Recently I was thinking about the estate tax exemption cliff that will happen at the end of 2025 and the rule of 72. We have many clients in the medium to large category regarding the size of their estates that may benefit from more advanced estate planning techniques with a guise towards the future expectation of growth in their estates.

It may be easy for people that have a middle-sized estate to think that they don’t need to worry about estate taxes due to the large $12.06MM current estate and gift tax exemption, but with the value of so many things going up due to inflation such as real estate, many more people could be subject to the estate tax after 2025 when the exemption is set to sunset to $5 million with an index for inflation.

You may have already heard of the rule of 72, but if not, I’ll give you a Cliff Notes definition. Basically what this general rule describes is how long an investment will take to double given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can obtain a rough estimate of how many years it will take for their initial investment to double.

Rule of 72

For example, let’s say your investment accounts have generally gone up by 8.5% over the last decade. In this example, the rule of 72 basically states that your investments will double their original value in about 8 1/2 years. Many clients fall into this type of category when you look at the types of assets they own. 

Though we never know with 100% certainty what the estate tax laws will be when someone passes, there are proactive things we can do to try to push some of the value of their estate outside of their taxable estate in order to allow that growth to occur unencumbered by estate taxes. One of the techniques we often talk with clients about is setting up some form of an irrevocable grantor trust for the benefit of children, grandchildren, a spouse or other beneficiaries. 

Even if you’re not ready to make a major gift to one of these trusts yet, it may be wise to set one up now and fund it minimally so that it is ready to go down the road before the estate tax exemption cliff in 2025 when the exemption is expected to fall. All or a portion of the estate tax exemption can be utilized through gifting before then. Assets can also be sold to a Grantor trust as well as gifted and valuation discounts can be utilized in some situations.

The real power attached to setting up an irrevocable grantor trust and making a completed gift to the trust is that you can “freeze” the value of the assets being transferred, “squeeze” the estate through valuation discounting in certain situations and you can “burn” the taxable side of the estate by allowing the trust grantor to continue to pay the income taxes generated by the assets contributed to the Grantor trust. And your generation-skipping transfer tax exemption can be allocated to the gift to the trust allowing the assets to grow in value inside the trust and eventually pass on to the next generation unencumbered by estate taxes.

If you think there’s a chance that your estate or that of a friend or family member’s estate could grow in value based on their life expectancy and be subject to estate taxes, please give us a call now at (760) 448-2220. We are happy to share more information about the above strategy and others that may be appropriate to help curtail or even eliminate potential future estate taxes in addition to protecting beneficiaries from creditors, predators, and divorcing spouses.

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