Estate Tax Planning for 2011...Part 1

We are less than two months away from 2011 and, if you have been following me over the last year via my newsletter, blog, or twitter feeds, you know I have been saying that the federal estate tax will be returning in 2011. Without Congressional changes, the estate tax will hit any estates over the federal exemption of approximately $1.0 million with a tax rate of fifty-five percent (55%). While I have discussed estate planning steps generally over the last year, there are some actions that you can take right now to mitigate the impact of the federal estate tax in 2011 and potentially future years. Part 1 will discuss the more flexible and cheaper options and Part 2 next month will discuss more permanent and expensive ones.

Annual Gifts

Any person can give up to $13,000 to any other person tax free.1 Unlike a disbursement given through a will, a gift allows a person to give money to family members and watch them enjoy the value of the gift. Any annual gifts in excess of the $13,000 will be used to consume a person’s lifetime exclusion, which is $1.0 million. Further, gift splitting can also be used, such that each parent can give a child $13,000, or a total of $26,000 per couple to one person in 2010. Also, a person can give an unlimited amount tax-free for health and education on behalf of another person, if that money goes directly to the health care or educational provider.

Another possibility is to give money in excess of lifetime gift tax amounts in 2010 and pay the gift tax in 2010. As an aside, gift tax is owed by the donor, or person giving the gift, not by the person receiving the gift, or donee. The 2010 gift tax rate can be up to thirty-five percent (35%). That seems stiff considering that money has likely already been hit with income tax. But in 2011, the gift tax rate will mirror the estate tax rate of fifty-five percent (55%).

Fund College Savings Plan

The emergence of Section 529 accounts as a saving tool for college can also be used for estate planning purposes in 2011. Earnings in a 529 are exempt from federal and state income tax, provided the money is withdrawn to pay for certain college or graduate school expenses. A person can deposit as much as $65,000 a person ($130,000 for married couples). There is a caveat. A gift tax return must be filed that treats the gift as if it had been spread over five years. If the donor dies before the five years is up, a pro-rated portion of the gift goes back into the person’s estate. The best part is the donor still controls the money and can pull it out if necessary (though penalties and taxes will be owed) but it does not count as part of the donor’s estate for estate tax consideration.

Convert an IRA to a Roth IRA

As I discussed in detail in my February newsletter, the income limits on a taxpayer being able to convert a regular IRA to a Roth IRA were removed for 2010. This provides a powerful estate planning tool based on the simple difference of when taxes are paid between an IRA and Roth IRA. A traditional IRA is generally funded with pre-tax dollars.2 Income distributions from a traditional IRA have income tax applied to them. If non-spouse inherits a traditional IRA, the IRA will also have estate taxes applied. Because Roth IRA’s are funded with post-tax dollars, distributions are not subject to income tax but do have estate tax applied to the distributions, when applicable. Whether conversion makes sense is up to an individual situation. Converting to a Roth IRA only for estate tax reasons might not make sense, but talk to a financial professional to see if a conversion will make financial sense.

Donations to Charity

If the federal estate tax returns in 2011 and a testator has a taxable estate at fifty-five percent (55%), then it would be a good idea to make donations to charity. Every dollar given to charity saves fifty-five (55) cents on estate tax. It also offers the added bonus of providing an income tax deduction for 2010. A donor gets the added satisfaction of being alive at the time of the gift to see the benefit the donation presents as compared to when a donor creates some form of charitable trust that is funded only when the donor dies.

Over the last 18 months, estate planning has been held hostage by lack of action by Congress on determining what, or even if, there will be a federal estate tax. Even without direction from Congress, a person can plan to take steps in 2010 to plan for some form of estate tax returning in 2011.

Basics of Estate Planning: Irrevocable Life Insurance Trusts

Barring Congressional action over the next two months, the 2011 federal estate tax exemption will return to an approximately $1.0 million level meaning less affluent estates will need to take steps to reduce the taxable portion of the estate. Last month, I went into some detail regarding how the death benefits from a life insurance payout could be included in a decedent’s taxable estate. There are several ways around including properly transferring ownership to another individual following life insurance and IRS guidelines, listing a surviving spouse as the beneficiary to utilize the unlimited marital deduction or establish an irrevocable life insurance trust, or ILIT to hold the life insurance policy. Many planners feel ILITS will be a key element in reducing a testator’s estate size.3

An ILIT is created by the formation of an irrevocable trust. Irrevocable means the trust terms cannot be rescinded, amended, or modified in any way after it is created. Once the grantor contributes property to the trust, the grantor cannot later reclaim ownership of the property or change the terms of the trust. Thus, an irrevocable trust is outside of the estate of the settlor of the trust for estate tax purposes. An ILIT can also be structured so that the trust will provide benefits to the insured's surviving spouse without inclusion in the surviving spouse's gross estate.

For tax reasons, it is generally better to establish an ILIT prior to the opening of a new life insurance policy. An existing policy may be transferred into an ILIT but there is a reason a new life insurance policy is better. For estate tax purposes, only after three years have passed after the transfer of the ownership of the life insurance policy to the ILIT has occurred will the life insurance death benefits be considered not included in the decedent’s estate. If an existing life insurance policy is transferred, the beneficiary will receive the money. However, the benefits will be considered part of the decedent’s taxable estate, which might push the decedent’s estate over the estate tax exemption level. A fail-safe provision, if the insured has a spouse, can be drafted in the ILIT in the event the insured dies within the three year time frame to insulate the benefits from the estate tax. With the creation of a new life insurance policy, the newly created trust purchases the policy before the insured takes ownership of the policy avoiding the gift transfer issues.

