How to Plan Around Estate Tax Uncertainties

After the federal estate tax exemption doubled in 2017, the number of tax-paying estates fell. In fact, according to Tax Policy Center estimates, less than 0.2% of individuals who died in 2023 will have taxable estate tax returns.¹ "For the past few years, most people haven't had to worry about estate taxes," says Bob Barth, a director of the Tax, Trust, and Estate Group for Schwab Wealth Advisory. But looming tax changes could alter that.

Unless Congress extends current tax law, estate tax exemptions—$13.61 million per individual and $27.22 million per married couple in 2024—will revert to pre-2017 levels, effectively cutting them in half in 2026. And regardless of what happens at the federal level, you could still face additional estate taxes if you live in one of the 12 states (or the District of Columbia) that levies them—the lowest of which kicks in at $1 million.

"With all the what-ifs around estate taxes, it's important to have a plan in place that will protect your heirs, come what may," says George Pennock, a director of the Tax, Trust, and Estate Group for Schwab Wealth Advisory. Here, Bob and George highlight three trust types that can help.

How it works: When one member of a married couple passes away, the couple's assets are separated into two trusts:

• A survivor's or "A" trust, which is revocable (meaning it can be changed) and belongs to the surviving spouse.
• A bypass or "B" trust, which is irrevocable (meaning it can't be changed) but can provide income to the surviving spouse before being passed down to the trust's beneficiaries tax-free upon the surviving spouse's death.

Who it's for: An A-B trust can help minimize estate taxes for heirs. Thanks to the unlimited marital deduction, spouses don't pay estate tax on assets inherited from each other, which allows an individual to transfer an unrestricted amount of assets tax-free to their spouse at any time, including at her or his death. "However, over time, appreciation alone can easily push a sizable estate over the estate tax exemption for your heirs," Bob says. "By moving some of those assets into a bypass trust at the time of the first spouse's death, they're excluded from the surviving spouse's estate even as he or she derives income from it." 

The bypass trust can also help preserve the generation-skipping transfer tax exemption, which may be relevant to future generations after the surviving spouse's death. "Often, a lot of people solely focus on estate tax and what happens when the grantors die," George says, "but an A-B trust also considers the income and estate taxes beneficiaries may face."

How it works: The GRAT's creator transfers assets into a fixed-term, irrevocable trust. During the term (of at least two years), the creator receives annuity payments that pay the value of the assets back to them in their entirety—plus a fixed interest (or "hurdle") rate set by the IRS. When the term expires, any growth in the invested assets over and above the hurdle rate passes to the trust's beneficiaries without gift or estate taxes. 

However, naming grandchildren as a GRAT's beneficiaries could trigger generation-skipping transfer taxes, so consult a tax professional before making any decisions.) In addition, if the creator passes away before the term ends, the value of the remaining assets, including earnings, will be included in her or his taxable estate.

Who it's for: A GRAT is most useful for those with assets that are likely to appreciate substantially during their lifetimes, such as a closely held business, real estate, or stocks. "A GRAT allows you to move some of that appreciation out of your estate, thereby reducing its overall size," George says. "And if the assets don't appreciate as expected, the GRAT's 'substitution transaction' provision allows you to swap them out for assets of equal value that may appreciate more during the annuity term." 

"By stringing together successive two-year GRAT's," Bob adds, "it's possible for you to move substantial appreciation of these assets out of your future taxable estate."

How it works: This irrevocable trust distributes a portion of the donated assets—at least 5% annually but no more than 50%—to its creator or another beneficiary for a specified term (or life). At the end of the term or the creator's death, the remainder goes to one or more designated charities. There are two main types of CRTs:

• Charitable remainder annuity trust (CRAT), which distributes a fixed annuity amount each year and does not allow additional contributions.
• Charitable remainder unitrust (CRUT), which distributes a fixed percentage of the trust assets annually and does allow additional contributions.

Who it's for: Those who want to generate income for themselves or their heirs can use a CRT to reduce the size of their taxable estate. "The beauty of charitable gifts is that they don't eat into your estate tax exemption," Bob says. "And with a CRT, you can receive an immediate partial tax deduction on the portion of the assets earmarked for charity, which must be at least 10%." What's more, putting highly appreciated assets into a CRT preserves their full fair market value because the trust is not required to immediately pay capital gains taxes on the sale of those assets. Instead, the income recipient will owe taxes on any gains when the trust distributes them.

Estate taxes are always a moving target, so it's important to revisit your estate plan—including your trust provisions—regularly. "With possible legislative changes on the horizon, it's wise to keep in close contact with your team—accountant, attorney, financial consultant, tax advisor, trust and estate professional, etc.—who can help you think through your options and keep your overall planning on track," George says.