If this article was a college course, it would be called Estate Taxonomics 101. We expose some sacred cows, but every word is true based on my 40-plus years of experience in the estate tax battlefield.
First, the IRS doesn’t want you to know that the estate tax—if your plan is properly done—is a voluntary tax. Sadly, if you have only a traditional estate plan (typically, a revocable trust) you have no chance to avoid the estate tax.
By adding a simple lifetime plan, it’s easy to legally avoid the estate tax.
The IRS never gives any public acknowledgement to the thousands of plans that legally beat the estate tax. It only attacks those plans that have a tax mistake. Find a professional advisor who can explain to you how each of the previously mentioned strategies wins the estate tax game for each asset class.
Next, the biggest transaction of your life will probably be the transfer of your business to your kids or employees. The IRS wants you to think that a taxable installment sale is the way to go.
Unfortunately, so do most professional advisors. Tell them to take a look at an IDT. The proof is always in the numbers. Simply ask your professional to run the number for the tax consequences of an installment sale versus an IDT. Remember, you want to see the tax impact for both the buyer and the seller. Hint: I have never seen an installment sale (or cash sale) beat the after-tax numbers of an intentionally defective trust.
Then there’s the double taxation of qualified plan funds. You folks with a large amount of money in a 401(k), rollover IRA or other qualified plan, listen up. Everyone—you, the IRS and your advisor—knows that those funds will be double taxed (hit hard by both income taxes and estate taxes)… with as much as 73% going to the tax collector. (That’s $73,000 out of every $100,000 you have in plan funds.)
There are multiple ways to avoid the double tax and even turn the tables on the IRS by multiplying the funds in your plan, risk free. Hint: If you are under 59 ½ years old, use a subtrust; if you’re over 59 ½ years old, use a retirement plan rescue. Always use a stretch-IRA for any funds still in the plan when you go to heaven. Talk to your professional advisor.
Finally, like it or not, life insurance proceeds are taxable for estate tax purposes. The IRS loves life insurance, there’s always the insurance company’s money to pay your tax bill. Fortunately, there are many strategies to convert a potential taxable life insurance death benefit, into a tax-free pool of money. It’s your professional’s job to walk you through the many possibilities for avoiding the estate tax when you buy the policy.
What, you already bought the policy, and it won’t be tax-free? Consult a new advisor immediately. There are many ways to correct this mistake. But hurry, there’s usually a three-year waiting period to get off the taxable boat and onto the tax-free one. The life insurance industry is highly regulated. Each of the states has an insurance commissioner, and generally they do a great job protecting the public.
But hey, insurance companies are in business to make a profit. Here are some important things they don’t want you to know: If you have a life policy that has built up enough cash surrender value (CSV) so you no longer need to pay more premiums to keep the policy in force, and you are still healthy enough to pass a physical to get more insurance, almost 100% of the time you can dump the old policy and get a new one with a larger death benefit (and never pay another premium). But the insurance company won’t tell you that.
Nor will the insurance company tell you that your CSV dies when you die. You and your family lose every penny. So while you are alive and healthy, check out your options to use that CSV toward a new policy.
Another thing you should know about life insurance: If you don’t need it, don’t buy it. Only buy life insurance if you intend to keep the policy in force till the day you die, so your family collects the death benefit. Otherwise, save your money.
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Why? This is hard to believe: 98% of term policies sold never pay a death benefit; 91.5% of CSV policies sold lapse for various reasons and don’t pay a death benefit.