Building an estate can take years of diligent saving and investing. Once you have built up an estate, you’ll want to make sure that you preserve its value for your heirs. You can also add to or create a valuable estate by using life insurance.
Why Create an Estate?
Premature death can result in financial difficulties for your survivors. By using life insurance to protect against this outcome, you can rest assured that your heirs will be cared for financially in your absence.
If you wish, you can also ensure that other financial goals are achieved. Because the premature death of a breadwinner could make college savings or mortgage repayment impossible, steps should be taken to prepare for these possibilities. Life insurance provides a cost-effective way to guard against the threat of interrupted financial goals.
A Case Study
The following example illustrates the concept of estate creation.
Paul Pringle, a 40-year-old computer programmer, would like to begin a savings program. He and his wife, Pam, have two children, ages 10 and 8. He feels he can afford to save about $3,000 per year.
Among his options, he could choose to invest in a traditional IRA. His contributions would be fully deductible and would grow on a tax-deferred basis. This could help provide a respectable retirement nest egg. However, it would not be accessible for most other purposes without penalty before he turns 59½.
For the same annual amount, he could choose to purchase a whole life policy. He could choose a fixed premium, and his cash value would be allowed to grow tax-free, under current tax law, just like in the IRA. Unlike IRA contributions, however, whole life policy contributions are generally not tax deductible.
Paul would have penalty-free access to the cash value through policy loans or withdrawals.* And in the event of Paul’s premature death, his family would receive the policy proceeds free of income tax. The proceeds would help to maintain his family’s standard of living, and it could ensure a college education for both of their children.
Financial Leverage
In the unfortunate event that Paul dies prematurely, his policy could generate a significant amount of wealth. For a potentially low premium investment, Paul can create an estate that might take 20 to 30 years to accumulate in an IRA.
Life Insurance: A Clear Advantage
The security provided by life insurance, combined with the opportunity to create an estate, makes this choice a logical one for many families. Consult an advisor to see how you can help provide financial security for your family.
* Access to cash values through borrowing or partial surrenders can reduce the policy’s cash value and death benefit, increase the chance that the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured. Additional out-of-pocket payments may be needed if the actual cash dividends or investment returns decrease, if you withdraw policy values, if you take out a loan, or if current charges increase. The cost and availability of life insurance depend on factors such as age, health, and type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable. Any guarantees are contingent on the claims-paying ability of the issuing company. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies typically have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
How Can My Charity and I Both Benefit from My Gift?
You could receive an immediate income tax deduction. With a properly structured gift, you could realign your investment portfolio without paying capital gains tax on appreciated property. Another strategy may allow you to pass your estate on to your children while avoiding both probate and estate taxes.
You’re free to give your property to whomever you choose. To retain the tax advantages associated with planned giving, however, your gift must be made to a qualified organization.
The vast majority of donations are made to charitable organizations. To qualify, a charitable organization must have been organized in the United States, be operated on a strictly non-profit basis, and not be politically active.
In addition to common charitable organizations, you may give to veterans’ posts, certain fraternal orders, volunteer fire departments, and civil defense organizations.
You can contribute almost anything to a qualified organization. The deduction limits are more restrictive for gifts other than cash, but you are free to give almost any property of value.
What Are Some Gifting Strategies?
In addition to making an outright donation, there are a number of different gifting techniques you can use.
You can give life insurance. This enables you to give a large future gift at a relatively modest cost.
Making a planned gift can provide some significant benefits.
A charitable contribution may qualify you to receive a significant current income tax deduction.
Your deduction for an outright gift will equal the value of your gift up to certain limits. You can carry forward any gift amount that exceeds these limits for up to five years.
With a charitable lead trust, the trustor places assets in the trust, which pays an income to the charity. At the end of the trust period, the remaining assets are paid to the trustor or the trustor’s heirs. This can help reduce, or in some cases even eliminate, estate taxes on appreciated assets that eventually go to the grantor’s heirs.
