Minimizing Taxes When Transferring Wealth

• KELLY KEARSLEY for the Wall St Journal writes:   
The client was an entrepreneur in his 60s with an estate worth about $30 million. His elderly parents had accumulated about $5 million in assets. Meanwhile, his children were just exiting college and entering the workforce.

"This is a wonderful American success story and we wanted to make sure that we minimized taxes when the time came to transfer the wealth to the next generation," says James B. Lebenthal, president of equity asset management and chief investment officer of New York-based Lebenthal Asset Management, which manages $425 million for 85 families.

Mr. Lebenthal and his team set up a sophisticated estate plan that included a dynasty trust to help accomplish those goals. The children already had UTMA (Uniform Transfer to Minors Act) accounts, and their parents had paid their college tuition. But the dynasty trust served a different purpose: Its role was to provide a vehicle for the client's elderly parents to reduce their estate through gifting, while creating a pool of assets to offset the estate-tax bill facing the father's heirs after his death.

"Between the two generations, there's an enormous amount of wealth being transferred to the kids," Mr. Lebenthal says.

The adviser recommended that the dynasty trust hold a $10 million life-insurance policy on his client, the entrepreneur, as its only asset. The grandparents would then gift their several grandchildren $60,000 each year through the trust to pay the policy's premium. They would use their annual gift-tax exclusion of $14,000 per recipient to avoid taxes, while simultaneously reducing the value of their own estate.

Mr. Lebenthal notes that the grandparents' gifts are subject to the generation skipping tax (GST), though he expects the tax bill to be nominal given the relatively small size of the gifts. However, any financial event that occurs within the trust after those contributions are made is not subject to the GST, the adviser says.

That means that once the adviser's client dies, the $10 million life-insurance benefit passes to the trust tax-free. The client's children can then use those funds to pay the taxes on their father's large estate. Or, the children can choose to leave the funds in the trust, which will continue in perpetuity to grow tax-free for the benefit of future generations.

"This creates a balloon payment to take care of the reduction in wealth that will occur when the parents die," Mr. Lebenthal says.

Mr. Lebenthal notes that dynasty trusts should be used carefully, primarily because they are irrevocable and the grantor gives up control over the assets once they are in the trust. However, this restriction didn't concern the grandparents, who did not need the money and were looking for ways to reduce their estate before their deaths.

The dynasty trust was a piece of a comprehensive plan with many moving parts that Mr. Lebenthal and his team implemented for the family. But the entrepreneur father was relieved to have a strategy that will reduce the sting of a potentially large estate-tax bill.

"The children are still a little bit unaware of what's going on, but for the first and second generation, it's a cogent plan that helps them maximize their wealth," Mr. Lebenthal says.