WHEN IT COMES to the wealth-robbing estate tax, almost every reader of this column who calls me asks this or a similar question, "Irv, can you help me avoid (beat/kill/finesse) the estate tax?" Often, an obscenity about the estate tax is tossed into our conversation.
If you are worth about $6 million (or less) the answer to the question is almost always "Yes"; worth more, usually, "No."
Let's talk real numbers: Say Joe is worth $10 million and Jack $20 million. Both are married. Joe's estate-tax damage (using 2011 rates) would be about $4 million; Jack's, $9.5 million.
The higher your wealth, the less your chance for killing the estate tax. Ah, but we can always, always avoid the impact of the estate tax.
For example, if you are worth $8 million, we know how to get the full $8 million (all taxes paid in full) to your family; worth $80 million, the entire $80 million to your family. Yes, it can always be done, whether you're single or married, young or old, and insurable or uninsurable.
Substitute your own numbers into the example that follows: Suppose you are worth $12 million and married. Subtract $2 million ($1 million if single), which leaves $10 million; then 50% times $10 million gives you your bitter estate tax bite; add 55% for your worth in excess of the $10 million.
Now, here's the secret for legally avoiding the estate tax: Create tax-free wealth using charity and life insurance. Both, if you do it right, put you in a tax-free environment.
Here's a real-life story of Joe (a 63-year-old business owner from Nebraska married to Mary, 62). Joe and Mary are worth $23 million. Using our example above, the estate tax monster would eat $11.05 million of their wealth.
We designed a comprehensive and coordinated succession plan and estate plan for Joe and Mary that included four significant strategies:
- An intentionally defective trust to transfer Joe's business to his kids tax-free;
- A family limited partnership for their investment assets (a stock and bond portfolio and real estate);
- and 4. Two different life insurance strategies, which are described below.
A side note: Every case is different. A big factor for Joe and Mary was that their health is excellent for their age so they're both insurable.
Now, Strategy No. 3: Joe had $600,000 in his company's 401(k) and $1.5 million in various IRAs, which we transferred tax free into the 401(k). Then, we created a subtrust for the 401(k) that purchased $6.5 million of second-to-die life insurance on Joe and Mary. Because of double taxation — first income tax and then estate tax — the $2.1 million in the 401(k) without the subtrust would only net about $600,000 to Joe's heirs. The tax collector would get the other $1.5 million.
The subtrust allows the entire $6.5 million of life insurance to go to Joe and Mary's heirs tax-free. In effect, we turned $600,000 into $6.5 million.
One more point. We showed Joe how to invest his $2.1 million funds in his 401(k) in transfer insurance policies, a form of senior settlements that we discussed in last month's column (February, pg. 34). TIPs earn in excess of 16% on average per year, without risk. Joe's investments were averaging a 7% return with stocks, bonds and mutual funds. Ask your professional to check out subtrusts and TIPs.
Finally, Strategy No. 4: Joe and Mary needed an additional $5 million of life insurance. At their age, if you don't use a subtrust, the premiums are steep. We used a strategy called "premium financing" to buy $5 million of life insurance on Joe's life. PF allows you to buy life insurance without paying your premiums in cash. Instead, you create a trust to pay the premiums, which are paid by the trustee signing a note to the lending bank. Interest is added to the loan. All premium loans, plus accrued interest, will be paid out of the death benefits when Joe dies. The only costs paid by Joe are to the banks for initiating and maintaining the loan: about $60,000 paid the first year and an additional $180,000, which is paid in small amounts each year to age 100.
This is an economic home run — $5 million tax-free to Joe and Mary's heirs for an out-of-pocket cost of $240,000 (or less), which is paid over about a 30-year period. No question about it, PF is the most inexpensive way to buy life insurance (whether you buy $5 million, $10 million or more). To qualify to use a PF you must be credit worthy and worth a minimum of $5 million.
These subjects, subtrusts, TIPs and PF, always create a blizzard of questions. So, if you would like to get more information about a subtrust (and/or TIPs) send me your birthday and your spouse's, if married. Also, the total value of all of your qualified plans: 401( k), IRAs, etc. (total should be $100,000 or more). Write "Subtrust" and/or "TIPs" at the top of the page.
If you are interested in PF, send birthdays for you and your spouse and your net worth (must be at least $5 million, more is better). Write "Premium Financing" at the top of the page.
Fax all inquiries to 847/674-5299. Please include your name, your company name, address and all phone numbers where you can be reached (home, business and cell).
If you want to read up about business succession plans and estate plans, check out my Website: www.taxsecretsofthewealthy.com
Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; tel. 312/ 207- 1040, or via e-mail at [email protected]