Avoiding Estate Tax

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davey
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Avoiding Estate Tax

Post by davey »

Hi, I'm curious as to what some of you may be doing to reduce your estate or avoid estate tax. My parents estate is over the threshold and so they have talked to some qualified people who told them to create an irrevocable trust fund and state in writing that it, and anything a part of it, is not a part of their estate. Considering an irrevocable trust is it's own entity as well when created. I'm curious though and have a question about placing principal into the trust. I researched that principal placed into the trust is not considered "trust income" and therefore would not be taxed to placed into the trust. Which would mean that there is a way to completely avoid any taxes when transferring your wealth to you descendants even if you are over the estate tax threshokd. It seems too good to be true and I'm curious if anyone has any knowledge about this. I have heard there are ways around it though and my father seems very sure from what he was told that this will work. Does anyone have any insight? Thanks. I could ask my parents but figure I ould be slightly rude and seemingly a bit overbearing to them. I'm also curious if there is any way to consider a revocable trust as not part of your estate as well as I know they have an irrevocable trust but also might have seen a revocable one in my mother's networth sheet.
RyeBourbon
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Re: Avoiding Estate Tax

Post by RyeBourbon »

IANAL or an accountant, but I think gift tax issues come into play. You should google it.
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unclescrooge
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Re: Avoiding Estate Tax

Post by unclescrooge »

davey wrote: Thu Sep 24, 2020 7:55 pm Hi, I'm curious as to what some of you may be doing to reduce your estate or avoid estate tax. My parents estate is over the threshold and so they have talked to some qualified people who told them to create an irrevocable trust fund and state in writing that it, and anything a part of it, is not a part of their estate. Considering an irrevocable trust is it's own entity as well when created. I'm curious though and have a question about placing principal into the trust. I researched that principal placed into the trust is not considered "trust income" and therefore would not be taxed to placed into the trust. Which would mean that there is a way to completely avoid any taxes when transferring your wealth to you descendants even if you are over the estate tax threshokd. It seems too good to be true and I'm curious if anyone has any knowledge about this. I have heard there are ways around it though and my father seems very sure from what he was told that this will work. Does anyone have any insight? Thanks. I could ask my parents but figure I ould be slightly rude and seemingly a bit overbearing to them. I'm also curious if there is any way to consider a revocable trust as not part of your estate as well as I know they have an irrevocable trust but also might have seen a revocable one in my mother's networth sheet.
I think you put an asset that is expected to grow substantially into a irrevocable trust, so it grows out side of your estate. However, the gift you made into it should still count towards lifetime limit.

Only the future growth is outside your estate.

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Gill
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Re: Avoiding Estate Tax

Post by Gill »

You need more than Google to answer your questions. Suffice to say, yes, you can transfer assets to an irrevocable trust but the transfer constitutes a gift and reduces your lifetime exemption for estate taxes. The gift tax was enacted to close the loopholes you are hoping exist.
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FIREchief
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Re: Avoiding Estate Tax

Post by FIREchief »

“Some qualified people” likely are not.
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senex
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Re: Avoiding Estate Tax

Post by senex »

Some ways to avoid estate tax are illegal, some aren't. Some things that seem too good to be true are illegal, some aren't (like rolling GRATs). If you post the details, there are experts here.

It is a pretty complicated topic to address in general terms. One decent start is here. Though a few years old, I think it's mostly relevant: https://www.alliancebernstein.com/Resea ... igenBB.pdf

If you're not willing to ask your parents for details, you may be out of luck.
hereverycentcounts
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Re: Avoiding Estate Tax

Post by hereverycentcounts »

Your parents should start a farm. https://thefederalist.com/2017/09/28/he ... y-farmers/

Also if your parents can pass on that much, then you're set for life -- estate taxes are not fun but they are important to help the economy.

More seriously though - They should be giving away max in gifts each year (30k per person if they are married) right now -- to you, your siblings, and anyone else they want to give money to. This doesn't count towards the lifetime estate limits. You don't need a trust for this. If they don't want you to have access to the money yet, I believe an irrevocable trust can be set up with the same amount put in per year.

They should consider donating a chunk of money to causes that matter to them. This won't help you but it will reduce taxes owed and give them control of where that money goes.

There are prob other ways to avoid estate tax like the farm situation w/ business structures, but I do not know the details on that. Ask a Trump. :)
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BruDude
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Re: Avoiding Estate Tax

Post by BruDude »

Step one is hiring a good attorney to advise them how to structure their assets and the best way to transfer them.

A second-to-die life insurance policy can be used to fund the estate tax at a fraction of the cost of paying it out of pocket, depending on their ages and health.

Ex: Parents have $50M. Estate tax exemption $22M. They die, tax is owed on $28M. An $11M life insurance policy would cover the cost of the tax. Depending on their age that policy could cost as little as around $50k per year. Is it better to pay $11M in tax or $50k per year for the rest of their lives?

