Has Your Estate Planning Caught Up with the Latest Tax Law Changes and Planning Opportunities?

Penn Mutual

By Penn Mutual | December 30, 2014

The American Taxpayer Relief Act of 2012 (ATRA), enacted January 2, 2013, made significant changes impacting federal wealth transfer taxes and income taxes – creating new planning challenges and opportunities. ATRA, together with the implementation of the 2010 Patient Protection and Affordable Care Act, changed the tax landscape significantly, prompting emerging needs for effective planning.

This legislation highlights the importance of focusing on key planning objectives, priorities and concerns – including strategies for managing income taxes and wealth transfer taxes, and ensuring adequate liquidity to support the plan.

Now is the time to revisit existing estate plans and consider timely planning opportunities, including the following:

1. Cash value life insurance and tax deferred annuities now hold even greater appeal:

ATRA imposed higher taxes on many aspects of individual income. The personal exemption phase out, itemized deduction limitations, along with higher marginal income tax and capital gains tax rates and a new 3.8% net investment income (NII) tax for higher income individuals, raise effective tax rates. Higher income taxes should increase interest in tax deferred investments – and the unique income tax attributes of cash value life insurance and tax deferred annuities are worth considering.

2. Maximizing participation in qualified retirement plans and non-qualified deferred compensation arrangements to defer income:

Increase in the highest marginal income tax rate to 39.6%, and the 3.8% NII tax, should increase interest in funding both qualified and non qualified deferred compensation arrangements – which permit deferral of income until retirement (when employees may be in a lower tax bracket). Individuals can reduce the impact of higher taxes by maximizing their participation in these arrangements. By deferring compensation until a later date, and receiving the benefit of income tax deferred earnings and growth, participants may be in a position to accumulate more than if they had received and reinvested their current after tax compensation.

3. Funding Roth IRAs and or completing Roth conversions:

Consideration should be given to funding Roth IRAs, or evaluating the benefits of converting a traditional IRA to a Roth IRA. This may be an attractive opportunity for individuals facing higher income taxes – as qualifying Roth distributions are not subject to income tax, the NII tax, or included in modified adjusted gross income (MAGI) for purposes of NII tax thresholds. ATRA also expanded the opportunity for individuals to convert pre-tax balances in certain employer retirement plans into designated Roth accounts.

4. Evaluating testamentary distribution planning options for IRAs and qualified plan interests:

An IRA or qualified retirement plan interest is often the most significant asset comprising an estate – and increasing as a percentage of many estates. An important aspect of planning for these assets centers on strategies to defer or mitigate income tax at death and enhance the legacy for beneficiaries. This includes exploring testamentary distribution options such as an inherited or “stretch” IRA, Roth stretch, or charitable bequest of an IRA or qualified plan interest.

5. Explore charitable planning to mitigate income taxes:

Increases in income taxes and capital gains taxes has increased interest in tax driven charitable planning. In addition to generating a current income tax deduction, an appreciated or low basis asset (e.g., stocks, marketable securities, real estate) contributed to a qualifying charity (tax exempt entity) will not incur income tax, capital gains tax, or be subject to the NII tax. Furthermore, “split interest” charitable giving arrangements, such as charitable remainder trusts (CRTs), charitable lead trusts (CLTs), and charitable gift annuities (CGAs) provide benefits to both charitable and non charitable beneficiaries – including the donor, spouse, children, or others.

6. Leverage gift, estate, and GST tax exemptions:

ATRA provided generous tax relief for lifetime gifts and testamentary bequests – offering unprecedented planning opportunities using the increased (and inflation indexed) federal gift, estate and generation skipping transfer (GST) tax exemptions – currently $5,340,000 ( for 2014). This enhances simplicity and facilitates the transfer of wealth, providing opportunities to implement and fund new plans, and fortify and enhance existing plans. The creation of long term intergenerational “dynasty” trusts can remove property from the wealth transfer tax system for many generations, and dramatically enhance the legacy passing to future generations. Opportunities also include premium funding for larger life insurance policies held in trust.

7. Consider valuation discount strategies to further mitigate tax:

ATRA did not address several recent tax proposals relating to valuation discount strategies for closely held business interests – such as family limited partnerships (FLPs), 10 year minimum term and “zeroed out” grantor retained annuity trusts (GRATs), 90 year limit to generation skipping “dynasty” trusts, or estate taxation of grantor trusts. As future tax legislation may potentially impact certain planning techniques not addressed by ATRA, wealthy clients (especially closely held business owners) should consider implementing these strategies sooner rather than later.

8. Utilize opportunities created by the low interest rate environment:

The current environment of historically low interest rates combined with recovering markets (e.g., undervalued assets with appreciation potential) represents an opportune time to implement certain interest rate sensitive planning strategies, which can help mitigate wealth transfer taxes, or income taxes. This includes grantor retained annuity trusts (GRATs), charitable lead annuity trusts (CLATs), installment sales, intra family loans, split dollar life insurance arrangements and premium financing arrangements.

9. Don’t forget planning and liquidity funding for state estate and inheritance taxes:

Given the currently elevated federal estate tax exclusion, individuals may be inclined overlook planning and liquidity funding if they will not likely face federal estate tax exposure – but may underestimate potential state estate or inheritance tax exposure. Planning and liquidity funding should address this exposure, particularly in states with an independent estate tax (“decoupled” states). In addition, most states do not impose a gift tax – and lifetime gifts, which remove future appreciation from the estate, can help minimize the impact of both state and federal estate taxes.

10. Maintain flexibility for a changing tax environment:

In the wake of ATRA, income tax planning has become increasingly important for many taxpayers, and wealth transfer tax planning will remain important for high net worth individuals. In addition, future tax reform may be on the horizon, so effective plans will incorporate flexibility for a changing tax environment. Recent tax law changes should also encourage individuals to review and update their estate plans, and re-evaluate their liquidity funding needs.

This is an excellent time for individuals to get in touch with their personal legal, tax, and financial advisors to discuss planning to minimize current and future taxes, and work as a collaborative and integrated team to ensure the best results.

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