Terms like “reverse estate planning” and “backdoor spouse planning” are becoming part of the new lexicon for estate tax advisers as millionaire clients live into their late 80s and beyond.
A central tenet of estate tax planning involves giving up control of assets, to remove them from an estate and lower the eventual tax bill. But if people plan too aggressively, too early—and live longer than they were expecting—they risk giving away too much to beneficiaries and forfeiting the lifestyle they’ve grown accustomed to in later years.
It gives rise to situations where “the kids are flying first class, and the parents are stuck in the middle seat in coach,” said William I. Sanderson, a partner and co-chair of McGuireWoods LLP’s private wealth services group in Washington.
The average life expectancy for a person living in the U.S. decreased to 78.6 years in 2017—the most recent year available from the Centers for Disease Control and Prevention. But studies paint a very different picture for the very wealthy.
Among men born in 1960, those in the top one-fifth by income could expect to live to age 89—12.7 years longer than men in the bottom fifth. For women born that year, the gap was 13.6 years, according to a 2015 study from the National Academy of Sciences.
“Because clients are living longer, I often find myself advocating for less tax planning,” Sanderson said. His philosophy is driven by an experience he had early in his career where an older rich couple hired his law firm to “reverse estate plan”—bring back assets from trusts and children because the couple had “effectively been pushed out of their own wealth.”
Jessica Galligan Goldsmith, co-managing partner of Kurzman Eisenberg Corbin & Lever LLP, has seen a similar trend in her practice.
“People used to do a lot of wealth transfer planning when they were in their 60s, and I’m seeing people waiting longer to focus on transfers of wealth to the next generation or generations,” said Goldsmith, who is chair of her firm’s trusts and estates department. They’re not as willing “to simply give up large chunks of wealth because there’s more concern that they will ultimately need some back.”
‘Turn Off’ Switch
One way that the rich are planning for longer lifespans is by making tried-and-true estate planning techniques more flexible.
For grantor trusts—where the creator of the trust pays the income tax on its assets—it’s important to be able to “turn off” grantor trust status, Sanderson said.
Over a long lifespan, the person who created the trust may not have the cash flow to pay income tax on assets they don’t have access to, he said.
“So monitoring grantor trust status is critical as clients live longer because in those later years it could become a real drag,” he said.
When grantor trust status is turned off, the income tax is paid directly out of the trust.
Making Plans Flexible
There are also several other ways the wealthy can make their trusts more adaptable, Sanderson said.
A grantor can’t amend an irrevocable trust’s terms—the beneficiaries, the terms of trust distributions, and the people chosen to serve in various fiduciary roles—after it has been created without jeopardizing the estate tax benefits.
But when drafting the terms, that individual can appoint trust protectors or advisers—typically credentialed and independent third-parties—who can modify things like distribution standards to adapt to the changing circumstances of the family, such as divorce.
Decanting, the ability to move assets from one trust into another, is permitted in some states and requires similar forethought. If the trust is set up in a certain way, trustees—the individuals who manage the property in a trust and carry out its terms—can move the trust’s assets into a newly created trust structured in a way that makes more sense for the family.
These types of tools become more important as the people who create the trusts see more of their children’s and grandchildren’s lives.
The longer a person lives, the more they see certain scenarios play out, Goldsmith said.
“And what you thought was your daughter’s fantastic marriage, 20 years later you’re still around and you see them getting divorced,” she said.
‘Backdoor’ for Spouses
Another way the wealthy can plan for longer lifespans and potential “donor’s remorse” is by using planning techniques that allow a spouse to remain a beneficiary of a trust.
One common tool is the spousal lifetime access trust. This is created by one spouse for the benefit of the other as well as additional family members—for example, children and grandchildren.
By maintaining the spouse as a beneficiary, a client can gain “backdoor access” to the assets in the trust if he or she wants or needs them back due to unforeseen circumstances, such as living longer, Goldsmith said.
She said her firm has started to see a lot more “backdoor spouse planning.”
Preparing for Incapacity
People who live longer are more likely to suffer from long-term illnesses related to old age, such as Alzheimer’s.
Wealthy clients are increasingly starting to plan for that, Goldsmith said.
“You can go through millions of dollars over a 10- or 15-year illness,” she said. “It can definitely ravage a lifetime of savings.”
From a tax planning perspective, one challenge arising from incapacity is ensuring that decisions regarding wealth transfers and trusts are being carried out in a way that aligns with the sick person’s wishes, Jeffrey K. Eisen, an estate tax partner at the Los Angeles office of Mitchell Silberberg & Knupp LLP who has represented the estates of celebrities including actress Farrah Fawcett.
“And if it is what they would have wanted, is there an ability to do it?” he said.
To plan for this, people need to ensure that legal documents such as a power of attorney or living trust account for potential long-term illnesses, he said.
Less Concern Among Ultra-Rich
Most of these estate planning considerations matter less for individuals making hundreds of millions to billions of dollars. They often can afford to give away more early on without fear of depleting their funds to a point where their lifestyle is affected, practitioners said.
Take gifting post-tax reform.
The 2017 tax law, by temporarily doubling the estate tax exemption, created a tax planning opportunity that only the extremely wealthy are able to fully seize. The higher exemption means in 2019 individuals can transfer up to $11.4 million to beneficiaries without paying estate tax at death, and a married couple can transfer twice that at $22.8 million.
Some people have been hesitant to make use of the entire increased exemption amount because they would have to give up control of so much of their wealth. But for clients with more than $100 million, “I’m not seeing that reluctance,” said Jenny Hill Bratt, a partner at Withersworldwide focused on U.S. and international estate and income tax planning.
So when it makes sense, people should plan, Sanderson said.
“Intensely wealthy families” with hundreds of millions of dollars can easily give away more than $22 million and reap the full estate tax benefit while the higher exemption is in place, he said.