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Tax-Oriented Planning Steps There are some planning techniques which can only be used by married couples. On the other hand, there a techniques which are useable by both married couples and individuals. Sometimes the latter seem to be ignored in the focus on explanations of the former. I've highlighted the latter group with **.
The First Level of Planning	Non-Tax Planning **
Pension Planning	Equalize Estates
Next - Move Insurance **	Use a QTIP for GSTT Planning
Reduce Values **	Reduce Creditor Exposure **
Gifts **	Buy Insurance **
The First Level of Planning Assume Mary has $1,500,000 in various assets. If she leaves everything to her husband, Roy, her estate can deduct it all and pay no Federal Estate Tax. Roy now has an estate of $1,500,000. When he dies, his estate will pay a tax of $320,250. (For the sake of ease, we'll assume Roy has no assets to start with, ignore potential growth or diminution, and ignore the increasing shelter equivalent -- all of which can change the particular numbers but not the overall effect). Mary can achieve a zero tax at her death by leaving Roy only $825,000. There will be no tax due on her $675,000 estate. The tax at Roy's death will be reduced to $57,000. This is the most basic step of tax planning for a couple. In essence we want to keep too much from going to the survivor - at least making sure there is enough going separately to use the shelter. This may mean breaking up joint tenancies, changing beneficiaries, etc. This is frequently referred to as an "AB trust" arrangement, though practitioners may use different names for the actual trusts or distributions involved. This basic plan, repeated over and over in thousands of estates, can have thousands of variations that will produce the same numbers. This is where the plan should be tailored to your individual needs and goals, rather than pulled out of boilerplate. ^Back to top
Non-Tax Planning ** In what form does that $825,000 go to Roy? In terms of tax planning, that can range from outright to a QTIP trust. That's a non-tax issue. What happens to that $675,000? It could range from passing immediately to the children (inadvisable in an estate this size) to a trust for the family with an outside trustee to one controlled by Roy (see Give the Advantages of Trusts), available for his benefit, but not includible in his estate. I'll refer to this generically as the shelter trust. Who gets it at the survivor's death? The descendants? Equal of special provisions? Are they mature enough to handle money or do you need a trust for a period? What ages for distribution? See Introduction to Trusts Rather than outright distribution, consider leaving in controlled trusts. (see Give the Advantages of Trusts) Mary should probably use a living trust for incapacity protection, with her will leaving her estate to the trust. Whether the trust should be funded to avoid probate is a separate question. ^Back to top
Pension Planning Qualified pension plans, including IRAs, require special thought. If paid to a surviving spouse, they can roll it over, delay distributions, defer and save income tax, and generally maximize benefits. If paid to a shelter trust, income tax cannot be spread over more than five years and part of the estate tax shelter will be wasted since it is, in effect, used on income tax. ^Back to top
Equalize Estates The previous plan works fine if Mary dies first. But what if Roy dies first? Mary's estate no longer gets a marital deduction, but pays a tax of $320,250. Roy's potential shelter is unavailable. If acceptable to the parties, some of Mary's assets could be given to Roy so he could leave them to a shelter trust for Mary if he died first. (Actually "equalizing" is too broad -- the important thing is that each have the shelter amount -- in larger estates, enough for the GSTT exemption). ^Back to top
Next -- Move Insurance ** If, after an AB arrangement to use both credit shelters, a couple or an individual still faces potential estate tax, the next consideration should be to remove life insurance from taxation with an irrevocable insurance trust. ^Back to top
Use a QTIP for GSTT Planning I favor leaving your estate to your children in trusts which they control rather than outright. Among other things, this avoids estate tax. This leads to potential Generation Skipping Transfer Tax. An estate this size will fit within the exemption without special planning, but as it gets larger we need special planning steps. A QTIP can maximize the exemption available. ^Back to top
Reduce Values ** Tax is based on numbers. We've been adding steps as the size of the estate increases. But what if we can reduce the value of the estate? A family limited partnership has become very popular as a means of reducing the value. A $3,000,000 estate might be reduced to a taxable $2,000,000 estate and worked from there. There are other tools available for value reduction, dependent on circumstances. ^Back to top
Reduce Creditor Exposure ** This probably runs across all sizes of estates, but if you face potential liability risks (your first line of defense is insurance) consider asset protection steps. Again, a family limited partnership is a good vehicle. ^Back to top
Gifts ** My first rule of gifts for tax planning is -- don't do it unless and until you are sure that you have adequate assets for yourself and your spouse. My second rule is -- once you're past that threshold why not make gifts? Why worry about estate taxes at your death, except to maximize benefits to your chosen beneficiaries? And if you're going to do that, why not use a method which both saves taxes and gives them benefit without having to wait for your death? The rest of this discussion assumes you are adequately provided for. And it has its own gradations. An individual may give another individual $10,000 per year tax-free. See Basics of the Gift Tax. A couple may give $20,000. A couple may give a couple $40,000. If you have two married children and three grandchildren you could be giving $70,000 to $140,000 annually without using your credit shelter. Every year you don't do so is a lost opportunity. A gift removes from your estate not only the current value of the gift, but all the future income and appreciation until your death. Therefore, the earlier the better. When you consider the last paragraph, you realize that a gift of $1 is more effective than leaving $1 at death, since the gift carries with it all the future growth. Therefore, make not only annual exclusion gifts but gifts using up your shelter -- there's no benefit in saving it for your estate. Go beyond your shelter -- pay gift taxes. When you write a check for $1,000 gift tax, you remove that $1,000 from your taxable estate. The math gets esoteric, but I assure you that making taxable gifts is more efficient (Congress has recognized this -- gift tax paid within three years of your death is pulled back into your estate). As you make large gifts, another factor comes into play -- capital gains tax (fortunately becoming a smaller consideration). Assume you bought XYZ stock at 20 and it's now 100. If you were to die now, your beneficiaries would receive it with a basis of 100 -- the appreciation goes untaxed. If you give it away, they take your basis of 20 and built-in tax of 16. In most cases, it is still worthwhile to make the gift, but the most efficient approach may be for you to sell it, pay the capital gains tax and give the money. ^Back to top
Buy Life Insurance ** In an irrevocable insurance trust, of course. Life insurance proceeds will always be more than you paid in premiums. By appropriate gift tax planning, you can use non-taxable gifts to generate non-taxable insurance proceeds. If your estate consists mostly of non-liquid assets, you'll need insurance to come up with the liquidity to pay taxes. But even if your estate was highly liquid, well planned insurance will usually produce more dollars for your family than keeping the money used for premiums, often more than making gifts to the family. ^Back to top