The Fate of Flexible Estate Planning…

During the last several years, the estate tax applicable exclusion amount has been on a steady, upward march.  It is now $5.25 million per person ($10.5 million for married couple with proper planning) and is indexed for inflation.  With such a generous exclusion amount, the Obama administration is seeking to close “tax loopholes,” including certain types of trusts used to limit or eliminate estate tax liability.  In the President’s proposed 2013 budget, he proposes to make significant changes to Grantor Retained Annuity Trusts (GRATs) in particular.  If his proposals are accepted, the emphasis on early planning will be even more important.

On a basic level, GRATs are irrevocable trusts created to hold certain assets and pay an annuity to the grantor (i.e. the creator of the trust).  If the grantor dies during the term of the annuity, all the trust property will be included in the grantor’s estate and subject to estate tax.  However, if the grantor outlives the annuity, then the amount remaining in the GRAT may be passed to the beneficiaries without the imposition of either gift or estate tax.  Depending on the amount funded in the trust and the grantor’s life expectancy, GRATs have typically been a reasonably flexible method of transferring property without incurring tax liability.  If the Obama administration has its way, the minimum annuity term will be 10 years, meaning that the grantor must live at least an additional 10 years in order to realize any tax benefit.  Individuals who wish to use this method of estate planning will have to begin planning and realistically assessing their future financial needs many years away from death.  Creating long-term annuity trusts may be unattractive for most estate planners making the GRAT among the less favorable methods of avoiding estate and gift tax.

However, irrevocable trusts will continue to be beneficial in a wide variety of other circumstances and are not used purely for avoiding estate and gift taxation.   Irrevocable trusts may be used to purchase life insurance.  The insurance policy can then be used to pay estate tax or provide money to heirs.  For individuals whose estates are more modest and unlikely to be subject to any estate tax, irrevocable trusts may still be beneficial in order to avoid Medi-Cal estate recovery.  If you are a beneficiary of Medi-Cal (Medicaid outside California) at the time of your death, the state has an obligation to pursue estate assets in order to reimburse itself for your medical expenses.

Irrevocable trusts are also useful for protecting your estate assets from your heirs’ imprudence or their creditors.  By doling out income or principal in set increments and times, you may insulate your heirs from the effects of poor investments or protect them from the claims of surprise creditors.
When creating your estate plan, it is important to speak with your attorney about all of your goals and how best to achieve them.  Make sure that your attorney is familiar with the full estate planning toolbox and knowledgeable about how feasible certain plans may continue to be!