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If you’re subject to estate taxes or not, estate planning is an important process and should be investigated by nearly everyone.

Wealth transfer

Connecting Your Estate and Financial Plans

  • Michael Prinzo
  • 2/24/2014

A client recently asked me whether he should implement a complex estate planning tool because one of his sibling’s advisors recommended the idea. The question captured what many people struggle with when they think about estate planning:  an item on a “to-do list” that should be crossed off as quickly and efficiently as possible. Unfortunately, no amount of bells and whistles can magically short cut your real mission: thoughtful planning for the future.

Explore our collection of trust and estate planning articles to help you build the financial future you envision.

The to-do list approach is contrary to the very purpose of estate planning and is likely due in part to the ever changing estate tax exemption that confused taxpayers over the past decade. However, in January 2013, the American Tax Relief Act of 2012 (ATRA) was signed into law. It created some certainty for taxpayers who engage in estate planning, including an increased estate tax exemption that is indexed for inflation each year and is $5.34 million per person in 2014.

Think of it as life planning

An estate plan, although important, should be a piece of your overall financial plan. A successful plan for the future uses a goals-based approach that helps you identify, implement, and achieve your big picture dreams. Just like your dreams evolve, your financial and estate plan should evolve to help you stay on track. Estate planning, when performed within an overall financial plan, can dramatically impact the following areas:

  • Cash flow
  • Harvesting potential income tax benefits
  • Balancing complexity versus cost

Trusts, cash flow, and income tax

Business owners, retirees, and soccer moms all would agree that the last five years have demonstrated the importance of cash flow to the survival of businesses, second homes — and family budgets. Many commonly used estate planning vehicles, such as intentionally defective grantor trusts (IDGTs), self-cancelling installment notes (SCINs), and spousal lifetime access trusts (SLATs) can positively or negatively impact cash flow.

For example, an IDGT is a grantor trust that can be utilized in an estate plan to transfer wealth (often at a discount) from one individual to another. However, the creator of the trust retains the responsibility for paying any income tax associated with assets owned by the IDGT. Therefore, be sure to understand and incorporate the cash flow implications of an IDGT with your financial advisor, so that the estate plan does not create unexpected, and undesirable, cash flow issues.

In many cases, estate planning vehicles not only affect your estate, but can also create income tax implications. For example, a charitable remainder trust (CRT) is commonly used to include philanthropic goals in your plan. A CRT lets you retain a cash flow stream that is paid over a period of years, while allowing the assets inside the CRT to transfer to a charity at some point in the future.

A CRT can be a helpful because it gives you cash flow, reduces the value of the estate and/or estate tax upon an individual’s passing, and fulfills your charitable legacy goals. Contributions to a properly structured CRT can also lower your income tax burden because they become an immediate charitable contribution deduction. A smaller tax bill can influence your financial plan in a number of ways, such as:

  • Reducing the cash distribution needs from a portfolio
  • Creating additional resources that can be invested in a portfolio
  • Providing the option to reduce or eliminate outstanding debt obligations

The cost of complexity

When estate planning is performed without regard to your life as a whole, the implementation and annual costs of an estate plan can be overlooked. Many estate planning vehicles have additional costs and professional fees, such as valuation requirements, annual income tax returns for new entities created as a result of the planning process, and in some cases, more complicated income tax returns. And while a CRT can yield many benefits, as discussed above, it will require you to file an annual income tax return to report the income and deductions generated by the trust, and to remit this information to the beneficiary of the trust.

Whether you are subject to estate taxes or not, estate planning is an important process and should be investigated by nearly everyone. Whether you want to plan a meaningful retirement, cement a lasting legacy, or pass your wealth to heirs (or all three), estate planning gives you the best opportunity for accomplishing your goals.