An Important Part of Your Estate Tax Plan
The Charitable Reminder Trust (CRT), when structured properly, will provide you and your spouse with a lifetime income stream, possibly reduce your current income taxes, and may potentially eliminate your estate tax exposure, with respect to an appreciated asset. This strategy takes advantage of several tax benefits:
- Charitable income tax deduction;
- Avoidance of long-term capital gains tax;
- Income tax-free compounding of assets;
- Charitable estate tax deduction;
- Life insurance cash values, which accumulate income tax deferred.
This couple has a fairly well diversified portfolio but a considerable portion of it is comprised of illiquid real estate properties. To increase their liquidity and overall financial security, they are contemplating selling the real estate portion of their portfolio. However, this could create a significant tax liability.
After assessing the couple's current financial situation, an estate planning professional and the couple's attorney recommend the following estate plan.
Step 1: Charitable Remainder Trust
The first step involves the transfer of ownership of the couple's real estate holdings into a tax-exempt charitable remainder trust. The charitable remainder trust converts a highly appreciated or low yielding asset (often closely-held stock or real estate) into a lifetime income stream. Here's how it works: The asset in the trust, in this case real estate (which must be free from any indebtedness, such as a mortgage or loan), is sold at fair market value with the proceeds reinvested in income-producing assets. Because of the trust's tax-exempt status, the appreciation from the sale is not subject to capital gains.
The trust, in turn, pays the couple a lifetime income stream to supplement their retirement. Additionally, the contribution to the trust qualifies for a partial income tax charitable deduction, subject to IRS rules, thereby reducing the couple's current income tax bill.* The savings and new income stream will improve this couple's retirement cash flow. (*A calculation based on actuarial assumptions to determine the charitable remainder man's split interest at the end of the income beneficiary(ies) life expectancy(ies). At death, any remaining assets in the trust will pass to the charity(ies) of their choice.)
Step 2: Irrevocable Life Insurance Trust
Next, the couple establishes an irrevocable life insurance trust. This accomplishes two goals: 1) Provides heirs with estate tax-free benefits upon death by using life insurance to fund the trust; 2) Purchases a sufficient amount of life insurance to replace the value of the asset transferred to the charitable remainder trust by utilizing the savings resulting from the charitable income tax deduction with a portion of the income stream. So, the heirs are often made "whole."
In this instance, the trust purchases survivorship whole life insurance or "second-to-die" insurance. Survivorship whole life insurance is permanent life insurance that covers the lives of two individuals in one insurance policy and pays the death benefit after the death of the second insured. As a result, the cost is usually more affordable than purchasing two separate life insurance policies. Proceeds, not included in the estate, will also avoid probate expenses since the assets pass under the terms of the trust.
Step 3: Unified Gift and Estate Tax Credit
The unified gift and estate tax credit allows each spouse to give $1,000,000 in 2004 - 2005 to anyone they choose, whenever they choose, gift and estate-tax free. The unified gift and estate tax credit of $345,800 in 2004 - 2005 is equal to an exemption of $1,000,000 in 2004 - 2005. By gifting money and property to their children and grandchildren while they are alive, the income and the appreciation of gifted assets is not part of their estate when they die. As a result of utilizing the unified tax credit, the couple can decrease the value of their estate by $1.5 million in 2004 - 2005.
A Win-Win Situation
As you can see, a charitable remainder trust with an irrevocable life insurance trust can benefit everyone you, your spouse, children, and charity.
- Transferring a highly appreciated or low yielding asset into a charitable remainder trust creates an income stream and avoids any capital gains tax. In addition, the charitable income tax deduction reduces your current income taxes.
- The irrevocable life insurance trust can replace the value of the asset gifted to charity and your beneficiaries may receive more than if you were to sell the asset and pay capital gains and estate taxes. The life insurance proceeds are generally free from income taxes and are not included in the estate.
- The unified tax credit provides an effective means of redistributing your wealth while further reducing your estate tax exposure.
- Finally, you will be able to give one or more charities a significant gift.
Estate planning is a complex process. For this reason, it's important to have a team of professionals working on your side. At New York Life, we believe in and practice the team concept of estate planning. Our agents will evaluate your specific needs and provide insurance and financial products for your estate plan with the recommendations of other team members, including your attorney and your accountant.
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New York Life Insurance and Annuity Company does not provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions.
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