How to Copy the Wealthy
Maybe you can live -- and die -- without them. Wealthy Americans often use a fistful of trusts to slash estate taxes, avoid probate and control how their money is divvied up. But if your worldly assets are shy of seven figures -- meaning you're unlikely to get hit with estate taxes -- you may want to consider some cut-rate alternatives.
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To be sure, sometimes a trust really is your only option, especially if you are leaving money to young children or you are trying to provide for a second spouse while ensuring your assets eventually go to your kids.
In other cases, however, you may be able to mimic the estate planning of the rich without incurring all the costs associated with setting up and running a trust. Intrigued? Here's how:
Suppose your adult son has a long history of financial foolishness. To make sure he doesn't quickly burn through the money you bequeath, the usual strategy is to funnel his inheritance into a "spendthrift" trust, so that a trustee can then dole out the money over time.
But instead of incurring the costs and hassles of a trust, you could simply arrange for your estate to buy an immediate annuity for your son, says Pittsburgh estate-planning lawyer and accountant James Lange. That way, as with the spendthrift trust, he will get his inheritance in the form of monthly income for life.
"In drafting wills, what I've done is given the trustee the option of either continuing the spendthrift trust or buying an immediate annuity," Lange says. "You want to give some flexibility. If you force the executor to buy an annuity within, say, nine months of death, it might be a bad time to buy annuities because interest rates are low."
The annuity works best if your son has a spending problem. It wouldn't be such a good idea if he had a drug or alcohol problem. After all, the monthly income could be enough to sustain his habit. A spendthrift trust would also be a better bet if there's a risk your son will get divorced or file for bankruptcy, says Stephen Maple, author of "The Complete Idiot's Guide to Wills and Estates."
If you die owning life insurance, the proceeds won't be dunned for income taxes, but they will be subject to estate taxes -- unless you arrange for the policy to be owned by somebody else.
For the wealthy, that "somebody else" is often a life-insurance trust. Rather than going that route, however, you could arrange for, say, your daughter to own insurance on your life, says David Handler, an estateplanning attorney with Kirkland & Ellis in Chicago.
If you are taking out a new policy, that is easy enough to set up. But what if you already have a policy? You could transfer ownership. As long as you don't die within three years, the proceeds will avoid estate taxes.
If you transfer an existing policy, you are making a gift to your daughter. In any given year, you can give $11,000 to anybody else without worrying about the gift tax. But your life-insurance policy may be worth more than that, which means the transfer will eat into your $1 million lifetime gift-tax exemption. That probably won't trigger an immediate tax bill, but it will reduce the amount you can leave tax-free at death.
Once your daughter owns the policy, she may have to pay premiums to keep the policy in force. To ensure she has the necessary money, you might have to give her additional money each year. With any luck, however, these ongoing gifts will fall within the $11,000 annual gift-tax exclusion.
I contacted Immediate Annuities.com to buy one of my immediate annuities. They were prompt, very responsive, paid attention to detail, understood my objectives, and were superb when it came to staying on top of seeing the funds transfer and issue of new policy documents through to completion.
To avoid the hassle and publicity of going through probate, wealthier folks often set up living trusts. Upon death, assets in the trust avoid legal review by the probate court and instead go directly to the designated beneficiaries.
But in many states, probate is no great hassle, so stashing assets in a living trust may not be much of an advantage. What if probate is costly and time-consuming in your state? Instead of a living trust, you could bypass probate by ensuring your assets are "titled" so they go directly to your intended heirs.
That means naming the right beneficiaries for your retirement accounts and your life insurance. Meanwhile, with other assets, you may be able to arrange for them to go directly to your heirs by owning them jointly with right of survivorship or by setting up "transfer-on-death" or "payable-on-death" accounts.
Before you go crazy re-titling your holdings, however, keep two things in mind. First, no matter how diligently you title your assets, you still need a will, because inevitably there will be some assets that won't pass directly to your heirs. "There is no substitute for a will," Handler says. "Without a will, your assets will go wherever the state says they should go."
Second, just because you avoid probate doesn't mean you avoid estate taxes. In fact, if you think you will be subject to estate taxes -- which this year hits estates valued at $1.5 million and up -think twice before owning property jointly and using transferon-death and payable-on-death accounts. The reason: Titling assets this way can make it more difficult to do the sort of sophisticated estate planning needed to trim taxes.
A Matter of Trust
Here are three trusts that are worth considering:
If you and your spouse are worth more than $1.5 million, a bypass trust will trim taxes by ensuring you both use your estatetax exemption.
If you have young kids, you can control their spending by funneling their inheritance into a child's trust.
If you are remarried, a QTIP trust will provide your new spouse with income while ensuring your assets eventually go to your kids.