How the Rich Stay Rich
Banks offer special services to help wealthy clients protect their funds and not-quite-so-wealthy ones climb the ladder.
Kate Randall Danella is an executive vice president and head of private wealth management for Regions Bank.
Who are the wealthiest among us?
In Alabama, the top 1 percent of income earners makes at least $283,899 annually, according to a 2013 Economic Policy Institute report. On average, however, the richest Alabamians make around $665,097 every year, while across the United States, the 1 percent class rakes in about $389,436.
But beyond earning money, many well-heeled Alabamians employ a number of strategies to help them protect their wealth from taxes, creditors and legal liabilities that can shrink their assets.
And they get plenty of help from tax attorneys, accountants and wealth managers to shield their assets.
“Wealth strategy plays an important role in safeguarding a family or business, avoiding unnecessary taxes, and ensuring that [someone’s] legacy will continue,” says Harvey Hutchinson III, senior wealth strategist for PNC Bank.
“Risks to successful wealth management are numerous and include more than investment loss associated with the stock and bond markets,” says Hutchinson. “Of equal concern are non-market risks to wealth that may result from life events, such as a debilitating illness faced by a spouse or other family member; death, either anticipated or unexpected; creditor claims against a family member or the family’s business, or domestic concerns, including divorce or a child’s choice of spouse.”
New Transfer Tax Rules
President Donald Trump provided relief to the nation’s super rich in December when he signed into law a new tax bill that, among other provisions, doubled the estate tax exemption from $5.4 million to at least $11.2 million for individuals and $22.4 million for married couples through 2025.
“With the credit amount being so high now, the vast majority of our clients don’t really have a transfer tax problem,” says Kate Randall Danella, an executive vice president and head of private wealth management for Regions Bank. “For those clients, we’re continuing to use similar estate planning strategies, but with more of an emphasis on income tax planning. For instance, under the law there is a step up in basis to date of death value on assets included in the decedent’s estate.”
Under the step-up rule, individuals can inherit a valuable asset without having to pay a capital gains tax on its appreciation before they took ownership.
“Therefore, we’re helping our clients with strategies to make sure low basis assets are in estates so that step up in basis will occur at death.”
Rich Americans also use an assortment of trusts to protect their wealth.
One kind is the marital trust. A marital trust allows one to place assets into a trust for the sake of a surviving spouse and one’s children. Moreover, assets within a marital trust are not subject to estate or gift taxes.
And Hutchinson says that as divorce rates continue to rise, marital trusts protect assets not only for a surviving spouse but for children from a previous marriage as well.
“The Qualified Terminable Interest Property (QTIP) trust is a marital trust that addresses this concern by providing resources to the surviving spouse during his or her lifetime, while also establishing an inheritance for the children of the prior marriage,” Hutchinson says.
Similarly, in a divorce, family wealth can become exposed if a child inherits assets directly, Hutchinson says.
A discretionary trust, he says, protects assets for children or grandchildren, providing them with needed cash flow, funds to maintain a standard of living, meet emergencies, or provide for education, while separating the assets from divorce proceedings, he says.
Additionally, if a discretionary trust beneficiary has a problem like an addiction, an independent trustee, such as a bank, can be appointed to administer the wealth in the trust for the beneficiary, he says.
Families with multigenerational estates often rely on corporate trustees to steward their legacies. It can become complicated, however, when estates include complex assets such as family businesses, multistate real estate holdings, or for portfolios managed by multiple advisers. In many states, trustees remain liable for the actions of delegated third parties or even named advisers.
“Delaware directed trusts can alleviate this issue, since the trustees should not be held liable for following the direction of an adviser named in the trust, absent willful misconduct. Also, establishing Delaware as the site of the trust’s administration allows those creating the trusts, the settlors, to take advantage of Delaware’s favorable trust laws.”
But, he says, when considering the designation of an adviser to a Delaware trust, the settlor should consult legal and tax advisers and use caution if the potential adviser is not a Delaware resident. The state of the adviser’s residence may potentially assert jurisdiction over the Delaware trust and apply its own state law, with possible adverse tax and nontax consequences.
Danella says the use of entities like LLCs, limited partnerships and corporations — both S and C — are also helpful. “These tools can be used to limit the risk of loss of assets and cash flow,” Danella says. “That hasn’t changed over the past 10 years. Some states — Alabama not being one at this time — have enacted legislation that allows for asset protection trusts. This has been a significant development in other jurisdictions and is a tool that’s often implemented to protect assets.”
Another strategy for shielding assets against taxes involves giving money to charities, which can include outright bequests, beneficiary designations, charitable trusts, private foundations, donor advised funds and charitable gift annuities, Hutchinson says.
One instrument used in particular, he says, is the Charitable Remainder Annuity Trust (CRAT) that allows the grantor to get income for a term of years, up to 20 years or for their lifetime. The rate is based on the total value of the gift at the time the trust is created, and the income is subject to certain Internal Revenue Service rules and limitations.
“Choosing the annuity rate is almost always done with the help of advisers, because it has such a big impact on any possible current income tax deduction,” he says. “Generally, the larger the annuity payment you choose, the smaller your potential deduction.”
At the individual’s death, or at the end of the chosen term, any remaining assets in the trust are distributed to the qualified charitable organizations named as the beneficiaries of the trust.
“A main feature of a CRAT is you may be able to receive an income tax deduction in the current tax year for the assets that will pass in the future to the charities you named as beneficiaries,” Hutchinson says.
“If you have highly appreciated assets, you would typically have to sell them if you wanted a higher income stream. Doing this would cause you to recognize capital gains and incur an immediate tax liability on the entire gain. However, if you use those highly appreciated assets, also known as low basis assets, to fund the creation of a CRAT, they can be sold by the CRAT, without incurring capital gains that are immediately attributable to you. This is another reason why so many charitably inclined people have created CRATs as part of their financial plan.”
Hutchinson says another attractive feature of a CRAT is that individuals will not immediately realize capital gains on assets sold inside the CRAT, and the associated taxes they otherwise would have had to pay can be deferred.
Overall, Hutchinson and Danella say their best advice is for individuals to seek competent advisers to help them make the best decisions regarding their wealth.
“Getting sound, solid advice from people who know your personal situation, needs and goals,” says Danella, “is imperative for long-term financial success.”
Gail Allyn Short is a Birmingham-based freelancer for Business Alabama.