Elevating Your Estate Planning: Innovative Strategies for High-Net-Worth Clients

Nobody wants to pay more in taxes than they have to. For high-net-worth clients, the tax talk usually involves a conversation about balancing taxes: gift and estate. There are a few tools that can help your high-net-worth clients remove accounts and property from their estate (lowering their potential estate tax liability) while limiting how much gift tax liability they owe.


Grantor Retained Annuity Trust

A grantor retained annuity trust (GRAT) is an irrevocable trust used by clients to make large financial gifts and minimize gift tax liability. The gifts remove the value of certain accounts and property (specifically appreciation) from the client’s estate (reducing the amount that will be subject to estate tax at the client’s death). However, there may be a gift tax liability, which would be owed and paid at the creation of the trust. The client creates a GRAT and funds it with accounts or property, such as those that are expected to appreciate in value over the term of the GRAT. Then they receive a fixed annuity payment, based on the original value of the trust’s accounts and property, for a determined period of time. Once the period has terminated, the remainder of the trust’s accounts and property are transferred to the named beneficiary.

The rate of return is based on the specific rate determined by the Internal Revenue Service, known as the 7520 rate. The key to saving taxes and having money available to be transferred to the beneficiary is for the trust’s accounts and property to outperform this rate. To limit or eliminate the gift tax that would be due when making a gift to someone, the value of the annuity interest that the client retains (the amount that is ultimately distributed back to them) is subtracted from the value of what was transferred to the trust. This is also known as the subtraction method. Ultimately, the goal is for this number to be zero or as close to zero as possible (known as a zeroed-out GRAT). This means that any appreciation is transferred to the beneficiary at the termination of the trust, free of gift tax.


Grantor Retained Unitrust

A grantor retained unitrust (GRUT) is an irrevocable trust similar to a GRAT. The client establishes a GRUT, transfers accounts or property to the trust, and retains a right to receive an annuity for a fixed period of time. At the termination of the trust, the remaining trust assets are given to the named beneficiary. However, with a GRUT, the annuity payment that the client receives each year is calculated based on a fixed percentage of the trust’s value that year. Therefore, since the value of the trust can vary from year to year, the annuity amount can vary even though the same percentage is being used each year to calculate the annuity.

Like a GRAT, the gift tax is due at the time the accounts and property are transferred to the trust, and the gift tax liability is based on using the subtraction method. Because the annuity is based on the trust value that year, it is unlikely that the end result will be zero, meaning that there will likely be some gift tax due. However, a GRUT can still allow the client to remove a large amount of potential appreciation from their estate.


Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) is an irrevocable trust that clients can use to remove their residence from their overall estate. The client transfers ownership of the residence to the trust and retains the right to use and enjoy the property for a determined period of time; once that time terminates, the residence is transferred to the named beneficiary. If the client would like to continue living in or using the residence, they would have to pay the beneficiary rent. Depending on the personal relationships involved, this may be an additional consideration when evaluating whether this tool will serve the client’s needs.

Although the transfer of their residence will reduce the amount subject to estate tax at the client’s death, gift tax will still be owed when the property is transferred to the QPRT. The amount subject to gift tax is the value of the residence less the value of what the client is keeping because they have the right to continue using it. The effectiveness of this estate planning tool depends on the federal interest rate at the time of creation. The higher the interest rate, the lower the gift value and the potential gift tax liability.

As your clients’ trusted advisor, you are likely well-versed in their financial situations. Understanding the different tools available to your high-net-worth clients can make you an even more valuable resource. Please reach out if you are interested in learning more about these or other estate planning tools to serve your clients.

To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer’s particular circumstances.

Nothing in this message is intended to provide legal advice.  This message is for educational purposes only.