Five Points to Consider for Successful Estate Planning During COVID-19

Written by Gregory E. Sellers, CPA, AEP® on July 24, 2020

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With all that’s happening in the world due to COVID-19, why consider estate planning?

In March, the stock markets lost 20+% of record value levels, countries were placed into shut-down mode, and businesses had to change in an instant to survive.  There is uncertainty concerning how the markets will react to earnings reports that include a full quarter of decreased business and earnings. National, state and local governments are expecting huge reductions in their tax revenues. Many are anticipating a recession to come, some say in epic proportions.

With all of these challenges, it may not seem like now is the time to worry about estate planning, but when you think about it, we have a “perfect storm” for wealth transfer planning.

The following are five points that should be considered to achieve a successful wealth transfer in this ever-changing environment.

1. Favorable valuations for wealth transfer

Closely held, non-publicly traded businesses depend on fair market value business valuations to determine the value of an entity that is transferred, either by gift, by sale/purchase transaction, or both.  Business valuations use economic conditions as the foundation in establishing values using forecasted future cash flows, comparisons to similar publicly traded companies and current costs to replace.

The forced shut-down of the economy during the COVID-19 pandemic has provided for a depressed foundation and uncertainty, which leads to less than optimistic expectations when valuing a company.  Even if the subject company has not yet been negatively impacted, the economic conditions that would fuel continued prosperity are not in the fundamental factors on which the values are built.

2. $11+ million lifetime exclusion

We all know that the “doubled” lifetime exclusion that passed in the TCJA 2017 was set to expire at the end of 2025.  We also know that the estate tax exclusion has become a perennial political hot topic and is the target of much political debate for both sides of the aisle.

While expected to be of interest during political campaigns, estate planners felt, before the pandemic, that there was likely time to effectuate transfers while still in the $11+ million lifetime exclusion realm.  The pandemic is putting financial pressures on the government that were not expected in 2019.  Relief packages, declines in tax revenues and the typical political rhetoric now cause estate planners to believe the reduction of exclusion amounts can certainly come before the 2025 law sunset.

Democratic presidential and congressional candidates have been proposing reductions to the exclusion, some as low as $3.5 million.  Regardless of the election results in November, the pressures for tax revenues to relieve the national debt are enough to cause a call to action and take advantage of the high exemptions now rather than waiting.

3. Historically low interest rates

The IRS publishes Applicable Federal Rates (AFR) each month based on national economic factors.  The AFR is used in many wealth transfer plans to determine minimum interest rates required.  The AFRs for August 2020 are .17% for short-term (three years or less) time frames, .41% for mid-term (between three years to nine years), and long-term 1.12% (over nine years).

Some wealth transfer strategies that provide for maximum transfer in low-interest environments are installment sales to an Intentionally Defective Grantor Trust (IDGT), intra-family loans, Grantor Retained Annuity Trusts (GRAT), and Charitable Lead Annuity Trusts (CLAT).  These strategies freeze the estate values using low interest rates and allow for future appreciation of the wealth to occur outside the estate of the wealthy owner.

Lower AFRs also provide for an optimal base for the addition of an interest rate premium on highly beneficial Self-Cancelling Installment Note (SCIN) transactions.

4. Dynasty Trusts and asset protection

Dynasty Trusts are irrevocable trusts that are not subject to estate taxes for as long as state law allows.

Some states have eliminated limitations imposed by the rule against perpetuities, while many other states have provided for long-lived trusts.  Instead of termination of the trust in generation two or generation three, trusts can potentially continue for up to and more than 300 years—which is a long time! Utilization of these provisions protects the assets of the trust for generations to come.

In the past, wills and trust documents often-times required staggered distributions of principal from the trust to the beneficiary.  This was viewed as a way to allow the trust assets to vest in the hands of the beneficiaries as they matured in their financial management ability.

Unfortunately, today half of all marriages result in divorce.  This staggered distribution requirement creates marital assets in the beneficiary and subjects the trust assets to negotiation of divorcing spouses.  Instead of requiring principal distributions, maintaining the trust structure that protects the assets from creditors can be achieved by incorporating provisions in the trust governance to allow for the beneficiary to control the trust assets at a certain age.

Education of the client and beneficiary as to the importance of a beneficiary-controlled trust will negate the need to terminate the trust.

5. Integration of Charitable Planned Giving and Lifetime charitable giving

For many years, it has been recognized that retirement plan assets are superb assets to fund end of life charitable intent.  The provision of Qualified Charitable Distributions (QCDs) from IRAs directly to charities has allowed IRA owners to incorporate those assets into their lifetime charitable giving.

Designating a charitable entity as the remainder beneficiary after a spouse’s or descendant’s life interest provides both estate tax and income tax benefits.  The tax-deferred “stretch” benefits of naming very young beneficiaries to the retirement assets kept some owners from incorporating charitable beneficiaries to their retirement assets.

The passage of the SECURE Act in late 2019 eliminated the “stretch” benefits of naming young beneficiaries.  Creative planners are advising charitably-minded IRA owners to consider establishment of a Charitable Remainder Trust (CRT) as the beneficiary of an IRA to provide a “pseudo-stretch” characteristic.

Upon the death of the IRA owner, the IRA is distributed to the Charitable Remainder Trust, providing for term or lifetime distributions to one or more non-charitable beneficiaries.  This vehicle provides for an income stream to be paid over time, potentially mitigating some excessive income tax ramifications created by short term required distributions.  After the term or lifetime of the beneficiaries, the balance of the CRT passes to the charitable beneficiary designated by the original IRA owner and CRT settlor.

Learn More about Estate Planning During the Time of COVID-19

Death and taxes are said to be the only certainties in life.  We do know that in most cases, death is the final transfer of wealth and that taxes are in place to also reap the benefit of that transfer. But, we have no ability to know when either occurs or changes.

As we navigate these uncertain times, it’s important to be proactive. There are some who might currently be sheltered from transfer taxes with $11.5 million or $23 million marital estates, but will certainly be taxed heavily if the exemptions decrease to $5 million or $3.5 million.

Gregory E. Sellers, CPA, AEP® is a member of Warren Averett, LLC, a leader in the firm’s Estates and Trusts service area, a past-president of the National Association of Estate Planners and Councils (NAEPC), and a past-president of the Montgomery Estate Planning Council.

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