Some Ways To Get Ahead Of Estate Tax Changes

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OCEAN CITY – When Congress adjourned in December 2009 without reaching an agreement to extend the 2001–2009 version of the federal estate tax, the estate tax — and the strategies for addressing it – suddenly became a lot harder for millions of mainstream investors to ignore.

Having likely disappeared altogether for 2010, the tax is now slated to return in 2011 at a maximum rate of 55% — 10 percentage points higher than in 2009. Of even greater concern, the personal exemption — the amount of a deceased’s estate that is exempt from the tax — is scheduled to fall from $3.5 million in 2009 to $1 million starting next year, lower than it’s been since 2003. Anyone with an estate valued at more than $1 million could thus have a substantial amount of every dollar above $1 million go toward estate taxes, unless measures are taken in advance to prepare.

Whether the federal exemption is ultimately set at $1 million or $3.5 million, it’s important to understand that any taxes owed to settle your estate will need to be paid in full before the assets can be distributed. Heirs could be forced to sell valuable antiques or a vacation retreat just to generate the cash needed to pay off the estate tax owed.

That’s why it’s important to consider some protective action and not to overlook one surprisingly conventional tool: life insurance.

People tend to look at an insurance contract purely as an expense, or to ensure a surviving spouse will have enough to live on," says Jim Gothers.

"In fact, when used in combination with the right kind of trust, insurance is free of both estate and income taxes, which can make it a highly effective way of covering the taxes on your estate and providing for heirs."

One example of such a strategy is an irrevocable life insurance trust (ILIT). You fund the ILIT with a gift of only enough assets to pay the premiums on a life insurance policy, which (assuming the ILIT is properly structured and maintained), stands outside of your estate. Upon your death, the proceeds from the policy can then offset the federal estate and state death taxes, lawyer’s fees and other costs.

An ILIT can be especially helpful in the transfer of a family business. Say you have one child in the business and a second child pursuing different goals. An ILIT can be created that names the second child as the beneficiary of a life insurance policy whose payout equals half the size of the overall estate. That way, the business doesn’t have to be sold to generate enough cash to split the estate equally.

Consider a wife and husband whose combined estate, including real estate and business holdings, is worth $5 million. If the husband dies, his wife could receive his entire estate tax-free, thanks to the unlimited marital deduction for spouses. But when the wife dies, even assuming a return to the 2009 exemption levels, everything in her estate above $3.5 million will be subject to the 45% federal estate tax.

These are just a couple ways in which trust and insurance strategies can be used to help limit the effect of estate taxes. Ask your financial advisor and your tax- and estate-planning professionals about some of the ways that insurance and other trust strategies can be used to help preserve your estate — from whatever happens.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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