A gift to charity and insurance help protect estate from tax man
Many people like to leave ``a little something'' for their heirs. Unfortunately, a little something may be all their heirs have left after paying out federal and state inheritance taxes.
While husbands or wives can pass their estates on to their spouses tax-free, their children, grandchildren, or any other heirs do not have the same benefit. If the estate taxes in a particular state are fairly high, this, combined with the 50 percent federal inheritance tax, can mean paying out some 65 percent of a large inheritance in taxes, says Ronald Meier, a financial planner with Seidman Financial Service in Houston.
This is why many people with fairly large estates are looking at legal ways to shelter more of it from the tax man. One such method, called a ``wealth accumulation trust,'' is suggested by Robert W. Schumm, senior vice-president and an investment broker with Wheat First Securities in Wilmington, Del.
Although he and his firm earn commissions and management fees for handling the investment aspects of such a plan, it is similar to those offered by other investment advisers.
In Mr. Schumm's example, he assumes a $1 million estate, including property and stocks, but it would work for an estate adding up to $250,000 or $500,000, he says. ``And it's not hard to find people with a net worth like that,'' he says. The equity in a home, a second home, stocks, and a pension can easily top $500,000 for many people, he says.
The first step is to transfer the property to the trust, an action that will not be considered a sale or exchange, so there will be no capital gains tax. Also, the trust is exempt from income gift and estate taxes.
At the same time this trust is being set up, a second trust will be established to purchase a life insurance policy equal to the value of the transferred property.
As long as they live, the couple will receive an annual income from the trust, based on 8 percent of its value. While this money will be taxed, assets built up in the trust will accumulate tax-free, so the income could increase as the value of the trust grows.
When both the husband and wife have passed on, the assets still in the trust will be given to a charity of their choice. Because they made this provision when the trust was first set up, they received the charitable income tax deduction in the year it was created.
Meanwhile, the insurance policy will pay the heirs a death benefit approximately equal to the value of the original estate. Since the policy was purchased by its own trust, the proceeds go to the family free of income, gift, or estate taxes.
Setting up these trusts will require the help of a lawyer or law firm with experience in taxes and estates, Schumm says. And the money in the trust has to be managed by someone experienced in these areas, like an investment advisory firm or bank trust department.
Mr. Meier, however, is a little concerned that a plan such as this may not accomplish all that it sets out to do.
``This is a perfectly legal, valid arrangement,'' he says. ``but I don't like to see two different strategies combined to achieve one goal.'' If a couple wants to make sure their heirs receive a full $1 million inheritance, for instance, Meier suggests they simply take out an insurance policy to cover the amount that would be lost to taxes.
``This is a more tax-efficient way to do it,'' he believes. Assuming the estate has grown in value over time, the heirs will get a greater benefit.
In the end, the right answer will be different for different people, so a comparison of choices from several advisers - including professionals on both sides of the sales commission fence - should be made before any formal trust arrangements are set up.
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