Inflation Adjustment Allows High-Income Individuals to Pass on More Tax-Free Inheritances

Even though most wealthy Americans lost money last year, they're still doing better than everyone else. In some cases, they lost a lot of money, but they're still coming out ahead.

The rich are starting 2023 with millions more dollars that they can use to provide for future generations without triggering the US estate and gift tax. Last year's inflation, the highest in decades, means that married couples can now pass on almost $26 million to their heirs tax-free, $1.7 million more than in 2022 and $2.4 million more than in 2021.

The hike in the lifetime estate-and-gift tax exemption is the largest since 2018, when the amount was doubled by Republican-passed legislation signed by former President Donald Trump the prior year. As a result, the individual exemption has rocketed to $12.9 million from $5 million in 2011.

The exemption for generational wealth transfers is set to be cut in half in three years, when provisions of Trump’s tax law are set to expire. This could have a significant impact on the ultra-rich, who rely on these transfers to maintain their wealth. Advisers can use loopholes and leverage to multiply the amount of tax-free money available to heirs, but it is unclear how long these strategies will be effective.

According to Brandon Smith, director of estate planning at Wetherby Asset Management in San Francisco, annual increases in prices will continue, and for wealthy heirs there will be plenty to work with. Smith notes that falling markets and rising rates are not all bad news, but simply signify a shift in the planning devices that make sense.

Giving away millions of dollars is not easy, even for the rich, according to Lisa Featherngill, national director of wealth planning at Comerica Wealth Management. For many people, she said, it’s a multi-year process. One option is to set up spousal trusts, which allows a husband or wife to access money if necessary, making the transfer feel less permanent.

Advisers say that the most popular vehicle for gifts is the dynasty trust. This is a pool of wealth that can fund many generations without ever facing the US estate tax. The ultra-wealthy typically lend assets to these trusts in order to maximize their exemption.

As interest rates rise, some estate planning strategies become more difficult to implement. Advisers say they are shifting their approach and focusing on techniques that can benefit from higher rates. For example, strategies involving charitable assets and personal residences can reduce the present value of future transfers to heirs, making them more advantageous in a higher rate environment.

Many Republicans have long opposed the estate tax, which they’ve labeled the “death tax.” Democrats have argued that it’s an important tool to reduce inequality and have proposed ways of plugging loopholes.

The future of the estate tax may hinge on the outcome of the 2024 election, with the higher exemption set to expire in 2026.

Michael Levy, a partner at Crowe, an accounting firm, said that if he could see the future, he would be able to advise his clients with more certainty. "You're making a decision right now for people who may live another 25 years and could go through four or five different presidents," he said.

He and other advisers are telling clients to take advantage of the increased exemption while they still can.

Levy said that all we can do is live in the present moment.