Estate and Wealth Tax Planning
One of the most essential aspects of wealth management is planning for after you are gone. You want to be sure that your wealth is passed to the right hands and that your values and wishes are honored in the process.
Estate planning is vital for everyone, but especially for high-net-worth individuals. The tax and regulatory implications complicate estate planning for those with significant assets. High-net-worth individuals (HNWI) benefit from working with qualified financial professionals who can craft an estate strategy that maximizes benefits for their heirs, manages tax liabilities, protects their wealth, and takes the mystery and stress out of the process.
Why Estate Tax Planning Matters for High-Net-Worth Individuals
Compared to individuals in lower tax brackets, high-net-worth individuals have to consider significant tax implications for their wealth when planning their estate. In addition, their beneficiaries will have to go through a lengthy probate process, which exposes their financial affairs to the public.
If you are a high-net-worth individual, it is possible to reduce and eliminate taxes and maintain greater privacy for your heirs with proper estate planning. In planning for the future, you will need to balance a number of priorities, including:
- Providing for your heirs
- Protecting your wealth from immature decisions
- Avoiding disputes among family members
- Minimizing your tax liability
- Avoiding the lengthy probate process
- Ensuring you have the right person to manage your estate after your death
There are various vehicles to accomplish this, but they all have the same general goal–to move assets out of the taxable estate and create a plan for the eventual distribution of those assets to heirs without conflict or probate court. A secondary goal is to move the assets into investments that continue to grow wealth for your future beneficiaries.
Tax Liabilities on High-Net-Worth Estates
Before you can craft an estate tax plan, you should understand the tax regulations that necessitate it. The federal tax code is not simple, and a CPA or tax attorney will understand the intricacies. However, here is a simple overview of what you need to know.
Estate taxes are paid out of the decedent’s estate before the assets can be distributed to heirs; therefore, they are based on the entire estate’s value. Inheritance taxes are paid by the recipients of the inheritance and are, therefore, based on the amount given to each beneficiary.
Federal Taxes
The federal estate tax is sometimes called the “death tax” because it applies to the inherited wealth and assets of a person who has passed away. It ranges from 18% to 40%, and in 2024, it only applies to assets valued over $13.61 million. If your estate was worth $15 million in 2024, the 40% tax would only be applied to $1.39 million of your taxable estate.
Those numbers are for individuals only. The tax exemption for married couples filing jointly in 2024 is $27.22 million. Above that number, the estate would again be taxed at up to a 40% rate.
The estate tax rate is calculated based on the current market value of the assets, not the value at which they were purchased.
State Taxes
In addition to the federal estate tax,12 states and the District of Columbia levy a state estate tax, and six states impose an inheritance tax. Maryland is the only state that has both.
Hawaii and Washington State have the highest rates, with the top bracket at 20%. DC and several states have a top rate of 16%. Check with your financial advisor to know if your state levies an additional estate tax.
Estate Tax Plan Strategies
A qualified trustee or tax attorney can help you understand the various strategies that allow you to minimize or even eliminate the estate taxes your estate and heirs must pay after your death.
Gift Planning
The IRS allows for an exclusion of up to $18,000 per year per person. This allows you to make yearly distributions to your beneficiaries without paying taxes on the excluded amount. For example, if you gift your grandchild $20,000 in 2024, the first $18,000 is tax-free. It is important to note that each gift will be deducted from the $13.61 million exclusion.
529 Education Fund for Student Heirs
If you have loved ones who are currently or will be attending school in the future, you can invest their inheritance into a tax-beneficial 529 education plan. You are allowed to invest $18,000 per student each year without incurring gift or income taxes. You can “superfund” the account once with up to five years of contributions–$85,000 for an individual or $170,000 for a couple.
Life Insurance as a Part of Your Wealth Tax Plan
If a large portion of your wealth is in illiquid assets such as real estate or business, you could consider purchasing life insurance to cover estate taxes. This could keep your heirs from having to sell your assets to pay estate taxes.
You can build your life insurance directly into a life insurance trust. In this scenario, you transfer the term or whole life insurance policy to a trust managed by a trustee. When the grantor dies, the death benefit is paid to the trust, and the trustee distributes the funds to benefactors as dictated in the trust document.
Revocable and Irrevocable Trusts
Trusts are frequently used in estate planning to move assets out of your estate and reduce your family’s overall tax burden. The trust’s creator or the grantor can change and modify a revocable trust. An irrevocable trust cannot be changed without the approval of all the beneficiaries and a court ruling.
Additionally, a revocable trust can be canceled at any time, but it may be subject to estate taxes since it is under the grantor’s control. An irrevocable trust is permanent, and because the grantor no longer has control over the assets, they are not subject to taxes. Both revocable and irrevocable trusts are excluded from probate court.
Charitable Remainder Trust
A charitable remainder trust (CRT) is an irrevocable trust that pays you or your beneficiaries an annual income. Anything left over is donated to a charity of your choice. It gives you a partial tax deduction, can be helpful in shrinking your taxable estate, and is a tool for philanthropy.
Spousal Lifetime Access Trust
A Spousal Lifetime Access Trust (SLAT) is an irrevocable trust created by one spouse (the donor spouse) to benefit the other spouse. It removes the assets in the trust from their combined taxable estate.
Because the donor uses a gift to fund the trust, the trust’s assets fall under the federal lifetime gift and estate tax exemption. Therefore, any appreciation of trust assets is excluded from the overall taxable estate.
