Planning for Vacation

Today’s blog takes a break from the complex gifting and tax issues we addressed in the past few posts to talk about aspects of estate planning that arise while preparing for a vacation. We will return to our discussion of gift issues next week. 

     With the unrelentingly cold weather and impending “Spring Break” weeks for many school districts, our thoughts turn to vacation, many of which involve trips to warmer climates. However, upcoming trips should prompt people to think about their current estate plans and some of the possible changes they have been putting off.

Here are a few tips to think about before setting off on vacation:

• Do you have a Grandparent/Caregiver Power Of Attorney? If you are vacationing but leaving your minor children home with a grandparent or caregiver, do you have a written document giving the caregiver authority to make medical or other decisions in your absence. This document can be crucial in the event of an accident, and can provide you comfort knowing that caregivers can handle emergencies even while you are relaxing and enjoying your trip.
• Do you have a list of assets, passwords, and important contacts? Many people manage most or all of their financial assets online and it is important to have a record of your accounts and passwords so that those you have named to act on your behalf for the benefit of your family can easily locate this information. This information should be part of the list of assets and advisor contact information you keep with your important estate planning documents. While this may require some time on your part, it can save your family significant time and money if misfortune should befall you. 
• Are your disability documents current and available to those you have named? In Michigan a Durable Power of Attorney, for financial decisions, and a Patient Advocate Designation, for medical decisions, are essential to allowing another to act on your behalf in the event you become incapacitated. Before vacationing, you should be sure the documents are up-to-date and that those designated know where to locate these documents. You may even want to discuss your wishes with your designated agents.
• Are your beneficiary designations are up-to-date? With proper designations, assets such as retirement accounts brokerage accounts and life insurance can pass directly to designated beneficiaries and avoid probate. If you have a Trust, these assets can be designated the beneficiary and allowed distributions pursuant to the provisions you have set forth in your Trust.
• Are there any changes you have been contemplating making in your Will and Trust? While we usually suggest you review and update your estate planning documents every 3 to 5 years, while planning for a big trip you also may want to review your documents to make sure that provisions for your family, and those you have designated to fulfill those provisions, are still as you want them.

     Time spent on these issues will allow you to relax and enjoy your vacation knowing that your estate planning is in good order.

The Grantor Retained Annuity Trust as a Tool for Wealth Transfer

     We often discuss the benefits of Living Trusts as part of an estate plan, but there are other types of trusts that may provide our clients with significant benefits as part of a larger estate plan, depending upon the client’s particular situation.

     A Grantor Retained Annuity Trust (GRAT) is one method for wealthy clients to maintain an income stream yet transfer property (often which is highly appreciating) to a child with minimal Gift or Estate Tax. A GRAT allows the client to transfer assets into an irrevocable trust and retain the right to annuity payments for a fixed term of years or their lifetime. When the set duration ends, the remainder of the trust, including any appreciation, can go to a named beneficiary. Alternatively, it is possible to structure the GRAT to return the principal and a certain amount of income to the grantor, and distribute the excess income to the remainder beneficiary. While it is possible that the trust will earn insufficient income to cover the required annual payment and thus the Trustee must make that payment from the principal, with proper planning the GRAT is a powerful tool for wealth transfer.

     When using a GRAT to transfer assets, the gift tax value of the assets is determined at the time of trust creation and funding by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust. The value of the annuity interest will depend on the interest rate used, the value received by the grantor, and the value of the remainder beneficiaries’ interest. The IRS Regulations set rules for determining what interest rates may be used in the calculation of valuations, especially when family members are involved.

     As an example, if a 60-year-old client sets up a GRAT to last two years and uses the following provisions:

• Contributed Asset Value: $1,000,000, 

• The §7520 interest rate required by IRS Regulations: 2%,  

• The asset earns 5% per year 

• The asset appreciates at 5% per year 

Over the term of the Trust, the client will receive two annual payments of approximately $515,000 and the remainder beneficiary will receive approximately $130,000 at the termination of the GRAT. Since the value of the annuity interest exceeds the fair market value of the assets transferred into the GRAT there is no Gift Tax liability to the client, nor do they use any of their Lifetime Gift Tax Exemption. If the client funds their GRAT with assets anticipated to appreciate faster than 5% per year, the benefit to remainder beneficiaries is even greater

     Since the GRAT permits payment of both income and trust principal to satisfy the annuity payments, it is important to treat the GRAT as a grantor trust for income tax purposes. This means the client retains liability for taxes on income and realized gains on trust assets even if these amounts are greater than the trust's annuity payments. This further enhances this tool's effectiveness as a family wealth-shifting and estate tax saving device because the client pays the income tax, thus reducing the their estate.

     In the right circumstances, the GRAT can be a powerful tool to transfer assets with minimal gift or estate tax consequences, but clients should carefully review their financial situation with both an experienced attorney and financial advisor before entering into such a transaction.