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Are you aware that at death your assets may not be automatically distributed to your loved ones?
Instead, several "unwanted heirs" may step forward first for their share of your estate.

The "Unwanted Heirs"

In a few hours of estate planning, many of our clients could save more than they have accumulated over the last several years.

Price Waterhouse

There is a mistaken impression that, at death, your assets will automatically be distributed to your loved ones. Instead, several "unwanted heirs" may step forward FIRST for their share of your estate.

These "unwanted heirs" include:

  • Federal Estate Tax
  • State Inheritance Tax
  • Estate Administrative Costs (funeral expenses, probate costs, professional fees, final expenses and debts)

Increasingly, business owners are buying life insurance to pay for estate taxes.

Wall Street Journal

What Might This Mean for Your Estate?

The problem is that the "unwanted heirs" can siphon off a significant portion of an estate's total value.

WHAT MIGHT THIS MEAN TO YOU?

The High Cost of Dying
Gross Estate Administrative Costs at 5% (1) Taxable Estate 2012 aFederal Estate Tax (2)
$ 1,000,000 $ 50,000 $ 950,000 $ 0
$ 5,000,000 $ 250,000 $ 4,750,000 $ 0
$ 7,500,000 $ 375,000 $ 7,125,000 $ 701,750
$ 10,000,000 $ 500,000 $ 9,500,000 $ 1,533,000
$ 15,000,000 $ 750,000 $ 14,250,000 $ 3,195,500
$ 20,000,000 $ 1,000,000 $ 19,000,000 $ 4,858,000
$ 25,000,000 $ 1,250,000 $ 23,750,000 $ 6,520,500
$ 30,000,000 $ 1,500,000 $ 28,500,000 $ 8,183,000

(1) Actual costs may be higher or lower.

(2) Based on the 2012 maximum 35% estate tax rate and $5,120,000 exemption equivalent.

What Can Be Learned from Public Probate Records?

You may be interested in what the public probate records of the estates of businessmen, attorneys, entertainers, accountants and even a President have to show.

Name Gross Estate Net Estate Percent Shrinkage
Franklin D. Roosevelt $ 1,940,999 $ 1,366,132 30%
Henry J. Kaiser, Sr. $ 5,597,772 $ 3,109,408 44%
Edwin C. Ernst, CPA $ 12,642,431 $ 5,518,319 56%
Robert S. Kerr (U.S. Senator, Oklahoma) $ 20,800,000 $11,300,000 46%
A.H. Wiggin (Chairman, Chase Bank) $ 20,493,999 $ 5,646,666 72%
William E. Boeing $ 22,386,158 $11,796,410 47%
Rick Nelson $ 744,357 $ 506,636 32%
Elvis Presley $ 10,165,434 $ 2,790,799 73%
Rock Hudson $ 8,600,000 $ 3,926,288 54%
James S. Kemper (Insurance Executive) $ 10,948,356 $ 7,007,560 36%
Nelson A. Rockefeller $ 79,249,475 $56,727,628 28%
Conrad Hilton $199,070,700 $93,288,483 53%

Source: Public Probate Records

If these people, who had access to the best advice money could buy, were not able to avoid the "unwanted heirs" (federal and state estate taxes and estate administrative costs), it will be difficult for the rest of us to avoid estate settlement costs.

There are, however, steps that can be taken...

The Federal Estate Tax

The federal estate tax is a progressive tax on the right to transfer property at death. In 2012, federal estate tax rates begin at 18% and increase to as much as 35% of the taxable value of an estate.

The federal estate tax is a transfer tax imposed on the privilege of transferring property at death, while the federal gift tax is imposed on the transfer of property during the property owner's lifetime. Both taxes are levied on the right to transfer property, and not on the property itself. The amount of tax payable, however, is measured by the value of the transferred property.

Once the tentative federal estate or gift tax is determined, it is then reduced by an estate and gift tax unified credit. This means that taxable estates with a value equal to or less than the unified credit equivalent will not be liable for federal estate tax. The same is true of cumulative lifetime taxable gifts which, however, will be brought back into the owner's estate for federal estate tax calculation purposes. The unified credit equivalent is equal to $5 million in 2011 and $5,120,000 in 2012 as adjusted for inflation, meaning that an individual currently can transfer property valued up to $5 million plus, whether during life and/or at death, without incurring a tax liability.

In addition, a surviving spouse can elect to take advantage of any unused portion of the estate tax unified credit of a spouse who dies in 2011 or 2012. As a result,  with this election and careful estate planning, married couples can effectively shield up to at least $10 million from the federal estate and gift tax without use of  marital deduction planning techniques, but only if one of the spouses dies in 2011 or 2012.

Due to a "sunset" provision in the 2010 Tax Relief Act, however, the current estate and gift tax rules terminate at the end of 2012. This means that in 2013, without future Congressional action, the federal estate and gift tax rules revert to those in effect in 2001, with a top estate tax rate of 55%, a $1 million unified credit equivalent and no "portability" of the unified credit exemption between spouses.

