Estate Taxes

Reduce Estate Taxes Through Trusts

There are several different types of trusts that can help reduce estate taxes. Learn what these trusts are and how they work here.

One of the best ways to reduce estate taxes is through trusts. Since there are a variety of types of trusts available, and each of these offers its own benefits, you should know as much about them as possible to be able to make the best decision.

Reduce estate taxes through Living Trusts:

A living trust, also known as a revocable living trust or a family trust, is a legal document that holds title or ownership to your real property and assets. When you create a living trust, you transfer ownership of your assets to the trust. Transferring assets is typically called "funding." When you transfer title of your assets to the trust, you do not relinquish any control. You can still buy, sell, borrow or transfer any of the assets you deeded to the trust.

For couples with estates that could exceed $1 million, it is possible to reduce estate taxes through a living trust. In fact, it could save thousands in estate taxes. Why? Because when a surviving spouse dies, estate taxes can be levied against their share of the estate and what their spouse left them.

Reduce estate taxes through an A-B Trust:

One kind of living trust, called an A-B, or bypass, trust, lets couples pass on the maximum amount of property to their children when they are both gone while providing financial support for the surviving spouse.

In an A-B trust, the estate is not left to the surviving spouse, but to the trust. Here’s how it works without an A-B trust:

Glynn and Shirley jointly own an estate of $3 million. Glynn dies in January 2004, and the $1.5 million of his estate goes to Shirley estate tax-free because of the unlimited marital deduction provision. Shirley dies in October 2004. Her estate is now $3 million because of the half of the estate she received from Glynn a few months before. The unified tax exemption is $1.5 million in 2004, so $1.5 million of the estate will be taxed at 48 percent. Glynn and Shirley’s kids shell out $720,000 in estate taxes.

If Glynn and Shirley had created an A-B trust, no estate taxes would be due! That’s because when Glynn died in January, his $1.5 million would be left to the B trust, and because his share of the $3 million estate equals the estate tax exemption, no tax is due. Shirley would have some access to his half of the estate in the B trust as long as she is living. When Shirley dies in October, her $1.5 million estate, in the A trust, would equal the exemption limit. The kids still receive $3 million from both trusts, saving the $720,000 in estate taxes.

Reduce estate taxes through an Irrevocable Life Insurance Trust:

Many people are not aware that life insurance proceeds left to their children may not be subject to income tax, but that the money is subject to estate tax. For families with a large amount of wealth, setting up an irrevocable life insurance trust can help preserve wealth that would otherwise by lost to estate taxes. An irrevocable life insurance trust is set up to pay insurance premiums on a policy that pays enough to cover estate taxes when the second spouse dies. You can reduce estate taxes through an irrevocable life insurance trust by quite a bit.

Reduce estate taxes through Charitable Remainder Trusts:

If you want to leave all or part of your estate to charity, ask what your attorney thinks about a charitable remainder trust. This is a living trust in which you set up two sets of beneficiaries. You and your spouse would be the income beneficiaries, meaning that you and your spouse receive an income from the trust’s principal while you are alive. After you die, the trust’s principle goes to the second set of beneficiaries—your favorite charities.

Charitable Remainder Trusts never owe any capital gains taxes, which helps you preserve wealth from real estate or stocks. Since these trusts have a charitable intent and do not have to pay capital gains, the full value of any assets transfers to the trust.

You choose how much income you will receive from the trust. However, the IRS requires you to take at least 5 percent of the fair market value of the trust assets each year. Since your payout affects your principal, it could lower your charitable income tax deduction. Talk to your CPA about strategies to successfully manage your charitable remainder trust.

Many couples set up a charitable remainder trust in addition to a living trust that can be passed on to their heirs. You can have both. Talk to your attorney about how a charitable remainder trust and living trust could preserve your wealth by reducing estate taxes.