Seven Estate Planning Techniques
1. Annual Gifts
Legal Principle: Every individual is permitted to make gifts of assets valued at up to $13,000 per year to as many persons (donees) as desired, with no gift tax consequences.
Application: If, for example, you have two children, both married, one of whom has a child, then you have at least five potential recipients of gifts, for a total of $65,000 per year. This may not appear to be significant, but over time it can have a large impact on your estate taxes. For example, if you made these gifts for ten years, you would reduce your estate by the $650,000 gifted, plus any increase in value of the gifted property.
Estate Tax Savings: Using annual gifts, of course, saves the estate tax on the gifted property. In addition, the appreciation on the gifted property escapes taxation altogether. Over time, a properly constructed gift giving plan might also lower your estate tax bracket, thereby saving tax not only on the gifted property but also on the property you retain.
Best Bet: Make gifts of property which will appreciate.
2. Unified Credit
Legal Principle: Every individual is allowed a tax credit, called the unified credit, of $1,730,800 which can be applied to gift or estate taxes. This credit is the equivalent of being allowed to transfer up to $5,000,000 of property during life, or at death.
Application: Transferring the unified credit equivalent during life, however, is a way of avoiding estate tax on the growth of the assets from the time of transfer through date of death. For example, assume a person, in the highest estate tax bracket of 35%, makes a gift of $625,000 during life. Assume further that the assets grow at an annual rate of 6% and that the transferor lives for 7 years from the time of the gift. By the date of death, the transferred assets have grown to $925,000. In a 35% bracket, the $300,000 in appreciation has escaped an estate tax of $100,000.
Estate Tax Savings: The decedent's estate tax bracket (rate) multiplied by the increase in value of the assets transferred from date of transfer through date of death.
Best Bet: As with annual gifts, try to pick property which will appreciate after the gift is made.
3. Grantor Retained Unitrust or Annuity Trust
Legal Principle: The value of a gift to a trust can be reduced by grantor's retained interest in the property gifted and by the grantor's retaining certain powers over the property.
Application: Under current law, if a grantor makes a transfer in trust and retains an interest in that trust, the retained interest will be deemed to have no value unless it is a so-called "qualified interest." If the trust is a qualified interest, for gift tax purposes, the value of the gift is the value of the property transferred to the trust, less the actuarial value of the retained interest in the grantor. Further reduction in the gift can be achieved by the grantor's retaining certain powers over the property. Accordingly, it is possible to transfer the remainder of the trust without having to use the full value of the property transferred for gift tax purposes.
A Grantor Retained Annuity Trust (GRAT) or Grantor Retained Unitrust (GRUT) can be used to establish qualified interests. Under a GRAT, the grantor transfers property to a trust and keeps the right to receive fixed yearly amounts for a period of years. Under a GRUT, the grantor transfers property to the trust and keeps the right to receive a yearly fixed percentage of the value of the trust for a period of years. At the end of the GRAT or GRUT period, the trust assets pass to the ultimate beneficiaries. If the grantor survives the annuity or unitrust, none of the trust is included in his estate. If the grantor does not survive the annuity or unitrust period, all of the trust property is included in the grantor's estate.
Estate Tax Savings: In using a qualified interest trust, the estate tax savings equals the reduction in tax at the time of the transfer caused by the retained interest and retained powers.
Caution: In considering creation of a GRAT or GRUT, a grantor needs to carefully examine whether the investment of the trust assets would generate a return greater than the rate required by law for purposes of calculating the gift tax. If the trust does not create income in excess of that rate, the tax advantages can be eliminated.
4. Qualified Personal Residence Trust
Legal Principle: A grantor may transfer a personal residence to an irrevocable trust, retaining the right to live there for a period of years. At the end of that period, the residence may be distributed to remainder beneficiaries, or held in further trust for their benefit. Once the property has been fully transferred to the remainder men, if the grantor wishes to continue to live at the residence, he must lease the property from the new owners. The amount of the gift of the residence is reduced by the value of the grantor's right to live at the residence.
Application: Unlike a GRAT or GRUT, a qualified personal residence trust is not required to pay any specific amount to the grantor. If the grantor survives the qualified personal residence trust period, the value of the residence is completely excluded from the grantor's taxable estate. If the grantor does not survive the qualified personal residence trust period, the entire value of the residence is included in the grantor's estate, but that is no worse than if the grantor had done nothing.
Estate Tax Savings: A qualified personal residence trust allows a gift to be made to ultimate beneficiaries, while reducing the gift by the right of the grantor to occupy the residence. Like a GRAT or GRUT, the tax savings is generated by reduction of the value of the gift. Use of a qualified personal residence trust can achieve additional leverage from the unified credit.
