Bob Carlson writes: A revolution is underway in estate planning. At this point, you know
about the 2012 changes to the tax law. Many people don’t realize the
extent to which these changes require fresh approaches and strategies.
Unfortunately, many people believe the new law means estate planning
is unimportant or at least much less important. That’s a mistake. Estate
planning still is required, but how we plan needs to change.
A result of the 2012 law is that for most people income taxes are a
higher burden than estate taxes, and as income rises the income tax
burden is higher. The top tax rate was increased to 39.6%. Long-term
capital gains and qualified dividends had their rates increased to 20%.
The phase outs of itemized deductions and personal exemptions were
restored. In addition a new 3.8% Medicare tax on investment income was
imposed by Obamacare.
These changes mean there should be new emphasis and focus in your
planning, and you should reconsider your view of some strategies.
The new regime means greater consideration of income taxes. Estate
planning can be much more important in helping to reduce income taxes,
and coordinating your estate plan with your income tax situation is more
important. Estate planners need to understand that estate planning
strategies can be a key way to reduce income taxes. Here are areas to
review.
Life insurance. Traditionally the main reason to buy permanent
life insurance was to help pay for estate taxes. The number of people
with that need is reduced, but other ways of using life insurance can be
more profitable, and some strategies that weren’t wise under the old
law now make more sense.
Permanent life insurance has an investment component. Earnings of the
policy’s cash value compound tax deferred as long as they remain in the
policy. In addition, after the earnings compound for years, loans can
be taken from the cash value. The loans are tax free and don’t need to
be repaid during life as long as the cash value is sufficient to help
pay premiums or you’re willing to make additional premium payments. The
loans eventually are subtracted from the death benefits, reducing the
amount available to heirs.
Higher income tax rates make life insurance more attractive as an
investment vehicle. The estate tax exemption can make it even more
attractive. Under the pre-2010 law, many people avoided owning policies
directly, because the benefits would be included in their estates and
potentially subject to estate taxes. The higher estate tax exemption
means fewer people have to worry about the estate tax reducing the
insurance benefits. Now, most people can own the policies directly, have
full access to the cash value, and their heirs still will receive the
full benefits, minus any loans, free of estate and income taxes.
Borrowing from insurance cash value isn’t risk free. Many people in
recent years found that because of low interest rates their policy cash
values didn’t generate enough income to keep the policies in force
without significant new premium payments. If you plan to use life
insurance as an investment vehicle, you need to work with a
knowledgeable broker or agent to select and manage the policy.
The new law also makes life insurance more attractive in employer
retirement plans. (They aren’t allowed in IRAs and some other retirement
plans.) Buying the insurance through a pension plan means tax
deductible dollars are used to make the purchase, and the insurance
benefits should be far more than the premiums paid.
Estate planners often advised against the strategy because the life
insurance would be included in the estate. With the higher estate tax
exemption, however, fewer people need to worry about the estate taxes
and can focus on the benefits of owning life insurance through a
retirement plan.
Another change: It used to be routine that substantial life insurance
policies would be held in trusts to ensure the benefits weren’t
included in the taxable estate. With the high estate tax exemption,
there is less need for incurring the expense and inconvenience of a
trust. Many people now can own the policies themselves and still be
confident the full policy value will be available to pay estate taxes or
debts or enhance the inheritances of their loved ones.
Trust taxes. Trusts are in many estate plans these days,
because they provide substantial benefits other than estate tax
reduction. The estate planning benefits, however, can be offset by
higher income taxes. Under the new law, even moderately well-off people
need to consider the effect on trust income taxes.
A trust reaches the top income tax bracket and also faces the new
3.8% Medicare tax on investment income in 2013 when its undistributed
income is only $11,950. Keeping income in a trust can provide creditor
protection and other benefits, but perhaps at the cost of substantially
higher income taxes.
The income taxes can be managed. The trustee can invest with taxes in
mind by focusing on long-term capital gains, qualified dividends, and
tax-exempt bonds. Assets with paper losses can be sold so the losses are
available to offset gains and other income. Ideally, the trustee has
the discretion to distribute income to beneficiaries and will consider
income taxes as one of the factors in making those decisions. Trustees
with that discretion should consult with beneficiaries to determine
their income tax situations before making distributions.
Many people should reconsider their decisions to create trusts in
their plans. As I said, there are many potential benefits of trusts.
These benefits need to be compared to the potential higher income taxes
of a trust. This new outlook applies whether trusts are created during your lifetime or in your will.
Charitable gifts. Planning for charitable gifts is affected in
several ways. Higher income tax rates mean some people will reap more
savings from making the gifts now, but at higher incomes the phase out
of itemized expenses could offset some of the benefits. Also, the higher
estate tax exemption removes some of the benefits of making charitable
gifts in your will. Taken together, these two changes mean that for some
people the tax benefits of charitable gifts are reduced.
That’s not the full story. Taxpayers who aren’t affected by the phase
out of itemized expenses receive the same income tax benefits from
their donations as before 2013. Because of that and the higher estate
tax exemption, there’s more of an incentive to make donations during
life instead of through the estate. You receive the income tax benefits
now and also see how your gifts are used. But if you make the gifts
through your estate there might be no tax savings, plus you won’t see
the results of your gifts.
Charitable remainder trusts still are valuable. They shelter
appreciated assets from capital gains taxes, provide immediate income
tax deductions, and generate a lifetime stream of income for you and
your spouse. Gift annuities also retain their benefits for most people.
You make a gift to charity, take a partial tax deduction, and receive a
lifetime stream of income.
Lifetime gifts. Many people need to reconsider their lifetime
giving strategies. With the higher exemption, fewer people need to
remove substantial assets from their estates. Instead, your main
concerns should be providing loved ones with wealth that will benefit
them and do so in a tax wise way.
Income taxes should take a bigger role in selecting gifts. When
someone receives a gift of property, they take the same tax basis the
giver had. If the property has appreciated, when the recipient sells the
property he’ll owe taxes on all the appreciation. That’s why you should
try to give property that hasn’t yet appreciated much but that you
expect will appreciate after the gift. An alternative is to consider
giving appreciated property to someone who will be in the 0% long-term
capital gains tax bracket when he or she sells.
State taxes. Many states don’t have estate or inheritance
taxes. About 20 states, however, impose one or both of them and often at
lower exemption levels than the federal law. Planning to avoid these
taxes is more important for residents of those states than planning for
federal taxes.
0 comments:
Post a Comment