Markets & Finance

Outwitting the Estate Tax


Here are some loopholes to put more money into the pockets of your heirs and less into the taxman's

In a time when many folks are worried they won't have enough money for retirement, others are worried they'll have too much left over. The estate tax now sits at 45%, and while the exemption will grow to $3.5 million and then disappear by 2010, the estate tax is set to return to pre-Bush levels: a maximum rate of 55% and an exemption of $1 million in 2011.

The longer you let your assets grow, the closer you get to the exemption threshold. So if you pass away in 2010, great. Afterwards, no such luck. Gifting, on the other hand, can reduce the size of your estate and, therefore, the tax hit. It has become an essential part of the estate planning process.

The easiest way to get cash into the hands of the next generation or two is to write a check, says Keith Fenstad, a certified financial planner with Tanglewood Asset Management in Houston. According to Internal Revenue Service rules, individuals are allowed to give $12,000 a year to an unlimited number of individuals. Couples can double that amount, meaning that it's possible to give $24,000 a year to as many recipients as you like. It's simple and tax-free.

Giving Money to Kids Requires a Little Work

If you'd like to give away more than that, there's a loophole for college tuition. Parents or grandparents can foot the university bill, and it won't count against the $12,000 annual exemption, says Marcel Florestal, a New York attorney. With college tuition rising over 6% just this year, according to the College Board, that can mean the difference between leaving college debt-free or with boatloads of student loans.

Gifting is a little more difficult with children under the age of 18, who are usually not permitted to own stock. A Uniform Transfer to Minors Account can get around that rule, allowing the money to be given to a child, says Barbara Potter of Seattle money management group Laird Norton Tyee. These accounts, which have an adult overseeing investment decisions, often make sense from a tax perspective because minors usually pay a lower rate than their parents.

However, these accounts have one problem: At 18 or 21, depending on the state, the minor has access to all the funds. Twelve thousand dollars per year has a way of adding up over 20 years, and most minors might not be prepared to deal with the windfall as a young adult.

A Trust Removes Temptation

If givers are worried about that, they might want to set up a trust, Potter says. With a trust, children must have the option of claiming the money at age 21. But if they don't (and they should be encouraged not to), the money stays put until a defined age, often 30 to 35. Along the way, a trustee can distribute the income according to the rules of the trust, often for expenses like college tuition or buying a house.

Other trusts provide even more options. For people who'd like to get money out of their estate as well as see it grow, there's the irrevocable life insurance trust, Barber Financial's Shane Barber says. A life insurance policy is bought and placed inside a trust. Money is gifted from the estate and used to pay the insurance premium. The only hitch is that the beneficiary has the right to keep the gifted cash instead of paying the premium. When an individual passes away, rather than having the policy included in an estate, it's paid to the trust tax-free.

A charitable annuity trust can allow for gifting of money and charitable giving. In this situation, an asset that has risen in value (usually property) is sold. Half the money is donated to a charitable annuity trust, and the write-off will cover a large portion of the capital-gains tax. The other half is put into a standard brokerage account to help pay for retirement. And what about the heirs? A $500,000 life insurance policy is purchased, and everyone ends up happy, says Kim Wright-Violich of Schwab Charitable Giving.

Check With Your Financial Planner

One word of caution: People are living much longer these days, and someone on the verge of retiring may live 30 more years where they once would have lived half that. It's enough to make people think twice about giving money away. "A lot of our clients are somewhat hesitant to let go of a lot," Tanglewood's Fenstad says. "But when you're comfortable in the retirement planning scenario, then you can incorporate a gifting strategy, which from a retirement perspective is just another expense."

The good news is there are now many tax-friendly ways to pass your wealth to your loved ones by gifting. Given the intricacies involved with the different trust options, check with your financial planner to determine which one works best for you.


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