More simple estate planning

A Fortune article reinforces the basics of estate planning; gifts, life insurance and trusts.

Gifts

Gifts of $13,000 or less a year to an individual aren't taxable.

Life Insurance

Look into using a life-insurance trust as the beneficiary of your life insurance policy. Another (maybe somewhat depressing) suggestion is to gift money to your children to use to take a life insurance policy out on you.

Trusts

Grantor-retained annuity trusts (GRATs) are seeing a surge in popularity due to depressed asset prices.

Estate planning for your home

Most of us won't be hit by the estate tax when we shed this mortal coil. Even adding in the value of a home, the vast majority of Americans won't owe an estate tax, so their homes can be passed on to their heirs and avoid most taxes. Those who would be hit by the estate tax can do some prior planning to pass on a home with as little tax implications as possible. One sophisticated strategy is a qualified personal residence trust.

Here's how a QPRT works. Say a retired doctor in Florida wants to give his $1 million beachfront home to his two daughters. This strategy would require the doctor to put his home into an irrevocable trust for several years, while he continues to live in it. Through a complex IRS calculation based on interest rates, the length of the trust and his age, the IRS values his right to live in the house at, say, $600,000.

For the purposes of his taxable estate, that knocks the value of his house down to just $400,000 -- regardless of how much the house appreciates in the meantime. (That $400,000, though, comes out of the doctor's federal gift- and estate-tax exemptions.) When the trust is up after the stipulated number of years, if he chooses to continue living there, he can pay his daughters rent, further reducing the size of his taxable estate.

Simple estate planning

Money Magazine recently covered the basics of estate planning. First, understand how the estate tax rates are going to change over the coming years.

In 2009 the federal exemption - the amount of an estate not subject to a 45% federal tax - has increased from $2 million to $3.5 million for individuals. This move is the result of a 2001 law that continually increased the limit for the eight years following. Oddly, the law calls for estate tax to be eliminated in 2010, then to revert back to 2001 levels ($1 million with a 55% tax rate above that) in 2011.

So, as of right now, you only have to worry about estate taxes if your estate is going to be over $3.5 million when you shed this mortal coil. However, even if your estate won't hit this level of assets, you should have an estate plan.

You need a will to make sure your inheritance plans are carried out as you instructed. Money recommended the site, aaepa.com, to help you find an estate planning attorney. You'll also want to do whatever you can to avoid probate. Why?

"It's not unusual for a $1 million California estate to generate $23,000 in probate fees," says Liza Weiman Hanks, a San Jose estate attorney and author of "The Busy Family's Guide to Estate Planning."

Some other things to understand; living trusts, 'pour over' will, irrevocable life insurance trusts, bypass trusts and disclaimer bypass trusts (read the fine article).

I'll describe irrevocable life insurance trusts to pique your interest. Normally, if you designate someone other than your spouse as the life insurance policy beneficiary, such as a child, the benefits paid will be taxed as being part of your estate. However, if there is a policy that covers you but that you don't own, the benefits shouldn't be subject to your estate taxes.

Enter the irrevocable life insurance trust. You set it up and the benefits are paid to the trust, free of estate taxes. There are some big caveats, however. For one, after the trust is established, you can't change the beneficiaries. This is part of the reason it's called irrevocable.

Estate planning tips for bear markets

There are a couple of estate planning "benefits" that you can get in bear markets and low interest rate environments. The first one is pretty trivial. Give away your assets that have lost value to your heirs. If an asset has fallen in value by 50%, you can now gift twice as much of it, up to the annual $13,000 limit, before having to pay taxes on the gift. Then, if the asset comes back in value, your heir should only have to pay the regular capital gains rates on the gain. If instead you held on to the asset and it came back to full value, when you shed this mortal coil, the asset could potentially be subject to the 45% estate tax, which is greater than the current capital gains rates.

Another tip is to use a grantor retained annuity trust, as described:

A GRAT is an irrevocable trust designed to transfer the appreciation on assets contributed to it with minimal or no gift-tax consequences. It's a popular strategy for transferring wealth in a low-rate environment. That's because of the current IRS-mandated interest rate of 2.4%. Here how it works: Let's say you set up a GRAT and fund it with $1 million in badly depressed stock. Assuming the simplest scenario and a trust term of two years (it could be longer), the GRAT would make annuity payments to you valued at $518,081 in each of those two years. (That includes a calculation of present value you don't want to do at home; those payments can be made in cash or stock.) If the asset appreciates more than those payments—and the odds of that seem good, with a low "hurdle" rate of 2.4%—the excess goes to your beneficiaries tax-free.

If it turns out the asset has appreciated less than those $518,081 payments, the trust fails. The asset returns to you, and you can start another GRAT and try again. A rolling GRAT strategy allows multiple possibilities of catching the asset's rise at a valuable moment. GRATs have a standard structure, so setting up the second or third one is less expensive than the first. (A simple GRAT might cost about $5,000.)

Now, those five grand fees can add up, so you wouldn't want to have too many failed GRATs.

Finally, the story points out that the IRS rate for intra-family lending is now %0.81. Try getting that rate from your local bank.

Vanguard's estate planning terms you need to know

Vanguard's site is a great source of financial information. They recently had a story on the 5 estate planning terms you need to know.

Living trust

A living trust is established while you are alive. At your death, any assets in the living trust do not have to go through probate, but pass as you've stated in your trust document.

Common misconception: A trust's primary purpose is to reduce taxes.

"People mistakenly think this, but the trust's most important role is to control your assets," says Ms. Smith.

The story also links to their estate planning brochure.

Multiple trustees

Here's another article I read as I research trusts (free WSJ Digg link). More trusts are being set up with multiple trustees.

Increasingly, however, families are "slicing and dicing" trustee duties, says Dennis Belcher, a trust lawyer with McGuireWoods LLP in Richmond, Va. Families are specifying that one trustee, typically an institutional trust company, hold custody of the assets and handle the administrative trustee duties. Meanwhile, another fiduciary -- often a family investment committee -- has the authority to direct investments. Trust creators are also naming separate trustees to handle distributions to beneficiaries.

Sharing ownership of vacation homes

BusinessWeek has an article on ways to share ownership of vacation homes without destroying family relationships. From the article:

The best way to keep the property and the family intact starts with the original owners. Rather than make heirs joint owners, most lawyers recommend leaving the property to an independent entity, such as a trust or a limited liability company (LLC), and giving the heirs shares in the enterprise. The plans should also include a way to sell or transfer shares. For tax reasons, property should not be placed in a corporation, says Stuart Hollander, a lawyer in Suttons Bay, Mich., and author of the forthcoming Saving the Family Cottage: A Guide to Succession Planning, which he is self-publishing.

(Mr. Hollander's book is on Amazon here.)

Trusts are one area where I will seek out expert advice from a trusts and estates attorney. I'm comfortable handling most other areas of my finances on my own, but when it comes to trusts, I will go to a professional. The article gives other pointers on how to structure the sharing of ownership that is palatable to all family members involved.