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Whittling away estate taxes through California trusts

The estates of wealthy California residents can be subject to high federal taxes unless provisions are made to preserve assets. One goal of estate planning is to minimize the tax burden so that beneficiaries are not deprived unnecessarily of full inheritances.

Federal estate taxes kick in when an estate is valued at more than $5.25 million or $10.5 million for married couples. The potential federal estate tax rate is 45 percent, but this applies only when available estate planning tools are ignored.

Few Americans are required to pay any estate taxes at all. Those who do make up less far less than one percent of the population and, among them, the average estate tax rate is 17 percent.

Trusts are available to match financial wishes before and after death. A grantor-retained annuity trust is effective for gift and estate tax avoidance. An annuity is built in to the trust over a set term for the benefit of the trust creator, known as the donor. What's left eventually passes to beneficiaries, minus the gift tax.

Trusts may involve charitable giving. A charitable remainder unit trust is similar to a GRAT. Upon the donor's death, the leftover principal is transferred to one or more charities. A donor who sets up a charitable lead trust will see no direct income. Money is directed to a charity before death and to beneficiaries thereafter.

An irrevocable life insurance trust prevents taxation of life insurance proceeds. Insurance policies become the property of an ILIT trustee, who cannot be a donor but may be a beneficiary. Because you no longer own assets placed in trusts, the property cannot be taxed as part of an estate.

Strategies used to reduce estate taxes vary with the assets and goals of the strategist. Estate tax reduction requires financial and legal assistance, but expenses to protect wealth can be well worth the investment.

Source: Bloomberg, "Who pays a 45% rate on estate taxes?" Barry Ritholtz, Jan. 30, 2014

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