94. Save $100,000s in taxes 7 ways to transfer your estate tax-free to your children
Logic and emotion may suggest that now is not the time to give anything away. Yet, although there hasn't been much to applaud in the financial news recently, an environment of depressed asset values and low interest rates actually may make it a good time, from an estate planning perspective, to consider some of your options.
Transferring assets to your children and grandchildren during your lifetime helps them now, while at the same time, decreasing the size of your estate and your estate tax exposure. But the IRS keeps a watchful eye out so that people don't try to give away too much now to avoid tax later. (That's why there is a gift tax.)
Here are 7 ways to transfer your estate (near or fully) tax-free (discuss these with your estate tax planner):
1. Take advantage of gift-giving opportunities
Family gifts are a good place to start. You can give up to $12,000 ($13,000 in 2009) to anyone you wish, gift tax free. When couples make the gifts together, the amounts double ($24,000/$26,000). Do that regularly over the years, and you can remove the potential threat of taxes on a significant sum.
Take this hypothetical: Jay and Kay have two children. They plan to write checks to each of them in December for $24,000. Suppose they own stock in XYZ Company, which had been valued at $50 per share earlier in the year. Had they made gifts of the stock instead of cash back then, they could have transferred 960 shares. In December the stock is valued at $32 per share and they can give away 1,500 shares. So more shares pass to their children tax free and, presuming that the XYZ Company shares rebound, any future appreciation is removed from their estates.
Two more gift giving ideas. One, beyond the gift tax exclusion, you and your spouse each have a $1 million gift tax exemption. The difference is, should you use it or any part of it, your estate tax exemption ($2 million in 2008, $3.5 million in 2009) drops dollar for dollar.
Two, you can help children or grandchildren with medical or education expenses tax free as well. There is no dollar limit on these gifts as long as they are paid directly to the health provider or school.
2. Make a low-interest loan
Low-interest rates make loans an attractive way to transfer money to your offspring as long as you follow the rules that will keep the loan from being treated as a gift.
IRS publishes monthly rates that set the minimum interest you must charge based on the loan's maturity date. For example, in November 2008, if your children borrowed money from you for nine years (a "mid term" loan), the annual interest rate must be at least 2.97%.
If your child then takes the money and invests it, what's left after making the interest payments to you is "profit." Want to help your children with the purchase of a home? Loan them the money at the current low rates and make annual exclusion gifts each year to help them buy down principal. But don't forgive the loan you could face unpleasant gift or income tax consequences.
3. Set up a GRAT
A more sophisticated way to transfer wealth to your children (or others) is to set up a grantor annuity trust, or GRAT). You transfer assets that you expect to grow in value in the coming years to the GRAT and receive annuity payments based on the initial value of the assets in the trust, at a set annual income rate and for a specified number of years.
The transfer to the trust is a gift based upon the value of what's left in the trust (the remainder) after the trust ends, reduced to reflect the time that passes until the assets are distributed to your children. The IRS assumes an interest rate 3.6% in November 2008 that the trust's assets will earn. If the actual income earned by the trust is higher, the excess stays in the trust and accumulates (as, presumably, over time, so will the value of the assets themselves).
At today's low interest rates, the remainder in the trust can grow significantly. Your children won't have to pay any tax on what the trust distributes to them, and the assets (and appreciation) escape tax in your estate as well.
But setting up a GRAT is not risk free. If you die before the trust ends, the assets will be included in your estate for estate tax purposes. The major tax benefit avoiding tax on the appreciation of the assets has been lost, plus you are out of pocket for the fees that you paid to set up and administer the trust. And, should the value of the assets in the trust decrease, you have used up a greater portion of your $1 million gift tax exemption for a transfer with a lesser value. In the worst-case scenario, the GRAT could be exhausted if the value of the assets falls precipitously.
4. Life insurance for wealth transfer my favorite
Deciding what assets to pass to your children and grandchildren can be complicated. Thats because when it comes to transferring wealth, all assets arent equal. Different assets are subject to different costs and problems when they are transferred. Some assets are illiquid or can lose value because of taxes, transfer costs, commissions or management fees. Other assets fluctuate in value; what they are worth can go up and down with changes in the marketplace. It can be very difficult to know how much your assets will be worth when they are passed to other family members. People who want to transfer their hard-earned wealth efficiently need to take a close look at their assets and analyze how much net value they are likely to pass on. Life insurance is an asset that can efficiently transfer wealth within a family.
Well-to-do families often use life insurance as part of their wealth transfer planning because it has a unique combination of potential advantages:
1. Predictable Value The policy may be structured to pay a known death benefit amount when the insured dies.
2. Value Not Directly Linked To Market Performance The policy may be structured so that the death benefit may not directly depend on financial market performance.
