The Estate-Tax Trap Most High-Net-Worth Owners Fall Into—Don't Become a Victim

If your net worth is high enough to be subject to the estate tax, chances are you worked your tail off all or most of your adult life to accumulate your wealth. But draw your last breath and the estate-tax monster wants to devour about half your wealth—not a pretty picture.

It’s sad. Die and your estate pays, but fortunately, you—with the right tax planning —don’t have to lose any of your wealth to the estate-tax monster.

Do you have enough wealth to be clobbered by the estate tax? Then read every word of this article. You’ll learn how to keep your wealth. But first I must ask you to open your mind, because we are about to kill some conventional wisdom of how almost all estate-planning advisors, inadvertently, make you a victim of the estate tax. 

What exactly are these advisors guilty of doing? Traditional estate planning.

What is “traditional estate planning” (TEP)? A TEP is the plan that most advisors use for a married couple. Chances are if your estate plan is done, you have a TEP (and that’s good). A TEP uses a rather simple will, called a “pour-over will” and an irrevocable trust. The will gathers any assets not in the trust when you die and pours these assets into the trust. All your assets are now in the trust, which contains your estate plan. The trust is commonly called an “A/B trust” or “family/residuary trust” or something similar.

Is there anything wrong with a TEP? Absolutely not, assuming it is properly drawn. Then what’s the problem? The TEP is normally the only plan, and a TEP is not designed to save estate taxes. If you are married, it does many other things (which makes a TEP a good start for your estate plan). A TEP does have two minor estate-tax tricks:

1. The marital deduction defers estate tax until the second death of the husband and wife (but when the second one dies, the IRS gets its pound of flesh); and
   
2. The so called “unified credit” in 2009 was $3.5 million per person that passed free of the estate tax, or $7 million for a married couple.

Let’s summarize: If the unified credit continues at $3.5 million, the best a TEP can do—as far as saving you estate tax—is to save tax on the $3.5 million for the first spouse who dies. That’s it.

It’s difficult for me to say what follows: Any claim that a TEP can save you even a dime in taxes, over and above the unified credit, is a myth, hoax and total illusion. If your estate plan consists of only a TEP or even includes an irrevocable life insurance trust (ILIT), chances are you’ve been duped. If your advisor claims otherwise, challenge him/ her to show you where and how in the document that the savings are created.

“I am working with a law firm… designing a will and trust (a TEP) and would like you to review them.” I agreed to review the documents if he sent three items: two financial statements (a personal one and the last year-end for his business, Success Co.) and a family tree (name and birthday for Joe, his wife and four kids).