Intermediate Estate Planning: Gifting, Sophisticated Insurance Options and Trusts

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Estate planning is essentially a set of tools that use the exceptions in the inheritance, probate, and tax process to give you more control over the outcome of your estate. In this series, we’ll cover these key tools, from the basics that everyone should have in place, into more sophisticated options for tax planning and complex situations.

A large portion of upper-middle-class and high-net-worth families would also benefit from intermediate-level planning: annual gifting, establishing trusts to carry out specific goals and/or using life insurance in a more sophisticated strategy.


GIFTING: Moving Assets Out Of Your Estate

Each year, you can transfer tax-free gifts to an unlimited number of family members and other individuals, and as long as you don’t exceed the per-gift limit, it is not taxable. However, any amount over the limit is taxable, and furthermore, must be added back to the value of your estate for tax computation purposes at death.

Gifting has the benefit of lowering your total estate value and moving future appreciation out of your estate. Considering that the tax exemption threshold only moves up at the rate of annual inflation, but your assets could grow at a much higher rate, that can be a substantial benefit.

  • Gifting. 2019 limits allow annually for $15,000 per gift to an unlimited number of family members or other individuals, or to organizations including trusts. Annual gifts larger than that amount may be subject to federal gift taxes. For married couples, each spouse can make a gift to the same person, transferring up to $30,000 tax-free.
  • An exceptional gift? Money paid directly to a healthcare or education provider on someone else's behalf is not considered a gift, for gift and estate tax purposes.


TRUSTS: Flexible Tools With Many Options

A trust is a legal entity that you set up through a lawyer which becomes “the owner” of your named assets. As part of creating a trust, you appoint one or more trustees, who are responsible for managing assets in the trust. Often, the grantor is the trustee, with a successor trustee also appointed.

A main benefit of putting your assets in a trust is that they will not also specify the beneficiaries, as if it has its own separate will. Another important benefit is that if you become incapacitated during your lifetime, the successor trustee is already set up to step in and manage those assets on your behalf.


REVOCABLE/LIVING TRUSTS VS. IRREVOCABLE TRUSTS: Control vs. Tax Efficiency

There are many specific types of trusts, but all fall into two categories: revocable or irrevocable.

  • Revocable trust. It’s simple and advantageous to set up a revocable trust to hold your assets. You can name and update your trustee(s) and beneficiaries, and the assets will typically not be subject to the probate process upon death. Revocable means that the trust creator, the grantor, retains control over the assets and can revoke the trust at any time. They can also be subject to creditor claims or lawsuits and used to pay your debts upon death.
  • Irrevocable trust. An irrevocable trust can provide immediate income tax benefits, as well as future estate tax benefits. An irrevocable trust is one that, once created, cannot be reclaimed by the grantor. The assets in an irrevocable trust “exit” your estate for tax purposes, a key benefit for those whose net worth may surpass estate-tax limits. In most cases, the taxable income on the assets is no longer attributed to the grantor; instead, the trust pays its own income tax.


Life Insurance As A Liquid Asset, Possibly Outside Of Your Taxable Estate

Life insurance benefits can be counted toward your taxable estate for two reasons: if the estate is named as the beneficiary, or if the deceased is the owner of the policy at the time of death. Most of the time, the named beneficiary is a spouse or children. The ownership of the policy is something that can be favorably adjusted using estate planning tools. This is where an ILIT, SLAT, or split-dollar arrangement can be used to move the value of the policy all or partially out of your taxable estate.

  • Irrevocable trust. Split dollar arrangements. In this setup, two parties “split” the premiums and benefits of a life insurance policy. It is often between employer and employee, but in estate planning it’s common to see a grantor and a trust as the two parties. Again, this functions as a way to make a trust the part owner of a life insurance policy.


Commonly Used Irrevocable Trusts

Life insurance benefits can be counted toward your taxable estate for two reasons: if the estate is named as the beneficiary, or if the deceased is the owner of the policy at the time of death. Most of the time, the named beneficiary is a spouse or children. The ownership of the policy is something that can be favorably adjusted using estate planning tools. This is where an ILIT, SLAT, or split-dollar arrangement can be used to move the value of the policy all or partially out of your taxable estate.

  • Irrevocable life insurance trust (ILIT). An ILIT is typically the owner and the beneficiary of a life insurance policy funded by the grantor. If funded properly, the ILIT is not subject to income tax or estate tax.
  • Spousal lifetime access trust (SLAT). In this type of ILIT, the grantor’s spouse is named as a beneficiary, giving the spouse access to trust assets which may include the cash value of life insurance policies.
  • Dynasty trust. These long-term trusts are meant to continue for as many generations as state law allows. They give future generations access to assets to pay for things like healthcare and education, providing an effective way for future generations to use those assets without an outright transfer, which would likely trigger the GST (generation-skipping transfer tax).
  • Intentionally defective grantor trust. This kind of trust removes assets for estate-tax purposes but the grantor continues to pay income taxes on the assets. This may be an advantage for assets that provide a high level of income, since trust tax rates can be higher than personal tax rates.


Control

Any kind of trust can include specific language for the trustees and beneficiaries to outline your wishes. For example, you can set an age at which minor children can access trust assets.

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