3. Liquidity The death benefits are automatically paid in cash; generally no income taxes, transfer costs, commissions or management fees are subtracted from the death benefit.
4. Growth/Leverage Premiums paid for death benefit protection can provide significant leverage in the early years and a competitive rate of return through life expectancy.
5. Income Tax-Free Payment Policy death benefits (including the amount in excess of premiums paid) are generally income tax free under IRC Section 101.
6. Easily Divisible Death benefits can be easily divided among several beneficiaries; through the beneficiary designation the policy owner directs how the proceeds should be distributed.
7. Avoids Probate Death benefits are paid directly to the beneficiaries without the costs and delays that often impact assets distributed through the probate court system.
8. May Avoid Estate Taxes Ownership of the policy may be structured so that the death benefits will not be subject to federal estate taxes as part of the insureds taxable estate.
9. Subject To Government Oversight All life insurance policies offered for sale as well as the insurance companies and representatives who sell them must satisfy state standards.
Each of these advantages is valuable by itself. The ability of life insurance to deliver ALL these advantages makes it an effective wealth transfer tool. Wealth transfer planning is something you do for those you love. Life insurance may be able to help you do it even better.
The need for coverage easily becomes a $2,000,000 life insurance need when that income earner makes $80,000 $100,000 per year.
Here are $1,000,000 and $2,000,000, 20 year Term Life Insurance Quotes:
The quotes below assume MALE, non tobacco user in excellent health. Please note that use of medications or health history may or may not increase the premium.
Age $1,000,000 $2,000,000
30 years old $37.19 $68.09
40 years old $55.63 $103.69
50 years old $154.44 $303.19
60 years old $424.98 $842.39
70 years old $1,547.64 $3,092.62
80 years old $4,303.82 $8,607.64
Does $842 per month for a 20 year term, $2 Million policy sound expensive to you?
If you can afford the premium, this could be the best investment you ever make. Lets say you purchased this policy at age 60 for $2 Million 20 year term, and lived for 10 years. You would have paid $101,086 into the policy over the 10 years, but your return upon death would be $2 Million. Thats an internal rate of return of 62% per year!
If you lived 15 years, your equivalent rate of return would be 32%, and it would be 20% if you lived 20 years. In other words, if you wanted to accumulate 2 Million dollars over the course of 20 years, and invested $842 per month into an alternate investment, it would need to earn 20% per year to accumulate to $2,000,000. So, yeah, its a great investment, if you can afford it.
5. Using single premium life insurance to transfer wealth
Single premium life insurance is a valuable investment when it comes to wealth creation and transfer. With this type of life insurance, a single premium is deposited, creating an immediate death benefit that is guaranteed until the owner passes away. The death benefit will depend on the amount deposited, gender, age and health of the insured. In many cases, the single deposit will be multiplied by a factor of two or more when the death benefit is calculated. Typically the younger the insured, the higher the benefit received. For instance, a 65 year old healthy, non-smoking woman who deposits $100,000 into a single premium life policy could pass $200,000 or more in death benefit to her beneficiaries. Moreover, the benefit is income tax free to her recipients!
Benefits of Using Life Insurance to Transfer Wealth: Single premium life insurance can also benefit the insured or the purchaser during his or her lifetime. The cash value in a fully funded policy will grow quickly and can provide income to the purchaser if needed. In turn, the purchaser can also surrender the policy for its cash value at any time. A few policies guarantee the cash value to be no less than the one time deposit. This way, if the insured needs to surrender the policy due to unforeseen circumstances, he or she is guaranteed to get the investment back. The insured also has the option of taking a loan against the policy instead of surrendering the contract if desired.
Good news: Congress finally dealt with the estate tax and created a $5 million gift and estate tax exclusion. That means you can gift or bequeath not only an unlimited amount to a spouse, but an additional $5 million to non-spouse beneficiaries. Between husband and wife, a minimum of $10 million can go to the kids.
Better news: The credit that shields these assets from taxation is now portable. That means that any credit not used by the first spouse who dies can automatically be claimed by the surviving spouse upon the second death. If there were multiple spouses, only the last one counts.
There's a hitch though -- a major trap for the unwary. In order to have the credit carry forward, the IRS wants an estate tax return (Form 706) to be filed for the first to die, even if no tax is owed. It's a small price to pay.
Couples will no longer have to equalize their assets to maximize their credit. The change also means that special credit-shelter trusts no longer have to be drafted into wills in order to minimize taxes. They may be appropriate for other reasons, though, such as to protect the assets for the children from a potential successor spouse.
But beware: Unless Congress acts, the $5 million gift and estate tax exclusion falls to only $1 million after 2012.