By Keven DuComb, , JD, MBA
Senior Financial Planning and Estate Specialist, Altfest Personal Wealth Management

We understand dentists’ financial lives can be complex; one important aspect of helping you manage that is crafting, and then regularly reassessing, your estate plan.

At Altfest Personal Wealth Management, we promote intentional and multi-generational estate planning. This means we encourage clients to think about what their estate looks like for the next generation and the generation beyond that, and how to achieve the best overall result. We encourage people to stop thinking there’s a one-size-fits-all estate plan, so I’d like to share some ways to custom- design yours.

With this goal in mind, here are four common gifting trusts we recommend for dentists like you and their families. We’ll also talk briefly about how to use these vehicles for creditor protection.

Irrevocable Life Insurance Trust (ILIT)

The first trust we often investigate for clients is called the Irrevocable Life Insurance Trust, or ILIT. As the name implies, it involves an insurance product. In some cases, there is a question of insurability, so depending on what stage you are in your life, this might mean the ILIT isn’t the right choice for you.

But for many dentists and other high-net-worth individuals early in their careers, this can be a good estate planning strategy. You may not have a large estate yet, but you know you’re earning significant annual income and plan to grow and save that. If you start an ILIT early in your working life, you can often purchase the policy for less while you’re younger and healthier and accrue a nice benefit for being proactive.

With an ILIT, you start with a trust shell. It’s created to own the policy that is purchased on your life, or in some situations, on the joint lives of you and your spouse. There are annual premiums to pay, so gifts can be made to the trust to cover this expense, often through what’s called the “Crummey power” notice procedure. This trust provision allows a gift that would otherwise be a future gift to be treated as a present one, making it eligible for the annual gift tax exclusion. In other words, these gifts you’re making into the trust are tax-excluded gifts up to $16,000 per year. (The annual gift tax exclusion rule currently lets anyone gift $16,000 per year per person. There are no recordkeeping requirements, it’s completely tax-free and tax-exempt. This amount is going to increase to $17,000 per person in 2023.)

When the ILIT owns a policy on your life, the policy’s death benefit is removed from your estate, so it doesn’t impact estate taxes the same as it does when you own the life insurance policy.  Thus, this simple change immediately reduces or potentially eliminates estate tax exposure.

In addition to estate tax savings, all ILITs provide the two main benefits that any life insurance product provides, namely that you should be able to leverage premium payments into a higher death benefit and the death benefit remains tax free to your beneficiaries.  Unlike standard ownership, though, the premium payments, themselves are removed from your estate when transferred into the trust.  In a way, you get a triple tax benefit from using an ILIT. So, even for those who don’t currently have high-enough incomes or assets to have concerns about owing estate tax, ILITs may still be the right choice.

When you use an ILIT, it removes the death benefit’s value from your estate, and it doesn’t count against it in the same way owning a life insurance policy in your estate does. If you’re setting up an ILIT to avoid or mitigate estate taxes, you’ve got those added benefits.

Last, and especially for clients such as dentists, you may have estate tax concerns because of the value of your practice even though it is an illiquid asset. ILITs can be used to provide liquidity in this case because the death benefit goes into your trust, as discussed, and your trustee can use that to purchase your practice out of your estate after your passing. The trustee can then either transfer the business to the next generation or other people in your practice or sell the practice to realize proceeds that are passed on to your family.

By doing this through the ILIT, your estate can proceed efficiently and pay any final expenses and taxes, while your trustee can handle more complex matters like the sale of your practice. That is preferrable to having the practice stuck in probate and needing a court to approve a sale, for instance. In short, an ILIT can really streamline the estate-settling process and bring down costs and headaches for your loved ones.

Intentionally Defective Grantor Trust (IDGT)

The next estate planning method we discuss with dentists is called the Intentionally Defective Grantor Trust, or IDGT. These trusts are the most common way to trigger the lifetime gifting exemption and to potentially avoid significant estate tax down the road. As you may be aware, currently, on the federal level, a single person has an exemption amount of $12.06 million, a married couple has $24.12 million (both will rise further in 2023). This is the highest these exemption amounts have ever been in the United States. However, the current law contains a “sunset” after 2025, which would effectively cut the exemption amounts in half and could pose taxation burdens for many dentists’ estates.

Again, with and IGDT, there’s an irrevocable trust shell used to receive the gift from you, then the trustee will manage those assets for your designated beneficiaries after your death.

The “defective” aspect here is that the trust remains what’s called a grantor trust for income tax purposes. That just means all the income, dividends and capital gains, if any, in the trust are still taxed back to you as the grantor and creator of the trust. Generally, this is considered an added benefit because although it’s a legal obligation to pay those taxes, it’s effectively an additional gift to your descendants by either keeping your estate value in check or lowering it by virtue of paying the taxes on assets that are actually outside of your estate.

Qualified Personal Residence Trust (QPRT)

Another vehicle that helps many dentists and similarly situated clients at Altfest is the qualified personal residence trust, or QPRT. In this strategy, a private residence and/or a vacation home is removed from your estate value and protected against future estate taxes, but at a discount.