Since the estate tax is progressive, and administrative costs tend to grow with the size of the estate, it is important to consider the impact of the growth of your estate on the amount payable to your "unwanted heirs."

Estate Growth Implications: Married Couple

What Are the Estate Growth Implications for a Married Couple?

In a properly arranged estate, the size of a married couple's estate at the death of the surviving spouse determines the estate taxes due. Consider the following:

Current Ages of SpousesAdditional Years to Life Expectancy*Estate Growth Rate Factors
MaleFemale5%8%10%
40404910.92143.427106.719
5045427.76225.33954.764
5050396.70520.11541.145
5550376.08117.24634.004
6055324.76511.73721.114
6060304.32210.06317.449
6560283.9208.62714.421
7065233.0725.8718.954
7070212.7865.0347.400
7570192.5274.3166.116

* Based on IRS Annuity Table VI.

FOR EXAMPLE...

A husband age 55 and wife age 50 with an estimated $1,000,000 estate today can expect to see it grow to $17,246,000 at 8% by the time the surviving spouse dies in 37 years. This results in the following estate settlement costs and estate shrinkage, assuming that no part of the estate growth is consumed:

$ 17,246,000 Estate

- 862,300 Administration Costs (5%)

- 8,625,220 Federal Estate Tax

$ 7,758,480 Net Estate to Heirs

$ 9,487,520 Total Estate Shrinkage (55%)

(1) Based on the estate reduced by administration costs, on 2001 estate tax rates and a $1 million unified credit exemption equivalent. The 2010 Tax Relief Act provides a maximum 35% estate tax rate, a $5 million unified credit exemption equivalent ($5,120,000 in 2012) and unified credit "portability" for married couples, but "sunsets" at the end of 2012. This means that, without future Congressional action, the 2001 federal estate tax rules will be reinstated in 2013 with a maximum 55% estate tax rate, a $1 million unified credit exemption equivalent and no unified credit "portability" for married couples.

Estate Growth Implications: Single Person

What Are the Estate Growth Implications for a Single Person?

In the case of a single person, the size of the individual's estate at death determines the estate taxes due. Consider the following:

 Additional Years to Estimated Life ExpectancyEstate Growth Rate Factors
Current Age5%8%10%
40438.15027.36760.240
45386.38518.62537.404
50335.00312.67623.225
55294.1169.31715.863
60243.2256.3419.850
65202.6534.6616.727
70162.1833.4264.595
75131.8862.7203.452
80101.6292.1592.594

* Based on IRS Annuity Table VI.

FOR EXAMPLE...

A single person age 65 with an estimated $1,000,000 estate today can expect to see it grow to $4,661,000 at 8% by the time death occurs in 20 years. This results in the following estate settlement costs and estate shrinkage, assuming that no part of the estate growth is consumed:

$ 4,661,000 Estate

- 233,050 Administration Costs (5%)

- 1,730,373 Federal Estate Tax (1)

$ 2,697,577 Net Estate to Heirs

$ 1,963,423 Total Estate Shrinkage (42%)

(1) Based on the estate reduced by administration costs, on 2001 estate tax rates and a $1 million unified credit exemption equivalent. The 2010 Tax Relief Act provides a maximum 35% estate tax rate and a $5 million unified credit exemption equivalent ($5,120,000 in 2012), but "sunsets" at the end of 2012. This means that, without future Congressional action, the 2001 federal estate tax rules will be reinstated in 2013 with a maximum 55% estate tax rate and a $1 million unified credit exemption equivalent.

A Common Misconception

Many people think that when federal estate taxes are payable, Uncle Sam simply takes his slice of their estate "pie," leaving the balance for the estate owner's heirs.

Your Estate

While this result would be bad enough, what actually happens is even worse!

In Reality

The federal estate tax is a TRANSFER TAX imposed on the privilege of transferring assets at death. The amount of tax payable is measured by the VALUE of the assets transferred from the estate to the heirs.

What this means is, while the estate tax is levied on the value of assets transferred, the estate tax CANNOT be satisfied simply by transferring a percentage of estate
assets to the IRS.

Instead, your estate must pay the federal estate tax in CASH, and it generally must pay it in NINE months! It may, however, be difficult, if not impossible, to liquidate
sufficient non-liquid assets in order to pay the tax in cash.

Estate administrative costs must generally be paid in cash as well.

How difficult would it be to convert 10 PERCENT to 60 PERCENT of your estate to CASH in just NINE MONTHS?

Potential Solutions

There are FOUR ways to provide your estate with the liquidity needed to meet its cash obligations.

