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Exploring Upstream Wealth Transfer

Three questions to ask clients considering “upstream” or “horizontal” wealth transfers.

Wealth managers are well aware of the $68.4 trillion in assets that baby boomers are expected to transfer to heirs and charities over the next two decades. While a significant portion of those assets will follow the expected pattern of parents giving to their children and grandchildren, many clients will also seek guidance on “upstream” giving (gifts moving in the opposite direction, from children to parents or grandparents) and “horizontal” giving (gifts to siblings, cousins, other extended family members and friends).

Advisors can play a valuable role in helping clients understand their options for making upstream and horizontal gifts, as well as developing long-term strategies for transferring wealth. The following three questions, followed by an example of how to implement the decision-making process, can help advisors clarify their clients’ needs and desires:

  1. What are you hoping to accomplish?

Clients may want to explore horizontal or upstream giving for any number of reasons, and the details of each situation are unique. Consider the following situations:

  • A sibling is under financial pressure after losing a job or going through a divorce;
  • A parent’s savings is being depleted by mounting medical bills;
  • A nephew has been accepted to a prestigious university but can’t pay tuition; or
  • A client wants to fund a family vacation for the entire extended family.

It is also possible that a client wants to give to a family member for personal tax benefits. Suppose, for example, a client has a low-basis property and a living grandparent with a small, nontaxable estate. There are strategies designed to transfer the property to the grandparent with the client receiving the property back after the grandparent passes, but with a step-up in basis to the current fair market value.

Understanding the purpose of the gift allows the advisor to develop an appropriate plan and suggest potential vehicles to achieve the client’s goals.

  1. When do you want to start giving?

If the client has a parent with overdue medical bills, then the advisor may not need to ask this question. However, if there is some runway, or gifts will likely be made over a longer period, planning is critical. And the advisor’s intimate knowledge of the client’s finances will help them determine the best approach.

  1. How much control do you want to retain?

Many clients want to control how their gifts are used. This is one reason why clients make gifts to irrevocable trusts. They allow the creator to determine the purpose and timing of distributions. But other clients, depending on the situation and the relationship with the beneficiary, may want to give outright with no formal limitations. Some clients fall in the middle, perhaps making some gifts outright and others in ways that are more restrictive.

Once the advisor understands the answers to these three questions, they can begin developing a plan that often involves one or more of the following strategies:

  • Annual exclusion ($16,000 per person, per year);
  • Unlimited medical exclusion (i.e., payments directly to providers for medical expenses and health insurance);
  • Unlimited tuition exclusion (i.e., tuition payments directly to qualifying educational providers);
  • 529 plans/UTMAs;
  • $12.06 million lifetime exclusion (for 2022);
  • Low-interest rate loans; and
  • Specialized trusts, including grantor retained annuity trusts (GRATs), charitable remainder trusts (CRTs), Crummey trusts and general power of appointment trusts.

Giving in Action: Client Case Study

To demonstrate how advisors can approach these three questions, let’s walk through an example of these client conversations.

An advisor is approached by a client who is a C-suite executive at a public company with a net worth of $50 million. Her older brother has been diagnosed with a chronic illness and can no longer work. He has three adult daughters, all of whom are in college or graduate school. While she does not know his finances intimately, she knows that mortgage payments are becoming increasingly difficult because of medical expenses and that he is not assisting his daughters with education expenses.   

This is when the advisor can walk this client through the three key questions:

  1. What are you hoping to accomplish?

The client would like to help with the medical bills so more of his assets are available for daily expenses. Additionally, she would like to assist her nieces with education expenses and set up a fund to help them buy a home.

  1. When do you want to start giving?

The client wants to begin helping her brother and nieces as quickly as possible, but in a tax efficient way. She also wants to start working on a longer-term plan to provide her nieces with the capital to buy a home.

  1. How much control do you want to retain?

She trusts her brother and her nieces, and does not want much direct control or involvement.

With the answers to these questions, an advisor is empowered to propose a strategy leveraging several tools for horizontal giving. In this example, the client may use the unlimited medical exclusion to pay for her brother’s health insurance and medical bills. Then, she (and her spouse) can maximize the annual exclusion gifts to transfer more than $30,000 to her brother each year. With respect to her nieces, she can use the unlimited tuition exclusion to pay for her some or all of her nieces’ tuition each year. In addition, she can create an irrevocable “Crummey” trust for her nieces. This type of trust could accept annual exclusion gifts for the nieces each year, thereby building up a fund over time for future purchase of a home.  

As high-net-worth individuals plan to transfer their wealth in the coming years, financial advisors will play an important role in helping their clients navigate all kinds of scenarios. From passing an inheritance down to younger generations to providing aid for loved ones in need, to supporting parents or grandparents during their golden years, the sooner advisors begin conversations the better positioned they will be to set their clients up for success.

David Jones is Senior Vice President, Director of Estate Strategy at Bailard Wealth Management.

The above should not be considered tax advice. Bailard, Inc. is not a tax professional and cannot and does not give tax advice. In addition, this piece contains the opinions of the authors as of that date and such opinions are subject to change without notice.

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