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Married couples: more tips for avoiding estate tax

In our last post, we began looking at an article with suggestions for married couples about how they can avoid estate taxation, particularly in the event of death in the next couple years. Here we continue that discussion.

In addition to taking advantage of the unlimited marital exemption, the "portable" estate tax exemption, annual gifts, and charitable donations, there are a few other options worth considering in order which will allow couples to avoid estate tax.

Federal law allows individuals to pay an unlimited amount of school expenses and medical bills without reducing their federal estate tax exemption or lifetime gift tax exemption, provided the payments are made directly to the school or medical service provider.

Another technique to keep in mind for avoiding estate tax is to take advantage of the lifetime gift tax exemption amount by giving away appreciating assets while you are still living. In 2011 and 2012, one is able to give up to $5 million of appreciating assets without incurring federal gift tax. Gifts exceeding the annual exclusion amount reduce your lifetime gift tax exemption. The important thing to realize about this strategy is that gifting appreciating assets, such as stocks or bonds, keeps future appreciation out of your taxable estate.

Yet another technique is to set up an irrevocable life insurance trust. In this approach, one takes advantage of the fact that life insurance proceeds are exempt from federal income tax provided one relinquishes the "incidents of ownerships" on the policy. The incidents of ownership include, among other things, the power to change beneficiaries, to borrow against or cancel the policy, and to select payment options.

Because of the unlimited marital deduction, proceeds from a life insurance policy can be left to a surviving spouse free of immediate estate tax. In order to avoid later estate tax, one may set up an irrevocable life insurance trust to hold ownership of one's life insurance policies. In this approach, the death benefit proceeds will not factor into one's estate, and one is still able to direct who receives the proceeds by naming the beneficiaries of the irrevocable life insurance trust.

Several things to keep in mind about irrevocable life insurance trusts are, first, moving existing policies into such a trust must not be done three years prior to one's death, or the proceeds are included in estate. Second, the cash value of existing whole life policies transferred into the trust will be counted as gifts to trust beneficiaries. In addition, there is a bit of maneuvering involved in paying annual insurance premiums into the trust without incurring any gift tax.

Another use of irrevocable life insurance trusts is that they can be designated to pay for part or all of the estate tax bill on a large estate that will inevitably owe some federal estate tax. In this approach, one can pay one's federal estate tax bill with money that is itself not subject to federal estate tax.

Each of these approaches offer unique advantages for a variety of situation, and can help married couples in reducing or eliminating their estate tax liability.

Source: Marketwatch, "Estate Tax Tips for Married Couples," Bill Bischoff, 18 Mar 2011.

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