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Your Money: Don’t Leave Your Money to Uncle Sam


Try these simple techniques for reducing your heirs’ estate tax obligations.

Like many successful people, physicians are often so busy dealing with their practices and personal lives that they never take the time to deal with the important challenge of creating a tax-wise estate plan for their families. In fact, a recent survey showed that fewer than 5 percent of all doctors had a proper estate plan in place.

In this article, we will examine the most significant mistakes physicians make when creating (or ignoring) their family’s estate plan. We’ll also cover simple tools that you can use to avoid such mistakes and allow your family to elude the unnecessary costs that come with poor planning.

Mistake No. 1: Losing half of your family’s life insurance proceeds to taxes. Life insurance is highly recommended as a tool to pay the estate taxes due when you die - because the funds will be available immediately to your survivors, without any delays or expenses involved with liquidating tangible assets. Furthermore, clients who set up policies in advance of their retirement years enjoy powerful leveraging of today’s dollars. Nonetheless, more than 90 percent of physicians fail to utilize a simple trust that enables all of the insurance proceeds to be estate tax-exempt.

The greatest misconception most people have when it comes to life insurance is that the proceeds are entirely tax-free. Wrong. The proceeds are income tax-free but are subject to both federal and state estate taxes. Federal estate taxes alone start at 37 percent and very rapidly rise to 50 percent. Why should you lose potentially hundreds of thousands of dollars of your policy proceeds after you paid those premiums so diligently - especially when you don’t have to? A simple trust can take the IRS out of the picture and provide better protection for your beneficiaries.

An irrevocable life insurance trust (ILIT) is simply an irrevocable trust that owns a life insurance policy. The ILIT saves you estate taxes because the trust owns the life insurance policy. Since you are not the policy’s listed owner, its proceeds will not be part of your net estate when you die (as long as you survive three years from the transfer to the trust). Thus, the proceeds will not be subject to the estate tax. This can save your family a great deal of money.

The ILIT gives you much more control over what happens to the policy proceeds than you would get from a bare insurance policy.

With an insurance policy alone, your only decision is to whom you will leave the proceeds; the insurance company will simply pay these people when you die. With an ILIT, you can control not only who gets the proceeds, but how they get it. You can have the trustee pay the beneficiaries directly or pay them over a period of months or years. You can incorporate spendthrift provisions and anti-alienation provisions to protect against your beneficiary’s financial problems or that of their spouse. In fact, an ILIT gives you all of the benefits of a trust arrangement while allowing you to provide for your family just as you would with a bare insurance policy.

That’s why we recommend to physicians that they use an ILIT to own a life insurance policy in their estate plans.

If you have already purchased a life insurance policy or are presently making payments on an existing policy, it is not too late. You can always transfer a policy to an ILIT. There may be some gift-tax issues associated with this maneuver, but they will be very minor compared to the large tax savings your family will ultimately enjoy.

Mistake No. 2: Leaving property to the IRS. While no physician leaves property to the IRS intentionally, quite often this is the effect of a physician’s estate if she has not implemented a gifting program during her lifetime. Simply put, after the exemption amount, any property not given away “in title” during your lifetime will be taken, in part, by Uncle Sam. To prevent this - along with the strategies explained above - you can “gift” property to family members.

Most of our clients initially hesitate to begin a gifting program, as they think they will have to give up control of the underlying assets. This is not true. You can use legal entities to remove asset values from your estate, thus lowering your estate taxes, while maintaining total control of the assets while you are alive.

Through entities like family limited partnerships (FLPs) and family limited liability companies (FLLCs), you can share ownership with family members, yet maintain control. In this strategy, you and your spouse gift ownership interests to children over time (using your combined $22,000 annual gift-tax exclusion), removing those interests from your estates for tax purposes. Still, as long as you and your spouse are the FLP general partners or FLLC managers, you will maintain control of the underlying assets. Confused? Consider this example:

Robert Jones, a 63-year-old retired physician, owned almost $1.1 million in mutual funds and real estate assets. He set up an FLP to own the mutual funds, naming himself the sole general partner. He initially owned 95 percent of the partnership interests, gifting 1 percent each to his five grandchildren. Since each 1 percent was worth approximately $11,000, the gifts to the grandchildren were tax-free.

Robert can continue to gift each grandchild $11,000 in FLP interests each year, tax-free. If Robert lives to age 75, he will have given $660,000 in FLP interests to his grandchildren. This $660,000 will not be subject to the estate tax since it is no longer in Robert’s estate. Because his other assets put him in the 50 percent estate-tax bracket, his tax savings using the FLP will be $330,000. Because he is the FLP’s sole general partner, Robert completely controls the mutual funds while alive and can distribute the income to himself or sell some of the funds for his expenses. Robert maintains control of his assets for his lifetime, pays less estate tax, and also provides more for his grandchildren.

Many clients put their families in an estate planning mess because of the mistakes described above. Clients with larger estates have even more potential pitfalls to avoid in their planning. There is no substitute for consults with a licensed professional experienced in these matters. In this way, an estate planning “physical” is the real first step in any worthwhile estate plan.

David B. Mandell, JD, MBA, is an attorney, lecturer, and author of “The Doctor’s Wealth Protection Guide” and “Wealth Protection, MD.” He is also a cofounder of The Wealth Protection Alliance, a nationwide network of independent financial advisory firms whose goal is to help clients build and preserve their wealth.

Vance Syphers is president of the Wealth Preservation Group in North Carolina and provides sophisticated business planning to physicians around the country. To reach David, Vance, and the Wealth Protection Alliance, please call 800 554 7233.

This article originally appeared in the May 2007 issue of Physicians Practice.

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