If your parents are old (over 75 or so) then the life insurance policy would not be as effective and may not be possible. If they’re in their 50s or 60s it can be very inexpensive in comparison to the tax.
neverpanic
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Re: Avoiding Estate Tax

Post by neverpanic »

BruDude wrote: Fri Sep 25, 2020 10:31 pm Step one is hiring a good attorney to advise them how to structure their assets and the best way to transfer them.

A second-to-die life insurance policy can be used to fund the estate tax at a fraction of the cost of paying it out of pocket, depending on their ages and health.

Ex: Parents have $50M. Estate tax exemption $22M. They die, tax is owed on $28M. An $11M life insurance policy would cover the cost of the tax. Depending on their age that policy could cost as little as around $50k per year. Is it better to pay $11M in tax or $50k per year for the rest of their lives?

If your parents are old (over 75 or so) then the life insurance policy would not be as effective and may not be possible. If they’re in their 50s or 60s it can be very inexpensive in comparison to the tax.
Yet more I never knew - thanks. Not a problem for my parents' estate, but is a likely concern for mine down the road if I remain lucky.
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hornet96
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Re: Avoiding Estate Tax

Post by hornet96 »

davey wrote: Thu Sep 24, 2020 7:55 pm Which would mean that there is a way to completely avoid any taxes when transferring your wealth to you descendants even if you are over the estate tax threshokd. It seems too good to be true
Yes, it’s too good to be true as generally the value of any existing property transferred into an irrevocable trust would count against their lifetime gift exclusion limit.

However, this is a question best suited for bsteiner, a highly reputable estate attorney and member of this forum.
afan
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Re: Avoiding Estate Tax

Post by afan »

To be fair to those "qualified people", it seems the OP has never spoken with them. Instead, OP is getting information second hand and who knows what the advisors really said.

Your parents need an expert trusts and estates attorney. Many who do some estate planning are not expert enough to handle this situation. If you are not discussing it with your parents, then you will not have the information to understand the plans proposed. Since it is not your estate planning, you would have no reason to hire an attorney to help. There is nothing for you to do.

At this level of assets, it is better if the heirs have some idea of the plan than if they are in the dark. But it also depends on what the parents want to do. If they want a lot to go to individuals, family members or not, then the irrevocable trust could be part of the solution.

Right now, many people are considering such trusts to lock in the current high exclusion amounts. Those cod go down in the future so this might be a use it or lose it opportunity.
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Admiral
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Re: Avoiding Estate Tax

Post by Admiral »

davey wrote: Thu Sep 24, 2020 7:55 pm Hi, I'm curious as to what some of you may be doing to reduce your estate or avoid estate tax. My parents estate is over the threshold and so they have talked to some qualified people who told them to create an irrevocable trust fund and state in writing that it, and anything a part of it, is not a part of their estate. Considering an irrevocable trust is it's own entity as well when created. I'm curious though and have a question about placing principal into the trust. I researched that principal placed into the trust is not considered "trust income" and therefore would not be taxed to placed into the trust. Which would mean that there is a way to completely avoid any taxes when transferring your wealth to you descendants even if you are over the estate tax threshokd. It seems too good to be true and I'm curious if anyone has any knowledge about this. I have heard there are ways around it though and my father seems very sure from what he was told that this will work. Does anyone have any insight? Thanks. I could ask my parents but figure I ould be slightly rude and seemingly a bit overbearing to them. I'm also curious if there is any way to consider a revocable trust as not part of your estate as well as I know they have an irrevocable trust but also might have seen a revocable one in my mother's networth sheet.
Welcome to the forum.

Perhaps--and with all seriousness and respect--they should count their tremendous good fortune rather than their potential estate tax liability and just plan to pay what they owe, based on current law.

Or, they could consider moving to a country that did not provide them with the means and opportunities they have had to create such tremendous wealth, and pay taxes there.

I guess for some, $22 million is just not enough. :?
BillWalters
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Re: Avoiding Estate Tax

Post by BillWalters »

Unless you’re being asked to participate, this is none of your business and I would advise you to stay out of it.

There are many estate tax avoidance options but it’s really not possible to offer an opinion without specific facts. If the wealth is in the form of a private business, for example, the advice will be much different than if it is in the form of liquid assets. And of course, the most important element is always family dynamics.
tibbitts
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Re: Avoiding Estate Tax

Post by tibbitts »

I understand wanting to legally shelter money to the extent possible, but this is really a case where you are not operating with all the information and the people with these assets really need to seek professional estate planning advice. What they may have "been told" suggests to me that they don't have a plan in place, and it's unlikely that this money just showed up out of nowhere, so maybe there is a reason they haven't done anything until now? If I had that much I wouldn't wait to make appropriate arrangements.
wolf359
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Re: Avoiding Estate Tax

Post by wolf359 »

