Did you know that with the exact same assets and the exact same beneficiaries, your estate plan may pay out significantly different amounts to your beneficiaries? In other words, the structure of your estate plan can make all the difference in the world to how much Uncle Sam gets as opposed to how much your beneficiaries receive. Consider this illustration:

A single client desired to give amounts to his two daughters and to charity. The client wants the charity to receive the remainder of a $1.5 million trust upon the tenth anniversary of his date of death, with the daughters receiving income during those ten years. The client owns a $1.5 million IRA with another $2.5 million of other investments that are owned outside of any qualified retirement plan. Client also owns a life insurance policy with a death benefit of $350,000 and a current cash surrender value of $120,000. Aside from the trust that is to be distributed to charity, the client wants everything else to go to his daughters.

Client’s prior planners carved out a $1.5 million bequest in his revocable trust that provides income to his daughters for ten years and then pays the remainder to the charity. His revocable trust is primarily funded with his $2.5 million investment account. Client’s life insurance policy designates his daughters as primary beneficiaries as does client’s IRA account. Assume that client passes away and his unused federal estate tax exemption equals $3.5 million (the current 2009 exemption amount).

In this scenario the daughters receive the income from the trust that designates charity as the ultimate beneficiary, but the trust as drafted does not qualify for the federal estate tax charitable deduction. Because client’s total estate exceeds the $3.5 million threshold, his estate must pay federal estate tax in the approximate amount of $360,000.

Assuming that the trust for the charity earns and pays 6% income to the daughters annually, they realize $900,000 of gross income from the trust. Upon the daughter’s death, the trust distributes a net $1.5 million to the educational institution. The daughters receive the life insurance proceeds of $350,000 outright, but withdraw the entire amount from the IRA in the year following their father’s death resulting in the payment of approximately $750,000 combined federal and state income tax.

Under the prior plan, the net to client’s daughters would therefore approximate $2 million and the net to the charity approximates $1.5 million. Uncle Sam became a beneficiary to the tune of $360,000 in the form of estate tax. These amounts do not reflect the “time value of money” – the effect of waiting for the income stream on the trust to mature.

Let’s assume that client restructures his plan as follows: Rather than the charity receiving net amounts from client’s after-tax assets, the IRA now names a 6% Charitable Remainder Trust for a ten year term payable to daughters, with the remainder distributed to charity. At client’s death, the charitable remainder trust provides his estate an estate tax charitable deduction in the approximate amount of $700,000. Client’s insurance was placed into an irrevocable life insurance trust, with daughters as the beneficiaries. Assume that client survives the three year inclusion period of the trust.

Under this new plan, there is no federal estate tax due since the use of the charitable remainder trust combined with using the IRA to fund client’s charitable intent. The combination of the charitable and insurance trusts brings client’s gross estate below the taxable level. Uncle Sam is no longer a beneficiary. The use of the IRA to fund the charitable intent also results in less income tax dollars being paid to Uncle Sam.

Daughters therefore receive income of $900,000 (before income tax) from the charitable trust for the ten years, $2.5 million of after tax assets from the estate, and $350,000 of life insurance proceeds for a total of $3.75 million. The net to charity remains at $1.5 million. Uncle Sam, you may recall is now excluded as a beneficiary for estate tax purposes. Like the prior example, the above amounts do not reflect the time value of money received over the course of the ten year charitable trust.

Comparing the two plans, the daughters make out significantly better under the revised scenario – $1.75 million better. We had the exact same assets as before, and the exact same beneficiaries as before. We just structured the plan differently, taking into account tools that reduce estate and income tax exposure.

This example clearly demonstrates that it does and it will often make a difference to your beneficiaries, sometimes to the tune of several hundred thousand dollars or more, how you structure your estate plan.

©2009 Craig R. Hersch