  1. 100% Method -- You could accumulate enough cash in your estate to pay estate settlement costs outright. Rarely, however, does a successful person accumulate such large sums of cash. Instead, the reason for financial success is usually due to the investment of cash in appreciating assets, rather than accumulating it in a bank.
  2. 100% Plus Method -- Your estate could borrow the cash needed to pay estate settlement costs.  This, however, only defers the problem, since the money will then have to be repaid with interest.
  3. Forced Liquidation Method -- Your estate could liquidate sufficient assets to pay estate settlement costs.  Keep in mind, however, that a forced liquidation may bring only a small fraction of the true value of your assets if there is not a ready market. In addition, sales expenses are bound to be incurred.
  4. Discount Method -- Assuming you qualify, you can arrange now to pay your estate tax bill with life insurance dollars. For every dollar your estate needs, you can give an insurance company from approximately one to seven cents a year, depending on your age and health. No matter how long you live, it is unlikely you will ever give the insurance company more than 100 cents on the dollar. In addition, the life insurance policy can frequently be structured to accommodate your unique premium payment requirements.

 

Ask Yourself

Does it make sense to pay all of your estate settlement bill from estate assets within nine months of death?

OR...

Does it make more sense to set aside one to two percent of your estate each year now, while you are still in control?

Regardless of your age, it is a fact that using life insurance is frequently the most economical method of providing needed estate liquidity.

 
Other Features of Life Insurance in an Estate Plan

In addition to serving as a source of estate liquidity, life insurance provides a variety of other advantages:

  • Payment is prompt and certain. Life insurance proceeds are not subject to the time and expense of the probate process.
  • The event creating the need for cash -- death -- also creates a source of cash -- the life insurance death benefit. The life insurance policy provides the dollars for a certain need -- estate settlement costs -- that arises at an uncertain time -- death.
  • If the death benefit exceeds the total premiums paid, this gain generally is received free of income tax. For example, if only 20 cents of each death benefit dollar received has been paid in premiums, the 80-cent gain is received income tax free!
  • The premium payments are spread out and not required in nine months.
  • Life insurance avoids all of the problems associated with the other methods for paying estate settlement costs.
  • By giving up ownership of the policy, the proceeds may be estate tax free. An attorney can provide you with the popular "Irrevocable Life Insurance Trust" for this purpose, or an adult child can be named as owner.

For these reasons, life insurance is frequently the most economical - and popular - method of providing needed estate liquidity.

Estate Planning Insurance Considerations Action Checklist

Now…

  • Depending on your situation, complete a detailed estate analysis or, alternatively, an analysis of your estate liquidity needs.
  • Purchase life insurance to pay for your estate settlement costs.
    • You may wish to have the insurance owned by an adult child, or by an Irrevocable Life Insurance Trust. Either of these techniques may be able to keep the insurance proceeds out of your estate, if properly implemented.
    • When using a survivorship policy, you may wish to retain ownership in order to use insurance cash values, if needed. The policy can be moved out of the estate by giving it away after the first spouse’s death. If, however, death occurs within three years of the transfer, the proceeds will be included in the surviving spouse’s estate.

Short-Term…

  • Consult with your attorney to verify that your estate is arranged to take best advantage of the unlimited marital deduction, which allows estate taxes to be deferred until the death of the second spouse, as well as unified credit "portability" between spouses (available in 2011 and 2012). This planning might include use of a Credit Trust provision in your will in order to reflect possible loss of unified credit "portability" beginning in 2013. This is also known as a Family or a By-Pass Trust.
  • Review current wills and trusts to determine if they will operate as intended under both current and possible future estate and gift tax rules.
  • Review the issued policy.

Long-Term…

  • Your estate plan, including wills, trusts and life insurance, should be periodically
    reviewed to ensure that it continues to meet your needs and objectives.
Important Information

The information, general principles and conclusions presented in this report are subject to local, state and federal laws and regulations, court cases and any
revisions of same. While every care has been taken in the preparation of this report, neither VSA, L.P. nor The National Underwriter Company is engaged in providing
legal, accounting, financial or other professional services. This report should not be used as a substitute for the professional advice of an attorney, accountant, or other qualified professional.

Life insurance contracts contain exclusions, limitations, reductions of benefits and terms for keeping them in force. All contract guarantees are based on the claimspaying ability of the issuing insurance company. Consult with your licensed financial representative on how specific life insurance contracts may work for you in your particular situation. Your licensed financial representative will also provide you with costs and complete details about specific life insurance contracts recommended to meet your specific needs and financial objectives.

NOTE ABOUT THE FEDERAL ESTATE TAX: The 2010 Tax Relief Act provides some certainty in estate and gift planning, but only for the next two years. The 2010
Tax Relief Act will terminate, or "sunset," at the end of 2012 unless a future Congress takes action to extend its provisions. This means that without future
Congressional action, the federal estate, gift and generation-skipping transfer tax rules in effect in 2013 will revert to those in effect in 2001. Whether your estate is
actually subject to the federal estate tax will depend on the size of your estate, the year you die and whether future Congressional action modifies the estate tax rules.

U.S. Treasury Circular 230 may require us to advise you that "any tax information provided in this document is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor."

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