Financial Planning for June 2004

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Maintaining Control of Your Estate
An elderly man walked into a CPA’s office one time and asked for estate planning advice. After a few preliminary questions, including the size of the estate, the CPA asked about heirs. The client mentioned two sons and three daughters, but said they were all worthless and didn’t want to leave anything to them. Ok, thought the CPA, maybe there were other family members or special friends? The client’s response was people are a bunch of bloodsuckers and he had no use for them.

The CPA was getting extremely frustrated. She asked the client about favorite charities or causes in which he was interested. Again, the client says the only thing a charity is good for is stealing from hard working people and they ought to be shut down.

Finally, the CPA asks the man why he even cares about estate planning. His response is, "I hate the government more than I hate anything else. I want a plan to keep it out of the government’s hands."

This is not an unfamiliar scenario and it’s played out in offices across the country every day. The fact is, you work hard all your life and, when you die, you have to pay for the privilege of dying. Of course, it’s not really you who will pay, but your heirs. And, don’t believe the estate tax is going away anytime soon. There may be changes, but the bottom line is it’s a source of revenue the government needs.

So, what are your choices in today’s environment? As it turns out, you have quite a few choices, so let’s talk.

A Few Preliminaries

First, you need to know that the law essentially makes a portion of your estate assets tax-free. Right now, that amount is $1.5 million and will gradually increase to $3 million by 2009. After that, the estate tax is repealed, but then reinstated in 2011. So about the best bit of advice we can give you is to plan. Plan that you will be facing estate taxes in the future if your estate is large enough, and when you plan, think about your state inheritance or transfer taxes. Some states have what amounts to estate taxes and some do not. We will not discuss state taxes here.

The Most Basic Plan

You might expect us to say that the most basic plan is no plan at all, but that’s not true. If you have a will and have left your entire estate to your spouse, at least you have planned to take care of your spouse in his or her lifetime. The beauty of such a plan is the will is easy to write and there won’t be much interpretation. Unfortunately, if you have children or heirs that you wish to benefit after your spouse’s death, this won’t do the trick.
Very Basic, But Effective Planning

As we said before, if you have an estate of less than $1.5 million, you won’t pay federal estate tax. This means that a husband and wife can have a combined estate of $3 million, assuming one-half is attributable to each spouse.

But what happens if you have a combined estate of $2 million and you die. If you left everything to your spouse, there won’t be any tax on your death. If, however, your spouse later dies and has an estate equal to your $1 million plus his or her $1 million, the combined estate of $2 million will carry tax on $500,000 if the exemption amount is $1.5 million. To avoid this, most planners now incorporate a trust commonly known as a "bypass trust." Such a trust takes the amount of the estate that can pass tax-free and places it into a trust where the spouse is entitled to the income, but the principle goes to the heir. The principal can be distributed for the benefit of the spouse in certain instances.

Let’s Get Beyond Basics

If you really don’t want the government getting your money, you could give it away in its entirety on your death. Gifts to charitable institutions are deducted from your gross estate, so if your will gives it all away, so there is effectively no estate. Of course, your kids won’t be happy with this, but if you don’t like them, who cares? If you do like them, there is a small problem - like they get nothing and you feel bad just before you die.

There are a few things you can do. First, using a life insurance trust or outright gifts, you could establish an insurance policy owned by your heirs that would replace any charitable bequests. The gifts to the trust or your children would be used to pay for the life insurance premiums. On your death, your favorite charity gets your money and your heirs receive the insurance proceeds. This can work nicely if the insurance premiums aren’t too large, but at some point these techniques can become cost prohibitive.

You could give the assets to your favorite charity or charities in your lifetime and take a deduction on your tax return, while leaving principle to your heirs. Using a charitable lead trust, you could place whatever you want into the trust and name the charity as the income beneficiary while naming your heirs as principle beneficiaries. You would get a charitable deduction of the value of the expected income to be paid to the charity based on your life expectancy. Your children, in turn, would receive the principle at your death.

If your concern is not for your children, but for income during your lifetime, you could put the assets you wish to leave to charity into a charitable remainder trust. This is the opposite of a charitable lead trust. You will receive the income, as defined in the trust instrument, over your lifetime and on your death, the charity will receive the principle. It’s sort of a case of having your cake and eating it too.

Life Gets More Complicated All the Time...

...and so do tax planning techniques. Believe it or not, we haven’t even scratched the surface of planning around the estate tax code. Terms like private annuities, grantor retained annuity trusts and grantor retained income trusts and a whole raft of other options may be available to you, but you won’t know if you don’t ask. While there are a number of decisions dependent solely on the dollar value of your estate, some decisions depend on other circumstances like providing for a disabled child or other relative. Give us a call today and let’s discuss your particular situation. We know how to help you keep control of your estate, maximize its value for your beneficiaries and minimize any tax bite.


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