The Perils of Making a Will as a High Net Worth Individual

Making a will can seem like the responsible thing to do when you have wealth to pass along to your loved ones. However, in reality, making a will can have some serious drawbacks for high net worth individuals because of the wealth protection factor.

The concept of wealth protection can seem odd. You have been able to accumulate wealth throughout your life, and you have paid taxes. What exactly are you protecting your wealth from?

There is a federal estate tax in the United States, and it can put quite a dent in the wealth that you are going to be passing along to your loved ones after you are gone. At the present time, the maximum rate of the federal estate tax is 40 percent so we are talking about quite a significant bite.

If you are thinking that you could just give gifts to your loved ones while you are living to avoid the estate tax, the tax man is one step ahead of you. There has been a gift tax in place for many decades, and it is unified with the estate tax so you only get limited estate tax savings if you give gifts while you are living.

There is an unlimited marital gift and estate tax deduction. Unlimited tax-free transfers are allowed between spouses, as long as the spouses are American citizens.

As far as transfers to others are concerned, there is a certain amount that you can transfer before the estate tax would be applicable. This is the unified gift and estate tax lifetime exclusion. During the 2016 calendar year, this unified exclusion is $5.45 million.

Relying on a will is not a good idea if the value of your estate exceeds the amount of the federal estate tax exclusion. There would be no estate tax savings. The portion of the estate that exceeds the exclusion would be subject to the estate tax and its devastating 40 percent maximum rate.

Wealth Preservation Trusts

While making a will is not the solution, there are some types of trusts that can be used to mitigate your transfer tax exposure. Irrevocable trusts that are commonly used for tax savings purposes. You give up ownership when you create this type of trust because you cannot dissolve the trust and take direct personal possession of the property once again. Plus, for the most part, you cannot change the terms once they have been established.

Because you are separating yourself from the resources that are conveyed into the trust, they are no longer part of your estate for estate tax purposes.

Let’s look at some of the trusts that can provide estate tax efficiency.

Qualified Personal Residence Trusts

You could convey your home into a qualified personal residence trust. When you create the trust agreement, you name a beneficiary who would assume ownership of the home after the term expires.

During this term, you can remain in the home as usual. You are removing the value of your home from your estate for tax purposes when you fund the trust. However, you will be giving a taxable gift to the beneficiary.

The good news is that the value of the gift will be far less than the true value of the home because you are retaining interest in the home by living in it after you convey it into the trust. The IRS takes this into account so the transfer will ultimately take place at a tax discount.

Generation-Skipping Trusts

A generation-skipping trust is another tax savings tool. With this type of trust, two generations can benefit from the assets, but there is just one round of taxation.

Grantor Retained Annuity Trusts

If you are in possession of highly appreciating assets, you could convey them into a grantor retained annuity trust. You would receive annuity payments from the trust throughout its term.

Assuming the assets in the trust perform very well, a beneficiary could eventually assume ownership of a remainder free of taxation.

Charitable Lead Trusts

With a charitable lead trust, you could support a charitable cause. If circumstances are favorable, you could also facilitate a tax efficient asset transfer to a beneficiary.

Let’s Get Started!

The estate tax is a looming threat for high net worth individuals. However, there are tax efficiency strategies that can be implemented, and wealth preservation trusts are often part of the plan.

If you are ready to protect your legacy, call us at (704) 944-3245 in Charlotte or Huntersville and we will set up a consultation time that fits into your schedule.