Admiral wrote: Sat Sep 26, 2020 7:54 am
davey wrote: Thu Sep 24, 2020 7:55 pm Hi, I'm curious as to what some of you may be doing to reduce your estate or avoid estate tax. My parents estate is over the threshold and so they have talked to some qualified people who told them to create an irrevocable trust fund and state in writing that it, and anything a part of it, is not a part of their estate. Considering an irrevocable trust is it's own entity as well when created. I'm curious though and have a question about placing principal into the trust. I researched that principal placed into the trust is not considered "trust income" and therefore would not be taxed to placed into the trust. Which would mean that there is a way to completely avoid any taxes when transferring your wealth to you descendants even if you are over the estate tax threshokd. It seems too good to be true and I'm curious if anyone has any knowledge about this. I have heard there are ways around it though and my father seems very sure from what he was told that this will work. Does anyone have any insight? Thanks. I could ask my parents but figure I ould be slightly rude and seemingly a bit overbearing to them. I'm also curious if there is any way to consider a revocable trust as not part of your estate as well as I know they have an irrevocable trust but also might have seen a revocable one in my mother's networth sheet.
Welcome to the forum.

Perhaps--and with all seriousness and respect--they should count their tremendous good fortune rather than their potential estate tax liability and just plan to pay what they owe, based on current law.

Or, they could consider moving to a country that did not provide them with the means and opportunities they have had to create such tremendous wealth, and pay taxes there.

I guess for some, $22 million is just not enough. :?
While the Federal estate tax exemption is $11 million per person, or $22 million per couple, it still requires some planning.

Some states don't tie their estate tax laws to the federal laws, so they have to adjust their limits when the feds change theirs (and they might not do so.) For example, a handful of states still have an estate tax for estates over $1 million. Others have a higher exemption, but still lower than the federal limit. You also still have to do some planning for couples that are over $22 million. If the surviving spouse inherits everything at first, then the first exemption is essentially wasted.

It's not about whether $22 million is enough. If you live in one of the states with really high estate taxes, or a very low exemption limit, you should be doing some planning.

There is a lot of misunderstanding about estate taxes. I know several people who planned ahead by putting their kids on the title of their homes and other assets to avoid the tax -- yet they were never subject to it in the first place. Instead, they had issues when the kids got into credit problems and the creditors started trying to seize homes. At the very least, they lost the step-up in basis on the inherited assets. If you're going to do planning, at least consult with someone who understands the law to help.
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TomatoTomahto
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Re: Avoiding Estate Tax

Post by TomatoTomahto »

OP: if your parents have enough to worry about this, hiring competent resources will be a drop in the bucket. It gets complicated quickly (e.g., MA exemption, blended family, portability), and I’d no sooner get advice here (other than general advice) than I would ask whether I should get surgery or not.

Beyond trusts and such, which we have set up but which IMO are specific to one’s particular situation, it is not too early to start gifting $30k/year to beneficiaries. It seems small, but over our hopefully long lives, it adds up.

ETA: welcome to the forum.
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Admiral
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Re: Avoiding Estate Tax

Post by Admiral »

wolf359 wrote: Sat Sep 26, 2020 9:11 am
Admiral wrote: Sat Sep 26, 2020 7:54 am
davey wrote: Thu Sep 24, 2020 7:55 pm Hi, I'm curious as to what some of you may be doing to reduce your estate or avoid estate tax. My parents estate is over the threshold and so they have talked to some qualified people who told them to create an irrevocable trust fund and state in writing that it, and anything a part of it, is not a part of their estate. Considering an irrevocable trust is it's own entity as well when created. I'm curious though and have a question about placing principal into the trust. I researched that principal placed into the trust is not considered "trust income" and therefore would not be taxed to placed into the trust. Which would mean that there is a way to completely avoid any taxes when transferring your wealth to you descendants even if you are over the estate tax threshokd. It seems too good to be true and I'm curious if anyone has any knowledge about this. I have heard there are ways around it though and my father seems very sure from what he was told that this will work. Does anyone have any insight? Thanks. I could ask my parents but figure I ould be slightly rude and seemingly a bit overbearing to them. I'm also curious if there is any way to consider a revocable trust as not part of your estate as well as I know they have an irrevocable trust but also might have seen a revocable one in my mother's networth sheet.
Welcome to the forum.

Perhaps--and with all seriousness and respect--they should count their tremendous good fortune rather than their potential estate tax liability and just plan to pay what they owe, based on current law.

Or, they could consider moving to a country that did not provide them with the means and opportunities they have had to create such tremendous wealth, and pay taxes there.

I guess for some, $22 million is just not enough. :?
While the Federal estate tax exemption is $11 million per person, or $22 million per couple, it still requires some planning.

Some states don't tie their estate tax laws to the federal laws, so they have to adjust their limits when the feds change theirs (and they might not do so.) For example, a handful of states still have an estate tax for estates over $1 million. Others have a higher exemption, but still lower than the federal limit. You also still have to do some planning for couples that are over $22 million. If the surviving spouse inherits everything at first, then the first exemption is essentially wasted.

