INSIGHT: Legacy Planning in 2020—How to Handle Uncertainty and Seize Opportunity

There are converging trends today that provide a tremendous need and opportunity for legacy planning that financial professionals and their clients should consider. Current economic and social conditions, many stemming from the Covid-19 pandemic, and recent policy changes have created a renewed need for many to review their legacy plans.

For starters, there is uncertainty in so many aspects of our lives today. The coronavirus, economic downturn, low interest rate environment and increased market volatility have many Americans feeling nervous, and understandably so. As a result, this is the perfect time to help your clients get their financial house in order, which includes their legacy plans.

In the background to all of this, we are in the midst of the greatest intergenerational transfer of wealth in the history of the U.S. According to Cerulli Associates, over the next 25 years, it is estimated $68 trillion will be transferred from one generation to the next. Approximately 70% of that will come from baby boomer. As a result, baby boomers will be replaced by Generation X as the generation with the greatest wealth. There will be a lot of money in motion.

On the policy side of things, there is a great opportunity to take advantage of the current tax environment. The lifetime federal gift tax exemption under the Tax Cuts and Jobs Act (TCJA) is at its historical high of $11.58 million per person in 2020, but this will not last forever.

Opportunities to create a concrete legacy plan with life insurance and specific action steps clients can take deserve a closer look.

Helping Clients Get Their Financial Houses in Order

The coronavirus pandemic should instill a renewed sense of urgency for clients to get their financial houses in order. Almost everyone can take the time to review existing wills, trusts, powers of attorney, health care powers of attorney, beneficiary designations and other planning documents to ensure they are properly updated and that their plans match what they intend for their legacy to their families. In addition, when reviewing legacy plans, financial professionals should review the client’s life insurance needs and consider some critical questions: Do they have enough life insurance? Are there ways to keep their current coverage but reduce their premiums? Are there ways to increase their coverage but not their premiums? Are there strategies to use life insurance to supplement income in retirement? Even in this pandemic, life insurers still offer coverage to qualified clients. In fact, life insurers are rapidly innovating to help financial professionals streamline the application and underwriting process online in many cases.

By working with clients’ attorneys and CPAs to review legacy plans and by helping clients review their insurance coverages, financial professionals help clients cover the fundamentals of planning.

Helping Clients Understand the Power of Gifting Now

It is time to carefully consider large gifts, especially if clients are in the high-net-worth category.

Many clients may use annual exclusion gifts. For 2020, the annual exclusion is $15,000 per person per recipient for present interest gifts. In addition, as noted above, everyone also has a historically high amount exempt from estate and gift taxation ($11.58 million for single individuals, $23.16 million for married couples in 2020). This exemption will not last forever. After 2025, it is scheduled to revert to $5 million ($10 million for married couples) (adjusted for inflation from 2010).

Importantly, the IRS clarified that, if the exemption level is lower at a client’s death than when a gift is made, no “clawback” of the higher gift will occur. With clawback concerns addressed, clients should consider gifting now to take advantage of higher exemption amounts before they expire in 2025 or are potentially changed by legislation between now and 2025, which is a possibility as 2020 is an election year.

If clients pursue gifting, many will also choose to make their gifting even more effective by integrating life insurance into their plan. Life insurance owned by a properly structured irrevocable life insurance trust (“ILIT”) keeps policy proceeds outside of a client’s estate. Depending upon the type of product, life insurance may also provide guaranteed death benefits. Some products offer significant internal rates of return on the death benefit in addition to offering tax-deferred growth within the policy.

When the death benefit is paid, life insurance provides an immediate source of cash for an estate. The trustee may loan funds to the decedent’s estate to pay obligations, such as administration expenses and estate and inheritance taxes. The trustee may also purchase assets from the estate, thereby providing liquidity to the estate.

Gifting to trust where the trustee purchases life insurance can have powerful wealth transfer results for clients. For example, let’s assume Michael and Mary are married, are each 61 years old and in good health. Furthermore, assume Michael and Mary have $30 million in net worth and have indicated a willingness to gift $10 million now. If they were to gift $10 million, leveraging part of their large gift tax exemption, then the $10 million plus the subsequent appreciation would also be out of their taxable estate. Assuming their assets grew by 5%, in 10 years the assets in trust could be worth nearly $16 million and, in 20 years, could be worth $27 million outside their taxable estate. This demonstrates the basic power of gifting.

Let’s take it one step further and assume that the trustee uses the original $10 million gift to make five $2 million premium payments into a life insurance policy. Depending upon the type of policy and Michael and Mary’s health, the policy death benefit could provide over $50 million to their heirs.

Helping Clients Incorporate Flexibility in Planning

Given the temporary nature of the federal estate tax exemption, many clients may object to irrevocable gifting and irrevocable planning. Consequently, flexibility in planning has become increasingly important for many clients. Flexibility in planning is a broad subject and may include many types of provisions. One that is particularly popular with many clients today is a provision that allows distribution from an ILIT to a non-grantor spouse. The benefit of such a provision is that, with the shifting exemption amount and uncertainty regarding the election, clients may want to gift their exemptions but also seek to preserve indirect access to the cash inside the ILIT. By building in a provision that permits distributions to the non-grantor spouse, the trustee would have the power to take withdrawals or loans from the life insurance and, in turn, distribute cash to the non-grantor spouse. This is sometimes referred to as a spousal lifetime access trust (SLAT).

For example, let’s assume the same factors as in the above example with Michael and Mary. However, let’s assume that Michael and Mary want indirect access to the monies inside the life insurance policy inside the trust. Michael establishes the ILIT and asks his attorney to include a power for the trustee to distribute funds to Mary, thereby providing her with indirect access to the monies in the trust.

When structuring a SLAT many considerations must be considered by the client’s attorney. In this case, Michael should make the gift to the trust out of his separately titled assets. An independent trustee is typically named in these situations and should always be named when a survivorship or second-to-die policy is the funding vehicle. If a single life policy on Michael is used, then Mary could potentially serve as trustee with the power to distribute money to herself if the power is limited to health, education, maintenance and support (HEMS). This strategy may help Michael and Mary if they present dual goals of using their exemption to benefit their descendants while providing indirect access to the cash value (through distributions to Mary).

One important item to remember when funding a SLAT is to consider using a cash accumulation type of policy because of these dual goals. Of course, there are many other considerations when implementing these strategies and there are other flexible strategies to consider. The main point is that it is important to help clients understand that they can build flexibility into their legacy plans.

The current environment creates great uncertainty, whether it is related to the pandemic, changing landscape of the estate tax or other concerns related to their facts and circumstances. In the face of this uncertainty and given the weight of this moment and what is at stake in terms of the massive shift in wealth underway, it is time for financial professionals to help make certain their client’s legacy plans are properly established, structured, updated and funded to achieve their client’s legacy goals. While it is always good practice to review legacy plans, financial planners should undertake this process before it’s too late.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Brett W. Berg serves as vice president of Advanced Planning for Prudential’s Individual Solutions Group.He may be reached at brett.berg@prudential.com.