Entrepreneur, author, and motivational speaker Jim Rohn famously once said, “All good men and women must take responsibility to create legacies that will take the next generation to a level we could only imagine.”
If there’s one thing nearly everyone can agree on, it’s that we want to leave the world a better place than we found it. To do that, we don’t want to squander the resources and wealth that we have been able to accumulate throughout this life. We want to make the most of them. That includes minimizing the tax we pay on them.
As an executive financial advisor, I’ve worked with countless families who, in addition to ensuring they will have enough income to live a comfortable retirement, want to create a legacy for the next generation and even the generations beyond. To help our clients accomplish this, my team and I have identified five family legacy planning strategies that minimize estate tax as well as accomplish the goal Rohn outlined—take responsibility to create legacies that will take the next generation to a level we could only imagine.
What Exactly Are the Estate Tax Laws?
Before you can fully understand and implement legacy planning strategies, you first need to understand how estate tax laws in 2018-2019 could affect you.
The current inflation-adjusted estate tax exemption amount is $11.18 million. The IRS requires estate tax to be filed for estates with combined gross assets above this dollar figure. If you receive an inheritance above $11.18 million, it will be taxed at a 40% tax rate.
While these estate tax laws almost double the estate tax exemption amount from 2017, these are still figures corporate executives should know. Even if you fall below the threshold, it’s important to work with a financial advisor while doing any estate planning due to the large swings in wealth that can occur from employee stock options. You may find yourself under this threshold one week and over it the next if your company performs considerably well over a stretch of time.
Family Legacy Planning Strategies
Now that you have a general understanding of the estate tax limits, let’s take a look at the strategies that can help you minimize that estate tax obligation, allowing you to leave more to family, friends, and charity.
1. Gifting stock options: Nearly every top-level executive has an equity compensation plan in one way, shape, or form. This means that a large portion of your wealth is likely allocated to stock options. One way to lower your overall estate tax obligation is to get that stock out of your name by gifting your stock options now rather than when you pass away.
When you do this, you are giving the recipient, whether it be family, friend, charity, or other organization, the ability to exercise the stock option at a time that makes the most sense for them. Because stock options fall under the tax-free annual gift amount of $30,000 per married couple or $15,000 per person, you can give away the equivalent amount of stock options each year without having it count against the lifetime gift tax amount, which we previously mentioned is currently $11.18 million.
You are responsible for the tax owed on the difference between the exercise price and current market value (known as the compensation element) when the option is exercised by the recipient.
2. Gifting cash using the annual federal gift tax exclusion: This brings us to our next strategy, briefly mentioned above—leveraging the annual federal gift tax exclusion. This can be done using your employee stock options, but it can also be used by donating cash directly to a family member or other recipient of your choice throughout your lifetime. If this strategy is implemented consistently year after year over a longer period of time, it can begin to make a large impact on reducing the size of your overall estate. As a reminder, the annual federal gift tax exclusion is limited to $15,000 per person or $30,000 for a couple.
3. Irrevocable life insurance trust (ILIT): This strategy can be a powerful family legacy planning strategy for executives to implement. We always recommend you work with an estate planning attorney in conjunction with an executive financial advisor when designing and implementing an ILIT.
This tool allows you to transfer ownership of a life insurance policy to a trust, set up by you, which then removes it from your overall estate. This allows you to keep only the assets that fall under the total estate tax exemption amount titled in your own name and place the insurance policy (usually a sizable face value amount for executives) inside the trust.
Once the ILIT is established, however, you are not able to make additional changes to the life insurance policy itself. Also, you need to be sure to set up the ILIT three years or more before you pass away. If you happen to set it up within three years of your death, the life insurance policy is considered part of your overall estate, which could cause you to fall above the federal estate tax exemption amount.
4. Family limited partnership: If you own a side business or real estate, which many top-level executives tend to do, then a family limited partnership should be a part of your family legacy planning strategy discussion with trusted financial advisor. The major benefit of the family limited partnership as it relates to minimizing your estate tax obligation is the fact that it allows other named family members to own a portion of the business or asset, which then effectively removes that portion from your estate.
When you establish a family limited partnership, you are considered the general partner, which means you maintain control of the asset or business while you are alive. This is an excellent strategy to ensure that certain assets remain controlled by family as well as to potentially minimize your estate taxation.
5. Charitable remainder trust: If you know that you will need to generate income for your retirement using some of your assets, but you still wish to leave a family legacy with those assets, a charitable remainder trust could be a good fit for you.
A charitable remainder trust is established by you, known as the grantor, and is administered by a trustee who is appointed by you. You title assets to the charitable remainder trust, allowing it to own them, which removes them from your estate. The person that you appoint as your trustee then sells the assets to purchase an income-producing asset, such as an annuity, when you need income.
The lifetime income generated from the charitable remainder is paid to you and your spouse. When you pass away, the remainder is then donated directly to the charitable organization of your choice. Another bonus to leveraging a charitable remainder trust is the avoidance of capital gains tax if the assets are sold within the trust.
Establishing an Estate Plan That Fits Your Needs
While we focused on these five family legacy planning strategies that minimize estate tax, there are others that could potentially fit your unique financial need and circumstance. We would encourage you to seek the help of a trusted financial advisor that has experience helping top-level executives with legacy planning before making any decisions regarding your estate. Developing an estate plan that fits your unique needs can help ensure you’re making the most of the resources you’ve worked so hard for, and are leaving a legacy that takes the next generation to a whole new level.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for estate planning. For more information on how Wade and the Carpenter Team can advise you on implementing family legacy planning strategies that minimize estate tax, reach out today for a complimentary consultation.
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