Advanced Estate Planning Techniques

by Leslie McClintock

Estate planning is the practice of structuring a family's finances to pass on assets to following generations in the most tax-efficient manner possible, while still providing for the income and desired lifestyle goals of the family members who currently possess the wealth. As of 2011, the IRS imposes an estate tax on assets over $5 million.

Life-Insurance Planning

Many estates use life insurance - especially permanent life insurance - as a source of liquidity to pay anticipated estate taxes. Term insurance does not usually work well for this purpose, as it is designed to lapse before life expectancy and becomes prohibitively expensive later in life. Permanent insurance is designed to pay out no matter when the insured dies. The accumulated cash surrender value is often protected from creditors in the meantime, in many states, and grows tax-free and is a ready source of liquidity while the policy owner is alive.

Irrevocable Life-Insurance Trusts

One of the downsides of holding life insurance to pay estate taxes on death is that the death benefit of a life-insurance policy is, itself, part of the taxable estate. Taxes are therefore due on death benefits if the deceased owned the policy. To circumvent this, some families set up an irrevocable trust that owns the life insurance policy. The trust gets the insurance policy out of the estate, reducing the overall estate tax. The disadvantage to this practice is that the policy owner loses the use of the life-insurance policy's "living benefits," or cash-surrender value.


Another way to get assets out of a wealthy person's estate is through a strategic gifting plan. Tax rules allow you to give up to $13,000 per year to any individual without a tax consequence. You can double that allowance to a married couple, and each member of a married couple can give up to the exemption, which means a married couple can give another married couple up to $52,000 per year in gifts without generating a gift tax. However, the IRS does impose a tax on cumulative lifetime gifts beyond $1 million. If the estate tax seems inevitable, the wealthy individual may even accelerate the gifting program, since the gift tax is generally lower than the estate tax. It is therefore sometimes better to pay the gift tax now to avoid the estate tax later. However, by planning ahead, a wealthy individual can move a significant amount of assets out of his estate through a consistent planned giving program.

Intentionally Defective Trusts

Trusts must pay income tax on any income earned within the trust, just like C corporations. An intentionally defective trust, however, results in the trust's grantor retaining the responsibility to pay the income tax on money in the trust. Setting up an intentionally defective trust has two effects: It moves money out of the estate when you gift assets to it in the first place; it also continues to move money out of the estate as the grantor pays the income taxes on it. Meanwhile, assets within the trust effectively compound tax-free, while the grantor is able to reduce the eventual estate-tax bill.

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