It's not about whether $22 million is enough. If you live in one of the states with really high estate taxes, or a very low exemption limit, you should be doing some planning.

There is a lot of misunderstanding about estate taxes. I know several people who planned ahead by putting their kids on the title of their homes and other assets to avoid the tax -- yet they were never subject to it in the first place. Instead, they had issues when the kids got into credit problems and the creditors started trying to seize homes. At the very least, they lost the step-up in basis on the inherited assets. If you're going to do planning, at least consult with someone who understands the law to help.
Granted. All true. But the OP said “avoid the estate tax.” All tax issues require some level of planning.
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Ben Mathew
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Re: Avoiding Estate Tax

Post by Ben Mathew »

BruDude wrote: Fri Sep 25, 2020 10:31 pm A second-to-die life insurance policy can be used to fund the estate tax at a fraction of the cost of paying it out of pocket, depending on their ages and health.

Ex: Parents have $50M. Estate tax exemption $22M. They die, tax is owed on $28M. An $11M life insurance policy would cover the cost of the tax. Depending on their age that policy could cost as little as around $50k per year. Is it better to pay $11M in tax or $50k per year for the rest of their lives?

If your parents are old (over 75 or so) then the life insurance policy would not be as effective and may not be possible. If they’re in their 50s or 60s it can be very inexpensive in comparison to the tax.
I have read that life insurance can be used to reduce estate tax, but have a hard time understanding how it's supposed to work. Proceeds of a life insurance policy that you own in included in the estate, so that does not seem useful. Proceeds of a life insurance that is held through an irrevocable trust with no "incidents of ownership" are not included in the estate. But the funds you transferred into the trust to cover the premiums counts as a gift. So the premiums are included in the estate/gift tax, but the proceeds are not. But for a life insurance company to make a profit, the expected growth of the premiums has to exceed the proceeds. So instead of putting in $5 million into a life insurance trust, you could just gift it instead, perhaps to an irrevocable trust, and simply invest the money in low cost index funds. That keeps the growth outside the estate, just not through a life insurance wrapper with its high costs. Am I missing some aspect of how this works?
Last edited by Ben Mathew on Sat Sep 26, 2020 10:18 am, edited 1 time in total.
BruDude
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Re: Avoiding Estate Tax

Post by BruDude »

Admiral wrote: Sat Sep 26, 2020 7:54 am Welcome to the forum.

Perhaps--and with all seriousness and respect--they should count their tremendous good fortune rather than their potential estate tax liability and just plan to pay what they owe, based on current law.

Or, they could consider moving to a country that did not provide them with the means and opportunities they have had to create such tremendous wealth, and pay taxes there.

I guess for some, $22 million is just not enough. :?
Many people with this level of assets don't have the money liquid though. For example, someone with a $100M real estate portfolio may have $5M sitting in liquid cash. They die, now they owe ~$30M in taxes. How will they pay for it? The heirs would have to sell off the assets to pay the tax. What if they don't want to sell off the assets? What if the housing market is way down and they'd be selling at fire-sale prices? Planning in advance can avoid this problem.
Last edited by BruDude on Sat Sep 26, 2020 10:20 am, edited 1 time in total.
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Re: Avoiding Estate Tax

Post by BruDude »

Ben Mathew wrote: Sat Sep 26, 2020 10:08 am I have read that life insurance can be used to reduce estate tax, but have a hard time understanding how it's supposed to work. Proceeds of a life insurance policy that you own in included in the estate, so that does not seem useful. Proceeds of a life insurance that is held through an irrevocable trust with no "incidents of ownership" are not included in the estate. But the funds you transferred into the trust to cover the premiums counts as a gift. So the premiums are included in the trust, but the proceeds are not. But for a life insurance company to make a profit, the expected growth of the premiums has to exceed the proceeds. So instead of putting in $5 million into a life insurance trust, you could just gift it instead, perhaps to an irrevocable trust, and simply invest the money in low cost index funds. That keeps the growth outside the estate, just not through a life insurance wrapper with its high costs. Am I missing some aspect of how this works?
An irrevocable life insurance trust (ILIT) is created which will own the life insurance policy that is being used to pay the tax. Since it is held in the trust, the payout from the life insurance is not subject to estate taxes. The premiums are gifted to the trust each year and the annual gifting exemption can be used, so if for example there are 3 beneficiaries then $90k can be gifted to the trust per year without using up part of the lifetime exemption (assuming there are two parents). If the premiums required to pay the policy are over the gifting limit, the difference would be counted against the lifetime exemption.

