Uncertainty about the economy, a new administration and tax laws means now is an opportune time to ensure your boomer clients have the right plan.
Depending on the tax strategies of the new Obama administration, estate planning specialists like Nathaniel Clement could see a flurry of new business in the coming year.
But Clement, owner of Chapel Hill, N.C.-based Wealth Strategies Consulting, is hoping that's not the case.
For 20 years, the structure of the federal estate tax remained largely unchanged until the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The act altered the tax structure with six changes to the federal estate tax exemption over its 10-year life span. As the changes were temporary, conventional wisdom held that Congress would make the changes permanent. But with Democratic majorities in Washington, wars in Iraq and Afghanistan, budget deficits and aging boomers, that seems unlikely. The continued uncertainty makes estate and gift tax planning more complex than ever, and advisors need to be aware of the estate planning landscape.
"The original stated position of Mr. Obama is that he would repeal all of the Bush tax cuts," Clement says. Doing so would mean that the federal estate tax exemption could fall all the way back to $1 million, far from the $2 million in 2008 and $3.5 million in 2009, prior to the scheduled one-year estate tax repeal in 2010.
"That would not be good," Clement says, looking at the big picture, despite the likelihood it would generate a flurry of estate planning needs that would benefit any attorney or advisor specializing in the area. Clement says he hopes President Obama and his economic advisors "see the light" and do not simply let the tax cuts expire, meaning a return to the $1 million federal estate tax exemption.
"My bet is they'll compromise," Clement says. "I'm telling my clients to plan on $3.5 million beyond 2009."
Uncertainty is a buzzword in estate planning circles as we enter 2009. Constance J. Fontaine, who teaches estate planning to aspiring financial planners at the American College and wrote the book Fundamentals of Estate Planning, says now is the time to make sure clients are aware of the consequences of their estate planning strategies.
"Although planners always recommend that clients review their estate documents periodically, never has this been more important than now due to changes and unpredictability of the recent financial and economic atmosphere," Fontaine says. "For instance, a review of an individual's will or trust may highlight that assets (stocks, etc.) passing to one child may now have a significantly lesser value than other assets passing to another child, and equalization was the client's testamentary objective."
Fontaine notes that an additional reason to review estate documents now is the scheduled increase this year in the applicable exclusion amount from $2 million to $3.5 million. "Boomers whose documents have made a credit bypass trust arrangements for marital deduction purposes need to determine whether or not this is still advisable and whether marital deduction formulas are still appropriate," Fontaine says. "As if the significant leap from $2 million to $3.5 million isn't noteworthy enough, boomers and planners will also be waiting to see what a new administration and Congress may accomplish prior to the slated one-year estate tax repeal in 2010."
Fontaine says she doesn't currently see much else on the regulatory radar. "Probably this is because the government has been so focused on the Emergency Economic Stabilization Act of 2008, mortgage foreclosure matters, potential bailout issues for various industry groups, the estate tax increase for 2009, the looming one-year repeal in 2010, plus all the changes and unknowns that accompany a new administration."
Gift giving
Many taxpayers make annual exclusion gifts regularly or sporadically as part of a gifting program. The annual exclusion increases to $13,000 this year.
"With the market being what it is at the moment, it may be prudent for boomers to revisit these programs for both noncharitable and charitable donees," Fontaine advises. "Perhaps boomers have seen their own portfolios decline and may need to put their gifting endeavors aside, at least temporarily. From the opposite perspective, making gifts that are currently lower in value may provide an even better opportunity for some boomers to get more value out of their estates (and within the annual exclusion amount), allowing later anticipated appreciation on the gifts to benefit recipients."
Life and taxes
William Magnusson, CLU, CFP, an advisor at Greenwood Village, Colo.-based Berkshire Advisor Resource Inc., says many practitioners expect taxes to go up in just about all areas. "The buildup of cash value inside a life insurance policy is still tax deferred/tax free (depending on how you manage it), and the deathtime taxation of life insurance is much better than annuities," Magnusson says. "That law has been in place for about 100 years. They could change it, but last time they made a major such change (1988), the tax treatment of old policies was grandfathered, so it might be good to get this stuff done soon."
If taxes do go up, Magnusson says putting pretax dollars into a retirement vehicle like a 401(k), and then paying taxes at higher rates on withdrawals later, might not work out so well -- especially if you don't get good asset growth in the meantime.
"Perhaps better, at least with some of [the client's] money, is to bite the bullet, pay tax now, and then get the money out of the tax system forever via Roth IRAs, irrevocable trusts, life insurance cash value, etc.," Magnusson says.
Trust or dare
"The biggest trend I see when boomers are doing their own estate planning is that more and more of them are seeing the wisdom in using trusts instead of an outright bequeath," Clement says.
There are numerous reasons why, and Clement points to the five personal protections a trust can provide.
Lawsuit protection, which protects a child's interest in the estate if that child is later sued;
Catastrophic health care protection, which guards the beneficiary's wealth from being used to pay for huge medical bills;
Remarriage protection, so that the surviving spouse can remarry and the children will not lose their future inheritance to the new spouse; divorce protections for the children, so that a child who inherits can't later lose her inheritance in a divorce action; and
Values protection, which allows parents to pass their value system along with the wealth.
Clement, who has specialized in estate planning for nearly two decades, has directed his own children to read two books he thinks best prepare them to manage the family's wealth once they own it: The Millionaire Next Door and Rich Dad, Poor Dad. He even had a client who wrote those titles into children's trusts as a condition for receiving benefits -- "a prime example of passing on one's value system," he says.
Trusts can be designed to be anything from very conservative to very progressive, and one of Clements' favorite aspects of a trust is that it separates ownership from use. They can protect wealth from creditors of all types, including lawsuits, businesses and claims by government. "A trust can make a dollar worth more than a dollar," Clement says.
Family Limited Partnerships are another avenue that might be appropriate for affluent boomers in certain situations. These limited partnerships are formed to hold the family business or investments with the idea that the parents will make gifts of their limited partnership interests to their children.
Because the interests are illiquid, the theory is that they should be subject to substantial discounts for federal gift and estate tax planning purposes and also have some benefits as asset protection vehicles.
FLPs are widely marketed by a variety of planners, but they are often not utilized correctly -- usually because they are not properly funded or maintained. Still, FLPs can be powerful estate planning tools for those with estates valued at more than $1 million.
"They are still viable if done properly," Clement says of FLPs. "But if you're not willing to spend money on lawyers, don't do it."
Clients want to be able to decide how their wealth will be distributed when they die. They won't be able to perpetuate their legacy effectively unless a solid estate plan is in place. With the future of federal estate taxes uncertain, it is important to encourage clients to review or develop an estate plan if they have not done so within the past year.
