Why Smart Investors Think About Estate Planning

Most Americans who die in 2011 or 2012 won’t be exposed to the federal estate tax, thanks to the $5 million federal estate tax exemption – but you may still need an estate plan in the form of a will and possibly even a living trust.

One goal of estate planning is avoiding probate, a court-supervised legal process that distributes a deceased person’s assets.

Probate typically involves red tape and legal fees, as well as your financial affairs becoming public information.

Having a will doesn’t help you avoid probate, but it is important.

If you die without a will, the laws of your state will determine what happens to your assets and your minor children. So, you’ll want to draft a will to name an executor for your estate, specify which beneficiaries should get which assets and name a guardian for any minor children.

However, whether your property needs to go through probate is actually determined by how that property is titled, not whether you have a will.

Therefore, in addition to drafting a will, you may want to consider a living trust.

With a living trust, you transfer legal ownership of certain assets to a trust.

Because a living trust is revocable, you can change its terms, or unwind it, at any time, as long as you are alive and legally competent.

But when you die, a trustee you have named to be in charge of the trust’s assets will distribute them in the trust according to your direction – bypassing probate.

The Property Tax Benefits of Using a QPRT

Declining property values and changes in tax rules mean it may be a good time to transfer property to your heirs by using a qualified personal residence trust (QPRT).

With a QPRT, you create a trust and transfer your home into it.

In doing so, you reserve the right to live in your home for a specified period of time.

At the end of that period, your home passes to your beneficiaries, free of gift tax.

As for the potential tax benefits of a QPRT, you can move a big asset out of your estate at a fraction of the future value.

If you set up a QPRT at age 60 when your property is worth $2.5 million, you may discount the $2.5 million by an interest rate set by the Internal Revenue Service.

The Internal Revenue Service sets the rate monthly.

At a recent 3% rate, the current value of a $2.5 million gift to be made in 10 years is $1.59 million.

If you die before the trust ends, the home is included in your taxable estate and estate tax will be paid on it, meaning the purpose of the trust will be defeated.

But if you don’t die before the trust ends, your home will be distributed to your heirs without further transfer tax.

The strategy may make the most sense for individuals with a net worth above the estate tax exemption, which is currently $5 million per person.

However, such a strategy may also be a smart move for those whose homes might appreciate or if the estate tax exemption drops.

Qualified personal residence trusts can be complicated, though.

For example, you have to give up the home when the trust ends, even if you are still alive.

As a result, if you’re considering a qualified personal residence trust, it’s a good idea to speak with a financial advisor first.