You would be surprised how inexpensive a second-to-die permanent policy can be relative to the death benefit. Premiums are commonly in the range of 0.5-1% of the death benefit per year, but of course it depends on age and health of the insureds. The life insurance payout is tax-free so in order to generate that equivalent amount of money in taxable investments you would need some lofty returns.
Last edited by BruDude on Sat Sep 26, 2020 10:24 am, edited 1 time in total.
JGoneRiding
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Re: Avoiding Estate Tax

Post by JGoneRiding »

I think its important to know which estate tax we are talking about. The federal tax limit is very high and only uber rich need worry. But some states have much lower like Maryland and so the irrevocable or spousal trusts make a lot of sense.
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Re: Avoiding Estate Tax

Post by hicabob »

Interesting that virtually no-one actually pays the estate tax ... from taxpolicycenter.org

"For decedents in 2018 (with an exemption of $11.18 million), the Urban-Brookings Tax Policy Center estimated that only about 4,000 estate tax returns were filed, of which only 1,900 were taxable. Estate tax liability totaled $14.9 billion after credits (table 1). The estimated number of total and taxable estate tax returns are 4,100 and 1,900 for both 2019 and 2020. Estimated estate tax liability is $15.6 billion in 2019 and 16.0 billion in 2020"

It seems the estate tax law is for the benefit of lawyers that do trusts and life insurance companies.
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Ben Mathew
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Re: Avoiding Estate Tax

Post by Ben Mathew »

BruDude wrote: Sat Sep 26, 2020 10:19 am
Ben Mathew wrote: Sat Sep 26, 2020 10:08 am I have read that life insurance can be used to reduce estate tax, but have a hard time understanding how it's supposed to work. Proceeds of a life insurance policy that you own in included in the estate, so that does not seem useful. Proceeds of a life insurance that is held through an irrevocable trust with no "incidents of ownership" are not included in the estate. But the funds you transferred into the trust to cover the premiums counts as a gift. So the premiums are included in the trust, but the proceeds are not. But for a life insurance company to make a profit, the expected growth of the premiums has to exceed the proceeds. So instead of putting in $5 million into a life insurance trust, you could just gift it instead, perhaps to an irrevocable trust, and simply invest the money in low cost index funds. That keeps the growth outside the estate, just not through a life insurance wrapper with its high costs. Am I missing some aspect of how this works?
An irrevocable life insurance trust (ILIT) is created which will own the life insurance policy that is being used to pay the tax. Since it is held in the trust, the payout from the life insurance is not subject to estate taxes. The premiums are gifted to the trust each year and the annual gifting exemption can be used, so if for example there are 3 beneficiaries then $90k can be gifted to the trust per year without using up part of the lifetime exemption (assuming there are two parents). If the premiums required to pay the policy are over the gifting limit, the difference would be counted against the lifetime exemption.
I understand this part. The alternative to beat, of course, would be gifting the same $90K/year to an irrevocable trust and investing it in low cost index funds.
BruDude wrote: Sat Sep 26, 2020 10:19 am You would be surprised how inexpensive a second-to-die permanent policy can be relative to the death benefit. Premiums are commonly in the range of 0.5-1% of the death benefit per year, but of course it depends on age and health of the insureds. The life insurance payout is tax-free so in order to generate that equivalent amount of money in taxable investments you would need some lofty returns.
If the $90K/year is instead gifted to an irrevocable trust and invested in low cost index funds, the eventual proceeds (from selling those investments) would also be estate tax free just like the life insurance proceeds would be. So it comes down then to whether the life insurance policy can really deliver a better expected return than mutual funds. Life insurance has the advantage of tax-free growth, but the disadvantage of high costs. In your estimation, the advantage outweighs the disadvantage and life insurance expected returns are indeed higher than index fund returns. But if that is the case, would it also not be better for people who wish to leave an inheritance but whose estates are small enough that the estate tax is not a consideration? And yet, the standard advice offered here is that permanent life insurance policies are an expensive way to invest, that it's best not to mix investment and insurance, and that it's cheaper to buy term life (if life insurance is needed) and keep your investments in low cost index funds, even if it's in a taxable account. If that is sound advice outside of the estate tax context, I don't see how it changes when estate taxes come into play. The estate tax rules itself does not seem to confer a special advantage to using life insurance over index funds.
Phil DeMuth
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Re: Avoiding Estate Tax

Post by Phil DeMuth »

The main thing is to get on the calendar of a good estate attorney before the election. I would also PM bsteiner for his advice if he doesn't jump into this thread soon.
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Re: Avoiding Estate Tax

Post by FIREchief »

wolf359 wrote: Sat Sep 26, 2020 9:11 am If the surviving spouse inherits everything at first, then the first exemption is essentially wasted.
Portability? :confused
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afan
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Re: Avoiding Estate Tax

Post by afan »

The life insurance strategy is clearly better if the insured dies not long after taking it out.

It is less of advantage if the insured lives for many years, piling up premiums.

