Large balances in tax-deferred accounts can be especially hard-hit by taxes after the death of the owner. If you have(or will have) lerge balances in IRAs, qualified plans or annuities, your beneficiaries could owe ordinary income tax of upto 39.6% on the deferred income when they take distributiion of your tax-deferred assets. On top of income taxes, the amount of your hard-earned wealth that exceeds the applicable exclusion amount in the year of your death($650,000 in 1999;$675,000 in 2000) will be subjected to estate tax from 37% up to 55%.
That's called double taxation, and you want to reduce, or eliminate, the likelihood that you will incur it. One way you can avoid double taxation is with a creative wealth transfer strategy that provides income for you and estate-and income-tax-free wealth for your heirs. |
To implement this strategy, first you apply for a life insurance policy with a death benefit at least equal to the value of your tax-deferred assets. You begin taking distributions form your tax-deferred account. Then after paying the income taxes on the distributions,
you use the reminder of the distributions to pay the life insurance premiums. When you die, your beneficiaries recieve the life insurance proceeds income-and estate-tax-free. |
It is not generally advisable for you to own the insurance policy. If you do, the proceeds are included in your estate and will increase your estate tax liability.
You may put the policy in your children's names, but there are potential disadvantages to this approach:
Your child may predecease you. Your child may divorce, and his or her ex-spouse could be entitled to a portion of the cash value of the policy. Your child could be sued, and the cash value of the policy could be subject to a judgement. Your child could go bankrupt and subject the policy to creditor's claims or fail to continue paying the premiums.
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