3 ways to avoid tax hits in estate planning
A well-conceived estate plan should eliminate most uncertainties, reduce taxes, and shield assets
Estate planning is an often-neglected aspect of wealth management, because it involves thinking about an inevitable reality few wish to confront. Thinking about the fine details and nuances of what will outlive us and be passed on to heirs can prove daunting even for the most pragmatic of physicians. Nevertheless, ignoring it is a mistake.
The savvy physician will not shy away from this needed component of wealth management, but instead will plan well, plan ahead, and reap the benefits. A well-prepared estate plan optimally serves several goals: eliminating uncertainties over the administration and probate of the estate itself; maximizing its value by reducing taxes and expenses; shielding assets from creditors, litigants, and ex-spouses; and ultimately passing the estate’s assets to heirs during (and after) the grantor’s lifetime.
The most effective estate plans are a road map across an investor’s portfolio to what will happen with all assets across many categories. Without a clear plan, an estate may be subject to several taxes right off the bat (depending on the state). These may include: capital gains, state, inheritance, and estate and gift taxes. With proper planning and forethought, these tax hits can be reduced—or avoided altogether. This article introduces three instruments that might be used in an estate plan:
- family limited partnerships (FLPs),
- freezing assets in an Intentional Defective Grantor Trust, (IDGT), and finally
- freezing assets using a Grantor Retained Annuity Trust (GRAT).
1. Family limited partnerships
FLPs have two types of partners:
- General partners, who hold control over the assets, decision-making and how the assets are distributed, and
- limited partners who hold an economic interest
It’s important to note that even if a general partner holds a substantially smaller percentage of the asset(s), she or he retains control. FLPs allow for up to a 40% discount on the market value of assets placed into trusts, which means the physician can effectively pass along up to $8.9 million (individuals) and $17.8 million (married couples). The math is simply $5.34 million divided by 60% and $10.68 million divided by 60%. (For 2014, over an investor’s lifetime, he or she can gift $5.34 million, or $10.68 million per couple, exempt from gift and estate taxes.)
While those amounts may sound substantial, a doctor who is nearing retirement and has invested wisely may wish to employ these techniques for two reasons:
Gifts of this magnitude can substantially reduce the taxable amount of the estate, and
gift, inheritance, and estate taxes are avoided.
What investors put into an FLP, or multiple FLPs, can include a range of assets. If, for example, a $2 million home is included in the FLP, and the market value of the home rises to $3 million, it is still “worth” only $2 million because it “resides” in the FLP.