With all the uncertainty we have faced during the COVID-19 pandemic, the need for effective estate planning has become more apparent than ever. Further, the prospect of significant changes to the federal transfer tax regime makes 2021 the perfect time for attorneys to help their clients focus on updating outdated estate planning documents, create new documents to ensure assets pass to clients’ intended beneficiaries, and advise clients about wealth transfer techniques to take advantage of the current federal transfer tax laws before any changes occur.
If 2020 has taught us anything, it is to expect the unexpected. So now, more than ever is an ideal time for clients to review or put in place their “basic” estate planning documents – wills, revocable trusts, powers of attorney, and health care directives – to ensure they are up to date, accurately reflect their wishes, and are flexible enough to take into consideration potential changes to the transfer tax laws.
In 2021, the federal transfer tax laws permit each person to transfer $11.7 million free of federal estate and gift tax to their heirs or intended beneficiaries. That federal exemption amount is set to expire on December 31, 2025, and revert to $5 million per person, adjusted for inflation. However, it is anticipated that Congress will enact new tax legislation, possibly in 2021 or 2022, reducing the federal estate tax exemption amount to $5 million or even $3.5 million before then. Also, new legislation could be enacted that would eliminate the favored step-up in basis for income tax purposes of a person’s assets at death.
Currently, New Jersey does not have an estate tax, having repealed it on January 1, 2018. However, some think that a permanent repeal of the New Jersey estate tax is unlikely, and it might be reinstated in the future.
Flexibility to address changes to the transfer tax laws is key for an estate plan. For married couples, having assets pass outright to a surviving spouse at the first death is simple, but provides little flexibility for tax planning. Attorneys might recommend that married clients instead consider options for their estate planning documents that allow certain tax decisions to be deferred until after a person’s death. Two options are utilizing a “Disclaimer Trust” or a “Clayton Qualified Terminable Interest Property (QTIP) Trust.”
The Disclaimer mechanism provides that assets pass outright to a surviving spouse at the first death, but he or she would have the option of disclaiming assets, so those disclaimed assets would instead flow to an estate tax-protected trust for the benefit of the surviving spouse. A Clayton QTIP Trust provides that assets would be held in trust for the surviving spouse at the first death but allows flexibility to wait and make tax elections after the death to determine if some or all of the trust should be estate tax-protected. Both options allow the decision of whether to fund an estate tax-protected trust for the benefit of the surviving spouse to be delayed until after the first death.
Additionally, it is important to remind clients that wills and trusts do not control the transfer of joint accounts or pay on death (“POD”) accounts, nor the disposition of assets for which there is a beneficiary designation on file, such as retirement accounts or life insurance. Thus, an estate planning update should include consideration of how a client’s assets are titled and a review of their beneficiary designations, to ensure that any insurance and retirement assets are distributed consistent with the client’s wishes.
Also, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”), effective January 1, 2020, made significant changes to the rules regarding the distribution of a qualified retirement account after a person’s death. A review of the SECURE Act is beyond the scope of this article, but changes to a client’s estate planning documents might be required due to the SECURE Act, particularly if qualified retirement assets flow to a trust for the benefit of a spouse or descendants.
For clients who would have a federally taxable estate if the exemption amounts were reduced, and who have not yet taken advantage of wealth transfer techniques to capture the current high federal transfer tax exemption amounts, there still may be the time in 2021. Many wealth transfer techniques are available, and some popular ones are summarized as follows:
Wealth transfer techniques have pros and cons, including the loss of access to transferred assets and potentially trading estate tax savings for capital gains tax savings. There are several factors to consider, but the techniques are worth contemplating now, particularly for high-net-worth clients.
If new transfer tax legislation is enacted, the question is when the new laws will be effective. New legislation could be effective on the date of enactment; at a future date, such as January 1, 2022; or possibly retroactively to January 1, 2021. Given the uncertainty of what future exemption amounts might be and when they might take effect, for clients seeking to make lifetime wealth transfers in 2021, it is prudent to build in flexibility to avoid an unintended gift or generation-skipping transfer (“GST”) tax due to a retroactive change in the federal transfer tax laws. A few options include the following:
For many clients in 2020, estate planning became a pressing need, and that need has continued in 2021. If the COVID-19 pandemic has taught us anything, it is that preparedness and flexibility are key. Given today’s uncertainty, for those who have not yet done so, the time to focus on estate planning is now.
Reprinted with permission from the March 16, 2021, issue of the New Jersey Law Journal. © 2021 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.