Would You Invest $2500, $5000 or $10,000 for a return of $657,250?

Sounds like a scam more than an investment these days, especially since interest rates on CD’s are hovering in the 1.7-2% range.  What I’m talking about is an investment in a solid estate plan for your family.

Maximum rates for federal estate taxes are 45% this year and scheduled to hit 55% in 2011.  What could this cost you?

An Estate Planning Case Study

Bill, 61 and Mary, 55 have been married 30 years and have two children, Casey 23 and Tom 25.  Bill and Mary have always been a practical couple who saved most of their income.  Bill worked as a senior manager for a hotel and Mary is a nurse.  When Bill recently passed away in 2009, their net worth was $2,287,000.  $1.5 million was in the form of an insurance policy paid out to Mary upon Bill’s death.  While Bill was careful enough to purchase an insurance policy, Bill did not have a will in place when he died.  Still, his assets passed to his wife under the state’s intestate statute.

Since assets left to one’s spouse after death is not subject to estate taxes, Mary ends up owning all the assets without having to pay any estate taxes.

Their assets comprised of:

Their home (owned free and clear) worth                   $  355,000
Stocks                                                                                     $      65,000
IRA accounts                                                                       $   275,000
Life Insurance (paid to Mary on Bill’s death)            $1,500,000
Bill’s Car                                                                                $     10,000
Mary’s Car                                                                            $      11,000
Personal property                                                               $      26,000
Joint Savings account                                                      $      45,000

                                                                            TOTAL $ 2,287,000

However, let’s take a look at what would happen if Mary died in 2011 without an estate plan:

In 2011, Mary still owns all of the assets above, but she paid Casey’s grad school tuition in 2010 for $18,000 and gave Tom a gift of $12,000 (free of gift tax) in the same year.  Mary also spent approximately $54,000 of the insurance proceeds in addition to the gifts to the kids.

So her assets are currently worth:

Home                                                                                   $      355,000
Stocks (value depreciated)                                              $        60,000
IRA accounts                                                                      $      275,000
Proceeds left from Life Insurance                                 $   1,446,000
Proceeds from Bill’s Car                                                   $        10,000
Mary’s Car                                                                           $          8,000
Personal Property                                                              $        26,000
Joint Savings (after tuition and gift to kids)              $        15,000

                                                                                TOTAL $2,195,000

Potential Estate Tax:

  $ 2,195,000
- $ 1,000,000      2011 federal personal estate tax exemption

  $ 1,195,000
x              .55       federal estate tax rate
$      657,250   estate tax owed

If Mary dies without a will or estate plan, her assets would still pass to her children under the state’s intestate statute, but the tax hit would be $657,250!

Planning before Bill’s death could have prevented this outcome.  He could have set up a life insurance trust to hold the proceeds of the life insurance.  If he named Mary as life beneficiary and the kids as remainder beneficiaries, the funds would be kept out of Mary’s estate while still allowing her to benefit from the proceeds. 

Still, even after Bill’s death, Mary could have implemented a gifting strategy (by using the annual $12,000 exclusion amount) to trusts for her children in order to slowly reduce her estate over the years.  However, in this illustration, Mary dies 2 years after Bill, so creating a life insurance trust before Bill’s death was the most practical way to save on estate taxes.

This is only one of many scenarios and estate planning solutions which could minimize or even eliminate estate taxes.  It does not take into consideration state inheritance taxes (CA has none) or probate costs (CA has very high probate costs) which could significantly add to costs.

In order to find the best solution for your individual circumstances, contact an experienced estate planning attorney to discuss your options.