Wealth Begets Wealth – The $25 Million Problem
By Mike Hoffman, Esq., CPA
There are certain laws of nature concerning wealth: Wealth increases over time. The stock market goes up over the long term. The S&P has averaged approximately 9.8% over the last many decades. Real estate generally appreciates in value. Finally, inflation devalues the dollar and makes hard assets more valuable. It was Albert Einstein who said the most powerful force in the universe is the power of compounding.
It matters when you die. Tax law is unpredictable and changes constantly. If you died with $10 million subject to estate tax in 1916 or 1940, your heirs would have paid $1 million or less in estate taxes. If your estate was subject to estate taxes in 1977, the IRS would have gotten approximately $3.5 million; slightly less than $3 million in 2009. If you died with an estate subject to estate taxes in 2010, you would have paid $0 estate taxes, in 2017 you would have paid $4 million of taxes to the IRS, and in 2018, $0 taxes! No one can predict what the tax rate will be or where the political winds will take us, but due to large deficits and historical bias toward taxing the wealthy, it is a safe bet that there will be a death tax for years to come. Since the tax law is so unpredictable, planning to reduce or eliminate death taxes is critical.
Remember that death taxes are absolutely voluntary! You can develop a plan that results in no taxes, without significantly surrendering control or the “security” of assets!
The $25 Million Problem
If we assume that the stock market goes up 9-10% annually, real estate grows 6-8% annually and family business assets generally grow at a faster clip, say 12-15% annually, then it is safe to say that wealth will double every 10 years.
We can also assume, based on my non-scientific study, that life expectancy grows about 2/10 of a year, each year. In 1960 the life expectancy was 69.77 years. By the year 2000 that grew to 76.64 years old. In 2020 that life expectancy is expected to be about 80.3, by 2040, 84.3.
If someone’s net worth was approximately $5 million in 2007 during their working years, let’s say age 50, it would double to $10 million by age 60. If a married couple both died at the age of 60 in 2017 with a $10 million estate, they would have paid $0 estate taxes. Both spouses would have enjoyed a $5.5 million exemption from federal estate tax, and as long as at least minimal planning was done, the total estate exemption would have exceeded the amount of their estate.
If the estate continued its growth at approximately 7.2% per year until age 65 it would have grown to $14,140,000 by the end of the year 2022. There still would be no estate taxes if both spouses died in 2022 since the projected combined estate tax exemptions are $24,700,000 for a married couple in 2022.
When a couple retires at 65, they may invest more conservatively, and their post retirement investments may be limited to stock market and real estate. Stock market returns may become more modest at 4-6%, since more assets are allocated to income generating portfolios, while real estate continues to grow at 6% annually. Therefore, let’s assume that after age 65 estates double every 12 years, let’s also assume that husbands live to their life expectancy and wives live 10 years longer.
Continuing with our example, the couple who had a $14,150,000 estate in 2022 when they were both 65 (and then retired) would have a $28,300,000 estate in the year 2034, when they were both 77 years old. If we assume the husband lived to 84.3, and the wife lived 10 years longer to the year 2051 (age 94), the estate would have grown to $75,740,000. Based on an exemption of $24,600,000 (the Trump Tax Act [Tax Cut and Jobs Act] extra exemption goes away in 2025, and the 2017 $5.5 million of exemption continues to grow at roughly the CPI index, which I am assuming is about 2.5% per year) the estate tax will arguably be about $25,570,000.
That is a lot of money, granted based on a lot of assumptions, but sound math and theory. It is payable in cash, nine months after the wife’s death! $25,570,000!
The conclusion is that wealth begets wealth and the $25 million problem could arise due to the laws of nature concerning wealth. We have no idea what the estate tax rate or the estate tax exemption will be in year 2051. It is generally safe to assume that there will be a death tax, and it is reasonable to assume that the death tax will be approximately 50%. The maximum tax rate when I began my practice was 77%, it dropped to 35% under President George Bush’s administration and crept back up under President Obama. Hillary Clinton campaigned to increase the federal estate tax rate back to 55% but that was waylaid by the 2016 Presidential election. No one can predict what the tax rate will be in the future however, due to large deficits and general biases against the wealthy, it is a safe bet that there will be a death tax for years to come.
Remember, death taxes are absolutely voluntary! You can develop a plan that results in no taxes, without significantly surrendering control or the “security” of assets! Be proactive about staying informed about taxes, and plan. I hope you have heard this many times before, a failure to plan becomes a plan to fail.
For questions regarding this or any other estate planning matter, please contact us at 404-255-7400 or info@hoffmanestatelaw.com.
