Wealth Transfer: The Clock is Ticking

Current market conditions and impending tax changes mean the wealthy have a limited window to optimize gifting to heirs.

By Mallon FitzPatrick & Alicia Denton
Mallon FitzPatrick and Alicia Denton

Now may be one of the best opportunities to transfer a significant amount of wealth to future generations. The present market and legislative landscape have created ideal conditions for high and ultra-high-net-worth individuals and families to gift as much of their assets as they can afford to part with. However, this moment may be fleeting.

What makes today unique from a gifting standpoint?

First, federal exemption limits on gifting are at all-time highs. The lifetime exemption is the amount that an individual can transfer during his or her lifetime (or at death) that is free from gift tax. In 2023, the lifetime exemption is $12.92 million per individual, doubling to $25.84 million for married couples. Apart from 2010, when there was an unlimited estate exemption, there has not been a better time to gift or pass assets since the federal estate tax was enacted in 1916.

Today’s large lifetime exemption was enabled by the Tax Cuts and Jobs Act of 2017 (TCJA) and is increasing with inflation each year. However, barring further legislation, the lifetime exemption will be halved when TCJA expires at the end of 2025.

Inherited-IRA expectations

Another tax rule impacting retirement accounts is expected to change even sooner — likely this year. The IRS proposed altering the rules for Inherited IRA distributions, which makes inheriting an IRA less attractive and makes inheriting a Roth IRA far more appealing. While the proposed rules have not yet been finalized, they are expected to require non-spouse inheritors to take distributions each year for ten years after the owner’s death. The beneficiary must deplete the account by the end of the tenth year. This may increase ordinary income taxes for the beneficiaries of IRAs and erode the benefits of tax-deferred growth.

One solution to avoid ten years of required distributions is a Roth conversion. Inherited Roths are not required to be distributed during the ten-year period after the owner’s death. Conversions trigger an income-tax liability on the assets moved from an IRA to a Roth. Those interested in a Roth conversion would be wise to act soon, as marginal income tax brackets will reset in 2026 with the expiration of the Tax Cut and Jobs Act.

Market mayhem

Besides changes in the tax code, current market conditions also indicate that now may be a unique time to transfer wealth. While the market’s depressed values may be causing anxiety, it can also benefit those looking to pass money down to the next generation. As of March 29, 2023, the S&P 500 is down nearly 14% from its peak in January 2022. Private market valuations are trending downwards with the public market. Closely held businesses, pending IPOs, and other off-market valuations have likely decreased as well.

Record-high gift tax exemptions and relatively low asset valuations open the door for high-net worth families to transfer a larger portion of their wealth to beneficiaries while minimizing the use of the lifetime exemption. Think of it as a variation on buying low and selling high: Assets are transferred at a depressed value, from which they will hopefully appreciate at some point. Markets have historically recovered after downturns, and allowing asset appreciation to occur outside the estate maximizes how much value the grantor can pass to the recipient without triggering taxes.

Family matters

There are several strategies clients and advisors can deploy to effectively transfer wealth in today’s environment. Keeping gift taxes in mind, individuals or couples can transfer $12.92 million or $25.84 million, respectively, without triggering gift taxes. This can be done directly or indirectly. For indirect transfers, there is a plethora of trust structures and uses that can be utilized to accommodate a transferor’s preferences regarding taxes, control and flexibility.

One recommended approach for larger estates is leveraging the $25.84 million exclusion by gifting an interest in a family limited partnership (FLP) or family limited liability company (FLLC) at a discount of 20% to 40%. This allows for upward of $40 million to be gifted while only triggering taxes on $25.84 million of assets, which is then covered by the exemption.

Home stretch

 Another strategy that is particularly attractive right now, in a high interest rate environment, is the qualified personal residence trust, or QPRT. Here, a residence is transferred to a trust and may be used by the grantor until the trust terminates. When the term of the trust ends, the residence is gifted to heirs.

How do interest rates factor in? The amount of the gift is based on the value of the home at the time it is contributed to the trust. The value of the home is then discounted by the Section 7520 interest rate, which trends with the federal rate. A higher 7520 rate translates to a lower gift valuation and additionally, any appreciation of the residence during the term of the trust is passed on free of gift tax.

Additional Reading: The Truth About the IRS’s New Funding

More on Roth conversions

Likewise, the Roth conversion may be a beneficial estate planning technique in today’s environment. IRAs are not as beneficial to inherit as Roth IRAs, and that issue only stands to be further complicated in the coming months. Adjusted IRS rules reducing the benefits of inherited IRAs to heirs will likely go into effect this year, further widening the benefits between traditional IRAs and Roths.

