2024 Planning Landscape: Focusing on the Lifetime Exemption

January 31, 2024

Inflation has created a planning opportunity as the sunset of the high exemption amount looms.

As we move into the new year, two key realities are converging to impact wealth transfer planning. One is recent high inflation, which has sharply increased annual adjustments in the generous federal estate, gift and generation-skipping tax exemption put in place by the Tax Cuts and Jobs Act of 2017; specifically, the exemption has risen in 2024 to $13.61 million per person, or $27.22 million per couple, up from $12.92 million per person, or $25.84 million per couple, in 2023. The other reality is that post-2025, the exemption is scheduled to revert to prior levels adjusted for inflation, estimated to be around $7 million per person or $14 million per couple (see display). So, although the exemption currently presents plenty of planning opportunities, there is a limited window in which to act.

Practically speaking, this means that those who have transferred assets or funded estate planning vehicles up to the exemption amount for 2023 can add an additional $690,000 per person this year. For those who have made few if any wealth transfers thus far, the increased exemption amount simply adds to the opportunity to reduce tax exposure.

A Limited Window

Federal Estate Tax Exemption per Individual (Millions)

A Limited Window 

Source: Internal Revenue Service. Assumes a 3.5% increase in the exemption to about $14.1 million for 2025, followed by the sunset of the 2017 federal tax reform provisions for a level of roughly $7 million in 2026.

Putting Theory Into Practice

What strategies are our clients using? A popular vehicle these days is the Spousal Lifetime Access Trust, or SLAT, which allows an individual to retain indirect access to assets while using the lifetime exemption. The grantor (or creator of the trust) typically funds an irrevocable trust for the benefit of his descendants that also permits his spouse to receive distributions at the discretion of a trustee, if needed. A SLAT is typically structured as a “grantor trust,” which means that the grantor bears the income tax burden of any trust earnings, allowing the trust assets to grow tax-free and to potentially experience greater appreciation.

The grantor’s spouse may potentially be given a special power of appointment at death to transfer the trust assets within a group of beneficiaries, including the grantor, enabling him access should his spouse predecease him. If structured properly, the trust removes the assets from the estates of both spouses.

Clients often find it advantageous to form such trusts under Delaware law, which affords investment flexibility in the management of assets, has the potential to benefit not only children and grandchildren, but future generations as well, and can even help save state income taxes in some cases too. 

Hypothetical Example: Spousal Lifetime Access Trust

Assume that a $13.61 million gift grows in a SLAT at an annualized 6% rate for 20 years, bringing the total amount available to children and future generations to $43,649,114. Given a 40% federal estate tax rate, the transfer has saved over $12 million in future estate taxes by removing appreciation from the grantor’s estate. Additionally, if the gift is made to a Delaware trust and uses the grantor’s generation-skipping tax exemption, it will avoid transfer tax at the beneficiary’s death. Assuming the same 6% growth rate, the value of the gift will increase to $139,988,621 over the subsequent 20 years.

Estate Freeze

Another category of strategies can create tax savings above and beyond the exemption amount. Such “estate freeze” methods set the value of assets for estate planning purposes at current levels plus a hurdle rate, allowing any additional appreciation to pass to heirs estate- and gift-tax free. Broadly speaking, such strategies are less attractive when interest rates are high, because that increases the required hurdle rate set monthly by the Internal Revenue Service. However, for assets that have meaningfully depreciated (e.g., a special situation) and/or have the potential to grow substantially (e.g., shares in a startup), the hurdle rate becomes less significant in relation to potential appreciation. Examples include:

  • A Grantor Retained Annuity Trust (GRAT), in which the grantor transfers property to the trust, retaining an annuity stream until the trust term ends, after which any remaining assets pass to heirs. Typically, the annuity is set to equal the present value of the property when originally transferred plus an IRS-determined interest rate. This approach results in little to no gift to the heirs upon funding, and any appreciation above that rate passes to them gift-tax free. Keep in mind that the grantor must survive the term of the GRAT to benefit from this strategy.

Hypothetical Example: Grantor Retained Annuity Trust

Assume that a grantor transfers $5 million in property to a three-year GRAT with a Section 7520 (or hurdle) rate of 5.2%—the level for January 2024. Each year for the next three years, he will receive an annuity payable either in kind and/or via cash of $1,842,910. If the assets appreciate by 12% per year, a total of $805,923 will be transferred to the grantor’s children (or a trust for their benefit) without the use of any exemption amount. Note that the return assumption is relatively high given the appreciation-oriented nature of assets that are typically placed in a GRAT.

  • An Intentionally Defective Grantor Trust (IDGT), in which the grantor transfers or “seeds” a trust and subsequently sells assets to it in exchange for a promissory note (with interest set by the IRS). Any appreciation after the payment of the note amount remains inside the trust for the benefit of the grantor’s children and future generations. The grantor also pays income taxes on the trust earnings, facilitating asset growth within the trust. Unlike a GRAT, this type of trust tends to work well for those who want to plan for generations beyond their children (as it allows them to allocate their generation-skipping tax exemption to the trust at funding, prior to any appreciation occurring inside the trust).

Hypothetical Example: Intentionally Defective Grantor Trust

Assume a grantor transfers $500,000 to a trust in a gift that employs part of his $13.61 million exemption amount. He then sells $4.5 million in assets to the trust in exchange for a seven-year promissory note with interest at 4.37%—the “midterm applicable federal rate” for January 2024. Each year for seven years, he will receive an interest payment of $196,650 for a total of $1,376,500 (which will not be subject to income tax given that the trust is a grantor trust for tax purposes). He will then receive a $4.5 million balloon payment at the end of the seventh year, for a total of $5,876,500. If the assets appreciate by 8% per year (a more modest assumption than in our GRAT example), a total of $2,314,452 will be transferred to the trust for the grantor’s children and future generations while only $500,000 of his exemption amount will be used up.

Changes Worth Remembering

Even as we look toward the post-2025 tax sunset, it’s important to note some key changes that will help your planning this year.

  • The annual gift tax exclusion has increased from $17,000 to $18,000, allowing you to give $18,000 this year ($36,000 per couple) to any number of recipients free of gift or estate taxes.
  • The annual gift tax exclusion for gifts to a non-U.S. citizen spouse has increased from $175,000 to $185,000. Note that gifts made to a U.S. citizen spouse are not taxable in any amount.
  • The annual limit on employee contributions to 401(k) plans has increased to $23,000, up from $22,500 in 2023. The “catch-up” limit for those 50 and older remains at $7,500. (A Secure 2.0 Act provision requiring that catch-up contributions be made in after-tax “Roth” dollars for those above certain income levels has been delayed until 2026.) The limit on IRA contributions has increased to $7,000 from $6,500 last year.
  • Due to inflation adjustments, the top ordinary income tax rate of 37% now applies to income over $609,350 for individuals and $731,200 for married couples filing jointly, compared to $578,125 and $693,750, respectively, last year.

Keeping Your Plan Up to Date

The start of the new year can be an ideal time to ensure that all your planning “ducks are in a row.” This review involves not just high-level assessments of your overall plan, but also more basic inventories of estate documents, designated beneficiaries and named fiduciaries, as well as matters such as the adequacy of your insurance coverage. All are important but may not get the attention they deserve. As always, your NB Private Wealth team is available to help you sort through these matters, both big and small, to set you and your family on the right path.

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Hypothetical growth examples are for informational and educational purposes only.

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