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How to Use Life Insurance Under the New Estate Tax Laws Part II

Last update on: Jul 23 2020

In last week’s edition of Retirement Watch Weekly, we re-examined some factors and tools of estate planning that were altered by the new estate tax regime. Today, we’ll complete the list…

Trust taxes. Trusts are in many estate plans these days, because they provide substantial benefits even when there’s no need for estate tax reduction.

The estate planning benefits, however, can be offset by higher income taxes.

Under the new law, even moderately well-off people need to consider the effect of trust income taxes.

A trust reaches the top income tax bracket and also faces the 3.8% Medicare tax on investment income when its undistributed income is only $12,300.

Keeping income in a trust can provide creditor protection and other benefits, but perhaps at the cost of substantially higher income taxes.

The income taxes can be managed.

The trustee can invest with taxes in mind by focusing on long-term capital gains, qualified dividends, and tax-exempt bonds.

Assets with paper losses can be sold so the losses are available to offset gains and other income.

Ideally, the trustee has the discretion to distribute income to beneficiaries and will consider income taxes as one of the factors in making those decisions.

Trustees with that discretion should consult with beneficiaries to determine their income tax situations before making distributions.

Many people should reconsider their decisions to create trusts in their plans.

As I said, there are many potential benefits of trusts.

These benefits need to be compared to the potential higher income taxes of a trust.

This new outlook applies whether trusts are created during your lifetime or in your will.

If you believe the potentially higher income taxes and the cost of setting up the trust offset its benefits, update your will to delete the trust.

Charitable gifts. Planning for charitable gifts is affected in several ways.

Higher income tax rates mean some people will reap more savings from making the gifts now, but at higher incomes the phase out of itemized expense deductions reduces the benefits.

Also, the higher estate tax exemption removes for many people the tax benefits of making charitable gifts in your will.

Taken together, these two changes mean that, for some people, the tax benefits of charitable gifts are reduced so the after-tax cost of making gifts is higher.

That’s not the full story.

Taxpayers who aren’t affected by the phase out of itemized expenses receive the same income tax benefits from their donations as before 2013.

Because of that and the higher estate tax exemption, there’s more of an incentive to make donations during life instead of through the estate.

You receive the income tax benefits now and also see how your gifts are used.

But if you make the gifts through your estate there might be no tax savings, plus you won’t see the results of your gifts.

Charitable remainder trusts still are valuable.

They shelter appreciated assets from capital gains taxes, provide immediate income tax deductions, and generate a lifetime stream of income for you and your spouse.

Gift annuities also retain their benefits for most people.

You make a gift to charity, take a partial tax deduction, and receive a lifetime stream of income.

Lifetime gifts. Many people need to reconsider their lifetime giving strategies.

With the higher estate tax exemption, fewer people need to remove substantial assets from their estates primarily to save taxes.

Instead, your main concerns should be providing loved ones with wealth that will benefit them and do so in a tax wise way, considering income taxes and gift taxes.

Income and capital gains taxes should take a bigger role in selecting gifts.

For example, when someone receives a gift of property, they take the same tax basis the giver had.

If the property has appreciated, when the recipient sells the property he’ll owe taxes on all the appreciation.

That’s why you should try to give property that hasn’t yet appreciated much but that you expect will appreciate after the gift.

State taxes. Many states don’t have estate or inheritance taxes.

About 20 states, however, impose one or both of them and often at lower exemption levels than the federal law.

Planning to avoid these taxes is more important for residents of those states than planning for federal estate taxes.

And speaking of planning, there’s no better resource for all things related to retirement planning than my monthly newsletter, Retirement Watch. Learn more about it by clicking here now.



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