Building Blocks

Estate Planning and CAP (“Curing Acronym Phobia”)

One thing I love about kids is their directness. They call things as they see them, rather than using jargon or seeing them through a complicated adult lens. Example: When my daughter Kaitlin was two years old, she called our pantry the “extra keeper.” That term made total sense for a place to keep extra food we weren’t eating right away. Kids instinctively know how to cut to the chase.

As adults and investors, we tend to get bogged down in fancy jargon for all sorts of things. That can make concepts more difficult to understand. The estate-planning field is particularly famous for turning financial options into multi-word titles that have to be reduced down to an alphabet-soup of acronyms like GRITs, GRATs, SLATs, ILITs and more.

To make estate planning a bit more understandable and accessible, it’s helpful to break the techniques down into general “buckets” a kid (albeit a somewhat smart one!) might be able to understand. And once you better understand estate-planning options, it’s often easier to take action on them.

Change is on the horizon

Understanding your options is particularly important right now, because two complicated-sounding estate-planning strategies—Grantor Retained Annuity Trusts (GRATs) and family-owned Limited Liability Corporations (LLCs)—are facing extra scrutiny right now. It’s possible that changes to estate-planning laws or Internal Revenue Service (IRS) regulations could make these options less attractive than they are now. I tell clients that if they’re thinking about implementing estate-planning strategies, they might want to do so before the guidelines change.

To begin with, let’s give estate-planning strategies some child-inspired directness and break down those pesky acronyms.

Estate planning to cut taxes

Many estate-planning strategies are intended to reduce the value of your estate by moving assets outside of your taxable estate to the next generation of your family or to a trust benefitting the next generation. Two general ways to do that are to 1) Discount parts of your estate and 2) Play “interest rate arbitrage” with the IRS. Arbitrage, by the way, means taking advantage of a price difference between two items.

Discounted LLC shares

One way to legally make your estate “less valuable” in the eyes of the IRS–and therefore subject to lower estate taxes–is by putting family businesses or property (like rental property) into a family-owned LLC. You remain the manager of the LLC and control it, but you gift minority LLC positions to your kids.

When you give them an LLC interest as a gift, you need to obtain a valuation from a consultant to determine what (if any) gift taxes might be due. This gift also affects the amount of your lifetime federal estate gift-tax exclusion you’re using. For both reasons, you want the LLC share valuation to be—legally—as low as possible.

The key here: Minority shares in a LLC aren’t liquid or marketable. Your kid can’t sell them or exercise control with them. So while your child’s 10% share in your hypothetical $1 million business should be worth $100,000 from a mathematical point of view, a non-usable minority share might actually be tax-valued at just $65,000 because of its limited viability. That’s a 35% discount on that portion of your estate—and on gift taxes you might owe.

IRS interest rate arbitrage​

GRATs—again, the estate planning acronyms reign supreme—are another legal way to transfer assets to your beneficiaries and reduce taxes. The advantage here is the difference between two interest rates: What your GRAT actually earns and what the IRS assumes it should theoretically earn. You “win” if the IRS assumes a low interest rate and your GRAT actually earns more. This is what I meant earlier when I mentioned playing “interest rate arbitrage” with the IRS.

How it works: A GRAT is essentially an irrevocable trust that makes an annuity payment back to you each year based on the IRS’s assumed interest rate. Here’s where it’s interesting: From the IRS’s view of the world, the only investment return they consider is the yield on Treasury bonds. Also, the IRS likes to value future gifts today. So when determining the value of the future gift your GRAT will make to your heirs, the IRS uses Treasury rates. If your GRAT earns more than Treasury rates over the two or so years it’s in place, that extra appreciation goes estate-tax-free to your heirs.

For example, if the IRS Treasury rate is 2% but your trust actually goes on to earn an average of 10% per year, that 8% difference in your GRAT’s return is not taxable. It moves tax-free outside of your estate. It can be a great deal.

Removing the mystery from estate planning

When you get down to it, estate planning isn’t as complex as we financial nerds tend to make it. And hopefully we’ve simplified it a bit more for you here. The message to take away is this: Don’t let the complex-sounding jargon of estate planning intimidate you. Don’t let odd acronyms stop you from taking advantage of great tax-advantaged opportunities. Now’s the time to look into both GRATs and LLCs before outside pressure dissolves their benefits.

Your RegentAtlantic Wealth Advisor always available to spell out the potential advantages of GRATs, GRITs, LLCs and every other estate-planning acronym you can imagine. And they’ll do it in plain English!

Important Disclosure Information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

Please remember that RegentAtlantic’s Wealth Advisors are not attorney. Please consult with an estate planning attorney of your choice prior to implementing any of the strategies mentioned in this article.

This article is based on RegentAtlantic’s understanding of current tax legislation. Congress may change this legislation at any time.