You've worked a lifetime to build your wealth and understandably want to pass much of it on to your loved ones. Estate plans are designed to help you do that in the most tax-efficient way possible. But first, to ensure you have something to leave, your estate plan should protect and preserve your assets. Here's how it can do that.
Using the Gift and Estate Tax Exemption
Traditionally, asset protection strategies have focused on avoiding or minimizing federal estate tax liability. Although estate taxes remain a concern for some families, most can find sufficient tax shelter under the current estate tax exemption amounts. However, be aware that taxes on estates may still apply at the state level.
For example, the Tax Cuts and Jobs Act (TCJA) hiked the unified gift and estate tax exemption to $10 million (subject to inflation indexing) for transfers to nonspousal beneficiaries and for assets passing tax-free to a spouse under the unlimited marital deduction. The indexed exemption amount for 2021 is $11.70 million. Also, portability effectively allows couples to double this tax shelter to $23.40 million. (Bear in mind, however, that the exemption amount is scheduled to drop significantly in 2026 unless Congress acts.) Finally, you can still use the annual gift tax exclusion of $15,000 per recipient in 2021. Thus, you can simply "gift" assets to your loved ones, realizing the estate tax benefits of the exemption and gift tax exclusion amounts.
For some, asset protection is as easy as that. But this simplified approach requires you to give up control of those assets during your lifetime, which might not be desirable or feasible. As a result, more complex techniques may be preferred.
Types of Trusts
Frequently, trusts are featured in an asset protection plan. The traditional bypass (or A-B) trust — which was created mainly to avoid federal estate tax — remains a viable option. Such trusts offer protection from creditors, while continuing to provide tax shelter. Other trusts that can help preserve assets include:
Spendthrift trust. This can be established for a beneficiary who isn't qualified to manage investments or might indulge in spending sprees. An independent trustee assumes the financial management responsibilities.
Qualified terminable interest property (QTIP) trust. QTIPs enable grantors to provide an income stream for a surviving spouse while still determining the disposition of the trust assets when the spouse dies. This enables a surviving spouse to maintain a comparable lifestyle. A QTIP trust is often used by someone who has remarried and has children from a prior marriage. The children typically receive the assets when the trust terminates.
Domestic asset protection trust (DAPT). These types of "self-settled" trusts have been growing in popularity because the grantor personally benefits from the income. The main objectives are to provide protection from creditors and retain control over the assets. Accordingly, DAPTs may be used when there's a divorce or spendthrift concerns. Currently, at least 19 states have enacted legislation authorizing DAPTs. Ask your estate planning advisor whether your state is one of them.
Considerations for Business Owners
Asset protection is also vital to business owners. Sole proprietorships and general partnerships can be risky because the owners' personal and business assets aren't separate. So if someone were to sue your business, you could potentially lose your home, car and personal financial accounts in a court-ordered settlement.
Depending on your situation, you might form a company as a C corporation to protect your business assets or as an S corporation providing partnership-type taxation. A limited liability company or limited partnership may also be options. There are many factors at work, so choose your business form carefully.
Your Unique Situation
Your estate plan should be as unique as you are. Work with an advisor who will consider your specific wealth preservation needs, as well as other concerns such as taxes and leaving wealth to your family.