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To Plan or Not to Plan, That is the Question
By Deborah Lust Zaluda, J.D.
As a result of the temporary repeal of the federal estate tax and the temporary reduction of the federal gift tax rate, one might wonder if this question is even being asked right now. On January 1, 2010, the federal estate tax expired due to the inaction of Congress, so anyone who died or dies during 2010, regardless of the value of his or her estate, will not be subject to federal estate tax. Prior to January 1, 2010, the amount that an individual could pass tax-free upon death (the exemption amount) was $3.5 million, and the top tax rate was 45 percent. If Congress takes no action prior to the end of 2010, the federal estate tax will once again rear its head, only this time the exemption amount will be $1 million and the highest rate will be 55 percent. As a result, a lot more families will feel the bite of the tax, and the bite will be a lot bigger. There is additional complexity in that the gift tax rate, currently at 35 percent, will once again rise to 55 percent on January 1, 2011 unless Congress acts.
Due to the uncertainty that Congress has bestowed upon us, tax, financial and estate planning have become more complicated, particularly for those in “the zone”–individuals worth more than $1 million and less than $3.5 million, and couples worth more than $2 million and less than $7 million. This group of people has not had to worry about the estate tax but will if the law does not change and the exemption reverts to $1 million.
So what planning can you or should you do?
- Review your existing estate planning For many, it has been years since their estate planning has been reviewed. The documents (wills, trusts, etc.) are only part of the plan; structuring of assets is essential to complete the process. In many instances, asset ownership and beneficiary designations are ignored to the detriment of the testator’s intentions, and they impact the plan regardless of the taxability of the testator’s estate. Now is the time to review and to discuss with your advisers.
- Consider life insurance. One of the simplest hedges against the estate tax is through life insurance. If it is possible that you will face an estate tax after 2010, determine what the tax might be, determine how much you wish to leave to your family, and look into a policy or policies to cover the tax bill. Proper use and structure of life insurance policies will allow for replacement of assets earmarked to pay taxes or, preferably, to go to charity. It is also important to ensure that the life insurance itself does not increase the estate tax liability. Be careful to ensure that ownership and beneficiary designation on the policy are coordinated with the balance of your estate plan.
Consider utilizing irrevocable trust(s) to provide for distributions to children if and when assets are needed. Trusts can also ensure that any distributions are carried out in a manner that is consistent with your values, while still providing that funds are available to them as necessary. In determining the amount of insurance and how much premium you can or should be paying, embrace a funding strategy that coincides with current cash flow and provides flexibility for future needs.
- Transfers to trust. At its most basic level, life insurance can provide a simple solution. It can also be used to enhance other planning that you may consider in this uncertain time, such as planning through grantor retained annuity trusts (GRATs) or qualified personal residence trusts (QPRTs). In these instances, trusts are established for a term of years. During the term, the grantor retains certain rights to the trust (an annuity or the right to live in the residence for a term of years). At the end of the trust term, assets remaining in the trust pass to the remainder beneficiaries (children or other family members). If asset values are low today and the assets appreciate in value over the term of the trust, then the appreciation passes to the family at the end of the term without any additional gift or estate tax.
These techniques are particularly attractive in a low-value, low-interest-rate environment. The only caveat is that you, the grantor, have to survive the trust term. If not, the trust assets will remain in your estate for estate tax purposes. To hedge against this possibility, you can purchase a term life insurance policy with a term tied to the term of the trust. If you survive, you can determine if you wish to allow the policy to lapse. If not, the insurance proceeds will be available to cover the tax liability.
- The Zero Estate Tax Plan. Charitable planning can allow you to satisfy your philanthropic goals while reducing or minimizing your estate taxes. One way to give the maximum amount to charity, whether directly or through a charitable trust or foundation, is to pass the estate tax exemption amount to your family--as discussed above, that amount might be $1 million ($2 million for married couples)--and have the balance of your estate pass to charity. You can then “replace” the amount going to charity with life insurance. If owned properly, such as through an irrevocable trust, the insurance will pass to your family estate tax-free, your charitable goals will be satisfied, and no Federal Estate Tax will be paid. Everybody benefits.
Any planning you do certainly will require coordination among your advisers. We would be pleased to discuss these techniques, as well as others that may embrace your goals and values. Contact your Bensman adviser at 847-572-0800.
Deborah Lust Zaluda is a Director in Private Client Services with The Bensman Group.