The QPRT is a strategy that’s even more beneficial when interest rates are higher, as they are now, because it’s going to discount the gift even more dramatically than when rates are lower. The basic structure, again, consists of a shell irrevocable trust to receive a gift — in this case, a personal residence. Note: you can’t use an active investment property in these types of trusts, and you’re also limited to only two QPRTs at a time.

Some clients will address the value of their primary residence and then a vacation home in this way, but we tend to see the vacation home as the optimal choice for this strategy. Once you’ve identified that this is a promising opportunity for your property, you must choose a potential term of years for the QPRT. The longer the term, the bigger the tax discount you receive, but there’s a trade-off. If you don’t survive the term, the tax code states you didn’t do anything at all, and the property goes back into your estate. So, your survivors potentially have to pay the estate taxes on it despite your best efforts. But if you survive the QPRT term, that’s when the official transfer occurs and everything at that point is out of your estate, including all the growth from the initial date that you put the residence into the trust.

As an example, let’s say there’s a couple with a $6M vacation home who select a 10-year QPRT term, and both have approximately a 21-year life expectancy. Surviving that 10-year time period, the owners only use $3.56 million of their ~$24 million federal estate taxation exemption even though they’re transferring what is really worth $6 million (plus all the appreciation over 10 years) out of their estate. This is due to the IRS discounting rules, and the decade-long term of years they have to survive.  In the end, it provides nice leverage to the gift relative to making an outright gift just to get assets out of their estate. After the term ends, the couple can continue to use the property by renting it from the new beneficiary owners. (Some clients prefer not to assign their primary residence to a QPRT because of the ultimate need to rent their house from, say, their adult children.) But the effect is similar in some ways to the defective grantor trust and paying taxes Because the rent is a legal obligation allowing you to move more money out of your estate to your beneficiaries without impacting your available estate tax exemption.

Grantor Retained Annuity Trust (GRAT)

A final estate planning choice to consider is called the Grantor Retained Annuity Trust, or GRAT. While it is often associated with extremely wealthy clients, there are uses for this vehicle even if you don’t have an exceptionally large estate.  Generally, it is useful any time you believe you have an asset that can appreciate significantly over a somewhat short period.

Most clients end up using a so-called Zeroed-Out GRAT. That’s a GRAT that you fund with the expectation of getting back more or less the exact amount you put in it, as an annuity. So, for clients that already used up all their gift and estate-tax exemptions a Zeroed-Out GRAT is still effective because technically they’re getting back the amount of money that they put in, so they’re not deemed to use any estate tax exemption. At the end of the GRAT term, all of the growth of the assets is left to your desired beneficiaries tax free.  Unlike QPRTs, GRATs are better when interest rates are low, because in addition to the amount you contributed to the trust you must receive interest at a set rate based on IRS rules, so to leave significant growth for your beneficiaries your trust assets must grow more than the interest rate. But if you own something that you’re confident is going to appreciate significantly, even though we have higher rates right now, a GRAT could still be a viable solution.

Creditor Protection Strategies

I also advise clients like you on ways to achieve creditor protection. Two types of trusts that can do this are called the Domestic Asset Protection Trust (DAPT) and the Spousal Lifetime Access Trust (SLAT). In particular, the DAPT is an emerging trend around the country. It is a specialized trust created under state statute but if funded properly, the trust will protect assets from your personal creditors even though you can technically still benefit from the trust in the future.

Note that extreme caution is needed in New York which not only does not have a DAPT statute but has a statute stating that DAPT-like trusts are ineffective. However, there’s also an argument that a state like New York can’t necessarily invalidate something that’s properly created in another state. Even if you are a resident of a state that doesn’t have these statutes, you are allowed to create them in other states, and you have a trustee that’s in that other state. So, there could be some value having a DAPT in the event of a malpractice claim or lawsuit.

On the other hand, a SLAT is basically an ILIT where one spouse is Grantor, and the trust holds a life insurance policy on the life of that spouse while the other spouse is a permissible beneficiary of the trust.  Typically, the trust would own a permanent life insurance policy with some cash value and the trustee would have discretion to pull from that cash value and make a distribution to the non-Grantor spouse. Certainly, as a married couple that benefits both of you, even though it’s not directly benefiting the Grantor spouse.

But what about a potential divorce? Or what if the beneficiary spouse passes away first? At those points, the SLAT reverts to a trust that is held for the benefit of your future beneficiaries and works more like either the ILIT or IDGT discussed earlier.

Find out more

We hope learning about these estate planning strategies and suggestions for creditor protection can help you start considering how to achieve the best plan for you and, ultimately, for your loved ones.

Learn more about how Altfest’s advisors have helped countless dentists shape a custom estate plan that’s intentional and satisfying. If you have specific questions or concerns about you and your family’s situation, please book some time for a complimentary consultation.

 

 

Investment advisory services provided by Altfest Personal Wealth Management (“APWM”). All written content on this site is for information purposes only. Opinions expressed herein are solely those of APWM, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.