Although death benefits are not usually subject to state or federal income tax, they can be at the mercy of state and federal estate tax, unless steps are taken to protect your future beneficiary’s inheritance. Currently an individual can leave to his heirs an amount up to $3.5 million without being subject to estate tax, up from $2 million due to a change in the law this year. While that amount might at first glance appear too high for most of us to be concerned with, taking into account real estate, IRAs, and life insurance payouts, a working couple just might find themselves in the sights of the estate tax collectors.
Estate tax laws are currently being reduced under the Economic Growth and Tax Relief Reconciliation Act enacted on June 7th, 2001 by President Bush. The estate tax will be repealed come 2010, but unless Congress acts before 2011, the law completely reverts to the pre-2001 estate taxation laws. Look forward to only a $1 million credit as there was before the Economic Growth and Tax Relief Reconciliation Act and the enactment of the Estate Tax repeal.
The estate tax rate is not an easy pill to swallow either, with each dollar of inheritance over the credit amount being subject to a 45 percent assessment, unless you take advantage of ways to circumvent it. A review of the estate plan is vital due to the rapidly changing laws and the significant penalty if you end up paying estate taxes on an inheritance. There are ways to protect your assets so that your endowment is not diminished by federal and state estate tax collectors before reaching your intended heirs.
Irrevocable Life Insurance Trust
To prevent your endowment from being subject to federal and state estate taxes, turn ownership of the estate to an irrevocable life insurance trust. Unless you die within three years of the transaction, your endowment is effectively owned by the trust and is not legally considered part of your estate. If you pass away within three years of enactment, your trust will be turned back in to your estate and subject to estate tax. In order to circumventing that snare, the trustee of your trust should seek the wisdom of financial experts who may suggest purchasing a replacement life policy which would be immune from inclusion in your estate.
For married couples who have an estate greater than $3.5 million, Bypass Trusts can be set up for both of you, totaling a credit of $7 million. It mitigates the delayed tax burden of the unlimited marital deduction when the second spouse dies.
QTIP (Qualified Terminable Interest Property) Trust
Often combined with a bypass trust, the QTIP trust transfers one spouse’s endowment to the other for her use. With the bypass trust in effect, the remaining assets from the estate then escape federal or state estate taxes and are passed to the heirs.
None of the methods described should be initiated without the assistance of a qualified estate planner, since estate laws are fluid and can change unpredictably.