An ILIT can be created with a term or whole life policy and there are numerous benefits in creating an ILIT including:

  • death benefits from the life insurance policy are removed from the insured’s estate and are free of estate taxes,
  • the trust does not pass through the public probate process eliminating unwanted disclosure of assets of the decedent,
  • beneficiaries can also use trust proceeds to pay estate taxes if the insured also has a taxable estate,
  • proceeds held in the trust may be protected from the creditors of the trust beneficiaries,
  • a surviving spouse can receive income from the trust during his or her lifetime,
  • insurance proceeds will be held in trust for the benefit of a surviving spouse instead of going directly to surviving spouse, thus, the proceeds cannot be taxed in surviving spouse's estate either, and
  • premium payments are made as annual gifts from the insured to the trust, potentially lowering the taxable estate.

While an ILIT has numerous positives when created, there are also several concerns with creating an ILIT. The largest issues deal with loss of control of the life insurance policy, but other issues include:

  • trust terms cannot be altered once the trust has been established,
  • life insurance policy transferred to an ILIT results in you:
    • giving up control over that policy,
    • being unable to make loans or withdrawals of the cash value of that policy, and
    • being unable to change its beneficiaries,
  • trustees and legal advisors must carefully handle gifts made to the trust to prevent triggering gift taxes,
  • professional trustees usually charge annual administration fees and may not agree to manage smaller trusts
  • the insured cannot be the trustee of the trust but spouse and/or children can be trustees, and
  • an ILIT requires annual maintenance requirements to keep the ILIT compliant with the IRS.4

As of November 2010, it appears that Congress is not going to take any steps to prevent the estate tax returning in January of 2011. That will mean a federal estate tax exemption of $1.0 million and many more Americans will have the taxable estate. Taking steps to remove assets from your estate will be critical in lowering an estate tax bill. One of those ways will be the creation of ILITs.

Estate of the Month: Sparky Anderson

Many of the issues in my Estate of the Month column address the lack of planning or errors the rich and famous make planning their estate. Beneficiaries consume countless hours and squander thousands of dollars in attorney and accountant’s fees rectifying the errors of the decedent. This month, I leave the physical documents of an estate plan and discuss a different topic: end of life planning. At the emotional level, end of life planning is more important than financial estate planning. Proper end of life planning ensures that loved ones get the closure they need while protecting the dignity of the dying. The recent passing of a famous baseball manager provides a good example of end of life planning.

George Lee Anderson, known to most baseball fans as “Sparky” Anderson, died on November 4th, leaving behind a remarkable legacy that included being the baseball manager of the Cincinnati's Big Red Machine that won the World Series in 1975-76 and the Detroit Tigers that won the World Series in 1986. He was inducted into the Major League Baseball Hall of Fame in 2000. His actions over the last couple of years are interesting from a planning view, especially in light of Anderson’s cause of death: dementia.

Dementia is defined as a loss of mental ability severe enough to interfere with normal activities of daily living, lasting more than six months, not present since birth, and not associated with a loss or alteration of consciousness. Dementia impacts millions of Americans, not only those with the disease but those around them. Most experts believe dementia is caused by the gradual death of brain cells resulting in impairments in memory, reasoning, planning, and behavior. Because of the gradual development of the disease, estate planning, end of life planning and post-death remembrances can be influenced.

A person drafting their will, creating a power of attorney, discussing their medical care desires or even planning their funeral requires a certain level of capacity to have those deliberations. A person requires certain standard to create legal documents but the person with dementia might not even be able to understand the reality of the situation to even discuss funeral arrangements. In short, dementia creates capacity issues that complicate all types of planning. Only through early planning, hopefully prior to a diagnosis, can a person take charge of end of life issues. Even, if a diagnosis occurs at an early stage of dementia, it might be too late to estate plan or have adequate end of life discussions.

From a Washington Post article posted on November 3rd, the day before he died, Anderson appears to have thought about the end of his life. From all outside evidence, it appears Anderson informed his loved ones of what steps he wanted taken near the end of his life before his diagnosis. Why do I say that? Instead of dying in a hospital, Anderson was placed in hospice care at his home and died a day later. Without communicating end of life desires, many loved ones will take the person to the hospital to live out their days unaware of the dying’s desire to pass in their own bed.

Hospice care is a program or facility that provides special care for people who are near the end of life and for their families. Hospice care can be provided at a multitude of places including at home, in a hospice center or another facility. It is not that loved ones make the wrong decision with respect to taking their loved one to a hospital; many do not know the flexibility hospice provides. So instead of a person passing on in the comfort of their bed, that person dies in the hospital.

Given Anderson’s use of hospice care and a public statement published prior to his death asking for people’s thoughts and prayers, it is likely Anderson sat down with his loved ones to discuss the end of his life. Maybe it was his great baseball manager background, which required him to deal with numerous personalities on his teams, that translated easily to handling family dynamics and led him to his end of life decisions. Clearly, he gave those around him the directions in how best to remember his name and life, even before he passed away. Hopefully, his actions will lead others to take similar steps in expressing their end of life needs.


1 Under IRS regulations, the donor is generally responsible for paying the gift tax on any gifts.

2 High income individuals/couples and those with certain retirement plans can only open non-deductible IRAs i.e. opened with post-tax dollars.

3 To see an example of a taxable estate click here.

4 Each year, after insured gifts money to ILIT to pay premiums, a “Crummey” letter must be written to each beneficiary stating that a gift has been made to the ILIT and the beneficiaries can withdraw it if they want within a certain timeframe, usually 30 or 60 days. If the beneficiaries don't exercise this right, the gift becomes a present interest gift to the trust. To be considered a gift, the gift recipient's enjoyment of the gift can't be postponed into the future. If the “present interest” is postponed, then the gift fails to qualify for the annual exclusion.


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