It’s Worth Breaking from Tradition

Do you have enough wealth that your estate will be clobbered by taxes? What can you do now to make sure your assets are intact for your heirs after you’re gone? We routinely preach the need for everyone in such a position to have plans in place to maximize the amount they leave to their families. Unfortunately, many financial advisors stick exclusively with conventional estate planning methods and, in doing so, can inadvertently turn their wealthier clients into estate tax victims. 

If you have a formal plan, chances are it is what we call a “traditional estate plan” or TEP, and the fact that you have any plan at all is still a good thing. A TEP includes a rather simple “pour-over” will and a revocable trust. After you die, such a will gathers together any assets you own that are not already in the trust and “pours” these assets into the trust. Your estate plan is contained in this trust, which typically is set up as an A/B trust or family/residuary trust or something similar.

Is there anything wrong with having a TEP? Absolutely not—assuming it is drawn up properly. The problem with such an estate plan is that it typically is not specifically designed to decrease or eliminate estate taxes. It is not enough, in and of itself.

A TEP tends to use two estate tax “tricks”: the marital deduction and the unified credit. The marital deduction defers any estate taxes until after the death of the deceased estate owner’s spouse, but the IRS will still get its pound of flesh at that time. The unified credit protects only $5.34 million of a person’s wealth (or $10.68 million of a married couple’s assets) from estate taxes. So a TEP is not necessarily a bad plan, but any claim that it can save even a dime in taxes over the unified credit is a myth.

If your estate plan consists only of a TEP or even if it also includes an irrevocable life insurance trust (ILIT), chances are your family will miss out on significant portions of your wealth after you die. You also need a plan for your estate while you are still alive that will protect your assets for later.

Improving Joe’s Plans
Joe’s entire estate plan was a typical TEP. He and his wife, Mary, own 5 percent of Success Co., an S corporation, in the form of all of its voting stock. Their children own the remaining 95 percent, or all of the non-voting stock. (This setup was created to allow Joe to maintain control throughout his lifetime of the company that he started, but to also get the company out of his estate.) In addition, Joe and Mary own $23 million of other assets. Since a TEP is essentially a death plan, and does not legally come into play until after they die, we suggested Joe and Mary also create a lifetime estate plan.

Simply put, everyone with significant wealth should have two plans: one that handles your assets after your death and one that protects that wealth during your lifetime so that estate taxes are eliminated by the time you die. Remember, it’s not what you are worth today that’s socked with estate taxes, but the amount you (or your spouse) are worth when you enter the pearly gates.

Here are six strategies we wove into a comprehensive lifetime plan for Joe, Mary, their family and their business:

1. Asset protection strategies to protect Joe’s personal assets and, separately, the 
business assets.

2. Creating a management corporation (C corporation) to provide Joe (but not other employees of Success Co.) with many tax-free fringe benefits, including long-term care and medical expense coverage.

3. Creating a family limited partnership for Joe’s investment assets (mostly real estate 
and a stock/bond portfolio). This reduced the value of these assets by 35 percent for 
estate tax purposes and was combined with an annual gifting program to Joe’s children 
and grandchildren.

4. Contributing to education funds for Joe’s grandchildren. A portion of the profits 
from Success Co. will be used to pay for their college education.

5. Creating a family foundation and a charitable lead trust as tax-effective ways to make substantial charitable contributions without reducing the children’s inheritance.

6. Purchasing life insurance on Joe. He secured an $8 million life insurance policy on himself, but the insurance premiums will be paid using a bank loan, which will be repaid through proceeds from the policy after Joe dies.

There are certainly other strategies that a qualified estate planning advisor should be able to suggest as solutions for minimizing or eliminating estate taxes. You will know that your own estate plan is done right if it is guaranteed to get every dollar of your wealth to your family after you are gone.