For those who entertain the idea of leaving an inheritance for beneficiaries or dependents, the thought of estate taxes depleting the benefit is not palatable. For those with estates above the estate tax threshold, that chunk lost could be between 25% and 45%. Fortunately, there is a host of strategies that can reduce the size of estate taxes.
♦ Lifetime gifting
Giving lifetime gifts is the best known method of reducing estate taxes. It involves bestowing a portion of an estate to loved ones or beneficiaries by way of trusts or annuities primarily. The amount of the gift no longer constitutes part of the value of the estate. With this strategy, there is the gift tax to factor in. When that is compared to the estate tax foregone, it is a win-win situation for the owner and beneficiaries.
This strategy has restrictions, as there is a one million dollar lifetime exemption before gift taxes are levied. One additional benefit of this strategy is that the beneficiaries benefit from any increase in value of the gift. However, the gifting strategy requires a good estimation of the size of the gift, because ownership and control of that part of the estate is relieved, and estate taxes might change in future.
Some annuities can be used to bestow gifts unto beneficiaries but, in some countries, the accumulated annuity fund of deferred annuities is exempt from estate taxation. To manage the value of an estate, Single Premium Immediate Annuities can be utilized to liquidate the estate. That allows the owner to benefit from the estate through annuity income without burdening beneficiaries. In addition, the annuity has settlement options, some of which allow for the beneficiaries to benefit from the income if the estate owner passes away.
There is a myriad of trust options for use in a sophisticated estate plan. Marital trusts increase the first-to-die tax exemption or unlimited marital deduction. Qualified Terminable Interest Property (QTIP) trusts are also available. QTIP trusts allow a spouse to benefit from the income generated by assets placed in the trust, but not ownership or control of the trust assets. When the spouse dies, the assets in the trust become taxable and are passed on to other named beneficiaries.
Other notable trusts worth investigating are the Bypass or Credit Shelter Trust, Grantor Retained Annuity Trusts, Charitable Remainder Trusts, Crummey power trusts, and the Irrevocable Life Insurance Trust. The Irrevocable Life Insurance Trust establishes a beneficiary relationship to the owner that ensures that the proceeds would not pass to the insured’s estate, but would be distributed tax-free to beneficiaries. A Charitable Remainder Trust allows donation of part of one’s estate to a charity, but the donor gets to benefit from the assets or income for an agreed period.
Each estate-tax reduction strategy needs to be assessed according to its merits and demerits, preferably with the assistance of a CPA or an estate tax attorney. Estate taxes are not inexorable and the strategies outlined can help persons avoid them altogether or reduce them significantly.