shelter up to $11.58 million ($23.16M for couples) from estate taxes as assets pass to our heirs.* The new tax law preserves portability, which was introduced in a revision of tax rules by Congress in 2012 called the American Taxpayer Relief ACT of 2012 (ATRA). What you may not know is the same act also made portability a permanent law, which in turn has prompted some to question the need of traditional trusts.
So what is “portability” and how does it affect you? The portability law allows us to transfer our $11.58M (2020) exemptions to our surviving spouses. Previously, we could have only accomplished efficient use of both spouses’ exemption amounts by dividing asset ownership between the two spouses and establishing a credit shelter trust, or an A/B Living Trust, that would be activated after one spouse passes.
While portability appears to simplify the estate planning process and perhaps make trusts obsolete, there are a number of drawbacks you may wish to consider:
There is potential to lose a deceased spouse’s unused exemption amount when a more recent spouse passes away. One solution may suggest using the first spouse’s exemption via gift and then creating a credit shelter trust with the second spouse. It is always a good idea to review your estate plan with your attorney before getting remarried.
- Watch out for appreciated assets
The exemption amount transferred to your spouse under the new “portability” law remains fixed and is not indexed for inflation. More inflation protection could be available under the credit shelter trust.
- Tax filings
Portability will require the executor to file a return at the death of the first spouse.
- Generation Skipping Tax (GST) Exemption
The GST exemption is not portable. By contrast an A/B Living Trust could take advantage of the GST exemption amounts for potential transfers to grandchildren.
- Asset Protection/Prior Marriage
The credit shelter trust may provide asset protection and secure inheritances for children of prior marriages, and if properly drafted protect assets from the children’s creditors.
- Living Trust avoids Probate
Besides allowing post-mortem portability, a Living Trust avoids the cost, delays and public disclosure that probate entails.
7. Considerations for Older State Plans
Many existing estate plans for married couples were designed prior to 2018 when the exclusion was much smaller. These older plans often call for automatic, maximum funding of a “credit shelter” trust at the first spouse’s death. This can result in “over-funding” of a credit shelter trust, which may realize less-than-optimal use of the deceased spouse’s exclusion, and sacrifice the opportunity for a “step-up” in cost basis at the surviving spouse’s death.
While “portability” may be here to stay, there are still a number of traditional planning solutions you may want to review:
- Annual Gifts: You may want to continue to gift to those other than your spouse to take advantage of the $15,000 (2020) annual gift exclusion per recipient. There are also exclusions for transfers for medical and education expenses. This is still a great way to gift assets and reduce your gross estate.
- As mentioned above the GST Exemption is not “portable” so you may want to consider gifting to lower generations to take advantage of the GST exemption amount now.
- Spousal Lifetime Access Trust (SLAT): Here one spouse makes a gift in trust and the Trustee has the right to make distributions to the other spouse. Thus the SLAT can be used to provide the other spouse with access to a potential cash flow (from cash values within the trust) while the insured (or insureds’) remains alive. For more details you can review my white paper on this topic.
Bottom line, keeping your estate current will help assure your assets end up in the hands of those you intend with the least erosion from taxes and legal fees. We typically recommend a review every 3-5 years or upon a life changing event such as marriage, divorce, or passing of a loved one.
*For 2020 the estate tax “basic exclusion” is $11.58M. This amount will continue to be indexed to inflation in future years, but is scheduled to “sunset” after 2025, essentially reducing it by one-half.
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Mitchell Kauffman provides wealth management services to corporate executives, business owners, professionals, independent women, and the affluent. He is one of only five financial advisors from across the U.S. named to Research magazine’s prestigious Advisor Hall of Fame in 2010, and among a select list of 100 over the past 20 years. Inductees into the Advisor Hall of Fame have passed a rigorous screening, served a minimum of 15 years in the industry, acquired substantial assets under management, demonstrate superior client service, and have earned recognition from their peers and the broader community.
Kauffman’s articles have appeared in national publications, and he is often quoted in the media. He is an Instructor of Financial Planning and Investment Management at the University of California at Santa Barbara and Santa Barbara City College.
For more information, visit www.kauffmanwm.com or call (866) 467-8981. Kauffman Wealth Management and serves clients from three office locations: 140 South Lake Avenue, Suite 307, Pasadena, CA 91101, 20750 Ventura Boulevard, Suite 240, Woodland Hills, CA 91364 and 550 Periwinkle Lane, Santa Barbara, CA 93108 (by appointment only). Investment products and services are offered through Wells Fargo Advisors Financial Network LLC (WFAFN), Member SIPC. Kauffman Wealth Management is a separate entity from WFAFN.