ESTATE PLANNING
Estate planning helps you minimize estate taxes and distribute your assets according to your wishes. While most people will need the help of professionals, we've included several articles on the topic:
If you have any questions or would like to discuss your
estate planning situation in more detail, please contact us at:
1-800-553-6700 or CSIC@CapitalSecurities.com
Thoughts
on Estate Planning
Many people assume that only the very wealthy need estate planning. Certainly those with estates in excess of the lifetime gift and estate tax exclusion ($675,000 in 2000, but scheduled to increase gradually to $1,000,000 by 2006) need to take active steps to reduce the impact of estate taxes, but there are other reasons to consider estate planning. Parents with minor children should name guardians and provide for their children's support. Individuals in other than first marriages need to protect children from prior marriages. Some items to consider include:
Leave written instructions for heirs. This gives you an opportunity to provide heirs with important financial and personal information and to clarify requests you have made in other legal documents.
Don't rely on joint ownership of property as your only form of estate planning. Although joint ownership can simplify estate planning, it may not be the most appropriate or cost-effective way to distribute assets.
Name executors, trustees, and guardians carefully. An executor (or personal representative) administers your estate through probate court, locates and values all assets, pays obligations of your estate, and distributes your estate to your heirs. A trustee manages your trust and distributes income and principal. A guardian takes physical care of your minor children and handles their finances. All three roles significantly impact your estate, so choose these individuals carefully.
Update beneficiaries. Beneficiaries can be named for many assets and should be reviewed after major changes, such as marriage, divorce, death, or the birth of a child.
Carefully consider whether you should leave your entire estate to your spouse. By using this strategy, you forfeit the use of your lifetime gift and estate tax exclusion. This can increase the ultimate amount of estate tax your heirs will pay on large estates.
A spouse who is a U.S. resident, but not a U.S. citizen, does not receive the unlimited marital deduction unless a special type of trust is established. Annual gifts of up to $100,000 may be made tax-free to spouses who are not U.S. citizens.
Set up a gifting program during your life. See the article "Gift Your Estate Away" for more details.
Skip a generation if your children already have sizable estates. Leaving assets to children with sizable estates means that the assets will be taxed again when your children leave them to your grandchildren. Transferring directly to your grandchildren may be a better strategy, although you can only transfer up to $1,010,000 (this amount is indexed for inflation, in $10,000 increments) before triggering an additional estate tax called the generation-skipping transfer tax.
Understand when a revocable living trust is appropriate. Living trusts can provide substantial estate planning benefits, such as removing assets from probate and preserving the use of the lifetime estate and gift tax exclusion. However, these trusts do not reduce estate taxes.
Shelter life insurance proceeds from estate taxes if your total estate, including those proceeds, exceeds the lifetime gift and estate tax exclusion. Although the proceeds will generally be free from income taxes, estate taxes will be assessed unless you set up an irrevocable trust or make your heirs the owners of the policy. See the article "Insurance Trusts and Estate Taxes" for more details.
Realize that a wide variety of trusts exist to meet specific estate planning needs. Trusts can be established to meet a variety of objectives: to reduce estate taxes, to control asset distribution, to make gifts to charities, to provide for the possible incapacity of the creator, to protect heirs from themselves or others, to avoid probate, to allow a professional to manage assets, or to ensure that minors are provided for.
Make provisions for the payment of estate taxes, possibly through the use of life insurance. Many large estates are cash poor and heirs have difficulty paying estate taxes, forcing them to sell assets at below market value.
Click here to return to Estate Planning topics.
Gift
Your Estate Away
With estate tax rates ranging from 37% to 55%, minimizing these taxes is a goal of many individuals with sizable estates. One of the more effective ways to accomplish this is to make gifts during your lifetime. Some strategies to consider include:
- Take advantage of your annual tax-free gift
allowance. Every year you can gift up to $10,000 ($20,000 if you
split the gift with your spouse) to any individual tax free. This amount is
adjusted for inflation, in $1,000 increments. You can make gifts to any
number of individuals, even those who are not related to you. However, you
can't increase your gift next year for any gifts not made this year. Over a
number of years, an annual gifting program can remove a substantial amount
of assets from your estate. For example, if you and your spouse have three
married children with two children each, you could gift $240,000 per year
($20,000 to each child, child's spouse, and grandchild). In addition, any
future appreciation or income generated on those gifts is also removed from
your estate.
- Pay medical and educational expenses for your
heirs. Certain amounts paid directly to institutions for these
expenses can be made tax free in addition to your annual tax-free gift
allowance.
- Use your lifetime estate and gift tax exclusion
during your life. This exclusion is $675,000 in 2000 and is
scheduled to gradually increase to $1,000,000 by 2006. This exclusion is in
addition to your annual gift allowance. Using the exclusion during your
lifetime removes from your estate any income or capital gains that would
accrue on those assets after the transfer.
- Consider making taxable gifts to heirs. Gift
taxes are typically lower than estate taxes because of the way the taxes are
assessed. Gift taxes are paid only on the value of the gift, while estate
taxes are paid on the total value of your estate, including the portion that
is being used to pay the tax. One caveat: you must live three years after
making the gift or your estate will have to pay the difference between the
gift and estate tax.
- Gift property that has the potential to
appreciate, but has not already done so. The tax basis of a
lifetime gift remains your original basis plus any gift tax paid. Thus, if
you gift an asset with a low basis, your heirs could owe significant capital
gains tax when the asset is sold. Assets received after your death are
stepped up to market value at the date of your death.
