Even though the stock market has been rebounding since March, it’s still down
significantly from where it was before it started tanking a year ago.
If you have a sizable estate, you might very well have watched it shrink over the
past year. But there’s a way to turn that to your advantage.
Poor markets offer investors the chance to transfer money out of their estates at
reduced tax liabilities. That’s because the taxes are based on the size of the
estate. The smaller the estate, the lower the tax you owe. Low interest rates also
help decrease the tax burden, in certain cases.
Start with the basics. You can hand out gifts of as much as $13,000 a year without
any tax liability. Those gifts can be to one person or numerous people. If you make
gifts along with your spouse, you can dole out $26,000 tax-free.
Tax law also includes a provision allowing people to give away as much as they want
in order to pay tuition or medical bills for another person. The key is to make
those payments directly to the school or to the medical provider, not to the person
whose bills you’re paying.
You can also make loans to your children. You have to use the Internal Revenue
Service’s current minimum interest rate, which changes regularly. In August it
ranged from 0.8 percent for a short-term loan to 2.8 percent for a mid-term loan
and 4.3 percent for a long-term loan. And you can forgive the interest, as long as
it falls below the tax-exempt annual gifting total of $13,000.
But beyond that, most estate gifting strategies involve taxes. That’s where the
down markets and lower interest rates come in.
One option is known as a grantor retained annuity trust. It’s set up for people to
put in assets that they expect to increase in value over time. The trust has a
specified term, during which you get annuity payments. After the term, the
remaining trust value goes to the beneficiaries.
When you gift assets into the trust, that transfer is taxable and based on a
current IRS rate. But the interest earned on the assets in the trust is typically
higher than that tax rate. The remaining asset value gets passed along tax-free
when the term of the trust is finished. So if you’re gifting assets such as stocks
that have a low current value and increase over time, you achieve a significant tax
savings on the transaction.
Another option is the intentionally defective grantor trust. This gives you some
control over the trust. But it also means you pay the taxes on income generated
from the trust, rather than the trust paying the taxes. That makes it a good
vehicle for transferring income-producing assets, because the tax payments come
from you rather than from the trust.
You sell your assets to the trust in exchange for a note that includes interest.
But that interest is not taxable. You also achieve tax savings because the value of
the assets you sell to the trust will likely exceed what you get back in the note.
And the assets in the trust are typically not part of your taxable estate when you
die.
Finally, a charitable lead trust works in many cases. You receive a gift tax
deduction for the income stream that you provide to a designated charity. The IRS
uses a preset current interest rate to determine the deduction. The deduction is
higher as the rate moves lower. And if the assets in the trust increase in valuebeyond that interest rate, the remainder gets passed on tax-free.
Nobody’s rooting for weak stock markets. But when it happens, be ready to take
advantage.