In my last post, we looked at a Case Study from the Academy’s New Orleans conference. I introduced you to your new clients, James and Susan. They’re a married couple in their late 50’s who met in college and have built a successful business, Widget Corp., amassing a current net worth of just under $20 million. Susan and James have two children. Mark, 35, is married with three children, and Emily, 33, is a newlywed with no children.

Susan and James’ estate planning goals are pretty straightforward: they want to leave their assets first to each other, then to their children and, of course, they want to reduce their ultimate tax burden as much as possible. So, what strategies do you suggest?

One advanced planning strategy we discussed at the Academy Spring Summit, and that Susan and James might want to consider, is gifting to irrevocable trusts. An irrevocable trust can be used to make a current gift to remove the assets from a grantor’s taxable estate. This is a particularly timely strategy, due to the temporary $5 million applicable exclusion available to each James and Susan under TRA 2010. Irrevocable trusts can be a great strategy for other reasons, as well:

• Protection of assets from beneficiaries’ creditors
• Protection of assets from future beneficiary divorce
• Protection of assets from the creditors of the grantor
• Protection  of assets from mismanagement by beneficiaries

In a jurisdiction that has repealed the Rule against Perpetuities, the assets in an irrevocable trust can be held for future generations and can avoid being subject to estate taxation or to creditors of any future generation.

As an example, let’s take a look at a trust established by James. James’s trust would be set up for the benefit of Susan, their two children, Mark and Emily, and their three grandchildren. James would gift into this trust any remaining portion of his $5 million applicable exclusion not used up through other planning strategies. The year following the transfer of these assets into the trust, he would file Form 709 to report the gift. In addition, he would allocate his GST exemption (currently $5 million) to the trust.

Each year James would contribute annual exclusion gifts for Mark, Emily, and the three grandchildren. Of course, the trust would be drafted so that additional grandchildren would also be included as beneficiaries and Crummey power holders.

Let’s assume James gifts $3,000,000 worth of assets into the trust plus the maximum annual exclusion gift each year during his life expectancy.

Assuming a 4% rate of return, the $3,000,000 initial gift to will grow to $7,998,000 during James’s 25-year life expectancy. With James in a 50% estate tax bracket, this results in tax savings of $3,999,000.

On to the annual exclusion gifts: with five beneficiaries at $13,000 each, that’s $65,000 in annual gifting. These annual exclusion gifts will grow to $2,812,000 during James’s 25-year life expectancy, again assuming a 4% rate of return. This results in a tax savings of $1,546,600 (without the use of the applicable exclusion).

Between the $3,000,000 initially transferred into the trust and the annual exclusion gifts added each year, the assets in the irrevocable trust at James’s death will have grown to $10,810,000. This results in an ultimate tax savings of $5,545,600 – and this is only the view from James’s side of the fence. Remember, we can set up a separate irrevocable trust for Susan!

In my next post, we’ll look at an additional strategy James and Susan can use to transfer wealth out of their taxable estate and ensure that it makes its way to their children.

Stephen C. Hartnett
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
6050 Santo Rd Ste 240
San Diego, CA 92124
(800) 846-1555
www.aaepa.com