However, the buy term and invest the difference has a problem when one anticipates using the full value of the trust to pay estate taxes. The money in the mutual funds would be taxable when sold to generate cash. These sales would generate taxable capital gains. The trust would be in the top tax bracket, so a substantial part of the trust assets would be lost to taxes. The income to the trust during the grantor's life would also be taxable. If, instead, the money was in a life insurance policy, then there would be no income taxes on the death benefit.
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Ben Mathew
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Re: Avoiding Estate Tax

Post by Ben Mathew »

afan wrote: Sat Sep 26, 2020 3:35 pm However, the buy term and invest the difference has a problem when one anticipates using the full value of the trust to pay estate taxes. The money in the mutual funds would be taxable when sold to generate cash. These sales would generate taxable capital gains. The trust would be in the top tax bracket, so a substantial part of the trust assets would be lost to taxes. The income to the trust during the grantor's life would also be taxable. If, instead, the money was in a life insurance policy, then there would be no income taxes on the death benefit.
OK, that makes sense. Because the trust assets lose the step up in basis and are taxed at the top tax bracket, reducing taxes on the growth of the investment becomes more important for a trust than when assets are held directly and left as a bequest. So even if "term and invest the difference" comes out ahead when held directly, a permanent life policy could in principle still come out ahead when held through an irrevocable trust.

So, if I'm understanding this right, the connection between estate taxes and the use of life insurance (besides liquidity) would be:

(1) Estate tax considerations might lead one to move assets to an irrevocable trust to keep the growth out of the estate.

(2) The growth of assets in irrevocable trusts are taxed heavily. So the tax savings associated with permanent life insurance become more important and might outweigh the high cost of the policy.
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Re: Avoiding Estate Tax

Post by BruDude »

Ben Mathew wrote: Sat Sep 26, 2020 6:32 pm
afan wrote: Sat Sep 26, 2020 3:35 pm However, the buy term and invest the difference has a problem when one anticipates using the full value of the trust to pay estate taxes. The money in the mutual funds would be taxable when sold to generate cash. These sales would generate taxable capital gains. The trust would be in the top tax bracket, so a substantial part of the trust assets would be lost to taxes. The income to the trust during the grantor's life would also be taxable. If, instead, the money was in a life insurance policy, then there would be no income taxes on the death benefit.
OK, that makes sense. Because the trust assets lose the step up in basis and are taxed at the top tax bracket, reducing taxes on the growth of the investment becomes more important for a trust than when assets are held directly and left as a bequest. So even if "term and invest the difference" comes out ahead when held directly, a permanent life policy could in principle still come out ahead when held through an irrevocable trust.

So, if I'm understanding this right, the connection between estate taxes and the use of life insurance (besides liquidity) would be:

(1) Estate tax considerations might lead one to move assets to an irrevocable trust to keep the growth out of the estate.

(2) The growth of assets in irrevocable trusts are taxed heavily. So the tax savings associated with permanent life insurance become more important and might outweigh the high cost of the policy.
Pretty much. However, there are a couple things you're missing:

1. Term life is for a temporary need. The estate tax is a permanent need, at least based on current tax laws. There is always a chance it could be repealed in the future but that's probably a longshot. If anything, I would expect the exemption amount to be reduced in the future. It was only $11M per couple until a few years ago, and it was only $7M per couple before that, and $4M per couple as recently as 2008.

2. A second-to-die policy only pays upon the death of the second insured, so it is significantly less expensive than a regular permanent life insurance policy which is only on one person's life. If you have one spouse that is 70 years old and one spouse that is 50 years old, the policy may not pay out for 50+ years if they live a long time, therefore it is much lower cost. This also allows for a lower rate when one of the two spouses is in excellent health and the other spouse has some health issues because the main risk is to the younger/healthier insured.
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Re: Avoiding Estate Tax

Post by ModifiedDuration »

With assets over $23 million, I would be considering a Jackie O Trust (charitable lead trust).
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Re: Avoiding Estate Tax

Post by afan »

Regarding term vs permanent, you are always paying the insurance company for the mortality risk. With the whole life designs, you pay much more than the cost of mortality charges in the early years and the extra money, after commissions, goes to cash value. As time goes by, the share of your premium that goes for mortality charges increases, but the premium does not change. You do not get the mortality risk covered at bargain rates, you just prepay for these charges in the early years.

With universal life, they show the charges explicitly each year so you can see them. The charges are there for whole life, although they do not break them out.

The big advantage of life insurance over a simple investment fund is the favorable tax treatment when you expect to hold the policy until death. In other planning, buy term and invest the difference comes out ahead when you plan to drop the insurance once the growth in your assets and drop in future needs means that at some point you will be alive, with no life insurance but with the investment account.
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Re: Avoiding Estate Tax

Post by Ben Mathew »

BruDude wrote: Sat Sep 26, 2020 10:19 am You would be surprised how inexpensive a second-to-die permanent policy can be relative to the death benefit. Premiums are commonly in the range of 0.5-1% of the death benefit per year, but of course it depends on age and health of the insureds.
What type of permanent life insurance would this be?