Best Bet: Because the value of the gift of the qualified personal residence trust depends upon the value of the occupancy rights retained by the grantor, the longer the term of the trust, the lower the value of the remainder interest.
Caution: If the term of the trust is too long, the grantor will not survive that term, and the value of the residence will be included in the grantor's taxable estate.
5. Life Insurance Trusts
Legal Principle: A decedent's gross taxable estate does not include the proceeds of life insurance held by an irrevocable trust if the decedent had no incidents of ownership in the policy. If the decedent transferred ownership of an existing policy to an irrevocable trust, the decedent must live at least three years after the transfer to exclude the policy proceeds from his estate.
Application: During life, the only value most life insurance has to the insured is the cash value. While this can be a benefit, it is usually small compared to the proceeds payable at death. The Internal Revenue Code mandates that the proceeds of life insurance on a decedent's life are fully includable in a decedent's taxable estate. An exception is made if the decedent held no incidents of ownership in the policy on the decedent's life. If life insurance is held by an irrevocable trust, premiums on the policy can be paid with contributions periodically made to the trust from the grantor. The trust becomes the owner of the policy and the insurance proceeds are paid to the trust. The trust contains a disposition of the proceeds at the grantor's death.
Estate Tax Savings: The estate tax savings in irrevocable life insurance trusts can be sizeable. The amount saved is the difference between the grantor's estate including the insurance proceeds and the grantor's estate excluding the insurance proceeds.
Best Bet: Have the trust buy a new policy. This way, the application for the insurance is made by the trustee after the trust is created and funded. At no time does the insured (grantor) have incidents of ownership with respect to the insurance policy. Consequently, the insured does not have to live three years to have the proceeds excludable from his estate.
6. Generation-Skipping Transfer Planning
Legal Principle: When a person transfers property to another person more than one generation below the grantor, that transfer is subject to a separate "generation-skipping transfer" tax, designed to prevent avoidance of gift or estate taxes which would have been paid had that property been transferred first to the intervening generation and then to the succeeding generation. All generation-skipping transfers, regardless of size, are taxed are the highest rate of estate tax, 35%. However, each individual can transfer up to $2,000,000 of property free from generation skipping tax.
Application: The concept of "sheltering" the generation-skipping tax exemption is identical to sheltering the unified credit equivalent. In the case of generation-skipping tax, in appropriate circumstances, the exemption can be placed in a separate trust for the ultimate benefit of grandchildren, grow substantially from the date of the death through the date of distribution to grandchildren, and avoid the estate tax which would have been otherwise payable by the child's estate had the decedent transferred the property to the child first and then the child transferred that same property to his children.
Estate Tax Savings: 35% of up to $2,000,000.
Best Bet: Consider dividing the marital trust under your existing estate plan into two shares, one to which your personal representative can allocate generation-skipping transfer equivalent property and the other to hold other marital property. Check to be sure your estate planning documents contain general powers for your fiduciaries to divide trusts into shares for this purpose.
7. Charitable Giving
Legal Principle: Property passing to qualified charities is deductible from the gross estate. There is no limit on the amount of the deduction.
Application: Charitable donations take many forms. Property can be given to a charity outright or in trust. The trust may be for the sole benefit of a charity or partially for a charitable purpose and partially for beneficiaries, called a "split interest" gift. Split interest gifts take the form of charitable remainder trusts (in which an individual receives income for a term of years or for life and, at the end of the term, the balance of the trust is paid to the designated charity or charities) or a charitable lead trust (in which the charity receives income for a term of years and, at the end of the term, the balance of the trust is paid to the individual or individuals named).
In the case of the charitable remainder trust and charitable lead trust, a partial estate tax deduction is allowed for the interest given to charity. An inter vivos charitable remainder trust provides, as noted, for a specific amount of income payable to the grantor for the term of the trust. In addition, a current charitable income tax deduction is allowed for the remainder interest ultimately passing to the charitable beneficiary or beneficiaries at the term of the trust term. The deduction for trusts for the grantor's life is computed on an actuarial basis, using life expectancy and current interest rates. In addition to this deduction, income tax savings can be achieved by funding the trust with appreciated property. Because the trust is a tax exempt charitable trust, any sale of assets by the trustee after the transfer of the trust is tax exempt.
Estate Tax Savings: The tax which would have been paid on property transferred to the charity.
Best Bet: No estate plan is complete without an examination of possible charitable giving vehicles.