Grantor Retained Annuity Trust
A Grantor-Retained Annuity Trust (GRAT) is a way for high-net-worth individuals to transfer assets to their heirs during their lifetime without using much (or any) of their lifetime gift exemption. This irrevocable trust works by essentially freezing the current value of the estate while passing on the appreciation of the assets within the trust to beneficiaries free of estate and gift taxes.
Deferred Sales Trust
A Deferred Sales Trust moves highly appreciated assets out of the taxable estate, freezing the estate for tax purposes. When built into an overall estate tax plan for high net-worth individuals, a Deferred Sales Trust is a flexible strategy that allows investors to avoid the 40% estate tax and the lengthy probate process.
How Does a Deferred Sales Trust Work?
Like many other trusts listed above, a Deferred Sales Trust works by moving assets out of the estate and direct control of the HNWI.
The first step is for the asset owner to sell an appreciated asset to the Deferred Sales Trust (DST) in exchange for a promissory note.
The DST and the trustee must be a completely independent third party. The promissory note outlines the payment terms and schedule for the repayment of the proceeds.
The DST simultaneously sells the asset to a buyer and collects the sale proceeds. Because the high-net-worth individual never takes possession of the sale profits, he or she doesn’t owe any capital gains taxes on the sale.
The DST invests the proceeds according to the seller’s goals and risk tolerance and with his or her approval.
In terms of estate planning, a Deferred Sales Trust removes the appreciated asset from the taxable estate. A tax attorney can structure the trust to fit into an overall estate plan, with payments made to beneficiaries or appreciation of invested assets held in trust for heirs.
Use a Professional Trustee
Using a trust is a powerful financial strategy that allows you to distribute holdings the way you want, minimize taxes, avoid lengthy probate, and move assets out of your estate so that you can pass more wealth onto your heirs. However, a trust is only as good as the trustee you choose to manage.
A Deferred Sales Trust requires a truly independent third-party trustee. That means no family members or close friends. You need a financial partner you can trust to navigate the tax code, make sound investments, and fulfill fiduciary responsibilities to the beneficiaries of your trust.
You’ve worked hard to build your wealth so that you have a legacy to pass on to your children and grandchildren. A good wealth plan will ensure that your legacy keeps growing and that you won’t lose half of it to Uncle Sam. To do that, you need a professional trustee who will manage the wealth you already have and has the skills and the team to invest your wealth in a way that keeps growing for you and your family.
What to Look for in a Trustee
The trustee you choose is crucial, especially when it comes to estate planning. You are entrusting someone to manage and grow your wealth and also distribute your estate to your loved ones after you are gone.
With any trustee, you are looking for someone with legal expertise, financial insight, compassion, good judgment, and objectivity.
Depending on the type of trust, the trustee will need different skills and have different responsibilities. Most people choose a family member, close friend, attorney, or professional trustee to oversee their assets. However, keep in mind that when creating a trust for the purpose of minimizing taxes, the trustee generally needs to be an independent third party.
When choosing a Deferred Sales Trust trustee, these are some of the qualities you should be looking for.
Knowledge
It takes expertise and experience to set up a Deferred Sales Trust so that it complies with all of the IRS regulations. Make sure that the trustee you choose is knowledgeable about tax law, particularly as it applies to Deferred Sales Trusts and estate planning. A DST has the dual objective of helping you defer capital gains taxes and avoid estate taxes, so the trustee should understand the tax laws for both scenarios.
A trustee should also be financially savvy, with knowledge of your various investment options. If invested wisely, the wealth you put into a Deferred Sales Trust can keep growing, maximizing the benefits for your heirs.
Experience
If you are a high-net-worth individual and want to use a Deferred Sales Trust as a part of your overall estate tax planning, choose a trustee and a company with DST experience. You can ask them to share their experience and the references of past clients.
If the IRS were to audit your trust, does your potential trustee have experience working through an audit? Have they navigated past audits with no changes?
Reliable
You will spend significant time working with the trustee you choose and entrust them to manage your affairs after you are gone. Can you count on them?
A good indicator is whether they return your calls, answer your emails, and come to meetings on time. If they are so busy or unprofessional that they can’t meet even these basic obligations, that might be a red flag for you.
Collaborates with Other Professionals
If you hire a professional trustee to manage your estate, they will not work alone. You will need a team of financial experts–CPAs, tax attorneys, financial advisors, and investment professionals. Does your potential trustee have a built-in team? Or do they have trusted partners they use when building and managing your trust? You will most likely be bringing your own CPA or financial advisor. Does the trustee work well with your trusted financial advisors in your initial meetings?
Capital Gains Tax Solutions
Capital Gains Tax Solutions has been helping clients transform and preserve their wealth with Deferred Sales Trusts for 14 years. We have used this versatile tax strategy in a wide range of situations and tax landscapes, including as a part of estate planning.
If you are a high-net-worth individual feeling trapped by the prospect of high capital gains and estate taxes, we can help you exit your assets now and reinvest the proceeds tax-deferred. At the close of DST 2.0, we will move the funds out of your taxable estate, avoiding the 40% estate tax and preserving wealth for your heirs.
Where you see challenges, we see opportunities to grow your wealth and secure your legacy. Call us today for an absolutely free, zero-obligation consultation to see how a Deferred Sales Trust can be a part of your estate tax strategy.