It’s an opportunity that ultra-high-net-worth households in the United States have never seen before—the chance to give away up to $5 million over the course of their lives, tax-free. Yet a good number of them are passing it up, some wealth management experts are saying.
Part of last December’s estate tax compromise included an increase in the lifetime exemption of the gift tax to $5 million, from the previous $1 million; the donor pays a 35 percent tax on gifts over that amount. Couples can gift $10 million tax-free over their lifetime. Like most things involving the estate tax these days, this one comes with an expiration date. On Jan. 1, 2013, both the gift tax and estate tax exemptions fall back to $1 million, with a 55 percent tax rate.
By gifting assets, donors can remove them permanently from their estates, lowering the estates’ future value and leaving them less exposed to estate tax liability when the donor dies. Assets that are likely to appreciate in value over the long term, such as real estate or shares in closely held business interests, are particularly suited to gifting for that reason, experts say. Yet some wealthy families, still stunned by the financial crash of nearly three years ago, are dragging their feet right now, they add.
“If this was 10 years ago and we had a $5 million (gift) exemption, I believe clients would be banging down the doors to take advantage of it,” says David T. Leibell, partner in the Private Client Services Department at Wiggin and Dana in Greenwich, Conn. “What happened in 2008 with the financial markets basically going into freefall has scared the pants off people. It has become almost a Depression mindset, that they need to hoard money.
“Sometimes they make decisions that are against the financial security of their families in order to make sure they never run out of money. The increased exemption actually comes at a psychologically bad time,” Leibell says.
“I’m having those exact same conversations with clients,” says Mary E. Owens, managing principal at Owens Estate and Wealth Strategies Group in Grass Valley, Calif., an affiliate with Raymond James Financial Services. “They’re traumatized by the past issues with the economy and they’re skeptical about what’s going to occur in the future.” Often the things that wealthy clients choose to gift away are potentially income-generating assets, such as bonds or dividend-paying stocks, she added; those are assets that nervous clients prefer to hang onto now.
“If this tax law change had occurred in a bull market, we’d be looking at a very different scenario,” Owens said. “If you’re 75, 80, and you want to maintain your lifestyle and you’re concerned about medical bills in the future, you’re going to be cautious before you make irrevocable decisions such as that.”
One exception that she sees is gifting to irrevocable life insurance trusts, since donating cash is less likely to impinge on future income than donating an asset that appreciates. She also notices less concern about gifting among ultra-high-net-worth (UHNW) clients, those with $10 million or more in assets. Gifting strategies are closely tied to estate planning, and Owens cautions against broad generalizations about techniques; any gift decision depends heavily on the individual circumstances of the donor.
No matter how wealthy clients are, their concerns are real, says Dan Prebish, an attorney in the Key Client Solutions Group of Wells Fargo Advisors. “It’s emotionally real to them. It may not be a real financial concern,” he says. “It’s one of those areas where the financial advisor can add something to the discussion that the lawyer or accountant might not be well-equipped to cover.” Advisors, for example, can provide clients with worst-case scenarios of their financial condition in the years that follow the asset transfers; the exercise can offer some perspective on gifting decisions, Prebish says.
Some investors are concerned about the sunsetting of the $5 million exemption at the end of 2012. What happens if you die in 2013 when the $1 million exemption takes hold, after you gifted $5 million of assets in 2011? Does the government hold your estate accountable for taxes on the difference? Some professionals were skeptical of such a scenario. Richard Behrendt, director of estate planning at Robert W. Baird and a former IRS tax attorney, says it’s more likely such gifting would be grandfathered. “People plan their entire estates around these rules. And I don’t want to say it’s unfair, but it’s unprecedented to reduce the exemption,” Behrendt says.
“These are the best years for wealth transfer that we’ve ever seen,” Prebish says. “Maybe it will continue. I don’t know. But it’s certainly appropriate for advisors to talk to clients about these issues.”
Some gifting techniques can lock the assets in trusts while still allowing donors enjoyment of the wealth, even though such gifts must be irrevocable in order to qualify for the exemption. Leibell says a husband can gift $5 million to a trust that names his wife as trustee and primary beneficiary. She can spend distributions of income and principal from the trust for health, education, maintenance and support expenses consistent with her accustomed manner of living. (She can access all the assets in the trust with the appointment of an independent co-trustee.) The gift removes $5 million from the husband’s estate, its presence in the trust removes it from the wife’s estate, and the flexible spending rules allow both spouses to benefit with the wife calling the shots on distributions.
The gifting can also reduce familial tensions in the case of remarriage, says Stanley R. Smiley, senior vice president for the Advanced Planning Group of Cetera Financial Group. He often finds cases in which adult children of first marriages resent the woman their father remarries, someone who may even be close in age to the children. Smiley says the higher gifting exemption allows for the easier separation of assets for wealth transfer years before the parent’s estate is executed and tempers flare, Smiley says.
The higher gifting exemption also is providing opportunities for the owners of family businesses to pass ownership wealth to their children before they die. Leibell says some families are recapitalizing their companies, creating voting and non-voting shares, and gifting the non-voting shares to children while retaining a controlling interest in the business. Such gifting needs to be done in ways that are consistent with the owners’ succession plans, he adds. If those plans don’t exist, a common occurrence, the new gifting exemption “may act as a motivator for a program that normally goes in fits and starts over a long period of time,” he says.