Case Studies and Articles

Creative Estate Planning When the Stock Market Declines – Vaughn Henry & Associates

Creative Estate Planning When the Stock Market Declines – Vaughn Henry & Associates

Making the Most of Market Declines

Vaughn W. Henry

Not all stock market gyrations are bad things. Recent declines in equity portfolio values actually may present some excellent opportunities for estate and gift planning. The IRS and Congress have been trying to tighten restrictions on “estate compression tools” (legal structures that deflate an asset’s fair market value), especially Family Limited Partnerships (FLP) with exclusive holdings in publicly traded stock. The feds’ argument is that publicly traded stocks have an established value, are easily partitioned, and that significant discounting taken for minority interests, lack of control and lack of marketability in those limited partnership units is abusive. On the other hand, the FLP with land and closely held businesses probably will not have difficulty using those same legitimate discounts. However, partnerships with cash and liquid assets may need more care in handling those assets. What other options exist to pass family wealth? Consider a lead trust. Why? The long awaited bull market correction presents an ideal opportunity to gift assets that have intrinsic worth, but are temporarily at a lower value without a lot of legal mumbo-jumbo. A stock portfolio of $1 million that suffers a 25% – 35% decline due to erratic and unjustified market behavior has presented the owner with a legal and timely way to trim the family’s estate and gift tax bill. The old adage about striking while the iron is hot is sure true in today’s financial environment.

Other than traditional outright gifts to heirs, the combination of the government’s low Applicable Federal Mid-Term Rate (ยง7520 120% Annual AFR) and the stock market decline means that a Charitable Lead Annuity Trust (CLAT) presents some very exciting ways to pass wealth to family. The added benefit is that of meeting philanthropic interests at the same time. The lead trust is a reciprocal version of the more popular Charitable Remainder Trust (CRT) in that a charity receives a stream of income from the lead trust and after a period of time, the remaining assets pass back to family or heirs at a significant discount. Create these trusts far enough ahead of time and inheritances pass with no tax cost at all. And since the assets placed into trust were in a temporary decline because of market fluctuations, the family inherits a solid portfolio with the capacity to grow significantly. If the charity receiving the trust payments is a donor advised fund inside a community foundation, charitable distributions can enhance family influence and support. The goal of preserving family wealth is not to protect just the hard assets, but to provide opportunities for the family to wield clout in a community and to continue a positive family legacy.

How would it work? George Smith (55 years old, married with 3 children) had a well-balanced and diversified portfolio worth $1 million in July, and in September, after his average values had declined 35%, his portfolio was worth $650,000. George felt his portfolio held some outstanding stocks and viewed this as a buying opportunity, but he wanted to solve estate tax problems too. Advised to think strategically and solve several problems at one time, George created a nongrantor charitable lead annuity trust with his temporarily depressed portfolio. The CLAT stipulated that 8.9% of the initial fair market value be paid out in a monthly annuity to his donor advised fund at a national community foundation. In this way, he funded his charitable interests through his family’s donor advised fund and after 20 years, the portfolio and all of its growth will pass to his family at zero cost in estate taxes. The family’s only cost was to wait for assets they were in line to inherit anyway. By passing assets without any tax cost, the appreciated portfolio is expected to be worth $1.84 million if the underlying funds just experience average market performance, and this will save the family over $1 million in unnecessary estate taxes. Additionally, his 8.9% his charitable gift fund payment of $57,850 for 20 years will provide for his discretionary philanthropic interests in a very tax efficient manner.