A Strategy to Keep Inheritance Taxes Low as Possible

By the Columnist
What might be your best strategy for maximizing growth while shrinking the tax bite from your estate? Most of us want to leave as much as possible to our heirs, rather than to the government, or to other beneficiaries like a college, school or charities.

And there is nothing illegal in that. Designing your portfolio to legally minimize the tax bite is perfectly rational and legitimate. Using well-designed life insurance policies, which are not taxable, is one way to do that.

One option to do so is to pay a single-premium immediate annuity. This HAS to be a life-only annuity, in order to avoid being included in the estate. This immediate annuity will generate a comfortable annual income. Depending on how high-value a plan you buy into, you could hit the 40 percent tax bracket. But this is still going to be a smaller hit than the estate tax to the full value of the the estate had you not purchased the annuity.

You could still use money that you do not need to live on, and pay that into a life insurance policy in an irrevocable trust. This will sweeten the inheritance pot for your heirs. You can also
use this idea for joint and survivor plans in the case of husband and wife. Designate the surviving spouse as the primary beneficiary, and the children as secondary beneficiaries who receive an equal share of the payout. Seek advice on how to minimize gift taxes to your beneficiaries.

Some number-crunching backs this up. If you deposit one million dollars in certificates of deposit for say, 5 percent interest, you generate income of $50K and a tax of $20K. The inheritance tax will take a large bite, and you will leave $550K (roughly) to your heirs. If you put a million dollars into this immediate annuity, your yearly income could be $90K (if the plan pays 9 percent), but the tax bite is lower, only $5,600. In the end, your estate is still worth $1.1 million at the end of the tax year. You have managed to leave twice as much to your heirs, and much less to the government.

Of course, should you be so lucky as to die in 2010, you would avoid the federal estate taxes altogether. But few of us a privileged to know when we will leave this earth and this mortal shell. And that also brings up the only possible negative about this strategy: if you outlive your life expectancy, the proceeds of the annuity will be fully taxable once you have received all your original principal. Natch.

The parameters of the ideal candidate for this strategy are as follows: is over age 70, is insurable, and possessing an estate worth at least $3.5 million and facing tax liability on that estate. 'Estate' includes all forms: cash and other liquid assets, stock, property, insurance policies, art or collectibles, etc.