All in the Family

Many people underestimate their estate and unknowingly face large tax obligations. Moreover, changes to the estate tax law under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) have only fueled confusion about how to protect assets and use the law to one’s advantage.

Your estate includes everything you own at the time of your death (cash, stocks and bonds, annuities, real estate, retirement benefits, life insurance and even jewelry). Currently, if the estate is valued at more than the $2 million exclusion, an estate tax is imposed on every dollar over this amount. Without proper preparation, a substantial percentage of the estate value can be lost to taxes after death. 

The good news is that a well-designed estate plan has the potential to minimize the impact of estate taxes while maximizing the amount that will pass to your heirs. A knowledgeable financial representative can help you find solutions for individual estate plans and discuss effective ways to reduce estate tax exposure.

For example, one useful way to remove assets from your taxable estate is through the gift tax annual exclusion. Annual gifting within the annual exclusion limits allows assets to be removed from an estate without being taxed, and the future value or appreciation from the gift also is estate and gift tax-free. 

But, it can get confusing. Under current tax law, annual gifts valued up to $12,000 can be given to any number of people and are excluded from federal gift taxes. The exclusion doubles to $24,000 each year for gifts that a husband and wife make together. In addition to gifts that fall under the annual exclusion limits, additional gifts are exempt from tax during your lifetime or at death as long as they do not exceed a total of $1 million.

Gifts do not need to be given in cash. If you plan to make a gift, consider gifting assets that have the potential to appreciate. That way you also remove the appreciation of those assets from your estate.

Permanent life insurance is an appreciating asset, which maximizes the use of the exclusion — the value of the gift is based on the premium paid, not the ultimate cash value or death benefit. Leveraging the annual exclusion by purchasing life insurance is an effective way to remove assets from an estate and meet other objectives, such as providing immediate, liquid funds after death to pay expenses. 

Permanent life insurance is often an ideal gift for parents or grandparents to make to children and grandchildren. In most cases, if your children own a policy on your life, the proceeds will not be included in your estate. Furthermore, you can use the annual exclusion to make gifts that can be used to pay the annual premiums. But be careful about naming your child or grandchild the owner of a life insurance policy if he or she is not of majority age. It is typically better to have an insurance policy owned by a trust or placed under a custodial arrangement than it is to name a minor child as the owner.

Other unique advantages of life insurance are:
•    Accumulated cash value can be used for college tuition or to purchase a home
•    Protection for family members against an economic loss
A good financial representative should help you determine if family gifting is an appropriate solution to reduce your taxable estate. Working in conjunction with your legal and/or tax consultant, he or she can help estimate the value of your estate, determine tax liabilities and offer solutions for your particular situation. This expert should guide you through the kinds of life insurance available and develop an ownership structure to meet your needs. 

Ralph E. Harold, MD, is a Financial Representative with Northwestern Mutual Financial Network the marketing name for the sales and distribution arm of The Northwestern Mutual Life Insurance Company (NM), Milwaukee, Wisconsin, its affiliates and subsidiaries. Financial Representative is an agent of NM based in Overland Park, Kan.  To contact Ralph, please call 913.676.8046, e-mail him at Ralph.harold@nmfn.com or visit his website at www.nmfn.com/ralphharold.