Normally, facing mortality and the difficult decisions that come with it serve as hurdles that must be overcome in order to even begin planning an individual's estate. However, these days, coronavirus presents an imminent threat, which is impossible to ignore. Accordingly, individuals should be (and are) more amenable to taking action now than they otherwise normally would be. We see the pandemic as expediting a process that people eventually planned to get to at some point anyway.
Below are some planning considerations to take into account during these unprecedented and uncertain times.
ESSENTIAL ESTATE PLANNING DOCUMENTS TO GET IN PLACE NOW
To answer your question, there are a number of essential documents that every adult needs to have in place in the event of his or her incapacity or death. These documents, together, provide a basic foundation for any estate plan - what we like to call “phase one” of estate planning.
The first set of documents is a Last Will and Testament and/or revocable trust. One of the most effective ways to direct the distribution of your assets upon your death is to create a Will or revocable trust. A properly drafted Will or revocable trust instructs how your assets are to be distributed upon your death; designates an Executor or Trustee who is responsible for marshaling your assets, preserving your estate paying creditors, administrative expenses and death taxes, and disposing of the remainder of your property among your beneficiaries; appoints Guardians for minor children; establishes trusts for asset protection and estate tax planning purposes; and in the case of a revocable trust, avoids probate upon your death.
The second document is a power of attorney. A power of attorney allows you to appoint an individual to handle financial decisions for you, including paying your bills and taxes and managing your investments and business. A springing power of attorney enables your agent to act only following your incapacity or incompetence, while a durable power of attorney allows your agent to act immediately. When coronavirus symptoms become acute, one common treatment requires intubation. That process can require inducing a coma until the patient can begin breathing on his or her own, resulting in a period of incapacitation that prevents patients from making financial decisions. It is particularly advisable to prepare for this type of scenario by authorizing someone to act as their agent while they are incapacitated by means of a power of attorney.
The third essential estate planning document is a health care proxy. The health care proxy is used to appoint an individual to make medical decisions for you, in the event of that you are unable to do so yourself.
Finally, we have the living will. A living will is used to express your wishes regarding your healthcare in the event that you have a terminal condition or are in a vegetative state, and may be used to evidence your intention to have artificial life support terminated.
If you already have living wills, “do not resuscitate” orders (DNRs) and health care proxies in place, especially standard forms that have been signed and obtained online or elsewhere, they should be reviewed, as they may contain language that could be completely contrary to what you might wish to have done from a treatment standpoint during the coronavirus pandemic. For instance, some of these documents may prohibit intubation under all circumstances. Many people who sign these forms picture an extended stay in a hospital, connected to a bunch of tubes, being artificially kept alive. However, if you are not presently in a terminal condition and contract coronavirus, since it is a respiratory tract infection, it is possible that you would need to be intubated in order to survive it.
SIGNING DOCUMENTS DURING THE QUARANTINE
Fortunately, options do exist in many states for creating valid estate planning documents, notwithstanding social distancing requirements. Depending on the state in which one lives, wills, trusts, health care proxies, powers of attorneys and living wills require the person signing them to have two witnesses and/or a notary present at the signing.
Given the difficulty that social distancing has caused with respect to getting these documents properly signed under state statutes, governors around the country have begun to pass orders allowing for remote witnessing and notarization, as is the case here in New York. These orders require that certain protocols be followed, including that the signing take place over audio-video conference and that documents are electronically shared between signers.
Alternatively, a mobile notary can be hired to receive a grantor’s acknowledgment briefly and at a safe distance in person, including in a drive-by meeting where the grantor remains in his or her vehicle, and the notary interacts at a distance.
Handwritten wills, known as holographic wills, are valid in New York and a number of other states if they are entirely in the testator’s handwriting and signed. In many states, holographic wills do not require witnesses or a notary to be valid. A holographic will might work particularly well in conjunction with a revocable trust. A holographic will could “pour-over” the testator’s estate to a revocable trust, which could then function like a will substitute. Meanwhile, the revocable trust could be typewritten by an attorney and signed by the grantor via remote notarization or, in some states, without a notary and still be valid.
While the circumstances of the pandemic and quarantines are of course not ideal, it should still be possible in nearly all instances for an individual to validly execute a will, trust agreement, durable general power of attorney or advance medical directive. Where property is owned in multiple jurisdictions, it is particularly important to consult with legal counsel for specific advice regarding the requirements of signings. In any instance where documents have not been signed in an in-person signing meeting, it would be prudent to execute the documents again in the traditional manner once it becomes safe to do so.
ESTATE PLANNING TECHNIQUES TO EMPLOY GIVEN DEPRESSED ASSET VALUES AND LOW INTEREST RATES
For individuals of significant wealth, once your primary estate planning documents are in place, you're ready for what I call "phase 2" of estate planning. You can take advantage of the downturn in the stock market as an opportunity to leverage your lifetime federal estate tax exemption to make gifts to loved ones and reduce your taxable estate. Because the stock market has suppressed the value of assets across most asset classes, making gifts at this time offers a low tax “cost” and an increased likelihood of appreciation of gifted assets in the hands of the donee.
Gifts can take many different forms; you can choose to use all or a portion of your lifetime exemption or the annual exclusion. For 2020, the lifetime federal gift and estate tax exemption has been increased to $11.58 million. This increased exemption amount is scheduled to sunset at the end of 2025 and return to $5 million (adjusted for inflation), assuming that it is not sooner reduced in the event that a Democratic president takes office next year. Additionally, with the recent passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), and with more stimulus bills to come, Congress may soon look for ways to reduce these deficits. This will undoubtedly lead to discussions about raising estate taxes.
