The trust hierarchy for tax-efficient wealth transfer planning

Written in partnership with Vanilla.

Nothing is certain but death and taxes. But taxes at death don’t have to be. The right trust strategies can help wealthy families transfer assets across generations tax efficiently.

87% of clients are concerned about the impact of taxes when they pass assets to heirs,¹ presenting opportunities for advisors to deliver value through tax-efficient wealth transfer planning.

If you’re an advisor to high-net-worth families, understanding the hierarchy of trusts in the wealth transfer planning toolkit is essential. Trust structures vary by how effectively they remove appreciating assets from the taxable estate, as well as the level of flexibility and control they retain for the grantor and beneficiaries. Optimal planning frequently involves removing appreciating assets from the taxable estate as early and efficiently as possible.

This article provides a practical framework to help you navigate available planning options.

GST tax-exempt trusts for multigenerational transfers

Generation-Skipping Transfer (GST) tax-exempt trusts are powerful structures for multigenerational wealth planning. When properly structured, trust assets are exempt from transfer taxes for as long as the trust exists (under current federal tax law).

Depending on the trust’s governing jurisdiction, GST tax-exempt trusts can provide additional benefits. When trust situs (the principal place of administration) is established in a favorable jurisdiction, the term of the trust may be unlimited, and trust income may be exempt from state taxation. Additionally, some states have more favorable rules for shielding trust assets from creditors and lawsuits.

SLATs for indirect access to assets

GST tax-exempt trusts are irrevocable (generally cannot be changed or revoked). If a client is hesitant to give up access to their assets, consider structuring their GST tax-exempt trust as a Spousal Lifetime Access Trust (SLAT), which can provide the grantor indirect access by including their spouse as a named beneficiary.

Non-GST tax-exempt trusts for transfers to the next generation

A non-GST tax-exempt trust removes assets from the client’s taxable estate but does not shelter them from the generation-skipping transfer tax. This means that distributions made from the trust to an individual who is more than one generation below the grantor (e.g., a grandchild, great grandchild, etc.) will be subject to the GST tax, currently 40%. A non-GST tax-exempt trust can be useful when a client has exhausted their GST tax exemption or does not plan to transfer assets beyond the next generation.

Revocable trusts for privacy, control and incapacity planning

Revocable trusts don’t immediately remove assets from the taxable estate, but they can:

• Avoid probate and preserve privacy of a client’s wishes at death.
• Enable the client to retain more control and management of assets.
• Support incapacity planning.

A revocable trust can facilitate the deferral of transfer taxes until a surviving spouse’s death and help to accomplish other important client objectives.

Which assets should you transfer to a client’s trust?

Not all asset transfers are created equally. It’s important to align your transfer techniques with your clients’ planning goals. Consider these strategies for your clients:

• Transfer assets at a lower tax value. Gift illiquid or unmarketable assets, such as an interest in a closely held entity or privately owned business. Such assets may be valued at a discount if they can’t be easily sold or if they represent a non-controlling interest.
• Freeze asset values and move future growth outside the estate. Sell appreciating assets to an Intentionally Defective Grantor Trust (IDGT) in exchange for a note. Any future appreciation in excess of an IRS hurdle rate happens inside the trust and outside the estate. The grantor continues to pay tax on income generated by the assets, which further reduces the estate indirectly.
• Annuitize the current value and give away the upside. Transfer rapidly appreciating assets to a Grantor Retained Annuity Trust (GRAT) or a Charitable Lead Annuity Trust (CLAT). Fixed annuity payments are received annually by the grantor in the case of a GRAT, or a charity in the case of a CLAT. When the trust term ends, any remaining assets and appreciation in excess of an IRS hurdle rate passes to the remainder beneficiaries free of transfer tax.

Choosing the right trust structure starts with the trust hierarchy

Planning for the transfer of wealth isn’t just about saving on taxes. It's about building estate planning structures that last. Start with the trust hierarchy. Prioritizing tax-efficiency and layering in flexibility can have a significant impact on your clients’ wealth and legacy for generations to come.