Right now, a Roth conversion allows individuals to convert at a depressed value, allowing for any asset appreciation to occur in tax-free Roths. The assets transferred from the IRA to the Roth are taxed and it makes sense to convert sooner rather than later to take full advantage of lower federal income tax rates. Today’s highest marginal income tax rate is 37% and is scheduled to increase to 39.6% in 2026.

Another benefit of the Roth is protection from tax-rate changes: What you see is what you get, and assets in Roth accounts are likely to be shielded from the risk of future tax increases. Some of the best assets to inherit are tax-free. With the expiration of the TCJA looming, transferors have less than three years to take full advantage of these circumstances.

Less-attractive strategies

The current inflationary environment makes some popular estate planning strategies less attractive. For example, planning vehicles that require hurdle rates to be cleared — grantor annuity trusts, intra-family loans, and installment sales to intentionally defective grantor trusts (IGDTs) — may not be as effective in a rising interest rate environment because they depend on assets earning a rate of return exceeding the applicable federal rate (AFR) and 7520 rate.

These strategies were more effective from 2009 to 2022 when ideal conditions were in play — namely, an extended bull market and historically low interest rates. Although it is possible for these estate planning techniques to yield positive results today, the hurdles are higher, and clients may find increased benefits from other strategies.

Location and liquidity

The wealth transfer process requires a thoughtful selection of assets to keep within the estate and which to transfer. We call this wealth transfer location. The transferors require sufficient assets and liquidity to fund their lifestyle but also should consider taking advantage of the step-up in basis at death. If possible, income-producing assets with a low basis should be kept inside the estate while the assets with high growth potential and minimal gains should be gifted to heirs.

Should the transferor need additional liquidity at some point, this can be achieved through the flexibility of spousal lifetime asset trusts (SLATs) or leveraging the holdings within the estate. Upon death, the assets held in the estate will receive the step-up in basis and avoid capital gains tax. These assets may be liquidated to pay down the liabilities.

Reassuring clients

Despite the advantages of transferring substantial wealth today, many clients are hesitant to pull the trigger. This is understandable. Transitioning assets means giving up control, a difficult prospect made even more daunting when there is a lot of wealth to relinquish. Typically, there are psychological concerns and obstacles at play, such as “What if I run out of money?” and “Will I spoil my children by giving them money?” Many clients are also wary of provoking inter-family conflict that may come up in estate planning and gifting discussions.

It’s okay. These concerns are natural. It falls upon advisors to help alleviate clients’ concerns and hopefully reassure them that there are ways to transfer wealth without exacerbating complicated family dynamics or depleting assets. At their core, these conversations are about discussing the root cause of hesitation. As the planning expert, it’s a wealth manager’s job to communicate to clients those solutions that can alleviate concerns in a way that makes sense to them. Consideration and patience from both parties are crucial for navigating these discussions.

Leave a long-enough runway

Don’t wait too long to discuss gifting and estate planning, especially now that the expiration of the TJCA is approaching. Between marginal income tax rates increasing and the gift and estate tax exemption decreasing, there are looming variables that may affect how much heirs will receive. The market will also inevitably change, and for the sake of economic considerations beyond estate planning, hopefully recover.

Determining, creating and implementing a wealth transfer plan may take anywhere from six to 18 months. As we inch closer to the sunsetting of TCJA provisions, estate attorneys will likely be maxed out at capacity as wealthy clients try to execute strategies at the last minute. Advisors and clients should begin communicating now to avoid future bottlenecks and to come up with plans and structures that are comfortable for all involved.

Mallon FitzPatrick, CFP, is a principal and managing director at Robertson Stephens and heads the firm’s financial planning center. Alicia Denton, CFP, is an associate wealth planner at Robertson Stephens. For more information about Mallon, Alicia or Robertson Stephens, please visit www.rscapital.com or email info@rscapital.com. Advisory services are offered through Robertson Stephens Wealth Management LLC. Opinions presented are those of the author and not necessarily Robertson Stephens. Please read important disclosures.






Latest news

Prominent Silicon Valley Investors Turn Against Biden

Support for Trump was taboo in the liberal bastion, but frustration with Biden has driven some influential venture capitalists to the right.

Self-directed Brokerage Accounts Continue Growth Spurt

Balances in advisor-led Schwab Personal Choice Retirement accounts maintain a strong lead over non-advised accounts.

Tuesday More Investment Transactions May Fail

U.S. trading moves to a shorter settlement on Tuesday, but it is expected to temporarily increase transaction failure for investors.

State Street Global Advisors Adds SPDR Portfolio Treasury ETF to lineup

Priced at 3 basis points, the new offering provides broad treasury exposure to customize bond portfolios.

Commonwealth Increases Alternative Market Access With iCapital Platform

The new system is targeted to high-net-worth investors but will be expanded to serve individuals of other wealth classes.

2024 ETF Insights for Financial Advisors

The use of active ETFs and model portfolios is rising, according to a Brown Brothers Harriman report.