I sat down with one of my executive clients the other day who had recently retired. It was interesting—this was the first time in all of our many meetings that he didn’t start the conversation by talking about the stock market and how his company stock was performing. This time, rather, he wanted to discuss estate tax and what it could mean for his family and the estate plan we’d been working on together.
One of the best parts of being a wealth manager is getting to see executives transition from working and accumulating to legacy planning. This legacy planning stage is when executives are finally able to slow down enough to reflect on all they have earned through their years of hard work. They also decide what will happen with their assets when they’re gone.
Of course, a main goal for any high-earning individual in this stage is to minimize the estate tax burden their family or heirs will face. With this goal in mind, there are certain tax exemption amounts and limits that corporate executives can’t afford to ignore. One of the most important is the federal estate tax exemption. Here’s a closer look at how the federal estate tax exemption amount can impact corporate executives, as well as some strategies for lowering your taxable estate so you can leave the most possible to the ones you love.
What Is the Federal Estate Tax Exemption?
If you plan on leaving less than $11 million (including the value of property and other assets) to your family, loved ones, and charities of your choice, then you currently don’t have to worry about federal estate tax. If, however, you will be leaving behind more than $11 million, you would be subject to estate taxation.
According to the current estate tax laws, a filing is required for estates with combined gross assets exceeding $11.18 million in 2018. This amount is up significantly over previous years. In 2017, the federal estate tax exemption amount was $5.49 million.
Any dollar over the exemption amount is subject to a 40% tax rate, which could significantly lower the amount your heirs receive. In fact, if the majority of funds you leave them are tied up in equities and real estate, they could be forced to sell some assets just to pay the tax bill. I’d like to discuss a few strategies that could help lower your estate and possibly help your family avoid federal estate taxation.
4 Strategies to Lower Your Taxable Estate
While there are a number of different ways you can lower the overall amount of your estate, here are a few common strategies to consider. Of course, these methods work well when you work with a team of estate planning advisors, including a trusted wealth manager and an experienced estate planning attorney.
To lower your taxable estate, consider:
- Gifting your stock options. As a corporate executive, your stock options could make up a large portion of your estate. When you gift your stock options, you are allowing the recipient the ability to exercise and sell the options you were granted while you pay the tax bill. You will be responsible for paying the difference of the current market value and the exercise price. This allows you to pay income tax now, rather than your family paying estate tax later. It will also completely remove the stock options as an asset from your estate.
If you gift $30,000 or less to a married couple, it falls under the tax-free gift amount. Anything gifted over that amount goes toward the $11.18 million lifetime gift tax exclusion, per the new estate tax laws in 2018.
- Establishing an irrevocable life insurance trust. Life insurance is often a valuable estate planning tool for families because the beneficiaries receive the proceeds tax free when they inherit them. However, when you have a large estate like many executives, the proceeds can be counted against your estate.
An irrevocable life insurance trust (ILIT) allows you to transfer ownership of the life insurance policy to the trust, which removes it from your estate. The only catch is that you can no longer make changes to the policy once this is set up, which is why it’s called irrevocable. There is some sense of urgency regarding this strategy as well. If you set up the ILIT less than three years before you pass away, the life insurance proceeds are still considered part of your estate and could likely cause you to be over the federal estate tax exemption amount.
- Setting up a family limited partnership. A family limited partnership (FLP) allows you to leave assets you’d like your family to continue owning and operating when you’re gone, such as a business or real estate. This can be achieved by setting up a general partnership and naming specific family members limited partners. You are considered the general partner and the boss for all intensive purposes, so you maintain control of the asset or business while you are living. However, because other people (your family) now own a portion of the business or asset, that portion is removed from your estate. This makes an FLP a good tool for reducing your taxable estate while guaranteeing your family-owned assets stay that way.
- Using a charitable remainder trust. A charitable remainder trust (CRT) is an estate planning option for anyone who needs to generate income from their assets but ultimately wants to leave those assets to charity. Not only is this a way to achieve your charitable gifting goals, but it can help reduce your estate to fall under the federal estate tax exemption amount.
A CRT is set up by you, the grantor, and administered by the trustee, who you appoint. As the grantor, you put your assets into the CRT. The trustee sells the assets to buy an income-generating asset, such as an annuity.
Because your assets were sold within the CRT, no capital gains tax is due on the income from selling the assets. The new lifetime income generated from the annuity is then paid to you (and your spouse, if you set it up that way) by the trustee. When you pass on, the portion of the annuity that is left is donated to the charity of your choice. Because the asset is technically out of your control, it is not considered part of your estate.
Ultimately, there are many strategies for lowering your estate to attempt to fall under the federal estate tax exemption. This truly is something as a top-level executive you shouldn’t ignore and certainly cannot put off until it’s too late. Estate planning is an important part of your overall financial plan and should be an ongoing discussion between you, your family, and your executive financial advisor. Be intentional with your wealth and you will leave a legacy to be proud of.
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 integrated asset allocation and equity compensation management. He has developed estate planning strategies for corporate executives with equity compensation plans. For more information on how Wade and the Carpenter Team can advise you on planning for the federal estate tax exemption, reach out today for a complimentary consultation.
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