Are there preferred types that deliver a higher expected return through lower costs?
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Re: Avoiding Estate Tax

Post by Ben Mathew »

afan wrote: Sat Sep 26, 2020 9:15 pm The big advantage of life insurance over a simple investment fund is the favorable tax treatment when you expect to hold the policy until death. In other planning, buy term and invest the difference comes out ahead when you plan to drop the insurance once the growth in your assets and drop in future needs means that at some point you will be alive, with no life insurance but with the investment account.
Would this advantage hold even outside of a trust with its unfavorable taxes? i.e. If someone wants to leave a bequest and is willing to hold a permanent life insurance policy for life, can they get a better after-tax return (leave a larger after-tax bequest) through a permanent life insurance policy than they could by investing in a taxable account?
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Re: Avoiding Estate Tax

Post by Lee_WSP »

Ben Mathew wrote: Sun Sep 27, 2020 10:13 am
afan wrote: Sat Sep 26, 2020 9:15 pm The big advantage of life insurance over a simple investment fund is the favorable tax treatment when you expect to hold the policy until death. In other planning, buy term and invest the difference comes out ahead when you plan to drop the insurance once the growth in your assets and drop in future needs means that at some point you will be alive, with no life insurance but with the investment account.
Would this advantage hold even outside of a trust with its unfavorable taxes? i.e. If someone wants to leave a bequest and is willing to hold a permanent life insurance policy for life, can they get a better after-tax return (leave a larger after-tax bequest) through a permanent life insurance policy than they could by investing in a taxable account?
That question depends deeply on tax rate, time before death (ie premiums paid), and returns from investments.
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Re: Avoiding Estate Tax

Post by afan »

Ben Mathew wrote: Sun Sep 27, 2020 10:13 am
Would this advantage hold even outside of a trust with its unfavorable taxes? i.e. If someone wants to leave a bequest and is willing to hold a permanent life insurance policy for life, can they get a better after-tax return (leave a larger after-tax bequest) through a permanent life insurance policy than they could by investing in a taxable account?
Comparisons of term and invest in a taxable account to buying whole life consistently show that the term approach is better. If the investment account is held by the insured, rather than by a trust, then there is a stepped up basis at death. So there would be no capital gains tax. As noted above, those taxes can take a big bite out of the investment fund if it were held by the trust.

Leaving a bequest using term insurance is exactly what it is for. But one typically plans to hold the term for a limited time, dropping it before the premiums get huge in older age. One can buy term policies that will go for life, although the premiums go up each year and get quite high in old age. Of course, embedded in a permanent policy, you have the same cost for mortality risk. The difference is that, depending on the type of policy, the insurance company may or may not show you how much it is charging for this risk.

Note that for the purposes of this thread we are talking about people who already have estates that will pay estate taxes. For them, it would be crazy for the insured to own the policies themselves. The death benefits WOULD be subject to estate taxes.

Buy term and invest the difference is almost always the solution for those who will not face federal estate taxes and who anticipate no longer needing insurance in old age. That describes the vast majority of people, which is why BTID is the standard recommendation. It just doesn't work when estate taxes come in to play.
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Re: Avoiding Estate Tax

Post by afan »

Ben Mathew wrote: Sun Sep 27, 2020 10:06 am
BruDude wrote: Sat Sep 26, 2020 10:19 am You would be surprised how inexpensive a second-to-die permanent policy can be relative to the death benefit. Premiums are commonly in the range of 0.5-1% of the death benefit per year, but of course it depends on age and health of the insureds.
What type of permanent life insurance would this be?

Are there preferred types that deliver a higher expected return through lower costs?
I think BruDude is talking about second to die whole life.
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Re: Avoiding Estate Tax

Post by BruDude »

afan wrote: Sun Sep 27, 2020 11:31 am
Ben Mathew wrote: Sun Sep 27, 2020 10:06 am
BruDude wrote: Sat Sep 26, 2020 10:19 am You would be surprised how inexpensive a second-to-die permanent policy can be relative to the death benefit. Premiums are commonly in the range of 0.5-1% of the death benefit per year, but of course it depends on age and health of the insureds.
What type of permanent life insurance would this be?

Are there preferred types that deliver a higher expected return through lower costs?
I think BruDude is talking about second to die whole life.
Second-to-die guaranteed universal life (aka survivorship GUL)

A second-to-die whole life would be a lot more expensive than the GUL and with the cash value being held in a trust it is effectively useless because the cash can’t be removed from the trust. The GUL policy is designed to have little to no cash value, which minimizes the cost of the policy while maximizing the permanent death benefit. It is effectively term insurance guaranteed for life but only pays on the death of the second insured.
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Re: Avoiding Estate Tax

Post by Ben Mathew »

afan wrote: Sun Sep 27, 2020 11:30 am
Ben Mathew wrote: Sun Sep 27, 2020 10:13 am
Would this advantage hold even outside of a trust with its unfavorable taxes? i.e. If someone wants to leave a bequest and is willing to hold a permanent life insurance policy for life, can they get a better after-tax return (leave a larger after-tax bequest) through a permanent life insurance policy than they could by investing in a taxable account?
Comparisons of term and invest in a taxable account to buying whole life consistently show that the term approach is better. If the investment account is held by the insured, rather than by a trust, then there is a stepped up basis at death. So there would be no capital gains tax. As noted above, those taxes can take a big bite out of the investment fund if it were held by the trust.

