Reduce Taxes Across Generations with Irrevocable Trusts

By: Brian Seay, CFA

Minimizing the estate taxes each generation of your family owes is a major factor in long-term wealth preservation. The top estate tax rate is 40%, which may create significant tax bills for families that have not planned and hold assets above the 2024 estate tax exemption of $13.6 million per person ($27.2 million per couple).

Where do you start to reduce the estate tax burden?

One of the most important strategies is moving assets to the next generation sooner rather than later. This allows assets to grow outside of a wealth creators’ estate. When assets are shifted to family members using a trust, estate taxes will still be owed on the current asset value that is transferred. However, any future appreciation is now owned by the next generation. Over several decades, assets will likely be worth substantially more than the amount that was initially transferred into a trust. All the future growth is shielded from the initial wealth creators’ estate and potential taxes. Think about transferring family business stock, publicly traded stocks, private equity interests or any other assets with significant growth potential.

How are assets transferred?

Assets are often transferred using Irrevocable Trusts. There are many variations that can be used to solve specific wealth transfer, income, and tax goals. The person funding the trust may continue receiving income from the trust.  The grantor may also be able to pay taxes on behalf of the trust, which leaves more assets for the next generation of beneficiaries. Swap provisions can also be utilized to allow assets to move between the trust and the creator’s direct ownership, allowing some assets to receive a step-up in basis when the wealth creator passes away. The trust may also include provisions about future distributions to family members. These provisions can delay distributions to certain ages or even limit them to specific activities, like buying real estate or starting a business. So, while the trust creator cannot “take the money back,” they can retain some control through the provisions in the trust.  

Grandchildren and beyond

Trusts can also be established as “Dynesty Trusts” in some states. In these situations, the trust is intended to hold assets for several generations and shares are created to be distributed to future heirs. The goal is to maintain assets in the trust rather than have them included in the estates of future family members. Over several generations, this structure can meaningfully increase the assets available to the family to accomplish their economic and philanthropic goals.

Training Ground

Trusts can also provide an excellent training opportunity for younger family members. They may be directly involved as co-trustees, or they may simply be participating in meetings and the decision-making process. They can meet with tax planners, attorneys, and investment advisors about the trust to develop their own understanding of the family’s economic, charitable and other goals. By watching the Trustees steward the assets over time, younger family members will be ready when they become formal Trustees or receive distributions.

To recap, the primary purpose of an irrevocable trust is to shift FUTURE growth downstream to younger family members. To maximize the opportunity, planning early when asset values are lower is key. We encourage families to start having long-term planning conversations well before their assets exceed the estate tax threshold so that they can begin using strategies to minimize taxes.

If you would like to start a conversation with a professional about your family’s situation, please schedule a call here. We would be happy to share our expertise and experience!