With most tax planning, there are certain strategies that are just about foolproof and shouldn’t be ignored. The same holds true for estate planning. Here are three essential estate planning strategies that will likely help you achieve your goals.
1. Take advantage of the annual gift tax exclusion
Don’t underestimate the tax-saving power of the annual gift tax exclusion. For 2013, the exclusion is $14,000 per recipient ($28,000 if you split gifts with your spouse).
If, for example, you and your spouse give away the maximum to five recipients every year for 10 years, you’ll have transferred $1.4 million tax-free without using any of your lifetime gift tax exemptions. Annual exclusion gifts can be more effective because, unlike lifetime exemption gifts, they don’t reduce the amount of wealth you can transfer tax-free at death under your estate tax exemption. Gifting, whether under the annual exclusion or lifetime exemption, also removes future appreciation from your taxable estate.
2. Use an ILIT to hold life insurance
Do you own an insurance policy on your life? Then be aware that a substantial portion of the proceeds could be lost to estate taxes. The exact amount will depend on the estate tax exemption available at your death as well as the estate tax rates that apply.
However, if you don’t own the policy, the proceeds won’t be included in your taxable estate. An effective strategy for keeping life insurance out of your estate is to set up an irrevocable life insurance trust (ILIT) to buy and hold the policy.
If you already own your life insurance policy, you can transfer the policy to an ILIT. But watch out for the “three-year rule,” which provides that certain assets, including life insurance, transferred within three years of your death are pulled back
into your estate and potentially taxed.
3. Place assets in a credit shelter trust
Designating your spouse as your sole beneficiary may seem like a good strategy. But doing so can waste your estate tax exemption.
Suppose you leave everything to your spouse. There will be no current estate tax at your death because of the unlimited marital deduction (assuming your spouse is a U.S. citizen). When your spouse dies, however, the assets transferred to him or her at your death will be included in his or her taxable estate (assuming the assets remain intact). A substantial portion of your spouse’s estate could be subject to estate tax, depending on a variety of factors such as the size of your spouse’s total estate and the estate tax exemption available at his or her death.
You can preserve your exemption and reduce or even eliminate estate taxes by placing assets in a credit shelter trust. If properly structured, the trust provides your spouse with income for life — and access to the principal as needed — but the assets aren’t included in his or her estate. Plus, your own exemption shields the trust assets from estate tax.
Use a Professional
There’s much you need to consider when developing or reviewing your estate plan. Make sure you work with a qualified tax advisor, so you can keep your plan on the right track.