Estate planning in uneasy times

Bankrate Logo

Why you can trust Bankrate

While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for .

Estate planning is never easy, and the uncertain economic and tax environment only adds to the difficulty. But you can and should still plan your estate. Changes can always be made later if they become necessary.

“The estate tax issue has left everyone in a real tizzy,” says Norman Boone, president of Mosaic Financial Partners in San Francisco. “It’s hard to know what to plan for. Many find it hard to feel sorry for the rich. But it’s difficult for any kind of planner to give thorough, good advice, because we don’t know what the environment will be.”

Estate tax policy is in flux. The estate tax exemption totals $3.5 million for this year. The estate tax is scheduled to disappear next year, but that disappearance would be only temporary. A $1 million exemption is slated to come back in 2011.

If the rules aren’t changed, “you may see a lot of people kept on resuscitators until January 1 and then see the plugs get pulled — death planning,” says Jeff Azis, a North Palm Beach, Fla., accountant with many wealthy clients. The idea, of course, would be for people to die next year, when their estates won’t be taxed.

Estate planning uncertainties
  1. Estate tax exemption.
  2. Investment and real estate values.
  3. Trusts and insurance.
  4. Social security and income taxes.

Extended $3.5 million exemption?

But Azis and others say Congress probably won’t leave estate taxes at zero next year. With the budget deficit expected to reach almost $2 trillion this year in the wake of the financial crisis, the government needs every dollar of revenue it can get its hands on.

“I can’t see them doing away with estate taxes next year,” says Certified Financial Planner Diane Pearson of Legend Financial Advisors in Pittsburgh. “The economy can’t do without the revenue.”

Charles Sachs, vice president at Evensky & Katz Wealth Management in Coral Gables, Fla., says the scuttle from Washington is that the $3.5 million exemption will simply be extended through next year. “We fear that’s so easy to do, that it just might happen,” he says.

“Typically when you don’t know what to do … the best plan is to assume there won’t be any changes,”

“Most people don’t care about the estate tax. The idea of another nickel or dime in taxes on cigarettes and beer gets people’s attention. But when the talk is about estates of $3.5 million and more, people say, ‘Go ahead and tax those rich folks.'”

So what are the wealthy and their estate planners to do? “Typically when you don’t know what to do, and things are in a state of flux like this, the best plan is to assume there won’t be any changes,” Azis says.

The current line of discussion in Washington probably runs something like this, he says. “We know that we have to do something, but we are too busy dealing with more important issues like health care.” That makes a one-year extension of the $3.5 million extension the easiest path.

“If you plan under current law, you know it might be in existence until the end of next year,” Azis says. “Beyond that is anyone’s guess. Every crystal ball has major cracks.”

The recession that began last year also has affected estate planning, and the uncertainty as to the timing and strength of the recovery has added complications, too.

Shrinking investment and real estate values

The economic downturn and the sharp drops in financial markets and real estate put a crimp on the value of people’s estates. “Many people might have dropped below the $3.5 million exemption level,” says Peter Tedstrom, a partner at Brown & Tedstrom financial advisors in Denver. “If they have, they might not see any need for estate planning.”

Those who are still above the exemption and give gifts to heirs and charities to avoid taxes might now want to lower those gifts. “One of the things we have been revising is gifting to heirs, beneficiaries and charities,” Pearson says.

The law allows people to give away up to $13,000 a year tax-free to heirs. In addition to that amount, you can give away $1 million tax-free over the course of your lifetime. But, obviously, if your estate is shrinking, you’ll want to give away less each year.

“We need to go back and revise life expectancies and cash needs, especially with the value of securities going down and potentially high inflation,” Pearson says. “People need to determine how much they will need from a cash-flow standpoint. They aren’t giving away as much or being as free with it as in the past.”

One benefit of lower asset values is that what is valued at $13,000 now may have been valued much higher before and soon will be again. So you are able to give away assets tax-free that may appreciate greatly.

“One thing we noticed very quickly is that one of our larger clients said he was thinking about gifting some of his business, whose value has dropped significantly,” says Sachs. “Gifting a business, real estate or an investment portfolio is much more attractive now based on valuations. That may be the biggest nugget you see out of this.”

Trusts and insurance

The current climate of near-record low interest rates makes Charitable Lead Trusts, or CLTs, attractive estate-planning vehicles, experts say.

A CLT lets you donate the income stream from an asset to a charity for a set number of years. At the end of the period, you can give the asset to your heirs. You can set up the trust to lower the value of your estate (a nongrantor trust) or to take a tax deduction (a grantor trust).

When interest rates are low, the tax deduction is larger on a grantor trust. So now is a good time to form one. “If you want to get something to your kids, you can practically give it away,” says Boone.

Many wealthy people buy life insurance as part of estate planning. The idea is that after the estate owner dies, the insurance policy will finance estate tax payments and perhaps living expenses for the heirs.

Azis says that with estate values dropping as a result of slumping financial and real estate markets, “I am seeing a decrease in interest to buy life insurance. Before you may have needed a $10 million policy. Now you may only need $6.5 million.”

Social Security and income taxes

The weak economy is having an indirect effect on estate planning through Social Security. Low inflation has led to a two-year freeze in the cost of living adjustment for Social Security benefits. That means some people may have to maintain a higher estate value to make up for the income they would have received from increases in Social Security payments.

Another issue affecting estate planning is general income tax policy. President Barack Obama hopes to increase the top tax rate, now 35 percent. “One thing is fairly certain,” Azis says. “We will at least see higher income tax rates for the wealthy.”

So if you’re giving money to charity to protect your estate from taxes, you may want to wait until next year, when you will receive a larger deduction for the charitable contribution, assuming your tax rate indeed rises.