Leaving a bequest using term insurance is exactly what it is for. But one typically plans to hold the term for a limited time, dropping it before the premiums get huge in older age. One can buy term policies that will go for life, although the premiums go up each year and get quite high in old age. Of course, embedded in a permanent policy, you have the same cost for mortality risk. The difference is that, depending on the type of policy, the insurance company may or may not show you how much it is charging for this risk.

Note that for the purposes of this thread we are talking about people who already have estates that will pay estate taxes. For them, it would be crazy for the insured to own the policies themselves. The death benefits WOULD be subject to estate taxes.

Buy term and invest the difference is almost always the solution for those who will not face federal estate taxes and who anticipate no longer needing insurance in old age. That describes the vast majority of people, which is why BTID is the standard recommendation. It just doesn't work when estate taxes come in to play.
Got it. Thanks!
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Re: Avoiding Estate Tax

Post by Ben Mathew »

BruDude wrote: Sun Sep 27, 2020 11:48 am
afan wrote: Sun Sep 27, 2020 11:31 am
Ben Mathew wrote: Sun Sep 27, 2020 10:06 am
BruDude wrote: Sat Sep 26, 2020 10:19 am You would be surprised how inexpensive a second-to-die permanent policy can be relative to the death benefit. Premiums are commonly in the range of 0.5-1% of the death benefit per year, but of course it depends on age and health of the insureds.
What type of permanent life insurance would this be?

Are there preferred types that deliver a higher expected return through lower costs?
I think BruDude is talking about second to die whole life.
Second-to-die guaranteed universal life (aka survivorship GUL)

A second-to-die whole life would be a lot more expensive than the GUL and with the cash value being held in a trust it is effectively useless because the cash can’t be removed from the trust. The GUL policy is designed to have little to no cash value, which minimizes the cost of the policy while maximizing the permanent death benefit. It is effectively term insurance guaranteed for life but only pays on the death of the second insured.
Thanks for the information!
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Re: Avoiding Estate Tax

Post by bsteiner »

Phil DeMuth wrote: Sat Sep 26, 2020 11:07 am The main thing is to get on the calendar of a good estate attorney before the election. I would also PM bsteiner for his advice if he doesn't jump into this thread soon.
Phil: thanks for the kind words.

I think that trusts and estates lawyers and appraisers will be busy the next few months. While we can't speculate on future changes in the law here, clients are free to do so, and some of them may want to take action this year in case there are changes in the law. Also, we've already been busier this year than usual as a result of the over 200,000 deaths so far from the virus, mainly older people (who on average are wealthier than younger people), and many others who want to do or update their planning as a result of the virus.

The estate tax exclusion amount is presently $11,580,000 (indexed), but is scheduled to revert to $5,790,000 (indexed) in 2026. There is no clawback for gifts made under current law. So you may give away $11,580,000 now, free of estate and gift tax. A couple may give away $23,160,000 now, free of estate and gift tax.

However, gifts come first out of the amount that will remain. In other words, if you give away $5,790,000 now, when the exclusion amount reverts to $5,790,000, you won't have any exclusion amount remaining.

So a couple may want to give $23,580,000 now. If that's more than they want to give, one spouse (or a single person) could give $11,580,000 now. The other spouse will still have his/her $5,790,000 exclusion amount available when it reverts to that level in 2026.

The gift could be to a grantor trust where the grantor pays the income tax on the trust's income and gains. Or, if the grantor is in a high tax state, depending on state law, the trust could be a separate taxpayer, in a state such that the trust isn't subject to state income tax in any state.

Other planning techniques include loans or installment sales at the current low interest rates, partnerships and LLCs to get valuation discounts for lack of control and lack of marketability, and grantor retained annuity trusts (GRATs) to shift the growth out of one's estate.

There's been some discussion of the donee (usually a trust or trusts) investing some or all of the gift in life insurance. Depending on how long the client lives, and the investment return on whatever the donee would otherwise have invested in, the donee might be better or worse off investing in life insurance as opposed to other assets. The principal benefit of the life insurance is certainty of result. In other words, you get the amount of the insurance coverage at death, even if the insured dies early. You also get the tax benefit of the income and gain in the policy being tax-exempt if you keep the policy until death. On the other hand, there's some cost to the insurance (it costs something to run the insurance company), and in order to get the income tax exemption the donee has to keep the policy until the insured dies. Another benefit of life insurance is that there's less pressure on the trustees for distributions than if the trust held other assets. On the other hand, if the trust invests in other assets, or if the gift is in the form of other assets, there may be valuation discounts available, and in the case of a grantor trust the grantor's payment of the income tax shifts additional wealth free of estate and gift taxes. I think in most cases the decision will turn on whether the client needs or wants the insurance. Of course, it doesn't have to be all or nothing -- the trust could buy some insurance and invest some in other assets.
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