- Make lifetime gifts of business interests. Business owners who transfer noncontrolling interests in their business during their lifetime may be able to assign a minority interest discount to the value of the gift.
Although lifetime gifts can be a good strategy to reduce estate taxes, you are permanently removing those assets from your estate. Don't gift so much of your estate that you have difficulty making ends meet later in life.
Click here to return to Estate Planning topics.
Insurance
Trusts and Estate Taxes
No one wants their life savings to go to the government in the form of estate taxes. An irrevocable life insurance trust can both reduce and help fund those estate taxes.
Life insurance proceeds are not subject to income taxes, but they are subject to estate taxes unless the policy is properly structured. An irrevocable life insurance trust is one way to exclude the proceeds from your taxable estate.
Basically, you set up a trust to own an existing insurance policy or a new insurance policy. Annually you can make gifts to the trust to pay the policy premium, with the gift subject to the annual gift tax exclusion ($10,000 per beneficiary; $20,000 if the gift is split with your spouse). After your death, the trust receives the insurance proceeds, which are distributed according to the trust's terms. For the proceeds to be excluded from your estate, a number of conditions must be met:
- The trust must be irrevocable. Once
the trust is set up, you cannot change the provisions or control the assets.
In legal terminology, you cannot retain any incidents of ownership. That
includes the power to change the beneficiary, to surrender or cancel the
policy, to assign the policy, to revoke an assignment, to pledge the policy
for a loan, or to obtain a policy loan. You can stop funding the premiums,
but you cannot recover any sums already paid to the trust.
- Assets transferred to the trust must represent a present interest to qualify for the annual gift tax exclusion. Typically, beneficiaries won't receive benefits until sometime in the future. To change this future interest to a present interest, the beneficiaries must be able to withdraw the money now. The trustee will normally send a written notice to all beneficiaries when the cash is received, giving them a short period, such as 30 days, to demand the assets. Once that period passes, the trustee will pay the insurance premium.
- You cannot specifically instruct the trustee to
pay the insured's estate tax liabilities. If you do that, the
proceeds are considered received for the benefit of the estate. However, the
trustee can have the power to loan money to the estate or to purchase assets
from the estate to provide liquidity for paying estate taxes.
- A special rule exists for transferred life insurance policies. If you transfer an existing policy to the trust and die within three years of the transfer, the proceeds will still be included in your estate.
Before setting up an irrevocable life insurance trust, consider all the pros and cons. While the estate tax savings can be substantial, you are giving up control of the life insurance policy.
Click here to return to Estate Planning topics.
Distributing
Money to Your Children
Turning wealth over to children or grandchildren can raise some troubling issues. While a large inheritance can alleviate financial concerns for your heirs, you probably don't want that inheritance to remove the incentive to work hard or to lead a productive life. You also don't want your heirs to spend the money irresponsibly, obtaining no long-term benefits from the inheritance.
To help you assess how your heirs would handle an inheritance, consider making lifetime gifts to them. Every year you can gift up to $10,000 ($20,000 if you split the gift with your spouse) to any individual tax free. You can then assess how well they handle these gifts. Do they waste the money on extravagant purchases or set it aside in savings? Are they appreciative of the gifts or feel it is their right to receive the gifts? Their actions can help you decide whether you need to control the distribution of their inheritance.
If you want to control distributions, you can set up a trust, attaching conditions to those distributions. Those conditions could include:
- Spreading the income over many years or decades. You
don't have to turn your entire estate over to your children when they turn
21. You may want to distribute pre-determined percentages of your estate
when your children reach certain ages. Or you can distribute only income
from the trust until your children reach a certain age, then distribute the
remaining assets.
- Making distributions contingent on achieving
certain goals. You can designate
that distributions be made when your child finishes college, gets a job, or
has children. You can also base distributions on how much income your child
earns. For instance, you can allow the child to take 50¢ from the trust for
every $1 he/she earns. Or you may wish to supplement the incomes of heirs
who choose careers in government, educational institutions, or charitable
organizations. These types of distributions can help encourage behavior you
feel is important.
- Designating some funds for health problems, education funding, or emergencies. That way, a child who is confronted with serious health problems or other emergencies will have financial resources to help deal with these problems. You can allow your trustee to decide when the funds should be distributed.
You can't totally control how your heirs spend their inheritance, but you can control when and how they receive it. By doing so, hopefully you can help teach them how to handle their inheritance responsibly.
Click here to return to Estate Planning topics.
Integrating
an Inheritance
When you receive investments as part of an inheritance, you must integrate them into your overall portfolio. In many cases, that will require changes to your portfolio. Consider the following:
- Review each inherited investment as if it were a
prospective investment. Retain those that fit your financial
goals and have good potential. Consider selling any that won't meet your
financial goals or that you don't have the expertise to manage.
- Evaluate the costs before selling. For
tax purposes, the inherited investment's tax basis is stepped up to market
value on the date of death. Thus, selling inherited assets soon after
receiving them typically won't result in large capital gains taxes. However,
review the transaction costs for both selling the existing investment and
reinvesting in a new one. Some investments may also have a deferred sales
charge.
- Your asset allocation percentages may change
drastically when you add the inherited portfolio to your existing
investments. Decide whether to move back to your original
allocation immediately or gradually over a couple of years.
- Don't keep inherited investments for sentimental reasons. Selling those investments doesn't mean that you're questioning the investment capabilities of the person who gave you the assets. You just have different financial goals than that individual.
Click here to return to Estate Planning topics.
Copyright © 2000. These articles intend to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.
FR1999-1230-0133