Attention, Heirs Apparent

Attention, Heirs Apparent

Ways to escape estate taxes and die happily ever after.

There’s no getting around death and taxes. Even after death, there can be taxes – and lots of them. Sure, if all of your assets go to your spouse, there won’t be any estate taxes. And you get break on the first part of your estate, which is tax-free. But after that, estate tax rates start at 37 percent and rise to 55 percent. For estates of $10 million to $21 million, there’s an extra 5 percent surcharge, which brings the the top rate to 60 percent. What’s a rich guy to do?

Well, buy insurance for one. Financial planners generally urge couples with estates of some million or more to look into using life insurance to pay estate taxes. When you die, you life insurance proceeds are not subject to income tax. If the policy is owned by someone else, such as a child or an irrevocable trust, it will not be part of your estate and will not be subject to estate taxes either.

Your first estate-planning step is to calculate the approximate value of your estate, including all the property you own and life insurance in your name. You then could buy a life insurance policy to cover the federal estate tax owed – or as much as you chose to cover with insurance. And remember, there may also be state taxes due on your estate.

House on the rocky ground. The estate tax bite. Your heirs only pay the top rate on the top end of your estate. Illustration: Megan Jorgensen (Elena)

Whether using life insurance to cover your estate taxes is a smart move or not depends chiefly on what kind of policy you buy and, of course, when you die. A 65-year-old man and 62-year-old woman, for example, could buy a $1 million policy for a premium of $24,420 for nine years and a final premium f $12,643, or a total of $232,423. The policy is a second-to-die, or survivorship, policy, which means that it does not pay off until the second person dies. This makes premiums significantly lower than they would be on a policy covering only one individual since, from the insurer’s perspective, it is more like that at least one of the two people covered will live a while and the death benefit won’t have to be paid. If both die during the first year after they bought the policy, their heirs would get a fantastic return of 3,995 percent. If, however, either one lives for 20 years, the return is reduced to 10.36 percent. If either one lives 30 years, the return is 7.72 percent.

There’s another catch: taxable gifts. You can give gifts of up to $10,000 per person per year without affecting the status of your estate, but if you give a single person more than $10,000 in a year, the difference will reduce the taxable threshold of your estate. If you give one of your children a gift of $50,000 in a given year, for instance, the taxable threshold of your estate will be $560,000.