Thanks to changes to estate tax laws, the federal government is taking less of what's left behind. Estates worth up to $1.5 million are exempt through 2005.
But take a close look at what you own. Many middle-class taxpayers are finding that when they combine their assets with a sizable pension account or insurance policy, estate planning is critical.
If your net worth is growing faster than the estate tax exemption, here are some strategies that could help you maximize what you leave to your heirs.
1. Give generously You can always shrink your estate tax liability by shrinking your estate. One good way to do this is to maximize annual gifts to your heirs-to-be, says Natalie Choate, estate planner with the Boston-based law firm of Bingham McCutchen LLP and author of "Life and Death Planning for Retirement Benefits." A single person can give up to $11,000 per year in cash or property without triggering any taxes; a couple can gift $22,000.
You're also allowed to make a once-in-lifetime gift of $1 million, in addition to the $11,000 annually, says Bill Kirchick, an accredited estate planner and partner at Bingham McCutchen. "And you could do it all at once or over a lifetime," he says.
2. Send the grandkids to college Beyond whatever cash and property you give to relatives, the government allows you to pick up educational (and medical) expenses for family members without triggering any additional taxes.
Granted, not every family will want to share these costs. "It's kind of messy and awkward," says Choate. "But it does minimize estate taxes."
And you must pay the bill yourself, not simply write the family member a check for the amount. "It's got to be paid directly to the medical provider or educational institution," says Stuart H. Sorkin, a tax attorney with Frank & Associates PC, a Bethesda, Md.-based law firm.
3. Divide and conquer marital asset estate limits Husbands and wives are generally allowed to leave unlimited amounts of money and property to each other without triggering any estate taxes. In addition, each spouse can leave an estate of up to $1.5 million (in 2004 and 2005) without triggering estate taxes. So a couple that shares a $2.5 million estate is all set, right? Wrong.
The surviving spouse is allowed to take total control of the couple's combined estate of $2.5 million without any tax consequences. But when he or she dies, that estate will be subject to estate taxes on the portion that exceeds the exemption amount at the time.
Sorkin recommends that both parties set up wills giving the survivor the option to put anything more than the estate-tax exemption into a unified credit trust. This trust gets its name from the tax provision that outlines the amount of money a person can give away, either before or after death, and not face any tax consequences. The trust shields a first-to-die spouse's assets above the tax threshold after the death of the second spouse.
But to be eligible for a unified credit trust, assets must be held separately. This could be a problem if you and your husband maintain your assets in both names. Divide your assets equally and title them separately so you can establish the trust.
Holding assets separately, however, is not for everyone. "You only want to look at this scenario if you are relatively comfortable in your marriage," says Sorkin.
And you should include a disclaimer that gives your spouse the final say. That way, a widow or widower has the option, but "is not forced to do one thing or the other," says Timothy M. Hayes, president of Landmark Financial Advisory Services LLC.
4. Loan assets to family members Bet you never thought you'd hear a financial planner tell you to make a loan to your relatives. But it can be a great way to keep growing assets from sabotaging your estate plan. By loaning an asset, the property itself will still be included in your estate, but the amount it appreciates while out of your care will not.
Here's how it works: You have $100,000 worth of real estate property and you expect it to double in value over the next 10 years. You loan that property to your son, in exchange for a $100,000 note plus interest. In 10 years, your estate contains $100,000, plus some interest, while your son has a $200,000 piece of property.
The loans work equally well with money, says Kirchick. You can invest $2,000 in the stock market, make $100 on it and leave your daughter that $2,100 in your estate. Or you can loan $2,000 to your daughter and have her invest it. She pays you back the $2,000, plus an amount of interest. But the profit of $100 is hers, not part of your estate.