The gift tax annual exclusion is currently at $15,000. This is an amount you can give to as many individuals as you choose, each year, without using a portion of your lifetime exemption and without having to file a gift tax return.
While all of the turmoil in the world has created a strong level of uncertainty, it has also created excellent opportunities for estate planning. This is a result of the combination of depressed asset values and low interest rates. For example, many estate planning techniques are based upon federally mandated interest rates, often referred to as Section 7520 rates. For the month of May 2020, the benchmark interest rate will be 0.8% (an historic low). When this interest rate is combined with depressed asset values, estate planning opportunities are possible if you believe that assets will appreciate at a rate greater than 0.8%. In this regard, there are several estate planning techniques worth considering.
The first technique is a grantor retained annuity trust (GRAT). A GRAT is a technique whereby assets are transferred to a trust and the grantor contributing the assets retains the right to receive annual distributions (an annuity) from the trust for a certain length of time. The amount of the gift is based upon what the beneficiary is assumed to receive upon the expiration of the trust term.
One of our favorite types of GRAT is referred to as a "Zeroed-Out GRAT". For example, under this approach, the donor transfers $10 million in assets to a trust with a term of 10 years and receives the right to receive assets equal to approximately $1 million per year for a ten-year period. Based on the mathematics of this approach, there would be little to nothing left over at the end of the term. The benefit occurs where the assets appreciate at a rate higher than the federally mandated interest rate (0.8% for the month of May 2020). If the assets appreciate at a rate higher than this interest rate, then value can be transmitted to the trust beneficiaries at no gift tax cost.
Another technique is known as an installment sale to an intentionally defective grantor trust (IDGT). This technique is based upon a family selling an asset to a trust and using the income from the trust to repay the loan (or at least the interest on the loan). By structuring the trust as a “grantor trust”, the grantor will not recognize any income taxes upon the sale of the asset. However, if the value of the asset being sold is depressed at the present time, and you are comfortable that the income generated from the asset will satisfy the installment obligation, this is a good way to transfer appreciation to your heirs.
Instead of structuring a sale to a grantor trust, the grantor can instead gift the assets to a grantor trust, using all or a portion of the grantor's lifetime exemption amount. The assets, including any income and appreciation on the assets after the date of the gift, will then be out of the grantor's taxable estate. With this technique, you are actually gifting the asset (plus income and appreciation on the asset), instead of just gifting the appreciation.
Finally, a charitable lead annuity trust (CLT or CLAT) is a favored technique in the current environment. Using a CLAT, assets are transferred to a trust, and a charity receives the income from the asset based upon the applicable IRS interest rate, for a term of years. Upon the expiration of the trust term, the assets are distributed to the trust beneficiaries. As with the GRAT, if the assets appreciate at or above the IRS interest rate, the ultimate beneficiaries can receive value at a reduced transfer tax cost.
TAKING ADVANTAGE OF THE LIFETIME ESTATE TAX EXEMPTION AMOUNT BEFORE IT POTENTIALLY DECREASES
For wealthy individuals, it is ideal to use the increased exemption of $11.58 million before it sunsets or sooner decreases. However, given the uncertain financial environment and inability to predict future financial needs, many clients are apprehensive about parting with ownership and control of their assets. A spousal lifetime access trust (SLAT) is an ideal planning strategy that balances a donor's desire to use this increased lifetime exemption with the need to retain access to the funds gifted in the event that the donor needs or wants them in the future.
This gift of the lifetime exemption amount allows the donor to reduce future estate tax liability by removing the asset and its income and appreciation from the donor's taxable estate. To the extent that the exemption amount is used and later decreases, the amount used is grandfathered and the IRS will not claw it back into the donor's taxable estate. By having the donor's spouse as a beneficiary of the SLAT, the spouse can receive distributions from the trust, thereby allowing the donor to indirectly benefit from these distributions, as well, should the need arise. I think of it as giving the donor "backdoor access" to the trust assets.
Additionally, in states, such as New York, that do not impose gift taxes but still impose estate taxes, a lifetime gift to a SLAT can result in reduced state estate tax exposure at death.
CONSIDER INTRA-FAMILY LOANS
With current interest rates at near historic lows, loans among family members, or "intrafamily loans," are an attractive way of assisting family members. Such loans can be part of more complex planning, including transfer of family business interests, or simply a way for parents to support children or other family members in financing major purchases (such as a home).
An intrafamily loan can offer many benefits, including (a) much lower interest rates for the borrower compared to commercial lending rates, (b) no credit checks or reporting, (c) no loan costs, and (d) better return rate for the lender than cash sitting in a bank account.
Intrafamily loans are generally scrutinized by the IRS in order to safeguard against family members making disguised gifts, and therefore must be carefully structured and administered. It is important that the borrower of an intrafamily loan have an unconditional obligation to repay the money, while the lender has an unconditional intent to secure repayment. There can be no prior agreement to forgive the loan. Intra family loans typically use the lower than commercial lending interest rate, called the Applicable Federal Rate (AFR), depending on the length of the term of the loan.
A promissory note containing arms’ length loan terms should be used to “paper” the arrangement. In addition to documentation, the IRS looks at whether the loan obligation was repaid, and if the lender and borrower observed the formalities of the loan terms and acted as an unrelated lender and borrower would.
CONSIDER CONVERTING A TRADITIONAL IRA INTO A ROTH IRA
Due to current depressed market values, low income tax rates, and tax free growth of Roth IRA assets, now might be a great time to consider converting a traditional IRA into a Roth IRA. Just be aware that income tax will be recognized on any such conversion, so talk to your advisor before moving forward.