By using a charitable remainder trust, the trustee can sell highly appreciated gifted investments and reinvest the proceeds to generate income without incurring a capital gains tax liability. Thus, a properly planned gift could enable you to realign your investment portfolio, allow you to diversify your holdings, and even increase your cash flow. You may also qualify for a current income tax deduction on the estimated present value of the remainder interest that will eventually go to charity.
One thing you can’t do is take back your gift. You can’t start selling assets and then pocket the money. But you can change the charity that will eventually receive your gift.
Whatever gifting strategy you choose, planned giving can be very rewarding. It’s wonderful to see your gift at work and to receive tax benefits as well.
While trusts offer numerous advantages, they incur upfront costs and ongoing administrative fees. The use of trusts involves a complex web of tax rules and regulations. You might consider enlisting the counsel of an experienced estate planning professional and your legal and tax advisors before implementing such strategies.
Have you ever wondered what will happen to your estate after you die? How long will it take for your loved ones to receive the estate you’ve left them? Will each receive what you’d like them to have?
If you’re like most people, your estate will go through a lengthy probate process.
Probate consists of the court proceedings that conclude all your legal and financial matters after your death. The probate court distributes your estate according to your wishes — if you left a valid will — and acts as a neutral forum in which to settle any disputes that may arise over your estate.
The probate process we have today is based largely on the medieval English legal system. In feudal times, only powerful families owned land. These large estates were normally passed down from father to son. This transfer was naturally a matter of great political consequence, and thus of great interest to the king. So the proceedings were made formal, complicated, and costly.
Over the years, while much of the legal system has been made easier and more accessible, the probate process has remained lengthy and complex.
There are a number of problems with the probate process that make it worth avoiding.
The probate process can take a great deal of time. The settlement time frame for many estates is from nine months to two years. Complex or contested estates can take much longer.
With few exceptions, your heirs will have to wait until probate is concluded to receive the bulk of their inheritance.
Of course, all the probate court’s “help” with your affairs comes at a price. Probate can be very expensive.
Depending on the state, probate and administrative fees can consume between 6 and 10 percent of your estate.1 That percentage is calculated before any deductions or liens are taken out.
The proceedings of the probate courts are a matter of public record. Anyone with the time and inclination can go to the county courthouse and find out exactly how much you left to each heir and to whom you owed money. This leaves your heirs with little or no privacy.
Fortunately, there are strategies you can use to help avoid the probate process altogether. A trust may enable you to pass your estate on to your heirs without ever going through probate at all. While trusts offer numerous advantages, they incur upfront costs and ongoing administrative fees. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional and your legal and tax advisers before implementing such strategies.
Proper estate planning could enable you to pass your estate to your loved ones privately, without undue delay or expense.
Living trusts enable you to control the distribution of your estate, and certain trusts may enable you to reduce or avoid many of the taxes and fees that will be imposed upon your death.
A trust is a legal arrangement under which one person, the trustee, controls property given by another person, the trustor, for the benefit of a third person, the beneficiary. When you establish a revocable living trust, you are allowed to be the trustor, the trustee, and the beneficiary of that trust.
When you set up a living trust, you transfer ownership of all the assets you’d like to place in the trust from yourself to the trust. Legally, you no longer own any of the assets in your trust. Your trust now owns these assets. But, as the trustee, you maintain complete control. You can buy or sell as you see fit. You can even give assets away.
Upon your death, assuming that you have transferred all your assets to the revocable trust, there isn’t anything to probate because the assets are held in the trust. Therefore, properly established living trusts completely avoid probate. If you use a living trust, your estate will be available to your heirs upon your death, without any of the delays or expensive court proceedings that accompany the probate process.
There are some trust strategies that serve very specific estate needs. One of the most widely used is a living trust with an A-B provision. The purpose of an A-B trust (also called a “bypass trust”) is to enable both spouses to use the applicable estate tax exemption upon their deaths, which shelters more assets from federal estate taxes.
