Bequests: The Beneficiaries of Your Estate
Who is the beneficiary of your estate? The answer is not, perhaps, quite so obvious. It may seem clear, for example, that if you plan to leave your estate to your children, they will be the beneficiaries. There may be a "hidden" beneficiary, however, that receives 40, 45, 50 percent or more of your estate.
This so-called hidden beneficiary is the tax collector. Federal estate tax rates, not to mention state death tax rates, go up to 55 percent on taxable estates above $3 million.
But you have the power to choose how much this unintended beneficiary receives. The key is to understand your choices.
Thinking in Visual Terms
Some situations are best thought of visually, including the situation at hand. You can think of your estate this way:
The pie can be cut many different ways; you get to choose how it is cut. In considering how to cut the pie, think of the portions going to your family and charity - that is, to your intended beneficiaries - as voluntary wealth redistribution, and the part going to taxes - as involuntary wealth distribution.
You can, if you wish, cut the pie so that all goes to your intended beneficiaries. Or you can choose to leave a certain amount to unintended beneficiaries (the tax collectors). The important thing is that you have the power to control how your estate is redistributed.
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100 Percent to Intended Beneficiaries
One way to leave your estate entirely to your intended beneficiaries is to take advantage of 1) the deduction allowed for charitable bequests and 2) the so-called federal estate tax exemption. The exemption is currently set at $2 million.
Example #1:
Hank Mustang, a widower, has accumulated a large estate over the years. Hank wishes to provide for his two children and for Cal Poly, and would just as soon not have any of his estate go toward estate taxes. (If Hank were to leave his entire estate to his children, the tax on his estate could be substantial - payable, of course, in cash.)
With the help of his lawyer, Hank revises his will to leave the exemption amount to his children and the balance of his estate to Cal Poly. The balance of Hank's estate will go to Cal Poly estate tax-free because of the unlimited deduction allowed for charitable bequests.
No amount will go toward the payment of federal estate tax. (Hank's estate also is likely to avoid state death taxes.)
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Providing an Income for Yourself or Another
In deciding how to "cut the pie," some individuals choose to balance their charitable and non-charitable interests by creating plans that pay an income to themselves or another, and later provide assets to Cal Poly.
These plans can work very well when established with appreciated securities or real estate.
Example #2:
Polly Royale, age 67, owns undeveloped land that has increased tremendously in value over the years. The land provides Polly with no income and is in fact a cash-flow drain because of real estate taxes. The land poses other tax problems as well. There will be capital gain taxes if Polly sells it in order to diversify and reinvest for income; and federal estate taxes down the road if Polly keeps the property.
After working with Cal Poly's planned giving staff and her own lawyer, Polly decides to use the land to establish a charitable remainder trust. The trust will pay Polly and her husband, Fred, a 6% income for life (a figure Polly chose) and then, afterwards, distribute its assets to Cal Poly.
Polly finds the trust advantageous because, in addition to paying Polly and Fred a life income, it provides the couple with a current tax deduction, which is helpful in reducing their current income taxes; allows Polly to avoid capital gain taxes (we at Cal Poly can furnish the details on this point); and removes the land from Polly's estate.
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A Way to Transfer Wealth to Family Members
In some situations, it is possible to "shift tax dollars" to family members while, at the same time, providing for favorite charities. These plans can work especially well when created with highly appreciated, low-yield investment.
Example #3:
Jack Green, age 66, owns some very highly appreciated stock that pays a negligible dividend. Jack would like eventually to leave the stock to his children, but he knows that if he leaves the stock to his son and daughter, estate taxes will severely erode his bequest. Jack is also concerned that if he sells the stock, he will face substantial capital gain taxes.
The solution for Jack is a two-step plan. First, Jack uses his stock to establish a charitable remainder trust, which is to make a 6% payout to Jack for life. This allows Jack to remove the stock from his estate, avoid capital gain taxes, claim a current income tax charitable deduction, and significantly increase his income.
Second, Jack uses part of his new income from the trust to create a fund for his children, which is set up so as to be outside his estate for tax purposes. (We at Cal Poly or your tax advisor can supply the details.) This fund will eventually provide a completely tax-free "inheritance" for the children. (Note: Sometimes, the fund is a life insurance policy on the donor's life.)
This plan allows Jack, in effect, to shift to his intended beneficiaries dollars that would otherwise be paid in taxes. Conceivably, Jack's children will receive more through this plan than they would, after taxes, if Jack simply continued to hold the stock or sold and reinvested it.
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An Informed Decision on How to Cut the Pie
The Planned Giving staff at Cal Poly will be pleased to work with you and your advisors to help identify and analyze ways you can "cut the pie" consistent with your assets, objectives, and situation.
Please contact us at:
(800) 549-2666 or (805) 756-7125
plannedgiving@calpoly.edu
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