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How to Plan Around Estate Tax Uncertainties

When the federal estate tax exemption doubled in 2017—it’s now $11.7 million per person ($23.4 million per married couple)—the number of tax-paying estates fell from 5,500 annually to just 1,900. “As a result, most people haven’t had to worry about estate taxes,” says Bob Barth, a Schwab wealth strategist based in Orlando, Florida. But looming tax changes could alter that:

  • A Biden administration proposal could cut the federal estate tax exemption to its 2009 levels of $3.5 million per person and $7 million per married couple. (If adopted, those exemption levels may or may not be adjusted annually to offset the effects of inflation.)
  • Even if that proposal doesn’t make it into law, the current estate tax exemption is set to revert to pre-2017 levels of $5 million per person and $10 million per married couple starting in 2026 (though both of those figures will be adjusted upward to account for inflation).
  • And if you live in one of the 12 states (or the District of Columbia) that levies taxes on estates—the lowest of which kicks in at $1 million—you could face such taxes regardless of what happens with the federal exemption.

“With all of the what-ifs around estate taxes, it’s important to have a plan in place that will protect your heirs, come what may,” says George Pennock, director of trust planning services at Charles Schwab Trust Company in Henderson, Nevada. Here, Bob and George highlight three trust types that can help.

1. A-B Trust

How it works: When one member of a married couple passes away, the couple’s assets are separated into two trusts:

  • A survivor’s or “A” trust, which is revocable (meaning it can be changed) and belongs to the surviving spouse.
  • A bypass or “B” trust, which is irrevocable (meaning it can’t be changed) but can provide income to the surviving spouse before being passed down to the trust’s beneficiaries tax-free upon the surviving spouse’s death.

Who it’s for: Spouses don’t pay estate tax on assets inherited from each other thanks to the unlimited marital deduction, which allows an individual to transfer an unrestricted amount of assets tax-free to their spouse at any time, including at her or his death. “However, over time, appreciation alone can easily push a sizable estate over the estate tax exemption for your heirs,” Bob says. “By moving some of those assets into a bypass trust at the time of the first spouse’s death, they’re excluded from the surviving spouse’s estate even as he or she derives income from it.”

2. Grantor Retained Annuity Trust (GRAT)

How it works: The GRAT’s creator transfers assets into a fixed-term, irrevocable trust. During the term (of at least two years), the creator receives annuity payments that pay the value of the assets back to them in their entirety—plus a fixed interest (or “hurdle”) rate set by the IRS. When the term expires, any growth in the invested assets over and above the hurdle rate passes to the trust’s beneficiaries tax-free.1 If the creator passes away before the term ends, however, the value of the remaining assets, including earnings, will be included in her or his taxable estate.

Who it’s for: A GRAT is most useful for those with assets that are likely to appreciate substantially during their lifetimes, such as a closely held business, real estate, or stocks. “A GRAT allows you to move some of that appreciation out of your estate, thereby reducing its overall size,” George says. “And if the assets don’t appreciate as expected, the GRAT’s ‘substitution transaction’ provision allows you to, during the annuity term, swap them out for assets of equal value that may appreciate more.”

3. Charitable Remainder Trust (CRT)

How it works: This irrevocable trust distributes a portion of the donated assets—at least 5% annually but no more than 50%—to its creator or another beneficiary for a specified term (or life). At the end of the term or the creator’s death, the remainder goes to one or more designated charities. There are two main types of CRTs:

  • Charitable remainder annuity trust (CRAT), which distributes a fixed annuity amount each year and does not allow additional contributions.
  • Charitable remainder unitrust (CRUT), which distributes a fixed percentage of the trust assets annually and does allow additional contributions.

Who it’s for: Those who want to reduce the eventual size of their taxable estate while receiving an immediate partial tax deduction on the value of the assets transferred into the trust. “The beauty of charitable gifts is that they don’t eat into your estate tax exemption,” Bob says. “And with a CRT, you can receive an immediate partial tax deduction on the portion of the assets earmarked for charity, which must be at least 10%.” What’s more, putting highly appreciated assets into a CRT preserves their full fair market value because the trust is not required to pay capital gains taxes on the sale of those assets.

Keep in mind

Estate taxes are always a moving target, so it’s important to revisit your estate plan—including your trust provisions—regularly. “With so many changes on the horizon, it’s wise to keep in close contact with your team—accountant, attorney, financial planner, etc.—who can help you think through your options and keep your overall planning on track,” George says.

1Naming grandchildren as a GRAT’s beneficiaries could trigger generation-skipping transfer taxes. Consult a tax professional before making any decisions.

What You Can Do Next

See how a corporate trustee can help plan for taxes and protect your financial legacy.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

The policy analysis provided by Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

Charles Schwab & Co., Inc., and Charles Schwab Trust Company are separate but affiliated companies and wholly owned subsidiaries of the Charles Schwab Corporation.

Charles Schwab & Co., Inc. (Schwab) is affiliated with Charles Schwab Trust Company (CSTC), the corporate trustee for Schwab Personal Trust Services (SPTS). Schwab may introduce clients to CSTC but does not evaluate whether SPTS is appropriate for each client or recommend SPTS for any particular client. It is the client’s responsibility to ensure that CSTC meets his or her trust needs and to conduct any due diligence that may be required before engaging CSTC.

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