Crucial wealth preservation strategies for 2023

We have all heard the quote: "In this world, nothing is certain except death and taxes."

Unfortunately, when it comes to protecting wealth, high net worth individuals should add to that list the increasing risks of lawsuits, divorce and irresponsible family members.  

Given the present realities of economic uncertainty and volatile markets, proactive wealth preservation strategies are more important than ever before. Teams that counsel wealthy clients — which usually include a wealth advisor and an attorney well versed in income, estate and gift tax planning strategies — should be aware that there are crucial tax-planning strategies that can provide the dual benefit of creditor protection. 

Wealth preservation plans for high net worth individuals often involve the creation of one or more entities including limited liability companies, limited liability partnerships, corporations and the like. Transferring client assets, such as marketable securities and/or real estate, into such entities may be desirable. That's because, depending on applicable state law, the use of such entities can provide a layer of protection from certain creditor claims that could materialize in the future, potentially keeping an individual's total net worth from becoming susceptible to the satisfaction of such claims. 

Note that it's crucial to implement such strategies far in advance of any potential claim. If a claim is reasonably foreseeable or imminent at the time of an asset transfer, the transfer could be reversed. Worse yet, it could potentially be deemed a "fraudulent transfer." In such a circumstance, any potential protection from a creditor claim could be lost, among other risks. 

These structures have the additional benefits of centralizing the management of assets and as a teaching tool for successor generations including children and grandchildren. Such education can work wonders against long-term extravagance and wasteful spending.

Generation-skipping transfers
Entity-based planning also creates a vehicle by which an individual may engage in wealth transfer through a highly efficient use of an individual's estate, gift and generation-skipping transfer (GST) tax exemption amounts. Under current law, each individual possesses an estate, gift and GST tax exemption of approximately $12.9 million, indexed for inflation. Married couples may shield approximately $25 million in net worth from estate tax. 

However, any net worth over this amount could be subject to a 40% estate tax. Assuming proper planning, estate tax liabilities are typically deferred and only become due and payable upon the death of the surviving spouse. Nevertheless, in terms of wealth preservation planning, the ability to minimize or potentially avoid a 40% estate tax on a substantial net worth is obvious.

These historically high estate, gift and GST tax exemption amounts are set to revert to prior lower levels in 2026. As a result, this is a unique window of time in which wealth transfer planning could be particularly advantageous to hedge against future taxes. 

An individual should consider the gifting and potential sale of their assets to an intentionally defective grantor trust (IDGT) or, if family circumstances so dictate, a spousal lifetime access trust (SLAT). The gift of an interest in an entity is an attractive asset for wealth transfer planning. 

A client could, for example, begin to gift non-voting ownership interests in an entity to an IDGT or SLAT. The gifting would require a valuation as of the date of the gift, and the gift would reduce the individual's estate and gift tax exemption amounts. If the interest in the entity transferred is illiquid, lacks control over the entity as a whole or would be generally undesirable in the eyes of a hypothetical willing buyer for various reasons, the valuation of the interest can be discounted significantly. Common discounts include lack of control and lack of marketability. The discounting of the value of an interest in an entity, when compared to the entity's underlying net asset value, for example, can be significant. 

Additionally, once the interest is transferred to the IDGT or SLAT, any subsequent appreciation in value grows in the IDGT or SLAT and outside of the taxable estate for estate tax purposes. This ability to shift years of growth of an asset outside the taxable estate and avoid a 40% tax on the transferred asset in the future can be tremendously beneficial. IDGTs and SLATs are also irrevocable trusts, which, when properly structured, provide wealth preservation benefits. 

Generally, the assets of the IDGT or SLAT are not subject to the claims of creditors of the grantor of the trust or the trust's beneficiaries, depending on the nature of the claim and the law that applies to the trusts. Such protection could become critically important in the future.  

Wealth preservation planning is, of course, not a one-size-fits-all approach and the devil is in the details of any plan. But one thing is certain: Failure to properly plan can leave an individual's wealth unnecessarily exposed, eroded or ultimately lost. With proper planning, such risks can be minimized or avoided entirely.