1. Bypass Trust.
One document deservedly popular with married couples is the bypass or credit shelter trust. You and your spouse each get a lifetime exemption from federal estate and gift taxes. It’s now $675,000, and it is scheduled to rise to $1 million in the year 2006. Make sure that both of you use your exemptions. You do this by setting up a bypass trust in each of your wills.
Let’s say that when you meet your maker, you have a taxable net worth of $2 million. If you leave it all directly to your spouse, he or she will get the full $2 million – free of estate or gift taxes, thanks to the marital exclusion. So far, so fine.
The trouble is that at your spouse’s death, only $675,000 of that amount can pass tax-free to your children or other heirs – that is the current estate and gift tax exemption. The remainder of what you have passed on – $1,325,000 – will be fully taxed.
You can prevent much of this by creating a bypass trust and putting into it the maximum $675,000. After you die, your spouse can draw interest and dividend income from that trust and even dip into its principal if needed.
When your spouse eventually dies, $675,000 of his or her assets and another $675,000 from your bypass trust – $1,350,000 in all – will go to your heirs, tax-free. Now that’s smart tax planning.
2. Q-Tip Trust.
If you don’t want to leave a large estate to your spouse outright, you could set up a Q-TIPÂ – it stands for qualified terminable interest property trust.
Property that you place in a Q-TIP qualifies for the 100 percent marital deduction, and your spouse gets lifetime interest from the trust. But when your spouse dies, the principal goes to your chosen heirs, thereby keeping your legacy out of a gold-digger’s hands should your widow remarry. The trust also is popular with divorced people who wish to ensure that their assets ultimately go to their heirs.
A life insurance trust will work only if it meets a number of conditions.
3. Life Insurance Trust.
Normally, your insurance proceeds are part of your estate and subject to tax. But you can shelter them by transferring ownership of your policies to an irrevocable life insurance trust (the “irrevocable” means that you can’t alter its provisions). You can name your children or other heirs as the trust’s beneficiaries. On your death, they collect your insurance proceeds, untaxed.
A life insurance trust will work only if it meets a number of conditions. The trustee whom you name – not you – must pay the policy premiums. Also, if you die within three years of setting up a trust, your insurance will become part of your taxable estate. So, your attorney should insert a clause in the trust stating that should you die within three years, your insurance proceeds will go directly to your spouse or into a trust for him or her.
With a charitable remainder trust, older donors get richer tax breaks than younger ones because they stand to collect income from their trusts over a shorter life expectancy.
4. Charitable Remainder Trust.
Through this trust, you give away during your lifetime stocks, bonds, mutual funds, real estate or other valuable property to a charity or religious or public service organization. But you continue to collect interest payments or other income from it until the trust ends, usually when you die.
Another benefit is that you get an immediate tax deduction for your donation. The higher the return you earn from the trust, the smaller your tax deduction. Also, older donors get richer tax breaks than younger ones because they stand to collect income from their trusts over a shorter life expectancy.
5. Charitable Lead Trust.
If you don’t need additional income and want to avoid estate tax on stocks or other property that you think will appreciate, set up a charitable lead trust instead of a charitable remainder trust. When you meet your maker, the property goes into an irrevocable trust that pays income to your favorite charity or pro bono organization for a limited period of time, typically for more than ten years. After that, the assets in the trust pass to your heirs.
This was the kind of trust that Jacqueline Kennedy Onassis used to brilliant effect to give immediate support to her favorite charities and simultaneously preserve a large share of her assets, which her heirs will collect 24 years after her death.
6. Generation Skipping.
This trust enables you to give assets to your grandchildren or, in some cases, your great-grandchildren instead of to your kids so that you can reduce the number of times it is whacked by the estate tax. The first $1,030,000 ($2,060,000 if spouses give jointly) that is transferred to a generation skipping trust escapes the punishing 55 percent federal generation skipping tax.
Note: The article above may not contain up-to-date information.
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