Matthew Erskine is managing partner for Worcester law firm Erskine & Erskine. Reach him at (508) 753-7100.
Updated: August 22, 2022
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Estate planning during a bear market
By Matthew Erskine
In April, the stock market officially entered bear market territory. Bear markets are when the market declines more than 20% below a recent market high, in this case the 52-week market high.
Why the market has declined has been attributed to many different factors, such as inflation, the energy shortages, the war in Ukraine, and so on, each contributing to investor’s fears and a desire by investors to cut their losses. In the short term, the volatility of the markets will remain, but estate planning is a long-term strategy.
Historically, bear markets are followed by bull markets, where the losses are more than recovered for those investors with the stomach to stick it out. Indeed, the best growth in the market most often comes in this subsequent bull market.
Leveraging gifts
The result is the bear market is an opportunity to take advantage of the decline in values in investments to leverage gifts to appreciate in the future, as well as take advantage of current income tax benefits.
Gifting can be done in many ways, but the most common is either to make an outright gift or to make a gift over time. Either type of gift can be structured as a trust.
In either case, the possible gift tax due is based on the fair market value of the assets transferred as of the day the transfer takes place.
If you gave away a share of Apple stock on Jan. 1, 2022, the fair market value would be $182.01.
If you gave away the same share of Apple stock on May 24, 2022, the fair market value would be $139.325, which is 30.6% less taxable value than if you gave the stock at the beginning of January.
When there is a recovery in the market, a company like Apple is more likely than not to lead such a recovery and even exceed the overall growth of the market in a recovery. In addition to the likely growth in the value of investments in a recovery, you are making a gift of the future income: dividends and interest paid by the investment.
Split-interest gifts
You can also make split-interest gifts. This is where you make a gift but split the interest in the gift between current beneficiaries and remainder beneficiaries, such as a grantor retained annuity trust, or GRAT. A GRAT is where you make a gift to a trust but retain the right to annuity for the term of the trust. Depending on the amount of the annuity, the actual gift value of the GRAT could be reduced to near zero. If the assets appreciate in value at a higher rate than the payout of the annuity, then the remainder beneficiaries will end up with an amount greater than the initial gift to the GRAT.
Many of these split-interest gifts are sensitive to rising interest rates, and some have been targeted for more onerous tax treatment in both regulations and proposed new tax laws. The result is there may be a narrowing window in which you can use these gifting techniques while the interest rates are at historical lows, there is a bear market, and while the tax laws and regulations are more favorable than they are likely to be in the future.
Although the bear market and rising inflation cause a great deal of short term pain, if you have the stomach to stick it out, then the bear market is an opportunity to take these short-term lemons and make them into long-term gifting lemonade.
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