Minimizing a Wealthy Client's Tax Liability

Austin Kilham for the Wall St. Journal writes: The 66-year-old widow had been a client of adviser Jay Wertz since her husband died in 2007, leaving her with had an estate worth $30 million.  Since then, one of her major goals was to minimize the tax liability on her estate and gift as much as possible to her four children while she was still alive.  "All the good investment management in the world doesn't make sense if it's not integrated with effective estate planning," says Mr. Wertz, director of Wealth Advisory Services at Cincinnati-based Johnson Investment Counsel Inc., which manages $6.5 billion for 3,200 clients.

Mr. Wertz says that upon his client's death, the tax liability against the estate would have been nearly $10 million. Then, after the market crash of 2008, Mr. Wertz saw a way to greatly reduce that burden by using zeroed-out grantor annuity trusts (GRATs).

GRATs allow an individual to gift assets to a trust with a set term, which then pays an annual annuity based on an Internal Revenue Service-set interest rate over the life of the trust. If the assets appreciate at the end of the term the grantor will have received back the equivalent of his or her initial gift, plus interest, thus eliminating any taxable gift for the trust's beneficiaries. However, anything left in the GRAT after the annuity payments can be left to the trust's beneficiaries tax free. If the assets don't appreciate, they revert back to the grantor's estate.

Mr. Wertz notes timing makes all the difference with GRATs: When working with this widow in February 2009, the interest rate for a GRAT was 2%. And market losses in the widow's portfolio made it likely she could grant assets that had a strong chance of appreciating at a higher rate than that--leaving a tidy tax-free sum for her children.

So Mr. Wertz advised the widow to place about $2 million worth of depressed securities in a two-year GRAT and just over $3 million in depressed securities in the three-year GRAT. "People were hoarding all the assets they could get their hands on because they were afraid the world was ending, but the world didn't end, and when the assets sprang back, we were able to easily meet the required annuity payments," he says.

That's exactly what happened for the widow. With the market's rebound over the next few years, her two-year GRAT generated a return of $840,000. Even after the required annuity payments, there was more than $780,000 left in the trust that could be passed tax-free to her children. The three-year GRAT generated a $1.9 million return. After annual annuity there was $1.7 million left over.

"The beauty of this was the client's children were able to unexpectedly receive a couple million dollars that they otherwise would have had to wait until their mother's passing to receive," says Mr. Wertz.

The client was so pleased she decided to use this technique again. Mr. Wertz set up two GRATS for her that will expire later in 2013 and 2015. "This wasn't so much of a stroke of planning genius as it was good integration of wealth management and estate planning," he says.