What You Should Know About Estate Tax Planning

If this article were a college course, it would be called “Estate Taxonomics 101.” We expose some sacred cows, but every word is true.


First, the IRS doesn’t want you to know that the estate tax, if done correctly, is a voluntary tax. Sadly, if you have only a traditional estate plan (typically, a revocable trust) you have no chance to avoid the estate tax. By adding a simple lifetime plan, it’s easy to legally avoid the estate tax. Just use the correct strategy for each significant asset you own:
• Residence—Use a qualified personal residence trust or 50/50 title.
• Your business—Use an intentionally defective trust (IDT).
• Funds in a qualified plan (such as a 401(k), profit-sharing or IRA)—Use a retirement plan rescue or subtrust.
• Investments (such as cash, CDs, stocks, bonds, real estate and more)—Use a family limited partnership or IDT.
Find a professional advisor who can explain to you how each of the above strategies wins the estate tax game for each asset class.
Next, the biggest transaction of your life will probably be the transfer of your business to your kids or employees. The IRS wants you to think that a taxable installment sale is the way to go. Unfortunately, so do most professional advisors. Tell ‘em to take a look at an IDT. The proof is always in the numbers. Ask your professional to run the numbers for the tax consequences of an installment sale versus an IDT. Remember, you want to see the tax impact for both the buyer and the seller. Hint: I have never seen an installment sale (or cash sale) beat the after-tax numbers of an intentionally defective trust.
Then, you should look at the double taxation of qualified plan funds. If you have a large amount of money in a 401(k), rollover IRA or other qualified plan, listen up. Everyone knows that those funds will be double taxed (hit hard by both income and estate taxes) with as much as 73 percent going to the tax collector.
There are multiple ways to avoid the double tax and even turn the tables on the IRS by multiplying the funds in your plan, risk free. Hint: If you are younger than 59 ½ years old, use a subtrust; if you’re older than 59 ½ years old, use a retirement plan rescue. Always use a stretch-IRA for any funds still in the plan when you go to heaven.
Finally, like it or not, life insurance proceeds are taxable for estate tax purposes. The IRS loves life insurance—there’s always the insurance company’s money to pay your tax bill. Fortunately, there are many strategies to convert a potential taxable life insurance death benefit into a tax-free pool of money. It’s your professional’s job to walk you through the many possibilities for avoiding the estate tax when you buy the policy.
If you already bought a policy that won’t be tax-free, consult a new advisor immediately. There are many ways to correct this mistake. But hurry—there’s usually a three-year waiting period to get off the taxable boat and onto the tax-free one.
The life insurance industry is highly regulated. Each state has an insurance commissioner, and generally they do a great job protecting the public. However, insurance companies are in business to make a profit. Here are some important things they don’t want you to know: If you have a life policy that has built up enough cash surrender value (CSV) that you no longer need to pay more premiums to keep the policy in force, and you are still healthy enough to pass a physical to get more insurance, you can dump the old policy and get a new one with a larger death benefit (and never pay another premium) almost 100 percent of the time. However, the insurance company won’t tell you that.
Nor will the insurance company tell you that your CSV dies when you die. You and your family lose every penny. So while you are alive and healthy, check out your options to use that CSV toward a new policy.
Another thing you should know about life insurance: If you don’t need it, don’t buy it. Buy life insurance only if you intend to keep the policy in force until the day you die, so your family collects the death benefit. Otherwise, save your money.
Here’s the logic: 98 percent of term policies sold never pay a death benefit; 91.5 percent of CSV policies sold lapse for various reasons and don’t pay a death benefit. One final point about life insurance: It is not for everyone. If you think that down the road you may have to choose between maintaining your lifestyle and paying a life insurance premium, rethink buying the policy in the first place. On the other hand, if you are fortunate enough to have excess funds, do not think of premium payments as a cost. The economic fact is, in such a case, the premium is simply a transfer of capital from a cash-like asset category to an insurance asset category. Again, run the numbers from today to at least seven years beyond your life expectancy.
Finally, make sure that when your estate plan is done, you will be able to legally avoid the impact of the estate tax. If not, you owe it to yourself and your family to get a second opinion.