Before enactment of the 2010 Tax Relief Act and the higher federal estate tax exemption (which increased to $5.45 million in 2016 as a result of the American Taxpayer Relief Act of 2012), some estate planning was involved to ensure that both spouses could take full advantage of their combined estate tax exemptions. Typically, it involved creation of a bypass trust. Now that portability is permanent, it’s possible for the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without creating a trust.
Even so, 18 states and the District of Columbia still have their own estate and/or inheritance taxes, many have exemptions of $1 million or less, and only one (Hawaii) has a portability provision.1 By funding a bypass trust up to the state exemption amount, you could shelter the first spouse’s exemption amount from the state estate tax.
Thus, an A-B trust may still be useful, not only to preserve the couple’s state estate tax exemptions but also to shelter appreciation of assets placed in the trust, protect the assets from creditors, and benefit children from a previous marriage. In most cases, however, when couples have combined estate assets of $10.9 million or less in 2016, they might be better off just leaving everything outright to each other.
A living trust with an A-B provision, also called a bypass trust, can help ensure that a couple takes full advantage of the estate tax exemption for both spouses. When the first spouse dies, two separate trusts are created. An amount of estate assets up to the applicable exemption amount is placed in the B trust. The balance is placed in the surviving spouse’s A trust. This then creates two taxable entities, each of which is entitled to use the exemption.
The B trust is taxed. But because it doesn’t exceed the estate tax exempted amount, no taxes will actually be paid. The surviving spouse retains complete control of the assets in the A trust. He or she can also receive income from the B trust and can even withdraw principal when needed for health, education, support, or maintenance.
Upon the death of the second spouse, only the A trust is subject to estate taxes because the B trust contained less than the exemption amount. If the assets in the A trust don’t exceed the applicable exemption amount, no estate taxes are owed. At this point, both trusts terminate and the assets are distributed to the beneficiaries, completely avoiding probate.
While trusts offer numerous advantages, they incur upfront costs and ongoing administrative fees. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional and your legal and tax advisers before implementing such strategies.
What Key Estate Planning Tools Should I Know About?
By taking steps in advance, you have a greater say in how these questions are answered. And isn’t that how it should be?
Wills and trusts are two of the most popular estate planning tools. Both allow you to spell out how you would like your property to be distributed, but they also go far beyond that.
Just about everyone needs a will. Besides enabling you to determine the distribution of your property, a will gives you the opportunity to nominate your executor and guardians for your minor children. If you fail to make such designations through your will, the decisions will probably be left to the courts. Bear in mind that property distributed through your will is subject to probate, which can be a time-consuming and costly process.
Trusts differ from wills in that they are actual legal entities. Like a will, trusts spell out how you want your property distributed. Trusts let you customize the distribution of your estate with the added advantages of property management and probate avoidance. While trusts offer numerous advantages, they incur upfront costs and ongoing administrative fees. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional and your legal and tax advisers before implementing such strategies.
Wills and trusts are not mutually exclusive. While not everyone with a will needs a trust, all those with trusts should have a will as well.
Incapacity poses almost as much of a threat to your financial well-being as death does. Fortunately, there are tools that can help you cope with this threat.
A durable power of attorney is a legal agreement that avoids the need for a conservatorship and enables you to designate who will make your legal and financial decisions if you become incapacitated. Unlike the standard power of attorney, durable powers remain valid if you become incapacitated.
Similar to the durable power of attorney, a health care proxy is a document in which you designate someone to make your health care decisions for you if you are incapacitated. The person you designate can generally make decisions regarding medical facilities, medical treatments, surgery, and a variety of other health care issues. Much like the durable power of attorney, the health care proxy involves some important decisions. Take the utmost care when choosing who will make them.
A related document, the living will, also known as a directive to physicians or a health care directive, spells out the kinds of life-sustaining treatment you will permit in the event of your incapacity. The directive creates an agreement between you and the attending physician. The decision for or against life support is one that only you can make. That makes the living will a valuable estate planning tool. And you may use a living will in conjunction with a durable health care power of attorney. Bear in mind that laws governing the recognition and treatment of living wills may vary from state to state.
