Are You a Smaller, a Baller, or an Aller?

Whether it happens sooner (perhaps as early as next year) or later (but likely no later than 2026), there’s a good chance we’re going to see a significant drop in the federal estate tax exemption amount. And while there’s some uncertainty around exactly when it will happen, one thing that is certain is that if/when it does, substantially more Americans will be subject to this tax.

Such potential changes on the horizon mean that one of the best ways to make the most of the current estate tax exemption, and to mitigate uncertainty around having to face a much lower exemption in the future, is to use it now, while it’s here. So, to figure out when it may make sense for you to take some prudent planning steps, as well as what those steps might be, it can help to think about a proposed decrease in the federal estate tax exemption as creating three groups: smallers, ballers, allers.

But before we get into where you might fall and some strategies specific to each, let’s cover a little background.

Where we stand now

A quick look at the lay of today’s estate tax landscape will give you a rough idea of the magnitude of the impact that any new exemption rules could have on the wealth transfer component of your financial life plan.

Currently, the federal estate tax exemption is $11.7 million per person, and the tax on an estate with assets above that amount is 40%. Today’s exemption is also portable between spouses, which means that a surviving spouse (if they follow certain rules) can use their deceased partner’s exemption in addition to their own. In other words, right now married couples have a total estate tax exemption of roughly $23.5 million. As you may imagine, very few families have worry about this tax right now.

That being said, various lawmakers have competing proposals on the table that could take the current exemption back down to a much lower amount. The new exemption amount in these proposals varies, with some legislators preferring to reduce it to as low as $3.5 million per person, next year. The draft legislation released last week by the House’s Ways and Means Committee, however, would reduce the current exemption amount by 50% (creating a roughly $6 million exception for 2022).

Of course, it’s not entirely clear what the situation will be going forward. Depending on the final legislation, if any, that ultimately gets adopted, current exemptions levels could remain, they could see significant reduction, or they could end up somewhere in between. But even if nothing happens, today’s estate tax exemption is scheduled to sunset in 2026, dropping to roughly $6 million per person and $12 million per couple.

The crux of the issue

Because we don’t know exactly when the exemption amount will change or how much it will drop, start thinking about what you may want to do now and talk with your advisor before the end of the year to put yourself and your family in the best possible position, no matter the outcome. It won’t be a wasted exercise, given the expiration date on today’s larger exemption.

So, let’s return to our three categories – smaller, baller, aller – to explore whether you need to act today to adjust your estate plan or if your runway to implement some common-sense strategies is a bit longer.

Smallers

While this term does refer to the size of your estate, please don’t take it to mean that your savings are “small,” especially in their importance to you. It just describes where your net worth (the sum of your house, retirement accounts, investment accounts and other assets) sits at the time you pass away relative to whatever exemption amount appears in the future tax code. If, after retirement expenses and others, you can be reasonably confident that your estate is going to end up under the amount where you’d have to worry about topping the federal estate tax exemption, then you’re in this group.

The good news for you is that there’s likely no need for a rush to action. But do discuss with your advisor where your financial plan’s retirement and other projections would put you at some future date, and take evolving family circumstances into account as much as you’re able.

It’s important to gut-check yourself and understand your tolerance for having to pay this tax should you choose to do nothing and your net worth ends up exceeding the exemption. Assume the lowest proposed estate tax exemption (about $3.5 million per person or $7 million for spouses) takes effect. How would you feel if you didn’t make use of the current exemption?

If you fit into this “smaller” category, your basic strategy is likely to simply sit tight for now unless new information comes to light or drastic, and at this point unexpected, changes in the tax landscape occur. Congratulations, you’ve already knocked any estate tax planning to-do’s off your list.

Ballers

In contrast, a “baller” has enough wealth that they can afford to give away their full exemption amount now, before any estate tax changes, without really feeling it or even worrying that they’ll still have enough other assets to meet their needs during their lifetimes. This group has the most reason to look for opportunities to take advantage of the current exemption amount now, perhaps even before the end of the year, and to give away whatever they can while exemption amounts are high rather than let them go back down.

Consider that right now the estate tax exemption for a married couple is roughly $23.5 million. If next year the lower proposed exemption of about $7 million for a married couple becomes law, that would represent a $16.5 million loss of estate tax protection. And recall that the current estate tax rate on assets over the exemption is 40%. For ballers, the difference between giving away assets now, under today’s larger exemption, versus waiting for any new rules to go into effect could be immense.

Again, gut-check yourself by assuming the lowest proposed estate tax exemption takes effect. If you have assets enough to put you over today’s exemption amount, how would you feel if you didn’t make full use of the current exemption?

For ballers, designing and building a plan to use today’s estate tax exemption amount to shield meaningful dollars is as close to a no-brainer as one can find in the estate planning arena, whether that plan is put into play nearer term because the exemption is lowered by law (as is likely to be the case) or it sunsets in 2026.

Finally, the IRS has already come out and said that it won’t retroactively apply a lower exemption amount if one becomes law, so assets you give away will not be subject to a “claw back.” Simply put, the IRS has said, “You’re OK to use your larger exemption amount now without fear of tax consequences if it is lowered in the future.”

Allers

An “aller” is someone who, to fully minimize their estate tax liability, would essentially have to give away all their assets – everything – before the exemption drops.

For example, let’s say an individual has a net worth of $10 million. Today, that person is covered by an $11.7 million estate tax exemption. But they also know there’s a chance that lawmakers might lower the exemption substantially next year. Maybe that person decides to give away some of their dollars while the exemption is high. Does that save on taxes if the exemption is rolled back next year?

It might, but it depends on how much they actually give away. The challenge is in how the rules work, because what counts is the combined gift-during-life and estate-tax-at-death amount.

So, let’s further assume the person above gives away $8 million of their $10 million net worth. They hold back the last $2 million because, after all, they still need something to live on. Then let’s say the exemption gets reduced to $6 million. Even though they only have $2 million left in their estate, if they die with that level of assets, the $8 million they gave away during life will completely wipe out the $6 million exemption, meaning the remaining $2 million would be taxable.

At today’s estate tax rate of 40%, that’s $800,000 in estate taxes! The only way around this is to have literally given it all away while the exemption was high (hence the term “allers”). Could you do that?

There may be some strategies that allers should discuss with their advisors if they’re not actually ready to give away everything and let their kids take care of them. For instance, employing a spousal lifetime access trust (SLAT) could allow one spouse to use all of the larger exemption now, essentially giving it all away to the trust while making the other spouse the beneficiary (though it should be noted that current proposed legislation could curb this strategy).

Wherever you find yourself on this spectrum, start preparing for potential changes now, so you have as much time as possible to think through the impact to your family and financial picture and to plan for what could be some big decisions. Discuss with your advisor whether you need to consider transferring significant assets out of your estate, potentially as early as the end of 2021, then explore your options and form a plan for the future that best fits your legacy goals.

The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Partners®. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice. The individual situations mentioned above are for illustrative purposes only and do not reflect an actual client’s situation. Individuals should speak with qualified professionals based upon their individual circumstances. The analysis contained in this article may be based upon third-party information and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed.

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EditorNovember 4, 2021