Most estate tax plans are really death plans. You have the documents prepared (typically, a will and revocable trust), put them away for safekeeping and then, forget about them. Someday you die, and the documents are dug up and read.
What’s the result? The IRS is guaranteed a big payday. On average, the family loses 41 percent of its wealth to the tax collectors, which is completely unnecessary.
Let’s set a new target for you to hit with your estate plan: All your wealth—every dime of it—will go to your family; all taxes paid in full. For example, if you are worth $3 million, then $3 million will go to your family; and if you are worth $30 million, then $30 million will go to your family. Stop for a moment and fill in your own current net worth. Then, estimate what amount it might grow to by the time you get hit by the final bus. That future amount—not your current net worth—is what the IRS will ravage with taxes.
A real-life example (the story of Joe) is the best way to illustrate what you and your family must face when you battle the estate tax monster. Joe (age 63) and his wife Mary (age 61) are worth $11 million. Before Joe called me, he and Mary did not have a lifetime plan.
Burn this into your mind: No matter how fancy the will and trust, death documents cannot whip the IRS. It takes a lifetime plan that dovetails with your death plan (the typical will and trust, which is only the first step you must take to win the estate tax game).
Here are the four main lifetime strategies we used for Joe and Mary (which will work for 19 out of 20 family businesses owners or retirees reading this column):
Strategy #1. We created a family limited partnership (FLIP) to own their investment assets (the real estate leased to Joe’s business and a stock/bond portfolio). We started an annual gifting program to the two non-business children. The estimated estate tax savings was $1.5 million.
Strategy #2. We used an intentionally defective trust (IDT) to transfer Joe’s business, Success Co., to his only business child, Sam. The transfer from Joe to Sam, using the IDT, is 100 percent tax-free, escaping all income taxes and capital gains taxes. This strategy had an estimated estate tax savings of $2.2 million.
Strategy #3. We used the funds in Joe’s 401(k) to purchase $3 million of second-to-die life insurance (for Joe and Mary). The way we structure the plan, the $3 million will be free of the estate tax. To help pay the premium, we had the 401(k) invest in life settlements (LS). This investment is not subject to market risk and has an average rate of return of 15.83 percent per year. The LS investment is the brainchild of a company that trades on the NASDAQ.
Strategy #4. Joe and Mary own two homes. We put the titles to each home into their existing trusts (death plans). For example, their Florida home is owned 50 percent by Joe’s trust and 50 percent by Mary’s trust. By doing this, the estimated estate tax savings was $350,000.
With the lifetime plan for Joe and Mary completed, the estimated amount of wealth that will go to their three children is $13 million (which includes the $3 million of insurance), all taxes paid in full. Not only is the impact of the estate tax eliminated, but additional tax-free wealth is created for the family. This is a typical result of proper lifetime planning.
Sam, the business child, commented that, “You turbocharged Mom and Dad’s plan.”
Here’s the lesson to be learned from Joe and Mary: The key to winning the estate tax game is a comprehensive lifetime plan. If the plan is properly done, the IRS is out of the game when you go to the big business in the sky.
One final point: Joe will stay in absolute control of all of his assets—including Success Co.—for as long as he lives.